** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-Q**

**x** QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE

**SECURITIES EXCHANGE ACT OF 1934**

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

**Commission file number:  1-2385**

**THE DAYTON POWER AND LIGHT 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 |
|-------|--------|------|

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 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 |
|-------|--------|------|

 

Asof August 1, 2006, there were 41,172,173 shares of common stock outstanding,all of which were held by DPL Inc.

 

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**THE DAYTON POWERAND LIGHT COMPANYINDEX**
| ** **                         | ** ** | **Page No.**                                                                           |
|------------------------------------|------------|---------------------------------------------------------------------------------------------|
| **Part I. Financial  Information** |       |                                                                                        |
| ** **                         |       |                                                                                        |
| Item 1.                            |       | Financial  Statements                                                                       |   |  3 |
|                               |       |                                                                                        |   |   |
|                               |       | Consolidated  Statements of Results of Operations                                           |   |  3 |
|                               |       |                                                                                        |   |   |
|                               |       | Consolidated  Statements of Cash Flows                                                      |   |  4 |
|                               |       |                                                                                        |   |   |
|                               |       | Consolidated  Balance Sheets                                                                |   |  5 |
|                               |       |                                                                                        |   |   |
|                               |       | Notes to Consolidated Financial  Statements                                                 |   |  7 |
|                               |       |                                                                                        |   |   |
| Item  2.                           |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |   | 18 |
|                               |       |                                                                                        |   |   |
|                               |       | Operating Statistics                                                                        |   | 28 |
|                               |       |                                                                                        |   |   |
| Item  3.                           |       | Quantitative and Qualitative  Disclosures about Market Risk                                 |   | 28 |
|                               |       |                                                                                        |   |   |
| Item  4.                           |       | Controls and Procedures                                                                     |   | 29 |
|                               |       |                                                                                        |   |   |
| **Part II. Other Information**     |       |                                                                                        |
| ** **                         |       |                                                                                        |
| Item  1.                           |       | Legal Proceedings                                                                           |   | 30 |
|                               |       |                                                                                        |   |   |
| Item  1A.                          |       | Risk Factors                                                                                |   | 31 |
|                               |       |                                                                                        |   |   |
| Item  5.                           |       | Other Information                                                                           |   | 31 |
|                               |       |                                                                                        |   |   |
| Item  6.                           |       | Exhibits                                                                                    |   | 31 |
|                               |       |                                                                                        |   |   |
| **Other**                          |       |                                                                                        |   |   |
| ** **                         |       |                                                                                        |   |   |
| Signatures                         |       | 32                                                                                          |
|                               |       |                                                                                        |   |   |
| Certifications                     |       |                                                                                        |
|                                    |            |                                                                                             |  |  |  |

 

**Available Information:**

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

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**Part I.  Financial Information**

**Item 1.  Financial Statements**

**THE DAYTON POWER AND LIGHT COMPANY**

**CONSOLIDATEDSTATEMENTS OF RESULTS OF OPERATIONS**
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **$ in millions**             | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                    |       |                             |       |                           |       |   |   |   |   |
| **Revenues**                            | ** ** | **$**                            | **306.7**  |                           | $          | 291.4 | ** ** | **$** | **645.8** |   | $ | 596.5 |   |
|                                    |       |                             |       |                           |       |   |   |   |   |
| **Cost of revenues:**                   | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fuel                                    | ** ** | **76.2**                         |       | 69.5                           | ** ** | **160.1** |   | 147.2 |   |
| Purchased power                         | ** ** | **38.4**                         |       | 38.4                           | ** ** | **64.0** |   | 67.7 |   |
| Total cost of  revenues                 | ** ** | **114.6**                        |       | 107.9                          | ** ** | **224.1** |   | 214.9 |   |
|                                    |       |                             |       |                           |       |   |   |   |   |
| **Gross margin**                        | ** ** | **192.1**                        |       | 183.5                          | ** ** | **421.7** |   | 381.6 |   |
|                                    |       |                             |       |                           |       |   |   |   |   |
| **Operating expenses:**                 | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operation and  maintenance              | ** ** | **59.6**                         |       | 50.6                           | ** ** | **113.8** |   | 99.4 |   |
| Depreciation and  amortization          | ** ** | **32.5**                         |       | 31.1                           | ** ** | **63.8** |   | 61.1 |   |
| General taxes                           | ** ** | **25.6**                         |       | 25.4                           | ** ** | **53.1** |   | 52.8 |   |
| Amortization of  regulatory assets, net | ** ** | **1.7**                          |       | 0.4                            | ** ** | **2.8** |   | 0.9 |   |
|                                    | ** ** | ** **                       |       |                           | ** ** | ** ** |   |   |   |
| Total operating  expenses               | ** ** | **119.4**                        |       | 107.5                          | ** ** | **233.5** |   | 214.2 |   |
|                                    |       |                             |       |                           |       |   |   |   |   |
| **Operating income**                    | ** ** | **72.7**                         |       | 76.0                           | ** ** | **188.2** |   | 167.4 |   |
|                                    |       |                             |       |                           |       |   |   |   |   |
| Investment income                       | ** ** | **1.3**                          |       | 1.0                            | ** ** | **3.2** |   | 2.1 |   |
| Other income  (deductions)              | ** ** | **0.8**                          |       | (2.6                           | )          | **0.3** |   | 4.1 |   |
| Interest expense                        | ** ** | **(5.3**                         | **)**      | (9.3                           | )          | **(12.0** | **)** | (20.6 | ) |
|                                    | ** ** | ** **                       | ** ** |                           |       | ** ** | ** ** |   |   |
| **Income before income taxes**          | ** ** | **69.5**                         |       | 65.1                           | ** ** | **179.7** |   | 153.0 |   |
|                                    |       |                             |       |                           |       |   |   |   |   |
| Income tax expense                      | ** ** | **25.5**                         |       | 29.2                           | ** ** | **68.8** |   | 63.8 |   |
|                                    | ** ** | ** **                       |       |                           | ** ** | ** ** |   |   |   |
| **Net income**                          | ** ** | **44.0**                         |       | 35.9                           | ** ** | **110.9** |   | 89.2 |   |
|                                    | ** ** | ** **                       |       |                           | ** ** | ** ** |   |   |   |
| Preferred dividends                     | ** ** | **0.2**                          |       | 0.2                            | ** ** | **0.4** |   | 0.4 |   |
| **Earnings on common stock**            | ** ** | **$**                            | **43.8**   |                           | $          | 35.7 | ** ** | **$** | **110.5** |   | $ | 88.8 |   |

 

See Notes toConsolidated Financial Statements.

These interimstatements are unaudited.

3

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**THE DAYTON POWER AND LIGHT COMPANY**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**
| ** **                                      | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **June 30,**              | ** ** |
| **$ in millions**                     | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities:**      | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net income                                      | ** ** | **$**                          | **110.9**  |   | $ | 89.2 |   |
|                                            |       |                           |       |   |   |
| Adjustments:                                    |       |                           |       |   |   |
| Depreciation and amortization                   | ** ** | **63.8**                       |       | 61.1 |   |
| Amortization of regulatory assets, net          | ** ** | **2.8**                        |       | 0.9 |   |
| Deferred income taxes                           | ** ** | **(4.0**                       | **)**      | (5.6 | ) |
| Changes in certain  assets and liabilities:     |       |                           |       |   |   |
| Accounts receivable                             | ** ** | **(7.5**                       | **)**      | (13.2 | ) |
| Accounts payable                                | ** ** | **65.5**                       |       | 9.4 |   |
| Accrued taxes payable                           | ** ** | **(42.8**                      | **)**      | 30.7 |   |
| Accrued interest payable                        | ** ** | **1.3**                        |       | (0.2 | ) |
| Prepayments                                     | ** ** | **1.9**                        |       | 5.6 |   |
| Inventories                                     | ** ** | **(16.2**                      | **)**      | (17.4 | ) |
| Deferred  compensation assets                   | ** ** | **4.3**                        |       | 2.5 |   |
| Deferred  compensation obligations              | ** ** | **(3.6**                       | **)**      | 6.9 |   |
| Other                                           | ** ** | **(1.2**                       | **)**      | (7.0 | ) |
| **Net cash provided by operating activities**   | ** ** | **175.2**                      |       | 162.9 |   |
|                                            |       |                           |       |   |   |
| **Cash  flows from investing activities:**      | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Capital  expenditures                           | ** ** | **(199.3**                     | **)**      | (80.6 | ) |
| **Net cash (used for) investing activities**    | ** ** | **(199.3**                     | **)**      | (80.6 | ) |
|                                            |       |                           |       |   |   |
| **Cash  flows from financing activities:**      | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Retirement of  long-term debt                   | ** ** | **—**                     |       | (0.4 | ) |
| Dividends paid  on common stock                 | ** ** | **—**                     |       | (75.0 | ) |
| Dividends paid  on preferred stock              | ** ** | **(0.4**                       | **)**      | (0.4 | ) |
| **Net cash (used for) financing activities**    | ** ** | **(0.4**                       | **)**      | (75.8 | ) |
|                                            |       |                           |       |   |   |
| **Cash  and cash equivalents:**                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net change                                      | ** ** | **(24.5**                      | **)**      | 6.5 |   |
| Balance at  beginning of period                 | ** ** | **46.2**                       |       | 17.2 |   |
| **Cash  and cash equivalents at end of period** | ** ** | **$**                          | **21.7**   |   | $ | 23.7 |   |
|                                            |       |                           |       |   |   |
| **Supplemental  cash flow information:**        | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Interest paid,  net of capitalized interest     | ** ** | **$**                          | **9.2**    |   | $ | 19.2 |   |
| Income taxes paid, net                          | ** ** | **$**                          | **91.5**   |   | $ | 36.8 |   |

 

See Notes to ConsolidatedFinancial Statements.

These interim statements areunaudited.

4

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**THEDAYTON POWER AND LIGHT COMPANYCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                      | ** ** | **At**            | ** **  | **At**                | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------|-------------|-----------------------|------------|
| ** **                                                                                      | ** ** | **June 30,** | ** **  | **December 31,** | ** ** |
| **$ in millions**                                                                     | ** ** | **2006**          | ** **  | **2005**              | ** ** |
|                                                                                            |       |              |        |                  |       |
| **ASSETS**                                                                                      | ** ** | ** **        | ** **  | ** **            | ** ** |
|                                                                                            |       |              |        |                  |       |
| **Current assets:**                                                                             | ** ** | ** **        | ** **  | ** **            | ** ** |
| Cash and cash  equivalents                                                                      | ** ** | **$**             | **21.7**    |                  | $          | 46.2 |   |
| Accounts  receivable, less provision for uncollectible accounts of $1.6 and $1.0,  respectively |       | **187.4**         |        | 182.7                 |       |
| Inventories, at  average cost                                                                   | ** ** | **93.9**          |        | 77.7                  |       |
| Taxes applicable  to subsequent years                                                           | ** ** | **22.9**          |        | 45.9                  |       |
| Other current  assets                                                                           | ** ** | **24.2**          |        | 19.3                  |       |
| Total current  assets                                                                           | ** ** | **350.1**         |        | 371.8                 |       |
|                                                                                            |       |              |        |                  |       |
| **Property, plant and equipment:**                                                              | ** ** | ** **        | ** **  | ** **            | ** ** |
| Property, plant  and equipment                                                                  | ** ** | **4,296.4**       |        | 4,118.0               |       |
| Less:  Accumulated depreciation and amortization                                                | ** ** | **(2,029.5**      | **)**       | (1,973.3              | )          |
|                                                                                            | ** ** | ** **        |        |                  |       |
| Net property                                                                                    | ** ** | **2,266.9**       |        | 2,144.7               |       |
|                                                                                            |       |              |        |                  |       |
| **Other noncurrent assets:**                                                                    | ** ** | ** **        | ** **  | ** **            | ** ** |
| Regulatory  assets                                                                              | ** ** | **80.5**          |        | 83.8                  |       |
| Other deferred  assets                                                                          | ** ** | **135.5**         |        | 138.3                 |       |
| Total other  noncurrent assets                                                                  | ** ** | **216.0**         |        | 222.1                 |       |
|                                                                                            |       |              |        |                  |       |
| **Total Assets**                                                                                | ** ** | **$**             | **2,833.0** |                  | $          | 2,738.6 |   |

 

See Notes toConsolidated Financial Statements.

These interimstatements are unaudited.

5

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**THE DAYTON POWER AND LIGHT COMPANY**

**CONSOLIDATEDBALANCE SHEETS**
| ** **                                                      | ** ** | **At**            | ** **  | **At**                | ** ** |
|-----------------------------------------------------------------|------------|-------------------|-------------|-----------------------|------------|
| ** **                                                      | ** ** | **June 30,** | ** **  | **December 31,** | ** ** |
| **$ in millions**                                     | ** ** | **2006**          | ** **  | **2005**              | ** ** |
|                                                            |       |              |        |                  |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                  | ** ** | ** **        | ** **  | ** **            | ** ** |
|                                                            |       |              |        |                  |       |
| **Current liabilities:**                                        | ** ** | ** **        | ** **  | ** **            | ** ** |
| Accounts payable                                                | ** ** | **$**             | **166.4**   |                  | $          | 116.2 |   |
| Accrued taxes                                                   | ** ** | **93.2**          |        | 167.7                 |       |
| Accrued interest                                                | ** ** | **11.4**          |        | 9.8                   |       |
| Other current  liabilities                                      | ** ** | **32.7**          |        | 28.4                  |       |
| Total current  liabilities                                      | ** ** | **303.7**         |        | 322.1                 |       |
|                                                            |       |              |        |                  |       |
| **Noncurrent liabilities:**                                     | ** ** | ** **        | ** **  | ** **            | ** ** |
| Long-term debt                                                  | ** ** | **685.6**         |        | 685.9                 |       |
| Deferred taxes                                                  | ** ** | **322.6**         |        | 323.2                 |       |
| Unamortized  investment tax credit                              | ** ** | **45.0**          |        | 46.4                  |       |
| Other deferred  credits                                         | ** ** | **264.5**         |        | 258.7                 |       |
| Total noncurrent  liabilities                                   | ** ** | **1,317.7**       |        | 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 $0.01 per share                  | ** ** | **0.4**           |        | 0.4                   |       |
| Other paid-in  capital                                          | ** ** | **781.3**         |        | 783.4                 |       |
| Retained  earnings                                              | ** ** | **400.9**         |        | 290.5                 |       |
| Accumulated  other comprehensive income                         | ** ** | **6.1**           |        | 5.1                   |       |
| Total common  shareholders’ equity                         | ** ** | **1,188.7**       |        | 1,079.4               |       |
|                                                            |       |              |        |                  |       |
| **Total Liabilities and  Shareholders’ Equity**            | ** ** | **$**             | **2,833.0** |                  | $          | 2,738.6 |   |

 

See Notes toConsolidated Financial Statements.

These interimstatements are unaudited.

6

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**Notes to Consolidated Financial Statements**

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

***Description of 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.

***Financial Statement 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 months ended June 30, 2006 may not beindicative of our results that will be realized for the full year endingDecember 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.  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 June 30, 2006, our results of operations for the three months ended June 30,2006, and our cash flows for the three months ended June 30, 2006 in accordancewith 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.  Differentestimates could have a material effect on our financial results.  Judgments and uncertainties affecting theapplication of these policies and estimates may result in materially differentamounts being reported under different conditions or circumstances.  Significant items subject to such estimatesand judgments include the carrying value of property, plant and equipment;unbilled revenues; the valuation of derivative instruments; valuationallowances for receivables and deferred income taxes; reserves recorded forincome tax exposures; litigation; regulatory proceeding and orders; and assetsand liabilities related to employee benefits. Actual results may differ from those estimates.  Certain amounts from prior periods have beenreclassified to conform to the current reporting presentation.

***RecentlyIssued Accounting Standards***

**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 provide service.  Liabilities initially incurred are based onthe fair-value of equity instruments and are to be re-measured at eachsubsequent 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 cash inflows.  The provisions of this Statement becameeffective as of January 1, 2006.  OurJune 30, 2006 year-to-date pre-tax results of operations were increased by

7

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approximately $0.4million as a result of the adoption of SFAS 123R, which we apply to stock-basedtransactions related to DPL Inc. common stock. See Note 5 of Notes to Consolidated Financial Statements.

**Accounting Changes and Error Corrections**

In June 2005, the FASBissued Statement of Financial Accounting Standards No. 154 (SFAS 154), “AccountingChanges and Error Corrections.”  This Statementreplaces APB Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3, “ReportingAccounting Changes in Interim Financial Statements,” and changes therequirements for the accounting for and reporting of a change in accountingprinciple.  This Statement applies to all voluntary changes in accountingprinciple.  It also applies to changes required by an accountingpronouncement in the unusual instance that the pronouncement does not includespecific transition provisions.  When a pronouncement includes specifictransition provisions, those provisions should be followed.  This Statement is effective for accountingchanges and corrections of errors made in fiscal years beginning after December15, 2005.  The adoption of this newaccounting standard had no impact on the Company.

**Accounting for Uncertainty in Income 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, cashflows or financial position.

8

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**2.  Supplemental Financial Information**

 
| ** **                                        | ** ** | **At**            | ** ** | **At**                | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **Balance Sheet**                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| **$ in millions**                       | ** ** | **2006**          | ** ** | **2005**              | ** ** |
|                                              | ** ** | ** **        |       |                  |       |
| **Accounts  receivable, net:**                    | ** ** | ** **        |       |                  |       |
| Retail customers                                  | ** ** | **$**             | **63.3**   |                  | $          | 71.1 |   |
| Unbilled revenue                                  | ** ** | **53.0**          |       | 57.5                  |       |
| Partners in commonly-owned plants                 | ** ** | **52.6**          |       | 37.7                  |       |
| Wholesale customers and subsidiary customers      | ** ** | **8.3**           |       | 3.4                   |       |
| Financial transmission rights                     | ** ** | **6.0**           |       | —                |       |
| Refundable franchise tax                          | ** ** | **3.1**           |       | 11.8                  |       |
| Other                                             | ** ** | **2.7**           |       | 2.2                   |       |
| Provision for uncollectible accounts              | ** ** | **(1.6**          | **)**      | (1.0                  | )          |
| **Total accounts receivable, net**                | ** ** | **$**             | **187.4**  |                  | $          | 182.7 |   |
|                                              | ** ** | ** **        |       |                  |       |
| **Inventories,  at average cost:**                | ** ** | ** **        |       |                  |       |
| Fuel and emission allowances                      | ** ** | **$**             | **64.5**   |                  | $          | 48.6 |   |
| Plant materials and supplies                      | ** ** | **29.4**          |       | 29.1                  |       |
| **Total inventories, at average cost**            | ** ** | **$**             | **93.9**   |                  | $          | 77.7 |   |
|                                              | ** ** | ** **        |       |                  |       |
| **Other  current assets:**                        | ** ** | ** **        |       |                  |       |
| Prepayments                                       | ** ** | **$**             | **8.1**    |                  | $          | 7.6 |   |
| Deposits and other advances                       | ** ** | **5.9**           |       | 5.8                   |       |
| Current deferred income taxes                     | ** ** | **5.1**           |       | 4.9                   |       |
| Derivatives                                       | ** ** | **4.3**           |       | —                |       |
| Other                                             | ** ** | **0.8**           |       | 1.0                   |       |
| **Total other current assets**                    | ** ** | **$**             | **24.2**   |                  | $          | 19.3 |   |
|                                              | ** ** | ** **        |       |                  |       |
| **Other  deferred assets:**                       | ** ** | ** **        |       |                  |       |
| Master Trust assets                               | ** ** | **$**             | **103.9**  |                  | $          | 107.7 |   |
| Unamortized loss on reacquired debt               | ** ** | **21.2**          |       | 22.0                  |       |
| Unamoritized debt expense                         | ** ** | **7.2**           |       | 7.4                   |       |
| Other                                             | ** ** | **3.2**           |       | 1.2                   |       |
| **Total other deferred assets**                   | ** ** | **$**             | **135.5**  |                  | $          | 138.3 |   |
|                                              | ** ** | ** **        |       |                  |       |
| **Accounts  payable:**                            | ** ** | ** **        |       |                  |       |
| Trade payables                                    | ** ** | **$**             | **83.1**   | ** **            | $          | 26.1 |   |
| Fuel accruals                                     | ** ** | **38.6**          | ** ** | 39.5                  |       |
| Other                                             | ** ** | **44.7**          | ** ** | 50.6                  |       |
| **Total accounts payable**                        | ** ** | **$**             | **166.4**  |                  | $          | 116.2 |   |
|                                              | ** ** | ** **        |       |                  |       |
| **Other  current liabilities:**                   | ** ** | ** **        |       |                  |       |
| Customer security deposits                        | ** ** | **$**             | **19.8**   |                  | $          | 19.2 |   |
| Financial transmission rights - future proceeds   | ** ** | **6.0**           |       | —                |       |
| Current portion of long-term debt                 | ** ** | **1.0**           |       | 0.9                   |       |
| Payroll taxes payable                             | ** ** | **0.9**           |       | 2.3                   |       |
| Unearned revenues                                 | ** ** | **0.1**           |       | 0.4                   |       |
| Other                                             | ** ** | **4.9**           |       | 5.6                   |       |
| **Total other current liabilities**               | ** ** | **$**             | **32.7**   |                  | $          | 28.4 |   |
|                                              | ** ** | ** **        |       |                  |       |
| **Other  deferred credits:**                      | ** ** | ** **        |       |                  |       |
| Asset retirement obligations - regulated property | ** ** | **$**             | **84.2**   |                  | $          | 81.7 |   |
| Trust obligations                                 | ** ** | **73.0**          |       | 74.5                  |       |
| Retirees’ health and life benefits           | ** ** | **32.6**          |       | 32.9                  |       |
| Pension liability                                 | ** ** | **25.8**          |       | 23.5                  |       |
| SECA net revenue subject to refund                | ** ** | **21.5**          |       | 20.5                  |       |
| Asset retirement obligations - generation         | ** ** | **13.1**          |       | 13.2                  |       |
| Litigation and claims pending                     | ** ** | **3.6**           |       | 3.0                   |       |
| Environmental reserves                            | ** ** | **0.1**           |       | 0.1                   |       |
| Other                                             | ** ** | **10.6**          |       | 9.3                   |       |
| **Total  other deferred credits**                 | ** ** | **$**             | **264.5**  |                  | $          | 258.7 |   |

 

9

----

** **
| ** **                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------|------------|
| **$ in millions**        | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
|                               | ** ** | ** **                                        |       |   |   |
| **Cash  flows - other:**           |       |                                              |       |   |   |
| Payroll taxes payable              | ** ** | **$**                                             | **(1.4**   | **)** | $ | (0.1 | ) |
| Deposits and other advances        | ** ** | **(1.8**                                          | **)**      | (1.1 | ) |
| Deferred storm costs               | ** ** | **—**                                        |       | (11.4 | ) |
| FERC transitional payment deferral | ** ** | **1.0**                                           |       | 9.9 |   |
| Other                              | ** ** | **1.0**                                           |       | (4.3 | ) |
| **Total  cash flows - other**      | ** ** | **$**                                             | **(1.2**   | **)** | $ | (7.0 | ) |

 
| ** **                                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **$ in millions**                                     | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                            | ** ** | ** **                                          |       |                                              |       |   |   |   |   |
| **Comprehensive  income:**                                      | ** ** | ** **                                          |       |                                              |       |   |   |   |   |
| Net income                                                      | ** ** | **$**                                               | **44.0**   |                                              | $          | 35.9 |   | **$** | **110.9** |   | $ | 89.2 |   |
| Net change in unrealized gains on financial instruments         | ** ** | **(0.2**                                            | **)**      | 6.8                                               |       | **0.6** |   | 5.5 |   |
| Net change in deferred gains (losses) on cash flow  hedges      | ** ** | **2.2**                                             |       | (1.5                                              | )          | **2.8** |   | (2.8 | ) |
| Deferred income taxes related to unrealized gains  and (losses) | ** ** | **(1.0**                                            | **)**      | (2.1                                              | )          | **(2.4** | **)** | (1.2 | ) |
| **Total  comprehensive income**                                 | ** ** | **$**                                               | **45.0**   |                                              | $          | 39.1 |   | **$** | **111.9** |   | $ | 90.7 |   |

 

**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 redemption provisionsoutstanding.

| Preferred  Stock | ** ** | **Rate** | ** ** | **Current  Redemption  Price** | ** ** | **Current  Shares  Outstanding at  June 30,  2006** | ** ** | **Par Value  At June 30,  2006  ($ in millions)** | ** ** | **Par Value  At December 31,  2005  ($ 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 June 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.

10

----

 

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

**Net periodic benefit cost**
| **$ in millions**    | ** ** | **Pension** | ** ** | **Postretirement** | ** ** |
|--------------------------------|------------|-------------|------------|--------------------|------------|
| ** **                     | ** ** | **2006**    | ** ** | **2005**           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                   | ** ** | **$**       | **1.1**    |               | $          | 1.0 |   | **$** | **—** |   | $ | — |   |
| Interest cost                  | ** ** | **4.1**     |       | 3.9                |       | **0.4** |   | 0.5 |   |
| Expected return  on assets     | ** ** | **(5.4**    | **)**      | (5.4               | )          | **(0.1** | **)** | (0.2 | ) |
|                           |       |        |       |               |       |   |   |   |   |
| Amortization of  unrecognized: |       |        |       |               |       |   |   |   |   |
| Actuarial (gain) loss          | ** ** | **1.0**     |       | 1.0                |       | **(0.2** | **)** | (0.2 | ) |
| Prior service cost             | ** ** | **0.6**     |       | 0.6                |       | **—** |   | — |   |
| Transition obligation          | ** ** | **—**  |       | —             |       | **—** |   | — |   |
| Net periodic benefit  cost     | ** ** | **$**       | **1.4**    |               | $          | 1.1 |   | **$** | **0.1** |   | $ | 0.1 |   |

 

Thenet periodic benefit cost of the pension and postretirement benefit plans forthe six months ended June 30 was:

**Net periodic benefit cost**
| **$ in millions**                   | ** ** | **Pension** | ** ** | **Postretirement** | ** ** |
|-----------------------------------------------|------------|-------------|------------|--------------------|------------|
| ** **                                    | ** ** | **2006**    | ** ** | **2005**           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                                  | ** ** | **$**       | **2.2**    |               | $          | 2.0 | ** ** | **$** | **—** |   | $ | — |   |
| Interest cost                                 | ** ** | **8.2**     |       | 7.8                | ** ** | **0.8** |   | 0.9 |   |
| Expected return  on assets                    | ** ** | **(10.8**   | **)**      | (10.8              | )          | **(0.2** | **)** | (0.3 | ) |
|                                          | ** ** | ** **  |       |               | ** ** | ** ** |   |   |   |
| Amortization of  unrecognized:                | ** ** | ** **  |       |               | ** ** | ** ** |   |   |   |
| Actuarial (gain) loss                         | ** ** | **2.0**     |       | 1.9                | ** ** | **(0.4** | **)** | (0.5 | ) |
| Prior service cost                            | ** ** | **1.2**     |       | 1.2                | ** ** | **—** |   | — |   |
| Transition obligation                         | ** ** | **—**  |       | —             | ** ** | **0.1** |   | 0.1 |   |
| Net periodic  benefit cost before adjustments | ** ** | **2.8**     |       | 2.1                | ** ** | **0.3** |   | 0.2 |   |
| Special  termination benefit cost (a)         | ** ** | **0.3**     | ** ** | **—**         | ** ** | **—** | ** ** | **—** | ** ** |
| Net periodic benefit  cost after adjustments  | ** ** | **$**       | **3.1**    |               | $          | 2.1 | ** ** | **$** | **0.3** |   | $ | 0.2 |   |

 

----

(a)             In2006, a special termination benefit cost was recognized as a result of 16employees who participated in avoluntary early retirement program and were all retired as of April 1, 2006.

The following estimated benefit payments,which reflect future service, are expected to be paid as follows:

**Estimated Future Benefit Payments**
| $ in millions | ** ** | **Pension** | ** ** | **Postretirement** | ** ** |
|-------------------------|------------|-------------|------------|--------------------|------------|
| 2006                    |       | $           | 9.9        |               | $          | 1.5 |   |
| 2007                    |       | $           | 20.0       |               | $          | 3.1 |   |
| 2008                    |       | $           | 20.2       |               | $          | 3.0 |   |
| 2009                    |       | $           | 20.5       |               | $          | 3.0 |   |
| 2010                    |       | $           | 21.0       |               | $          | 2.9 |   |
| 2011                    |       | $           | 21.4       |               | $          | 2.7 |   |
| 2012 – 2016        |       | $           | 114.6      |               | $          | 10.7 |   |

 

11

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

We adopted Statement ofFinancial Accounting Standard 123 Revised (SFAS 123R) on January 1, 2006 usingthe modified prospective approach for stock options and restricted stock units(RSUs).  As a result of our adoption ofSFAS 123R, we recognized $0.4 million less compensation expense for the sixmonths ended June 30, 2006, as compared to what we would have recognized underSFAS 123.

In 2000, our Board ofDirectors adopted and our shareholders approved The DPL Inc. Stock Option Plan.  The plan provides that “no single Participantshall receive Options with respect to more than 2,500,000 shares.”  Options granted in 2000, 2001 and 2002 werefully vested as of December 31, 2005 and expire ten years from the grantdate.  In 2003, 100,000 options weregranted which vested equitably over five years and expire ten years from thegrant 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 over threeyears and expire ten years from the grant date. In 2005, 350,000 options were granted that vested in June 2006 andexpire three years from the grant date. At December 31, 2005, there were 1,488,500 options available forgrant.  On April 26, 2006, DPLshareholders approved the DPL Inc. 2006 Equity and Performance Incentive Plan(EPIP).  With the approval of EPIP, nofurther awards will be made under the DPL Inc. Stock Option Plan.

Theschedule of non-vested option activity for the six months ended June 30, 2006was as follows:

| $ in millons         | ** ** | **Number of Options** | ** ** | **Weighted-Average Grant  Date Fair Value** | ** ** |
|--------------------------------|------------|---------------------------------|------------|------------------------------------------------------------|------------|
| Non-vested at January  1, 2006 |       | 510,000                         |       | $                                                          | 1.9        |   |
| Granted in 1st half  2006      |       | —                          |       | —                                                     |       |
| Vested in 1st half 2006        |       | 450,000                         |       | $                                                          | 1.7        |   |
| Forfeited in 1st half  2006    |       | —                          |       | —                                                     |       |
| Non-vested at June 30, 2006    |       | 60,000                          |       | $                                                          | 0.2        |   |

 

Summarized stock optionactivity was as follows:

** **

|                                              | ** ** | **Six months  ended  June 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                                    | ** ** | **0**                                               |       | (4,000                                                 | )          |
| Outstanding at end of  period                | ** ** | **5,476,500**                                       |       | 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                                    | ** ** | **—**                                          |       | $                                                      | 29.63      |   |
| Outstanding at end of  period                | ** ** | **$**                                               | **21.90**  |                                                   | $          | 21.86 |   |
| Exercisable at end of period                 | ** ** | **$**                                               | **20.98**  |                                                   | $          | 20.98 |   |

 

----

*a)**           **In dispute with certain formerexecutives, among other things, are approximately 1 million forfeited optionsand 3.6 million outstanding options that are included above (see Note 7 ofNotes to Consolidated Financial Statements).*

No stock options weregranted in the first two quarters of 2006. The weighted-average fair value of options granted was $3.80 per sharein 2005.  The fair values of the optionswere estimated as of the dates of grant using a Black-Scholes option pricingmodel.

12

----

 

Inthe first quarter of 2006, 10,000 stock options were exercised.  No stock options were exercised in the secondquarter of 2006.  The market value ofoptions that were vested at June 30, 2006 was $145.1 million.  Shares issued upon share option exercise areissued from treasury stock.  We havesufficient treasury stock to satisfy outstanding options.

The following tablereflects information about stock options outstanding at June 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                           |       | 4,690,000       |       | 4.0 years                                 |       | $                                       | 20.44      |   | 4,650,000 |   | $ | 20.47 |   |
| $21.01-$29.63                           |       | 786,500         |       | 3.2 years                                 |       | $                                       | 28.08      |   | 766,000 |   | $ | 28.08 |   |

 

As of June 30, 2006,there was $0.2 million of total unrecognized compensation cost related tonon-vested stock options granted under the Plan.  We expect to recognize$0.1 million of this cost over the remainder of 2006 and $0.1 million in 2007.

In addition, RSUs weregranted to certain key employees prior to 2001. There were 1.4 million RSUs outstanding as of June 30, 2006, of which1.3 million were vested.  Substantiallyall of the vested RSUs are in dispute as part of our ongoing litigation withPeter H. Forster, formerly DPL’s Chairman; Caroline E. Muhlenkamp,formerly DPL’s Group Vice President and interim Chief Financial Officer; andStephen F. Koziar, formerly DPL’s Chief Executive Officer and President.  The remaining 0.1 million non-vested RSUs willbe paid in cash upon vesting and will vest as follows:  24,891 in 2006; 21,978 in 2007; 15,904 in2008; 11,199 in 2009; and 5,560 in 2010. Vested RSUs are marked to market each quarter and any adjustment to compensationexpense is recognized at that time. Non-vested RSUs are valued quarterly at fair value using theBlack-Scholes model to determine the amount of compensation expense to berecognized.  Non-vested RSUs do not earndividends.

The following assumptionswere used in the Black Scholes model to calculate the fair value of thenon-vested stock options and RSUs:

| Volatility              | ** ** | **24.0  – 29.1**            | **%**      |
|-------------------------|------------|---------------------------------------|------------|
| Expected life  (years)  | ** ** | **0.3  –   8.0**  | ** ** |
| Dividend yield  rate    | ** ** | **3.7  –   4.8**  | **%**      |
| Risk-free interest rate | ** ** | **3.7  –    5.2** | **%**      |

 

At the 2006 AnnualShareholder’s Meeting, the shareholders approved the DPL Inc. 2006 EquityPerformance Incentive Plan (EPIP).  Underthe EPIP, the Board adopted a Long-Term Incentive Plan (LTIP) under which DPLwill award a targeted number of performance shares of common stock toexecutives.  Awards under the LTIP willbe awarded based on a Total Shareholder Return Relative to Peersparameter.  No performance shares will beearned 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 at200% of the target number of performance shares, if the Total ShareholderReturn Relative to Peers is at or above the threshold of the 90th percentile. The Total Shareholder Return Relative to Peers is considered aperformance condition under FAS123R.  Therequisite service period for each tranche of the Performance Shares is:

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

 

13

----

 

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

 

| $ in millions        | ** ** | **Number of  Performance Shares** | ** ** | **Weighted-Average Grant  Date Fair Value ($ millions)** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| Non-vested at January  1, 2006 |       | —                                      |       | —                                                                            |       |
| Granted in 1st half  2006      |       | 223,289                                     |       | $                                                                                 | 5.9        |   |
| Vested in 1st half 2006        |       | —                                      |       | —                                                                            |       |
| Forfeited in 1st half  2006    |       | —                                      | *          | —                                                                            |       |
| Non-vested at June 30, 2006    |       | 223, 289                                    |       | $                                                                                 | 5.9        |   |

 

----

*      On August 1, 2006,James V. Mahoney, President and Chief Executive Officer, signed an amendment tohis Employment Agreement, dated May 18, 2006, in which he agreed generally toextend his service to the Company until a successor is appointed. Under thatamendment, Mr. Mahoney acknowledged he is not entitled to participate in theCompany’s Long Term Incentive Program or the Performance Shares Agreement datedMarch 7, 2006.

 

|                                   | ** ** | **Six months**         | ** ** | **Twelve months**          | ** ** |
|-----------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **ended**                   | ** ** | **ended**                       | ** ** |
| ** **                        | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
| Performance Shares:               |       |                        |       |                            |       |
| Outstanding at  beginning of year | ** ** | **—**                  |       | —                          |       |
| Granted                           | ** ** | **223,289**                 |       | —                          |       |
| Exercised                         | ** ** | **—**                  |       | —                          |       |
| Forfeited                         | ** ** | **—**                  |       | —                          |       |
| Outstanding at end of  period     | ** ** | **223,289**                 |       | —                          |       |
| Exercisable at end of period      | ** ** | **—**                  |       | —                          |       |

 

There are no exercise prices associated withperformance shares.

As of June 30, 2006,there was $3.9 million of total unrecognized compensation cost related tonon-vested performance shares granted under the LTIP.  We expect torecognize $2.1 million of this cost over the remainder of 2006 and $1.8 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.

The following assumptionswere used in a Monte Carlo simulation calculated by  a bonded consultant to estimate the fairvalue of the performance shares:

| Volatility              | ** ** | **20.3** | **%**      |
|-------------------------|------------|----------|------------|
| Expected life (years)   | ** ** | **3.0**  | ** ** |
| Dividend yield rate     | ** ** | **3.7**  | **%**      |
| Risk-free interest rate | ** ** | **4.7**  | **%**      |

 

Compensation expense forthe first half of 2006 was $3.3 million for all share-based compensation (stockoptions, RSUs, and performance shares) and the tax benefit associated withthese expenses was $1.2 million.

Operating income was $0.4million higher under SFAS 123R than under SFAS 123.  The impact on net income was $0.3 million dueto a decrease in the tax benefit of $0.1 million.  There was no impact on basic or dilutedearnings per share.

14

----

 

**6.****              Long-term Debt  **

|                                                             | ** ** | **At**            | ** ** | **At**                | ** ** |
|-------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| **$ in millions**                                 | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| First Mortgage Bonds maturing  2013 - 5.125%                | ** ** | **$**             | **470.0**  |                  | $          | 470.0 |   |
| Pollution Control Series maturing  through 2034 - 4.78% (a) | ** ** | **214.4**         |       | 214.4                 |       |
|                                                        | ** ** | **684.4**         |       | 684.4                 |       |
|                                                        |       |              |       |                  |       |
| Obligation for  capital leases                              | ** ** | **2.4**           |       | 3.0                   |       |
| Unamortized debt  discount                                  | ** ** | **(1.2**          | **)**      | (1.5                  | )          |
| Total                                                       | ** ** | **$**             | **685.6**  |                  | $          | 685.9 |   |

 

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(a)  Weighted average interest rates for 2006 and2005.

 

The amounts of maturitiesand mandatory redemptions for first mortgage bonds and capital leases are $0.5million for the remainder of 2006, $0.9 million in 2007, $0.7 million in 2008,$0.7 million in 2009 and $0.6 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 currently met.  We had no outstanding borrowings under thiscredit facility at June 30, 2006.  Feesassociated with this credit facility are approximately $0.2 million per year.  Changes in credit ratings, however, mayaffect the applicable interest rate for our revolving credit agreement.

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 June 30, 2006, we had two outstandingletters of credit for a total of $2.2 million.

During the first quarterof 2006, the Ohio Air Quality Development Authority (OAQDA) awarded us theability to issue over the next three years up to $200 million of qualifiedtax-exempt financing from the OAQDA’s 2005 volume cap carryforward.  The financing is expected to be used topartially fund the ongoing flue gas desulphurization (FGD) projects.  The PUCO approved our application for thisadditional financing on July 26, 2006.

There are no inter-companydebt collateralizations or debt guarantees between us and our parent.  None of our debt obligations are guaranteedor secured by affiliates and no cross-collateralization exists between anysubsidiaries.

**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 ourconsolidated financial statements, as prescribed by GAAP, are adequate in lightof the probable 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 andregulations, will not exceed the amounts reflected in our ConsolidatedFinancial 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 state

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and federal laws.  We record liabilities for probable estimatedloss in accordance with Statement of Financial Accounting Standards No. 5 (SFAS5), “Accounting for Contingencies.”  Tothe extent a probable loss can only be estimated by reference to a range ofequally probable outcomes, and no amount within the range appears to be abetter estimate than any other amount, we accrue for the low end of therange.  Because of uncertainties relatedto these matters, accruals are based on the best information available at thetime.  We evaluate the potential liabilityrelated to probable losses quarterly and may revise our estimates.  Such revisions in the estimates of potentialliabilities could have a material effect on our results of operations andfinancial position.

**Legal Matters**

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,investigations and proceedings by governmental and self-regulatoryorganizations regarding our business. Certain of the foregoing could result inadverse 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 14 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 8 to the consolidated financialstatements and Part II, Item 1, included in our Form 10-Q for the quarterlyperiod ended March 31, 2006. The following discussion is limited to recentdevelopments concerning our legal proceedings and should be read in conjunctionwith those earlier reports.

Regarding our litigationwith three former executives of the Company, on July 24, 2006 the trial courtset a new trial date commencing April 30, 2007.

On June 24, 2004, theInternal Revenue Service (IRS) began an audit of tax years 1998 through 2003and issued a series of data requests to us including issues raised in theMemorandum.  The staff of the IRSrequested that we provide certain documents, including but not limited to,matters concerning executive/director deferred compensation plans, managementstock incentive plans and MVE financial statements.  On September 1, 2005, the IRS issued an auditreport for tax years 1998 through 2003 that showed proposed changes to ourfederal income tax liability for each of those years.  The proposed changes resulted in a total taxdeficiency, penalties and interest of approximately $23.9 million as of December31, 2005.  On November 4, 2005, we fileda written protest to one of the proposed changes.  On April 3, 2006, the IRS conceded theproposed changes that we filed a written protest to and issued a revised auditreport for tax years 1998 through 2003. The revised audit report resulted in a total tax deficiency, penaltiesand interest of approximately $1.2 million. We had previously made a deposit with the IRS of approximately $1.3million that we requested on April 14, 2006 be applied to offset the $1.2million tax deficiency, penalties and interest for tax years 1998 through2003.  The Joint Committee on Taxationcompleted its review of the revised audit report for tax years 1998 through2003 and sent us a letter dated June 16, 2006 stating that it took no exceptionto the revised audit report.

In November 2005,AMP-Ohio, a wholesale supplier of electricity to its thirteen membermunicipalities, requested arbitration of its power supply agreement withDP&L.  AMP-Ohio alleged it had a right to receive certain capacitycredits.  DP&L disagreed with this position and agreed to arbitratethe dispute.  The arbitration was concluded in May 2006, thus ending anypotential negative exposure to our results of operations, cash flows andfinancial position.

On January 13, 2006, wefiled a claim against one of our insurers, AEGIS, under a fiduciary policy torecoup legal fees associated with our litigation against three formerexecutives.  An arbitration of thismatter is set to begin on August 4, 2006. We cannot predict the timing or outcome of this arbitration.

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**Contractual Obligations and Commercial Commitments**

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

**Contractual Obligations**
| ** **                           | ** ** | ** ** | ** ** | **Payment Year**           | ** ** |
|--------------------------------------|------------|------------|------------|---------------------------------|------------|
| **$ in millions**          | ** ** | **Total**  | ** ** | **Less Than 1  Year** | ** ** | **2 - 3 Years** | ** ** | **4 - 5 Years** | ** ** | **More than 5  Years** | ** ** |
|                                 |       |       |       |                            |       |   |   |   |   |   |   |
| Long-term debt                       |       | $          | 683.2      |                            | $          | — |   | $ | — |   | $ | — |   | $ | 683.2 |   |
| Interest payments                    |       | 446.7      |       | 34.3                            |       | 68.7 |   | 68.7 |   | 275.0 |   |
| Pension and  postretirement payments |       | 254.5      |       | 23.0                            |       | 46.6 |   | 47.7 |   | 137.2 |   |
| Capital leases                       |       | 3.4        |       | 1.0                             |       | 1.5 |   | 0.9 |   | — |   |
| Operating leases                     |       | 0.9        |       | 0.5                             |       | 0.4 |   | — |   | — |   |
| Fuel and limestone  contracts (a)    |       | 646.4      |       | 174.4                           |       | 287.4 |   | 97.5 |   | 87.1 |   |
| Other long-term  obligations         |       | 34.1       |       | 12.0                            |       | 14.8 |   | 7.3 |   | — |   |
| Total contractual obligations        |       | $          | 2,069.2    |                            | $          | 245.2 |   | $ | 419.4 |   | $ | 222.1 |   | $ | 1,182.5 |   |

 

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(a)DP&L operated units

 

Long-term debt:

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

Interest payments:

Interest payments associated with the long-term debtdescribed above.

Pension andpostretirement payments:

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

Capital leases:

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

Operating leases:

As of June 30, 2006, wehad 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 units (FGDs).  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 June 30, 2006, we hadvarious other contractual obligations including non-cancelable contracts topurchase goods and services with various terms and expiration dates.

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We enter into variouscommercial commitments, which may affect the liquidity of our operations.  At June 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 June 30, 2006, there were no borrowingsoutstanding under this credit agreement. The new facility may be increased up to $150 million.

Guarantee:

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

**Item2.  Management’s Discussion andAnalysis of Financial 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.  We disclaim any obligation or undertakingto provide any updates or revisions to any forward-looking statement to reflectany change in our expectations or any change in events, conditions orcircumstances on which the forward-looking statement is based.

**OTHERMATTERS**

**Peaking Generating Facilities**

DPL is reviewing its peaking generationportfolio.  As a part of that process,the Company is soliciting bids for three peaking generating sites, representinga combined capacity of 872 megawatts. DPL will determine the number of sites it may sell, if any, after itreceives the bids, which are expected in early September.

**Updateson Competition and Regulation**

On April 4, 2005, we filed a request at the Public UtilitiesCommission of Ohio (PUCO) to implement a new rate stabilization surcharge effectiveJanuary 1, 2006 to recover cost increases associated with environmentalcapital and related operations and maintenance costs, and fuel expenses.  On November 3, 2005, we entered into asettlement agreement that extended our rate stabilization period throughDecember 31, 2010.  During this time, wewill continue to provide retail electric service at fixed rates with theability to recover increased fuel and environmental costs through surchargesand riders.  Specifically, the agreementprovides for:

·                  A rate stabilization surcharge equalto 11% of generation rates beginning January 1, 2006 and continuing throughDecember 2010.  Based on 2004 sales, thisrider is expected to result in approximately $65 million in net revenues peryear.

·                  A new environmental investment riderto begin January 1, 2007 equal to 5.4% of generation rates, with incrementalincreases equal to 5.4% each year through 2010. Based on 2004 sales, this rider is expected to result in approximately$35 million in annual net revenues beginning January 2007, growing toapproximately $140 million by 2010.

·                  Anincrease to the residential generation discount from January 1, 2006 throughDecember 31, 2008 which is expected to result in a revenue decrease ofapproximately $7 million per year for three years, based on 2004 sales.  The residential discount will expire onDecember 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 OCC on April 21, 2006.

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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.  During 2005,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.  The first round of bids, due July 10, 2006, resulted in no bidsbeing received.  There will be three additional rounds of bids during thethird and fourth quarters of 2006.  The magnitude of any customerswitching and the financial impact of this program cannot be determined at thistime.

As of June 30, 2006, fourunaffiliated marketers were registered as CRES providers in our serviceterritory; to date, there has been no significant activity from thesesuppliers.  DPL Energy Resources, Inc. (DPLER), one of our parent’ssignificant subsidiaries, is also a registered CRES provider and accounted fornearly all load served by CRES providers within our service territory in2005.  In addition, several communities in our service area have passedordinances allowing the communities to become government aggregators for thepurpose of offering alternative electric generation supplies to theircitizens.  To date, none of thesecommunities have aggregated their generation load.

On September 1, 2005, DP&L filed an applicationrequesting the PUCO grant it authority to recover distribution costs associatedwith storm restoration efforts for ice storms that took place in December 2004and January 2005.  In February 2006,DP&L filed updated schedules in support of its application.  On July 12, 2006, the PUCO approved DP&L’sfiling, allowing the Company to recover approximately $8.6 million inadditional revenues over a two-year period.

OnJuly 23, 2003, the FERC issued an Order that the rates for transmission serviceof seven companies, including us, may be unjust, unreasonable, or undulydiscriminatory or preferential.  Inaddition, the FERC ordered transitional payments, known as Seams EliminationCharge Adjustment (SECA), effective December 1, 2004 through March 31, 2006,subject to refund. Through this proceeding, we are obligated to pay SECAcharges to other utilities, but we receive a net benefit from thesetransitional payments.  Several partieshave sought rehearing of the FERC orders, and there likely will be appealsfiled in the matter.  All motions forrehearing are pending.  The hearing washeld in May 2006, with an initial decision expected in August 2006.  Beginning May 2005, we began receiving theseFERC ordered transitional payments and have received over $24.8 million of SECAcollections, net of SECA charges, through June 2006.  We have entered into a significant number ofbi-lateral settlement agreements with certain parties to resolve the matter,although several SECA claims are still outstanding.  Our management believes that appropriatereserves have been established in the event that SECA collections are requiredto be refunded.  The ultimate outcome ofthe proceeding establishing SECA rates is uncertain at this time. However,based on the amount of reserves established for this item, the results of thisproceeding are not expected to have a material effect on our results ofoperations.

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 Commission order on this issue later this year.  Due to the comment and appeal process, wecannot determine what effect the final outcome of this proceeding may have onour future recovery of transmission revenues.

**Updateson Environmental Considerations**

***Airand Water Quality***

On December 17, 2003, the USEPA proposed the Interstate AirQuality Rule (IAQR) designed to reduce and permanently cap sulfur dioxide (SO2) and nitrogen oxide (NOx)emissions from electric utilities.  Theproposed IAQR focused on states, including Ohio, whose power plant emissionsare believed to be significantly contributing to fine particle and ozonepollution in other downwind states in the eastern United States.  On June 10, 2004, the USEPA issued asupplemental proposal to the IAQR, now renamed as the Clean Air Interstate Rule(CAIR).  The final rules were signed onMarch 10, 2005 and were published on May 12, 2005.  On August 24, 2005, the USEPA proposedadditional revisions to the CAIR and initiated reconsideration on one issue.  On March 15, 2006, the USEPA announced it hadcompleted its review of the requests for reconsideration and determined that itwould propose no changes to CAIR and denied the requests for stay.  We have determined that CAIR requirementswill have a material effect on our operations, requiring the installation ofFGD equipment and continual operation of the

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currently-installedSelective Catalytic Reduction (SCR) equipment. As a result, we are proceeding with the installation and have begun theconstruction of FGD equipment 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 willspend more than $465 million from 2006 through 2008 to install the necessarypollution controls.  If CAM-R litigationresults in plant specific mercury controls, our costs may be higher.  Due to the ongoing uncertainties associatedwith the litigation of the CAM-R, we cannot project the final costs at thistime.

**RISKFACTORS**

This quarterly report andother documents that we file with the SEC and other regulatory agencies, aswell as other oral or written statements we may make from time to time, containinformation based on management’s beliefs and include forward-lookingstatements (within the meaning of the Private Securities Litigation Reform Actof 1995) that involve a number of known and unknown risks, uncertainties andassumptions. These forward-looking statements are not guarantees of futureperformance, and there are a number of factors which could cause actualoutcomes and results to differ materially from the results contemplated by suchforward-looking statements. We do not undertake any obligation to publiclyupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise. These forward-looking statements are identified by terms and phrasessuch as “anticipate”, “believe”, “intend”, “estimate”, “expect”, “continue”, “should”,“could”, “may”, “plan”, “project”, “predict”, “will”, and similar expressions.

A comprehensive listing ofrisk factors that we consider to be the most significant to your decision toinvest in us is provided in our most recent 10-K and may be obtained asdiscussed on page 2, ‘Available Information.’ Any updates are provided in Part II, Item 1A. “Risk Factors” of thisquarterly report.  If any of these eventsoccur, our business, financial position or results of operation could bematerially affected.

**RESULTSOF OPERATIONS**

**Income Statement Highlights**
| ** **                               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **$ in millions**              | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                     |       |                                                |       |                                              |       |   |   |   |   |
| Revenues                                 | ** ** | **$**                                               | **306.7**  |                                              | $          | 291.4 | ** ** | **$** | **645.8** |   | $ | 596.5 |   |
| Less:  Fuel                         | ** ** | **76.2**                                            |       | 69.5                                              | ** ** | **160.1** |   | 147.2 |   |
|   Purchased  power                  | ** ** | **38.4**                                            |       | 38.4                                              | ** ** | **64.0** |   | 67.7 |   |
| Gross margin                             | ** ** | **$**                                               | **192.1**  |                                              | $          | 183.5 | ** ** | **$** | **421.7** |   | $ | 381.6 |   |
|                                     |       |                                                |       |                                              |       |   |   |   |   |
| Gross margin as a percentage of revenues | ** ** | **62.6**                                            | **%**      | 63.0                                              | %          | **65.3** | **%** | 64.0 | % |
|                                     |       |                                                |       |                                              |       |   |   |   |   |
| Operating income                         | ** ** | **$**                                               | **72.7**   |                                              | $          | 76.0 | ** ** | **$** | **188.2** |   | $ | 167.4 |   |

 

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**Revenues**

Revenues increased 5% to $306.7 million in the second quarter of 2006compared to $291.4 million for the second quarter of 2005 reflecting higheraverage rates for retail sales and greater wholesale sales volume.  These increases were partially offset bylower retail sales volume, lower wholesale average rates and slightly decreasedancillary revenues associated with participation in a RTO.

Retail revenues increased $8.1 million in the secondquarter of 2006 compared to 2005, primarily resulting from $14.4 million inhigher average rates and $0.1 million of higher miscellaneous revenues, offsetby decreased sales volume of $6.4 million. The higher average rates were primarily the result of rate stabilizationplan increases, regulated asset recovery riders, and changes in the customermix of sales.  Wholesale revenueincreased $7.3 million, primarily related to a $10.2 million increase relatedto higher sales volume, offset by a $2.9 million decrease in average marketrates.  During the second quarter of2006, RTO ancillary revenues remained relatively flat, decreasing $0.1 millionto $17.4 million from $17.5 million in the second quarter 2005.  Heating degree-days were down 10% to 554 forthe second quarter of 2006 compared to 618 for the same period in 2005.  Cooling degree-days were down 26% to 206 forthe second quarter of 2006 compared to 278 for the same period in 2005.

Revenues increased 8% to $645.8 million in the first half of 2006compared to $596.5 million for 2005, reflecting higher average rates for retailrevenues, greater wholesale sales volume and increased ancillary revenuesassociated with participation in an RTO. These increases were partially offset by lower retail sales volume andlower wholesale average rates.

Retail revenues increased $24.6 million in the first half of 2006compared to the first half of 2005, primarily resulting from $35.2 million inhigher average rates and $0.4 million of higher miscellaneous revenues, offsetby decreased sales volume of $11.0 million. The higher average rates were primarily the result of rate stabilizationplan increases, regulated asset recovery riders, and a change in the customermix of sales.  Wholesale revenuesincreased $22.6 million, primarily related to a $28.6 million increase relatedto higher sales volume, offset by a $6.0 million decrease in average marketrates.  During the first half of 2006,RTO ancillary revenues increased $2.1 million to $35.1 million from $33.0million in the first half of 2005. Heating degree-days were down 13% to 3,068 for the first half of 2006compared to 3,515 for the same period in 2005.  Cooling degree-days were down 26% to 206 for the first half of 2006compared to 278 for the same period in 2005.

**GrossMargin, Fuel and Purchased Power**

Gross margin of $192.1 million in the second quarterof 2006 increased by $8.6 million from $183.5 million in the second quarter of2005.   As a percentage of totalrevenues, however, gross margin remained relatively stable, decreasing only 0.4percentage points to 62.6% from 63.0%. The dollar increase in gross margin was primarily the result of greaterrevenues, partially offset by increased fuel costs.  Fuel costs increased by $6.7 million or 10%in the three months ended June 30, 2006, as compared to the same period in2005, primarily resulting from higher market prices.  Purchased power costs remained flat in thesecond quarter of 2006 compared to 2005.

Gross margin of $421.7 million in the first half of2006 increased by $40.1 million from $381.6 million in the first half of2005.   As a percentage of totalrevenues, gross margin increased by 1.3 percentage points to 65.3% from64.0%.  This improvement is primarily theresult of increased revenues and a slight decline in purchase power costs,offset by increased fuel costs.  Fuelcosts rose by $12.9 million or 9% in the six months ended June 30, 2006,  as a result of higher market prices and highergeneration output as compared to 2005. Purchased power costs decreased by $3.7 million or 5% in the first halfof 2006 compared to prior year primarily resulting from lower purchased powervolume, offset slightly by increased average RTO ancillary charges.

**Operationand Maintenance Expense**

Operation and maintenance expense increased $9.0million or 18% in the second quarter of 2006 compared to the same period in2005, primarily resulting from $3.3 million in PJM administrative feesincluding $2.5 million deferred in 2005 by PUCO authority until rate relief wasgranted in February 2006; increased employee compensation and benefit expensesin the amount of $2.6 million, including group medical, pension, ESOP and stockoption compensation costs; a $2.0 million increase in power production costs primarilyrelated to increased operating expenses; and increased Low-Income Payment Programcosts of $0.8 million. These increases were partially offset by a $1.2 milliondecrease in mark-to-market adjustments for restricted stock units (RSUs).  

Operation and maintenance expense increased $14.4million or 14% of the first half of 2006 compared to prior year primarilyresulting from increased employee compensation and benefit expenses in theamount of $4.5 million, including group medical, pension, ESOP and stock optioncompensation costs; $2.8 million in PJM administrative fees including $2.5million deferred in 2005 by PUCO authority until rate relief was granted inFebruary 2006; a $2.5 million increase in power production costs related toincreased operating expenses; increased Low-Income Payment Program costs of$2.1 million; a $2.0 million increase in reserves for injuries and damages; andincreased service operations costs of $1.9 million primarily related to greaterline clearance activity. These increases were partially offset by a $1.1million decrease in Directors’ and Officers’ liability insurance costs and a$0.4 million decrease in mark-to-market adjustments for RSUs.

We have filed insurance claims for recovery of legalfees associated with the former executives litigation.  The amount and timing of any insurancerecovery cannot be determined.

**Depreciationand Amortization**

Depreciation and amortization increased $1.4 millionand $2.7 million in the second quarter and in the first half of 2006, respectively,compared to the same periods in 2005 primarily reflecting a higher amount ofproperty, plants and equipment.

**GeneralTaxes**

General taxes for the second quarter and the firsthalf of 2006 were relatively flat compared to prior year.

**Amortizationof Regulatory Assets, Net**

For the three months ended June 30, 2006 compared to the three monthsended June 30, 2005, amortization of regulatory assets, net increased $1.3million primarily reflecting $0.7 million for the amortization of costsincurred to modify the customer billing system for unbundled rates and electricchoice bills and $0.3 million for the amortization of PJM administrative feesdeferred for the period October 2004 through January 2006.

Amortization of regulatory assets, net increased $1.9 million for thesix months ended June 30, 2006 compared to the prior year primarily reflecting$1.0 million for the amortization of costs incurred to modify the customerbilling system to accommodate unbundled rates and electric choice bills and$0.5 million for the amortization of deferred PJM administrative fees.  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.  The customer billing costsrate rider is expected to be in place for five years and the PJM administrativefee rate rider is expected to continue for three years.

**InvestmentIncome**

Investment income increased $0.3 million during the secondquarter of 2006 compared to 2005 primarily due to increased interest incomeearned from cash on deposit.

Investment income increased $1.1 million during thefirst half of 2006 as compared to prior year primarily resulting from a $0.7million net gain on Master Trust investments (related to deferred compensation)and a $0.6 increase in interest income earned from cash on deposit.

## **Other Income (Deductions)**

Other income (deductions) for the second quarter ended June 30, 2006increased $3.4 million compared to the second quarter ended June 30, 2005primarily reflecting $2.3 million in reduced investment management fees and$0.7 million from an IRS refund of a prior year penalty.

Other income (deductions) for the six months endedJune 30, 2006 decreased $3.8 million compared to the same period in 2005.  This decrease is primarily attributable to a$12.3 million gain recognized on the sale of pollution control emissionallowances during the first half of 2005 (there were no such sales in 2006),partially offset by $7.0 million in reduced investment management fees, a $0.7million refund of a prior year IRS penalty and lower revolving credit facilityfees of $0.4 million.

## **Interest Expense**

Interest expense decreased $4.0 million or 43% for thethree months ended June 30, 2006 compared to the same period in 2005, primarilyrelating to $2.0 million of greater capitalized interest resulting fromincreased capital expenditures for pollution control equipment at thegenerating plants and $1.5 million of lower interest expense reflecting the2005 refinancing of pollution control bonds at reduced interest rates, theelimination of the interest penalty resulting from the delayed exchange offerof the $470 million 5.125% Series First Mortgage Bonds due 2013 that was completedduring the second quarter of 2005 and lowerdebt service charges

21

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associated with DPL Inc.’s early retirement ofESOP debt.

Interest expense decreased $8.6 million or 42% in thefirst half of 2006 compared to the first half of 2005, primarily relating to$4.3 million of increased capitalized interest resulting from higher pollutioncontrol capital expenditures at the generating plants and $3.6 million of lowerinterest expense reflecting the refinancing of pollution control bonds atreduced interest rates in 2005, lower debtservice charges associated with DPL Inc.’s early retirement of ESOP debt, andthe elimination of the interest penalty resulting from the delayed exchangeoffer of the $470 million 5.125% Series First Mortgage Bonds.  See Note 6 of Notes to Consolidated FinancialStatements.

## **Income Tax Expense**

Income taxes decreased $3.7 million for the secondquarter of 2006 compared to 2005 reflecting a decrease in the effective taxrate due primarily to the phase-out of the Ohio Franchise Tax and a decrease inthe tax reserve, partially offset by higher book income.

Income taxes increased $5.0 million for the first halfof 2006 compared to the first half of 2005 reflecting higher book income offsetin part by a decrease in the effective tax rate related to the phase-out of theOhio Franchise Tax and a decrease in the tax reserve.

**FINANCIAL CONDITION, LIQUIDITY AND CAPITALRESOURCES**

Our cash and cash equivalents totaled $21.7 million atJune 30, 2006, compared to $46.2 million at December 31, 2005, a decrease of$24.5 million. This decrease was attributed to $199.3 million in capitalexpenditures and $0.4 million in dividends paid on preferred stock, offset by$175.2 million in cash generated from operating activities.

We generated net cash from operating activities of$175.2 million and $162.9 million for the first half of 2006 and 2005,respectively. The net cash provided by operating activities in both years wasprimarily the result of operating profitability, and by cash provided bycertain assets and liabilities.  Thetariff-based revenue from our business continues to be the principal source ofcash from operating activities. Management believes that the diversified retail customer mix ofresidential, commercial, and industrial classes provides us with a reasonablypredictable cash flow from utility operations.

Net cash flows used for investing activities were$199.3 million in the first half of 2006 and $80.6 million in the first half of2005 to provide funding for capital expenditures.

Net cash flows used for financing activities were $0.4 million in thefirst half of 2006 compared to $75.8 million in the first half of 2005.  Net cash flows used for financing activitiesfor each of these periods were to pay dividends on preferred stock and, for 2005,to pay dividends on common stock to our parent company and to retire long-termdebt.

We have obligations tomake future payments for capital expenditures, debt agreements, leaseagreements and other long-term purchase obligations, and have certain othercontingent commitments.  We believe ourcash flows from operations, the credit facilities (existing or futurearrangements), 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**

Capitalexpenditures were $199.3 million and $80.6 million for the first half of 2006and 2005, respectively, and are expected to approximate an aggregate amount of$360 million in 2006.  Plannedconstruction additions for 2006 primarily relate to our environmentalcompliance program, power plant equipment, and our transmission anddistribution system.

Capital projects are subject to continuing review and are revised inlight of changes in financial and economic conditions, load forecasts,legislative and regulatory developments and changing environmental standards,among other factors.  Over the next threeyears, we are projecting to spend an estimated $810 million in capital projects(previously $745 million), approximately 55% of which is to meet changingenvironmental standards.

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Our ability to complete our capital projects and the reliability offuture service will be affected by our financial condition, the availability ofinternal and external funds at reasonable cost, and adequate and timely returnon these capital investments.  We expectto finance our construction additions in 2006 with a combination of cash andshort-term investments on hand, tax-exempt debt and internally-generated funds.

**Debt and Debt Covenants**

AtJune 30, 2006, our scheduled maturities of long-term debt, including capitallease obligations, over the next five years are $0.5 million for the remainderof 2006, $0.9 million in 2007, $0.7 million in 2008, $0.7 million in 2009and $0.6 million in 2010. Substantially all of our property is subject to the mortgage liensecuring the first mortgage bonds.  Debtmaturities in 2006 are expected to be financed with internal funds.  Certain debt agreements contain reporting andfinancial covenants for which we are in compliance as of June 30, 2006 andexpect to be in compliance during the near term.

Issuance of additionalamounts of first mortgage bonds is limited by the provisions of our mortgage;however, management believes that we continue to have sufficient capacity toissue first mortgage bonds to satisfy our requirements in connection with ourconstruction programs.  The amounts andtiming of future financings will depend upon market and other conditions, interestrate increases, levels of electric sales 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 June 30, 2006. Fees associated with this credit facility are approximately $0.2 millionper year.  Changes in credit ratings,however, may affect the applicable interest rate for our revolving creditagreement.

Duringthe first quarter of 2006, the Ohio Air Quality Development Authority (OAQDA)awarded us the ability to issue over the next three years up to $200 million ofqualified tax-exempt financing from the OAQDA’s 2005 volume capcarryforward.  The financing is expectedto be used to partially fund the ongoing FGD projects.  The PUCO approved our application for thisadditional financing on July 26, 2006.

On February 17, 2006, we renewed our $10 millionMaster Letter of Credit Agreement for one year with a financial lendinginstitution.  This agreement supportsperformance assurance needs in the ordinary course of business.  We have certain contractual agreements forthe sale and purchase of power, fuel and related energy services that containcredit rating related clauses allowing the counter parties to seek additionalsurety under certain conditions.  As ofJune 30, 2006, we had two outstanding letters of credit for a total of $2.2million.

There are no inter-company debt collateralizations ordebt guarantees between us and our parent. None of our debt obligations are guaranteed or secured by affiliates andno cross-collateralization exists between 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. (a) |       | BBB        |       | Positive    |       | August 2006   |       |

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*(a) Upgraded onAugust 1, 2006.

 

**Off-BalanceSheet Arrangements**

We do not have anyoff-balance sheet arrangements that have or are reasonably likely to have acurrent or future effect on our financial condition, revenues or expenses,results of operations, liquidity, capital expenditures or capital resourcesthat are material to investors.

**ContractualObligations and Commercial Commitments**

We enter into various contractual and other long-term obligations thatmay affect the liquidity of our operations. At June 30, 2006, these include:

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**Contractual Obligations**

|                                      | ** ** | ** ** | ** ** | **Payment Year**           | ** ** |
|--------------------------------------|------------|------------|------------|---------------------------------|------------|
| **$ in millions**          | ** ** | **Total**  | ** ** | **Less Than 1  Year** | ** ** | **2 - 3 Years** | ** ** | **4 - 5 Years** | ** ** | **More than  5 Years** | ** ** |
|                                 |       |       |       |                            |       |   |   |   |   |   |   |
| Long-term debt                       |       | $          | 683.2      |                            | $          | — |   | $ | — |   | $ | — |   | $ | 683.2 |   |
| Interest  payments                   |       | 446.7      |       | 34.3                            |       | 68.7 |   | 68.7 |   | 275.0 |   |
| Pension and  postretirement payments |       | 254.5      |       | 23.0                            |       | 46.6 |   | 47.7 |   | 137.2 |   |
| Capital leases                       |       | 3.4        |       | 1.0                             |       | 1.5 |   | 0.9 |   | — |   |
| Operating leases                     |       | 0.9        |       | 0.5                             |       | 0.4 |   | — |   | — |   |
| Fuel and  limestone contracts (a)    |       | 646.4      |       | 174.4                           |       | 287.4 |   | 97.5 |   | 87.1 |   |
| Other long-term  obligations         |       | 34.1       |       | 12.0                            |       | 14.8 |   | 7.3 |   | — |   |
| Total  contractual obligations       |       | $          | 2,069.2    |                            | $          | 245.2 |   | $ | 419.4 |   | $ | 222.1 |   | $ | 1,182.5 |   |

 

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(a) DP&Loperated units

 

Long-term debt:

Long-term debt as of June 30, 2006, consists of ourfirst 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 June 30, 2006, we had estimated future benefitpayments as outlined in Note 4 of Notes to Consolidated FinancialStatements.  These estimated futurebenefit payments are projected through 2016.

Capital leases:

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

Operating leases:

As of June 30, 2006, wehad 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 FGDs.  Coal contractprices are subject to periodic adjustment, and have features that limit priceescalation in any given year.

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

Other long-termobligations:

As of June 30, 2006, wehad various other contractual obligations including non-cancelable contracts topurchase goods and services with various terms and expiration dates.

We enter into various commercial commitments, whichmay affect the liquidity of our operations. At June 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 June 30, 2006, there were no borrowingsoutstanding under this credit agreement. The facility may be increased up to $150 million.

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Guarantee:

We own a 4.9% equityownership interest in an electric generation company.  As of June 30, 2006, we could be responsiblefor the repayment of 4.9%, or $21.8 million, of a $445 million debt obligationthat matures in 2026.

**MARKETRISK**

As a result of ouroperating, investing and financing activities, we are subject to certain marketrisks, including fluctuations in interest rates and changes in commodity pricesfor electricity, coal, environmental emissions and gas.  Commodity pricing exposure includes theimpacts of weather, market demand, potential coal supplier contract breaches ordefaults, 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.

**Commodity Pricing Risk**

Approximately 21% of our first half 2006 revenues werefrom sales of excess energy and capacity in the wholesale market.  Energy and capacity in excess of the needs ofexisting retail customers are sold in the wholesale market when we can identifyopportunities with positive margins.  Asof June 30, 2006, a hypothetical increase or decrease of 10% in annualwholesale revenues could result in approximately a $17 million increase ordecrease to net income, assuming no increases or decreases in fuel andpurchased power costs.

We have approximately 95% and 83% of the total expected coal volume neededfor 2006 and 2007, respectively, under contract.  The majority of our contracted coal ispurchased at fixed prices.  Somecontracts provide for periodic adjustment and some are priced based on marketindices.  Substantially all contractshave features that 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 generatingunits.  The utilization of SO2 allowances will depend uponactual sulfur content of the coal burned. Fuel costs are impacted by changes in volume and price and are driven bya number of variables including weather, reliability of coal deliveries,scheduled outages and generation plant mix.  Fuel costs are forecasted toincrease approximately 7% in 2006 compared to 2005 and are forecasted to beflat in 2007 compared to 2006. This is primarily due to a delay in plannedoutage for a co-owner plant from 2006 to 2007. This forecast assumes coalprices will increase approximately 10% in 2006 as compared to 2005 and remainflat in 2007 as compared to 2006.

Purchased power costs depend, in part, upon the timingand extent of planned and unplanned outages of our generating capacity.  We will purchase power on a discretionarybasis when wholesale market conditions provide opportunities to obtain power ata cost below our internal production costs. As of June 30, 2006, a hypotheticalincrease or decrease of 10% in annual fuel and purchased power costs, excludingRegional Transmission Organization (RTO) services, could result inapproximately a $25 million increase or decrease to net income.

We have entered into an agreement with Merrill LynchCommodities Inc. (MLCI) intended to expand our ability to manage our coalportfolio and long-term coal procurement strategy.  We will use MLCI’sanalytical, optimization, marketing, and risk control capabilities to enhanceour ability to manage our coal portfolio.  MLCI will assist us in thedevelopment of our future requirements, management of existing commitments, andthe overall management of coal issues.

**Interest Rate 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 andinvestments in cash equivalents that may be affected by interest ratefluctuations.  Our long-term debtrepresents publicly-held secured notes with fixed interest rates.  At June 30, 2006, we had no short-termborrowings.

The carrying value of ourdebt was $686.6 million at June 30, 2006, consisting of our first mortgagebonds, our tax-exempt pollution control bonds and our capital leases.  The fair value of this debt was $661.2million, 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 June 30, 2006 are as follows:

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|                            | ** ** | **Long-term Debt**       | ** ** |
|----------------------------|------------|-------------------------------|------------|
| **Expected Maturity** | ** ** | **Amount**                    | ** ** | ** ** | ** ** |
| **Date**                   | ** ** | **($ in millions)** | ** ** | **Average Rate** | ** ** |
|                       |       |                          |       |   |   |   |
| 2006                       |       | ** **                    | **$**      | **0.5** |   |   | 6.1 | % |   |
| 2007                       |       | ** **                    | **0.9**    |   |   | 6.2 | % |   |
| 2008                       |       | ** **                    | **0.7**    |   |   | 6.9 | % |   |
| 2009                       |       | ** **                    | **0.7**    |   |   | 6.9 | % |   |
| 2010                       |       | ** **                    | **0.6**    |   |   | 6.9 | % |   |
| Thereafter                 |       | ** **                    | **683.2**  |   |   | 5.0 | % |   |
| Total                      |       | ** **                    | **$**      | **686.6** |   |   | 5.0 | % |   |
|                       |       |                          |       |   |   |   |   |   |
| Fair Value                 |       | ** **                    | **$**      | **661.2** | ** ** | ** ** | ** ** |   |   |

 

Debt maturities in 2006 are expected to be financedwith internal funds.

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

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.

The preparation offinancial statements in conformity with GAAP requires us to make estimates andjudgments that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the financialstatements, and the revenue and expenses of the period reported.  Different estimates could have a materialeffect on our financial results.  Judgments and uncertainties affecting theapplication of these policies and estimates may result in materially differentamounts being reported under different conditions or circumstances.  Significant items subject to such estimatesand judgments include the carrying value of property, plant and equipment;unbilled revenues; the valuation of derivative instruments; valuationallowances for receivables and deferred income taxes; reserves recorded forincome tax exposures; litigation; regulatory proceedings and orders; and assetsand liabilities related to employee benefits. Actual results may differ from those estimates.  Refer to our 2005 Annual Report filed on Form10-K for a complete listing of our critical accounting policies and estimates.

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**THE DAYTON POWER AND LIGHT COMPANY**

**OPERATING STATISTICS**

 
| ** **                           | ** ** | **Three Months Ended** | ** **  | **Six Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|-------------|--------------------------------|------------|
| ** **                           | ** ** | **June 30,**                | ** **  | **June 30,**              | ** ** |
| ** **                           | ** ** | **2006**                         | ** **  | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                 |       |                             |        |                           |       |   |   |   |   |
| Sales (millions of kWh)              |       |                             |        |                           |       |   |   |   |   |
|                                 |       |                             |        |                           |       |   |   |   |   |
| Residential                          | ** ** | **1,039**                        |        | 1,101                          | ** ** | **2,507** |   | 2,636 |   |
| Commercial                           | ** ** | **938**                          |        | 966                            | ** ** | **1,831** |   | 1,851 |   |
| Industrial                           | ** ** | **1,097**                        |        | 1,097                          | ** ** | **2,085** |   | 2,107 |   |
| Other retail                         | ** ** | **351**                          |        | 366                            | ** ** | **689** |   | 697 |   |
| Other miscellaneous  revenues        | ** ** | **—**                       |        | —                         | ** ** | **—** |   | — |   |
| Total retail                         | ** ** | **3,425**                        |        | 3,530                          | ** ** | **7,112** |   | 7,291 |   |
|                                 |       |                             |        |                           |       |   |   |   |   |
| Wholesale                            | ** ** | **681**                          |        | 577                            | ** ** | **1,500** |   | 1,194 |   |
|                                 | ** ** | ** **                       |        |                           | ** ** | ** ** |   |   |   |
| Total sales                          | ** ** | **4,106**                        |        | 4,107                          | ** ** | **8,612** |   | 8,485 |   |
|                                 |       |                             |        |                           |       |   |   |   |   |
| Revenues ($ in  thousands)      |       |                             |        |                           |       |   |   |   |   |
|                                 |       |                             |        |                           |       |   |   |   |   |
| Residential                          | ** ** | **$**                            | **101,464** |                           | $          | 100,025 | ** ** | **$** | **232,095** |   | $ | 225,957 |   |
| Commercial                           | ** ** | **67,630**                       |        | 62,323                         | ** ** | **133,520** |   | 119,497 |   |
| Industrial                           | ** ** | **32,537**                       |        | 31,931                         | ** ** | **63,372** |   | 61,715 |   |
| Other retail                         | ** ** | **21,626**                       |        | 20,979                         | ** ** | **42,295** |   | 39,863 |   |
| Other miscellaneous  revenues        | ** ** | **2,427**                        |        | 2,283                          | ** ** | **5,411** |   | 5,065 |   |
| Total retail                         | ** ** | **225,684**                      |        | 217,541                        | ** ** | **476,693** |   | 452,097 |   |
|                                 |       |                             |        |                           |       |   |   |   |   |
| Wholesale                            | ** ** | **63,671**                       |        | 56,400                         | ** ** | **134,031** |   | 111,462 |   |
|                                 |       |                             |        |                           |       |   |   |   |   |
| RTO ancillary revenues               | ** ** | **17,339**                       |        | 17,451                         | ** ** | **35,043** |   | 32,952 |   |
|                                 | ** ** | ** **                       |        |                           | ** ** | ** ** |   |   |   |
| Total revenues                       | ** ** | **$**                            | **306,694** |                           | $          | 291,392 | ** ** | **$** | **645,767** |   | $ | 596,511 |   |
|                                 |       |                             |        |                           |       |   |   |   |   |
| Electric customers at  end of period | ** ** | **513,965**                      |        | 511,393                        | ** ** | **513,965** |   | 511,393 |   |

 

**Item3.  Quantitative and QualitativeDisclosures about Market Risk **

See the “Market Risk” section of Item 2.

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**Item4.  Controls and Procedures**

Our Chief Executive Officer (CEO) and Chief FinancialOfficer (CFO) are responsible for establishing and maintaining our disclosurecontrols and procedures.  These controlsand procedures were designed to ensure that material information relating to usand our subsidiaries is communicated to the CEO and CFO.  We evaluated these disclosure controls andprocedures as of the end of the period covered by this report with theparticipation of our CEO and CFO.  Basedon this evaluation, our CEO and CFO concluded that our disclosure controls andprocedures are effective (i) to ensure that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC’s rules and forms and (ii) to ensure that information required to bedisclosed by us in the reports that we submit under the Exchange Act isaccumulated and communicated to our management, including our principalexecutive and principal financial officers, or persons performing similarfunctions, as appropriate, to allow timely decisions regarding requireddisclosure.

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**PartII.  Other Information**

**Item 1. LegalProceedings**

In the normal course of business, the Company has beennamed a defendant in various legal actions, including arbitrations, classactions and other litigation. Certain of the legal actions include claims forsubstantial compensatory and/or punitive damages or claims for indeterminateamounts of damages. The Company is also involved in other reviews,investigations and proceedings by governmental and self-regulatoryorganizations regarding the Company’s business. Certain of the foregoing couldresult in adverse judgments, settlements, fines, penalties or other relief.

Because litigation is inherently unpredictable,particularly in cases where claimants seek substantial or indeterminate damagesor where investigations and proceedings are in the early stages, the Companycannot predict with certainty the loss or range of loss related to suchmatters, how such matters will be resolved, when they will be ultimatelyresolved, or what the eventual settlement, fine, penalty or other relief mightbe. Consequently, the Company cannot estimate losses or ranges of losses formatters where there is only a reasonable possibility that a loss may have beenincurred. Although the ultimate outcome of these matters cannot be ascertainedat this time, it is the opinion of management, that the resolution of theforegoing matters will not have a material adverse effect on the financialcondition of the Company, taken as a whole; such resolution may, however, havea material effect on the operating results in any future period, depending onthe level of income for such period.

We have provided reserves for such matters inaccordance with SFAS 5, “Accounting for Contingencies.” The ultimate resolutionmay differ from the amounts reserved.

Certain legal proceedings in which we are involved arediscussed in Note 14 to the consolidated financial statements and, Part I, Item3, of our Annual Report on Form 10-K for the fiscal year ended December 31,2005; and Note 8 to the consolidated financial statements and Part II, Item 1,included in our Form 10-Q for the quarterly period ended March 31, 2006. Thefollowing discussion is limited to recent developments concerning our legalproceedings and should be read in conjunction with those earlier reports.

Regarding our litigation with three former executivesof the Company, on July 24, 2006, the trial court set a new trial datecommencing April 30, 2007.

On June 24, 2004, the Internal Revenue Service (IRS)began an audit of tax years 1998 through 2003 and issued a series of datarequests to us including issues raised in the Memorandum.  The staff of the IRS requested that weprovide certain documents, including but not limited to, matters concerningexecutive/director deferred compensation plans, management stock incentiveplans and MVE financial statements.  OnSeptember 1, 2005, the IRS issued an audit report for tax years 1998 through2003 that showed proposed changes to our federal income tax liability for eachof those years.  The proposed changesresulted in a total tax deficiency, penalties and interest of approximately$23.9 million as of December 31, 2005. On November 4, 2005, we filed a written protest to one of the proposedchanges.  On April 3, 2006, the IRSconceded the proposed changes that we filed a written protest to and issued arevised audit report for tax years 1998 through 2003.  The revised audit report resulted in a totaltax deficiency, penalties and interest of approximately $1.2 million.  We had previously made a deposit with the IRSof approximately $1.3 million that we requested on April 14, 2006 be applied tooffset the $1.2 million tax deficiency, penalties and interest for tax years1998 through 2003.  The Joint Committeeon Taxation completed its review of the revised audit report for tax years 1998through 2003 and sent us a letter dated June 16, 2006 stating that it took noexception to the revised audit report.

In November 2005, AMP-Ohio, a wholesale supplier ofelectricity to its thirteen member municipalities, requested arbitration of itspower supply agreement with DP&L.  AMP-Ohio alleged it had a right toreceive certain capacity credits.  DP&L disagreed with this positionand agreed to arbitrate the dispute.  The arbitration was concluded in May2006, thus ending any potential negative exposure to our results of operations,cash flows and financial position.

On January 13, 2006, we filed a claim against one of ourinsurers, AEGIS, under a fiduciary policy to recoup legal fees associated withour litigation against three former executives. An arbitration of this matter is set to begin on August 4, 2006.  We cannot predict the timing or outcome ofthis arbitration.

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**Item 1A. Risk Factors**

A comprehensive listing of risk factors that weconsider to be the most significant to your decision to invest in us isprovided in our most recent Annual Report on Form 10-K and may be obtained asdiscussed on page 2, ‘Available Information.’ If any of these events occur, our business, financial position orresults 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 primarilyof carbon dioxide emissions, are presently unregulated.  Numerous bills have been introduced inCongress to regulate GHG emissions, but to date none have passed.  Future regulation of GHG emissions isuncertain.  However, such regulationwould 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.

In August of 2006, an electric supply contract withWright Patterson Air Force Base (WPAFB) is set to expire.  WPAFB represents approximately 1% of ourannual revenues.  At this time, WPAFBwill revert to our standard offer rate until such time as they choose tocontract with an alternative supplier. We are not anticipating a material impact on our results of operationsif they choose another supplier.

**Item 5.  Other Information**

On August 1, 2006, the Board of Directors of theCompany and DP&L amended the Employment Agreement dated as of May 18, 2006with James V. Mahoney to extend his employment with the Company and DP&L atthe pleasure of the Company and DP&L or until Mr. Mahoney providesfourteen (14) days written notice of his intent to terminate his employment.Except for the changes noted here, the Employment Agreement dated as of May 18,2006 remains in full force and effect.

**Item6.  Exhibits**
| 10.1   |   | Employment Agreement with James V. Mahoney, DPL Inc.  and The Dayton Power and Light Company, dated as of May 18, 2006 (Filed as  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 24,  2006, file #1-9052)         |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                          |
| 10.2   |   | Letter Agreement between Glenn E. Harder DPL Inc.  and the Dayton Power and Light Company dated as of June 20, 2006 (Filed as  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 21,  2006, file #1-9052)           |
|   |   |                                                                                                                                                                                                                                          |
| 10.3   |   | Participation Agreement dated as of June 30, 2006  between DPL Inc., The Dayton Power and Light Company and Frederick J. Boyle  (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on  July 3, 2006, File #1-9052) |
|   |   |                                                                                                                                                                                                                                          |
| 10.4   |   | Participation Agreement dated as of June 20, 2006  between DPL Inc., Dayton Power and Light Company and John J. Gillen (Filed as  Exhibit 10.2 to the Company’s Current Report on Form 8-K on July 3, 2006,  file #1-9052)               |
|   |   |                                                                                                                                                                                                                                          |
| 10.5   |   | Amendment of Employment Agreement dated as of July 31,  2006 between James V. Mahoney, DPL Inc. and The Dayton Power and Light  Company (Filed herewith as Exhibit 10.5)                                                                      |
|   |   |                                                                                                                                                                                                                                          |
| 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 the  Sarbanes-Oxley Act of 2002                                                                                                                                                                      |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|   | **THE  DAYTON POWER AND LIGHT COMPANY** |
|--------|-----------------------------------------|
|   | (Registrant)                            |
|   |                                    |

 
| Date:  | August  1, 2006 |   | /s/ James V. Mahoney                                                                             |
|--------|-----------------|--------|--------------------------------------------------------------------------------------------------|
|   |            |   | James V. Mahoney  President and Chief Executive Officer  (principal executive officer)           |
|   |            |   |                                                                                             |
|   |            |   |                                                                                             |
|   | August 1, 2006  |   | /s/ John  J. Gillen                                                                         |
|   |            |   | John J. Gillen  Senior Vice President and Chief Financial Officer  (principal financial officer) |
|   |            |   |                                                                                             |
|   |            |   |                                                                                             |
|   | August 1, 2006  |   | /s/ Frederick J.  Boyle                                                                          |
|   |            |   | Frederick J.  Boyle  Controller and Chief Accounting Officer                                     |
|   |            |   | (principal  accounting officer)                                                                  |

 

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