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Duquesne Light Co, et al. – ‘10-K’ for 12/31/06

On:  Thursday, 3/1/07, at 3:56pm ET   ·   For:  12/31/06   ·   Accession #:  1193125-7-44336   ·   File #s:  1-00956, 1-10290

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 3/01/07  Duquesne Light Co                 10-K       12/31/06   21:2.4M                                   RR Donnelley/FA
          Duquesne Light Holdings Inc

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report                                       HTML   1.74M 
 4: EX-10.15    Preformance Award                                   HTML     47K 
 2: EX-10.2     Pension Service Supplement Plan                     HTML     66K 
 5: EX-10.20    Directors' Compensation                             HTML     12K 
 6: EX-10.38    First Amendment to Membership Interest Purchase     HTML     19K 
                          Agreement                                              
 7: EX-10.39    Second Amendment to Membership Interest Purchase    HTML     27K 
                          Agreement                                              
 3: EX-10.6     Amendment to Severance Agreement                    HTML     16K 
 8: EX-12.1     Ratio of Earnings to Fixed Charges and Preferred    HTML     28K 
                          and Preference Stock                                   
 9: EX-12.2     Ratio of Earnings to Fixed Charges                  HTML     28K 
10: EX-21.1     Subsidiaries of Duquesne Light Holdings, Inc.       HTML     24K 
11: EX-23.1     Consent of Deloitte & Touche LLP                    HTML     12K 
12: EX-23.2     Consent of Deloitte & Touche                        HTML     11K 
13: EX-31.1     Section 302 Certification of the CEO - Duquesne     HTML     17K 
                          Light Holdings                                         
14: EX-31.2     Section 302 Certification of the CFO - Duquesne     HTML     17K 
                          Light Holdings                                         
15: EX-31.3     Section 302 Certification of the CEO - Duquesne     HTML     17K 
                          Light Company                                          
16: EX-31.4     Section 302 Certification of the CFO - Duquesne     HTML     17K 
                          Light Company                                          
17: EX-32.1     Section 906 Certification of the CEO - Duquesne     HTML     13K 
                          Light Holdings                                         
18: EX-32.2     Section 906 Certification of the CFO - Duquesne     HTML     13K 
                          Light Holdings                                         
19: EX-32.3     Section 906 Certification of the CEO - Duquesne     HTML     12K 
                          Light Company                                          
20: EX-32.4     Section 906 Certification of the CFO - Duquesne     HTML     13K 
                          Light Company                                          
21: EX-99.1     Additional Information Regarding Duquesne Light     HTML    165K 
                          Holdings, Inc.                                         

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the Fiscal Year Ended December 31, 2006

or

For the Transition Period From              to             

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Indicate by check mark if either registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Duquesne Light Holdings, Inc.    Yes  x    No  ¨

Duquesne Light Company    Yes  ¨    No  x

Indicate by check mark if either registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Duquesne Light Holdings, Inc.    Yes  ¨    No  x

Duquesne Light Company    Yes  ¨    No  x

Indicate by check mark whether each registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.

Duquesne Light Holdings, Inc.    Yes  x    No  ¨

Duquesne Light Company    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of each registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

Duquesne Light Holdings, Inc.    x

Duquesne Light Company    x

Indicate by check mark whether each registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one):

Duquesne Light Holdings, Inc.    Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨

Duquesne Light Company    Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

Indicate by check mark whether either registrant is a shell company (as defined in Rule 12b-2 of the Act).

Duquesne Light Holdings, Inc.    Yes  ¨    No  x

Duquesne Light Company    Yes  ¨    No  x

The aggregate market value of Duquesne Light Holdings, Inc. voting common stock held by non-affiliates as of June 30, 2006 (the last business day of its most recently completed second fiscal quarter) was $1,282,884,813 based on the New York Stock Exchange closing price of $16.44 per share on that date.

No common stock of Duquesne Light Company was held by non-affiliates as of the last business day of its most recently completed second fiscal quarter.

As of January 31, 2007, there were 87,795,792 shares of Duquesne Light Holdings, Inc.’s single class of common stock outstanding.

As of January 31, 2007, there were 10 shares of Duquesne Light Company’s single class of common stock outstanding, all held by Duquesne Light Holdings, Inc.

Table of Contents

TABLE OF CONTENTS

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GLOSSARY OF TERMS

COMPETITIVE TRANSITION CHARGE (CTC) – During the electric utility restructuring from the traditional Pennsylvania regulatory framework to customer choice, electric utilities have the opportunity to recover transition costs from customers through this usage-based charge. As of December 31, 2005, Duquesne Light has fully collected the CTC.

CUSTOMER CHOICE – The Pennsylvania Electricity Generation Customer Choice and Competition Act gives consumers the right to contract for electricity at market prices from PUC-approved electric generation suppliers.

DISTRIBUTION – Distribution is the flow of electricity from our substations to the ultimate customer (businesses and homes).

ENERGY COMMODITY CONTRACTS – Contracts for the purchase or sale of electric energy and capacity credits.

FEDERAL ENERGY REGULATORY COMMISSION (FERC) – The FERC is an independent five-member commission within the United States Department of Energy. Among its many responsibilities, the FERC sets rates and charges for the wholesale transportation and sale of electricity (i.e., transmission).

PENNSYLVANIA PUBLIC UTILITY COMMISSION (PUC) – The governmental body that regulates all utilities (electric, gas, telephone, water, etc.) that do business in Pennsylvania. In our case, the PUC regulates our distribution business.

PROVIDER OF LAST RESORT (POLR) – Under Customer Choice, the local distribution utility is required to provide electricity for customers who do not choose an alternative generation supplier, or whose supplier fails to deliver. (See Item 1, “Business,” for a description of our historical and current POLR arrangements.)

REGIONAL TRANSMISSION ORGANIZATION (RTO) – Organization formed by transmission-owning utilities to put transmission facilities within a region under common control. Duquesne Light is a member of PJM Interconnection, the RTO which coordinates the movement of electricity in all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia.

REGULATORY ASSETS – Ratemaking practices grant regulated utilities exclusive geographic franchises in exchange for the obligation to serve all customers. Under this system, certain prudently incurred costs are approved by the regulators for deferral and future recovery. These deferred costs are capitalized as regulatory assets by the regulated utility.

SEAMS ELIMINATION CHARGE ADJUSTMENT (SECA) – A transitional pricing mechanism put in place by the FERC through March 2006 in order to compensate transmission owners for the estimated revenue lost as a result of the elimination of the regional through and out rates (RTOR). SECA charges must be paid by load-serving entities, including Duquesne Light and Duquesne Light Energy on a current basis. The PUC granted a request by Duquesne Light to pass SECA charges through to its POLR customers, effective for service beginning August 26, 2005. As of December 31, 2006, Duquesne Light has fully collected its SECA charges.

SECTION 45K – Until January 1, 2006, Section 29 of the Internal Revenue Code provided tax credits through 2007 for the production and sale of non-conventional fuels, including solid synthetic fuels and landfill gas. On August 8, 2005, the Energy Policy Act of 2005 was signed into law. This new federal law contains key provisions affecting the electric power industry, including the redesignation of the Section 29 tax credit as a general business credit under Section 45K of the Code. The previous amount of Section 29 tax credits that we were allowed to claim in any calendar year through December 31, 2005, was limited by the amount of our regular federal income tax liability. Section 29 tax credit amounts allowed but not utilized are currently carried forward indefinitely as deferred alternative minimum tax credits. The redesignation of Section 29 tax credits as a Section 45K general business credit removes the regular federal income tax liability limit on synthetic fuel production and subjects the credits to a 20-year carry forward period.

TRANSITION COSTS – Transition costs are the net present value of a utility’s known or measurable costs related to electric generation that are recoverable through the CTC.

TRANSMISSION– Transmission is the flow of electricity from generating stations over high voltage lines to substations. The electricity then flows from the substations into our distribution network.

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PART I

CORPORATE STRUCTURE

Part I of this Annual Report on Form 10-K should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II, Item 7, and with the audited consolidated financial statements, set forth in Part II, Item 8.

This combined Annual Report on Form 10-K presents information on both Duquesne Light Holdings, Inc. (Holdings) and Duquesne Light Company (Duquesne Light). Information on Holdings and its subsidiaries (not including Duquesne Light and its subsidiaries) shall not be deemed to be included as part of Duquesne Light’s Annual Report on Form 10-K. Specifically, information on the Energy Solutions, Financial and Communications business segments, the “all other” category, and discontinued operations is not so included.

References in this report to “we,” “us” and “our” are to Holdings and its subsidiaries, collectively. References to “Notes” are to the notes to the consolidated financial statements set forth in Item 8.

Holdings is an energy services holding company formed in 1989 to serve as the holding company for Duquesne Light and to engage in unregulated energy and related businesses.

On July 5, 2006, we entered into the merger agreement with a consortium (the Macquarie Consortium) led by Macquarie Infrastructure Partners and Diversified Utility and Energy Trusts (DUET). Under the terms of the agreement, the Macquarie Consortium will acquire all of the outstanding common shares of Holdings for $20.00 per share in cash.

The Holdings Board of Directors and shareholders, and the Federal Energy Regulatory Commission (FERC) have approved the transaction, but it is subject to customary closing conditions, including the approval of the Pennsylvania Public Utility Commission (PUC). A merger agreement application was filed with the PUC in September 2006.

On February 9, 2007, Duquesne Light entered into a Joint Petition of Settlement among all parties resolving all issues in the merger agreement application. The settlement provides for rate benefits and protections to customers, corporate governance requirements, commitments to the community and service reliability protections. The settlement agreement has been submitted to the administrative law judge presiding over the merger application. Final effectiveness of the settlement is subject to (i) the administrative law judge’s review and recommendation and (ii) PUC review and approval. Both the judge and the PUC can accept, revise or reject the settlement, with the final determination being at the PUC’s discretion. Although Duquesne Light cannot predict the ultimate timing or outcome of these proceedings, we anticipate a timeline that will allow for a PUC decision during the second quarter of 2007.

The merger agreement contains termination rights for both Holdings and the Macquarie Consortium, and further provides that, upon termination of the merger agreement under specified circumstances, including (a) by Holdings accepting a proposal by another entity to acquire 50% or more of Holdings’ common stock and (b) Holdings’ board withdrawing or modifying its approval or recommendation of the merger, approving or recommending entering into an agreement with a party other than the Macquarie Consortium, Holdings may be required to pay the Macquarie Consortium a termination fee equal to $40 million in cash plus certain documented out-of-pocket expenses and fees incurred by the Macquarie Consortium not in excess of $10 million. The merger agreement defines “material adverse effect” as any material adverse effect on the business, assets, liabilities, properties, financial condition or results of operations of Holdings and its subsidiaries taken as a whole. If a material adverse effect occurs and is continuing at the time for closing the transaction, it could be a failure of a closing condition and/or a breach of one or more of Holdings’ representations and warranties. The Macquarie Consortium may be required to pay Holdings an amount equal to all documented out-of-pocket expenses incurred by Holdings not in excess of $10 million if the merger agreement is terminated due to a breach of the Macquarie Consortium’s representations, warranties and covenants. In addition, the Macquarie Consortium may be required to pay Holdings up to $70 million in the aggregate for damages resulting from willful and material breaches of the merger agreement by the Macquarie Consortium.

Under the terms of the merger agreement, all options (whether vested or unvested) to purchase our common stock outstanding at the time of the completion of the merger, including those held by executive officers and directors, will be cashed out by Holdings for an amount equal to the number of shares of Holdings common stock such options were convertible into immediately prior to the merger multiplied by the excess, if any, of $20.00 over the per share exercise price of such option, less any applicable withholding tax. In addition, all other equity-based grants (if not then vested) will vest immediately prior to the effective time at the target performance levels (if applicable) and will be eligible to receive the $20.00 per share merger consideration, less any applicable withholding taxes. The merger agreement also contains provisions that require Holdings not to increase its common stock dividend.

As compensation for services in connection with the merger, Holdings has agreed to pay Lehman Brothers a fee of $10 million, of which $2 million was paid upon

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public announcement of the transaction and $2 million upon stockholder approval of the sale, with the balance to be paid upon closing of the transaction. We have also agreed to reimburse Lehman Brothers for certain expenses incurred by Lehman Brothers and to indemnify Lehman Brothers and related parties against liabilities arising out of Lehman Brothers’ engagement and the rendering of its opinion.

The foregoing description of the merger agreement does not purport to be complete and is qualified in its entirety by reference to the merger agreement, which is included as an exhibit to a Form 8-K filed with the SEC on July 6, 2006.

Continuing Operations

Duquesne Light was formed in 1912 by the consolidation and merger of three constituent companies. Duquesne Light is an electric utility engaged in the supply (through its provider-of-last-resort service (POLR)), transmission and distribution of electric energy.

Under Pennsylvania ratemaking practice, electric utilities were granted exclusive geographic franchises to sell electricity, in exchange for making investments and incurring obligations to serve customers. Through the rate making process, these prudently incurred costs were recovered, along with a return on the investment, from customers. Additionally, certain operating costs were approved for deferral for future recovery from customers. As a result of this process, utilities had assets recorded on their balance sheets at above-market costs, creating transition costs. With the 1996 passage of the Pennsylvania Electricity Generation Customer Choice and Competition Act, electric generation was deregulated, allowing customers to purchase electricity at market prices from a variety of electric generation suppliers. Under the Competition Act, utilities are permitted to recover transition costs by collecting the competitive transition charge (CTC). Transmission and delivery of electricity remain regulated in substantially the same manner as under historical regulation.

In early 2000, Duquesne Light completed the divestiture of its generation assets, and applied the net sale proceeds to reduce transition costs, thus accelerating its CTC collection period for most customers. In conjunction with the sale of its generation assets, Duquesne Light entered into POLR I, a full requirements arrangement with an unrelated vendor, which provided Duquesne Light the necessary electricity to satisfy its POLR obligation during the CTC collection period. Although the CTC collection period ended during the third quarter of 2005, POLR I remains in place for a few industrial customers under special contracts. From January 2002 through December 2004, Duquesne Light operated under POLR II, which extended the full requirements arrangement to service customers from whom the CTC had already been fully collected. Unlike POLR I, which was income neutral, the POLR II arrangement permitted Duquesne Light to collect a margin on the energy supplied.

POLR III is Duquesne Light’s rate plan and related generation supply plan for the period which began January 1, 2005. Currently, most customers who do not choose an alternative generation supplier are served through POLR III. Under POLR III, residential and small commercial customers receive electric supply through December 31, 2007 at fixed rates approximately 11.5% above POLR II generation rates. For our large commercial and industrial customers, the current POLR III supply options are either a fixed price service based upon the results of a competitive request-for-proposal process (available through May 31, 2007), or an hourly price service that passes through real-time spot market electricity prices. Duquesne Light receives an adder as compensation for costs and risks involved in providing energy to these customers. Concurrently with the beginning of POLR III, Duquesne Light joined PJM Interconnection (PJM), as part of its commitment to ensuring reliability to its customers.

In November 2006, the PUC approved a distribution rate increase of $117 million in annual operating revenues, and an automatic pass-through for charges that Duquesne Light will pay for transmission services it purchases under tariffs regulated by the FERC. The rate increase was effective beginning in January 2007.

In September 2006, Duquesne Light filed a transmission rate case with the FERC requesting a rate increase of approximately $27 million related to transmission services that Duquesne Light and other suppliers in the Duquesne Light zone purchase under tariffs regulated by the FERC. An initial order was issued in February 2007, granting the requested increase, subject to refund, to be retroactively effective as of December 1, 2006.

In January 2007, Duquesne Light filed a petition with the PUC requesting approval of a plan that will supply a secure source of electricity for customers from 2008 through 2010 (POLR IV). Generation rates then would stay fixed through the end of 2010. The filing seeks approval of the petition by July 1, 2007, which will allow Duquesne Light time to communicate with customers and its supplier. We cannot predict the timing or outcome of the PUC’s review and approval process.

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See “Rate Matters” under Management’s Discussion and Analysis in Item 7 for more details regarding the above filings.

Duquesne Power, LLC, an unregulated subsidiary, maintains a portfolio of energy commodity contracts to supply energy to both (i) Duquesne Light’s residential, commercial and industrial POLR customers and (ii) Duquesne Light Energy, LLC’s (DLE) large commercial and industrial customers. These energy commodity contracts are with unrelated parties and include payment guarantees from Holdings.

DLE is an unregulated, competitive, retail electric generation supplier that offers customized solutions tailored to meet its customers’ specific electricity needs. DLE’s primary focus is on the large commercial and industrial customer market segment in Duquesne Light’s service territory.

Duquesne Generation Company owns minority interests in the coal-fired Keystone and Conemaugh power plants. It acquired a 2.47% interest in the Keystone plant and a 3.83% interest in the Conemaugh plant, plus related inventories, equipment and other property interests, on September 1, 2006 for an aggregate purchase price of approximately $177 million, which includes applicable closing costs and working capital adjustments.

Duquesne Energy Solutions, LLC (DES) is an energy facilities management company that provides energy outsourcing solutions including operation and maintenance of synthetic fuel and energy facilities.

DQE Financial Corp. is an investment and portfolio management organization focused on structured finance and alternative energy investments. DQE Financial previously owned and operated landfill gas collection and processing systems.

DQE Communications, Inc. owns, operates and maintains a high-speed, fiber optic based metropolitan network, and leases dark fiber from the network to commercial, industrial and academic customers.

Discontinued Operations

Effective December 29, 2006, DQE Financial sold its landfill gas business. Holdings has agreed to guarantee certain of DQE Financial’s obligations related to this transaction. During 2003, AquaSource, Inc. (formerly our water resource management subsidiary) completed the sale of its assets, pursuant to agreements entered into in 2002. We sold the propane distribution business of our subsidiary, Pro Am, Inc. in December 2002. See Note 18 for additional information regarding our discontinued operations.

Service Areas and Customer Concentrations

Duquesne Light’s electric utility operations provide service to approximately 587,000 direct customers in southwestern Pennsylvania (including in the City of Pittsburgh), a territory of approximately 800 square miles.

Our other business lines have operations and investments in several states and Canada. Our Canadian operations recognized revenue of $14.4 million, $9.4 million and $11.9 million in 2006, 2005 and 2004. Associated long-lived assets, excluding financial instruments, were zero, zero and $4.2 million as of December 31, 2006, 2005 and 2004. DES relies on a single customer, that owns several synthetic fuel facilities, for substantially all of its revenues and earnings.

Regulation

Holdings and Duquesne Light are subject to the accounting and reporting requirements of the Securities and Exchange Commission (SEC). Duquesne Light’s electricity delivery business is also subject to regulation by the PUC and the FERC with respect to rates for delivery of electric power, accounting and other matters. The power supply business is regulated by the FERC for wholesale power sales.

Business Segments

This information is set forth in Item 7 under “Results of Operations” and in Note 21 to the consolidated financial statements.

FORWARD-LOOKING STATE MENTS

We use forward-looking statements in this report. Statements that are not historical facts are forward-looking statements, and are based on beliefs and assumptions of our management, and on information currently available to management. Forward-looking statements include statements preceded by, followed by or using such words as “believe,” “expect,” “anticipate,” “plan,” “estimate” or similar expressions. Such statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events. Actual results may materially differ from those implied by forward-looking statements due to known and unknown risks and uncertainties, some of which are discussed in Item 7.

EMPLOYE ES

As of December 31, 2006, Holdings and its subsidiaries had approximately 1,500 employees. Duquesne Light is party to a labor contract with the

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International Brotherhood of Electrical Workers (IBEW), which represents 71% of Duquesne Light’s approximately 1,400 employees. Duquesne Light and the IBEW are parties to a collective bargaining agreement which was renegotiated in 2005 and expires in September 2010.

ENVIRONMENTAL MATTERS

Legacy Liabilities

In 1992, the Pennsylvania Department of Environmental Protection (DEP) issued Residual Waste Management Regulations governing the generation and management of non-hazardous residual waste, such as coal ash. Following the generation asset divestiture, Duquesne Light retained certain facilities which remain subject to these regulations. We have assessed our residual waste management sites, and the DEP has approved our compliance strategies. As of December 31, 2006, we expect the costs of compliance to be approximately $4 million with respect to sites we continue to own. These costs were recovered in the CTC.

Duquesne Light also owns the closed Warwick Mine, located along the Monongahela River in Greene County, Pennsylvania. This property had been used in the electricity supply business segment. Duquesne Light has been selling unused portions of the property and plans to continue to do so. As of December 31, 2006, Duquesne Light’s current estimated liability for closing the Warwick Mine, including final site reclamation, mine water treatment and certain health care liabilities, is approximately $34 million.

These amounts are combined and included in legacy liabilities on both Holdings and Duquesne Light’s consolidated balance sheets. Our operations are subject to environmental laws and regulation by federal, state and local authorities. Due to the inherent uncertainties surrounding the development of federal and state environmental and energy laws and regulations, we cannot determine the impact such laws may have on our existing and future facilities.

Discontinued Operations

AquaSource Inc.’s (formerly our water resource management subsidiary) former water and water-related operations were, and remain, subject to the Federal Safe Drinking Water Act, which provides for uniform minimum national water quality standards, as well as governmental authority to specify treatment processes to be used for drinking water. AquaSource’s former operations also were, and remain, subject to the Federal Clean Water Act, which regulates the discharge of pollutants into waterways. AquaSource is aware of various compliance issues at its former water and wastewater facilities attributable to the period of time during which it owned these facilities. AquaSource has agreed to indemnify the purchasers of these facilities for certain pre-closing environmental liabilities.

Prior to divesting its former operations, AquaSource entered into various consent agreements regarding certain environmental compliance matters. In connection with divesting its former operations, AquaSource assigned these consent agreements to the relevant purchasers. AquaSource has agreed to indemnify the purchasers of its former operations for certain pre-closing environmental liabilities.

As part of the transaction, we retained certain obligations related to the business that was sold to Aqua America, Inc., including responsibility for certain existing litigation matters as well as a 10-year indemnity for certain pre-closing environmental claims. We purchased an environmental liability policy to mitigate this indemnity.

We do not believe that any of AquaSource’s indemnity obligations described above will have a material effect on Holdings’ financial position, results of operations or cash flows.

OTHER

Recent Accounting Pronouncements

On January 1, 2007, we adopted the Financial Accounting Standards Board’s (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48). The Interpretation clarifies the accounting for uncertainty in income taxes recognized and stipulates a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on various other items. We are currently evaluating the overall impact of FIN 48 on both Holdings’ and Duquesne Light’s financial statements.

On January 1, 2007, we adopted FASB Staff Position No. 13-2 “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (FSP No. 13-2). As the December 2003 settlement with the Internal Revenue Service (IRS) regarding DQE Financial’s structured lease and other similar investments modified our tax benefits under these leases, this FSP requires recognition of the modified tax benefits from the inception of the leases. Upon adoption, we expect to record an after-tax, non-cash cumulative effect charge of approximately $85 million. After adopting this FSP, the amount of the cumulative effect charge initially recorded will be recognized as additional lease earnings over the remaining lives of these leases, which range from approximately 22 to 30 years (with

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early buy-out periods ranging from 6 to 17 years). Our current and future cash flows are unaffected by the adoption.

In September 2006, the FASB issued Statement of Financial Accounting Standards (No. 157), “Fair Value Measurements.” This statement defines fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This statement does not require any new fair value measurements. However, for some entities, the application of the statement will change current practice. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. This statement applies to both Holdings and Duquesne Light. We are currently evaluating the overall impact of this statement on both Holdings’ and Duquesne Light’s financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards (No. 159), “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.” This statement permits entities to choose to measure eligible items at fair value at specified election dates. This statement is effective for the first fiscal year that begins after November 15, 2007. This statement applies to both Holdings and Duquesne Light and we are currently evaluating the overall impact of this statement on both Holdings’ and Duquesne Light’s financial statements.

In September 2006, the Emerging Issues Task Force (EITF) ratified EITF Issue No. 06-5, “Accounting for the Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4.” This consensus reached in this issue requires policyholders of corporate-owned life insurance to consider additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the contract. This consensus is effective for fiscal years beginning after December 15, 2006. This statement applies to both Holdings and Duquesne Light and we are currently evaluating the overall impact of this statement on both Holdings’ and Duquesne Light’s financial statements.

Pending Litigation

See Item 3, “Legal Proceedings,” for a discussion of pending litigation.

Available Information

Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports for both Holdings and Duquesne Light are available free of charge through our website (www.duquesnelightholdings.com) when they become available on the SEC website.

EXECUTIVE OFF ICERS OF THE REGISTRANTS

Set forth below are the names, ages as of January 31, 2007, and positions during the past five years of the executive officers for Holdings and for Duquesne Light.

Ms. Hogel and Messrs. O’Brien, Kaplan, Fields and Schott are executive officers of both Holdings and Duquesne Light. Mr. Wilson is an executive officer only of Holdings.

Morgan K. O’Brien, age 46. At Holdings: President and Chief Executive Officer since September 2001.

At Duquesne Light: Director since June 1999. President and Chief Executive Officer since August 2003.

Maureen L. Hogel, age 46. At Holdings: Senior Vice President and Chief Legal & Administrative Officer since August 2003. Senior Vice President and Chief Administrative Officer from December 2002 to August 2003.

At Duquesne Light: Director since April 2003. Senior Vice President and Chief Legal & Administrative Officer since August 2003. Senior Vice President and Chief Administrative Officer from December 2002 to August 2003. Senior Vice President—Human Resources and Administration from October 2001 through November 2002.

Mark E. Kaplan, age 45. At Holdings: Senior Vice President and Chief Financial Officer since September 2005.

At Duquesne Light: Director, Senior Vice President and Chief Financial Officer since October 2005.

Previously: Managing Director of CLJ Consulting Group LLC (a management consulting firm) from 2004 until September 2005. From 1995 until 2004, served in various capacities with Weirton Steel Corporation, including as President and Chief Financial Officer, Senior Vice President - Finance and Administration, and Vice President and Controller. Also a director of WesMark Funds, an open-end, management investment company.

William F. Fields, age 56. At Holdings: Vice President and Treasurer since December 2002. At DQE Financial: Treasurer since December 2002. President from June 2001 to August 2004.

At Duquesne Light: Vice President and Treasurer since December 2002.

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Stevan R. Schott, age 43. At Holdings: Vice President—Finance since September 2005. Senior Vice President and Chief Financial Officer from August 2003 to September 2005. Vice President and Controller from October 2001 to August 2003.

At Duquesne Light: Director from April 2003 to October 2005. Vice President—Finance since October 2005. Senior Vice President and Chief Financial Officer from August 2003 to October 2005. Vice President and Controller from October 2001 to August 2003.

James E. Wilson, age 41. At Holdings: Vice President—Corporate Development since September 2005. Senior Vice President and Chief Strategic Officer from August 2003 to September 2005. Vice President—Corporate Development and Rates from December 2002 to August 2003. Vice President—Corporate Development from October 2001 to December 2002.

At Duquesne Light: Director from April 2003 to June 2004. Senior Vice President and Chief Strategic Officer from August 2003 to June 2004. Vice President—Corporate Development and Rates from December 2002 to July 2003. Vice President—Corporate Development from October 2001 to November 2002.

There are risks if we do not complete the proposed merger with the Macquarie Consortium.

If the merger is not completed for any reason, Holdings will remain an independent public company and the common stock will continue to be listed and traded on the New York Stock Exchange (NYSE). While we expect that management will operate the business in a manner similar to that in which it is being operated today, if the merger is not completed, Holdings may suffer negative financial ramifications, including the following:

There are risks associated with a successful consummation of the proposed merger with the Macquarie Consortium.

If we complete the merger, Holdings will be a more leveraged company.

Following a successful merger, it is likely that we will remove the Duquesne Light preferred stock and 6.7% public income notes from listing on the NYSE, which could affect the liquidity of any trading market for those securities. In addition, it is likely that we will deregister the preferred stock, the public income notes and all the remaining publicly held debt of Holdings and Duquesne Light, which means that neither Holdings nor Duquesne Light will continue to file the SEC-mandated disclosure reports (e.g., 10-Ks, 10-Qs and 8-Ks).

Individual employees may experience uncertainty about their post-merger roles. Issues relating to the uncertainty or a desire not to remain with Holdings and its affiliates after the merger may cause them to voluntarily leave for other career opportunities.

We are subject to substantial governmental regulation. If we receive unfavorable regulatory treatment, our business could be negatively affected.

Our transmission and distribution businesses are subject to regulation by various federal, state and local regulatory agencies that significantly affects our operations. The PUC regulates, among other things, the rates we can charge retail customers for the delivery of electricity. In addition, the FERC regulates, among other things, the rates that we can charge for electricity transmission. We cannot change transmission or delivery rates without approval by the applicable regulatory authority. While the approved transmission and delivery rates are intended to permit us to recover costs of service and earn a reasonable rate of return, there is no guarantee that the rates authorized by regulators will match our actual costs or provide a particular return on capital at any given time. Additionally, we are in the midst of a three-year, $500 million to $550 million capital expenditure program ending in 2007. While we will attempt to recover a portion of our capital expenditures by passing these costs along to our customers, there is a risk that governmental regulation of the rates we may charge to customers will prevent, hinder or delay our recovery of these capital expenditures.

The FERC also regulates the rates that other utilities charge to us for wholesale sales of electricity and can change the rates that other utilities charge for wholesale electricity sales. Since electric generation is now deregulated, we may not be able to recover increased costs associated with higher rates charged to us by electric generation suppliers.

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We also are required to have numerous permits, approvals and certificates from governmental agencies that regulate our business. We are unable to predict the impact of future regulatory activities of any of these agencies on our business.

The FERC also has authority to review mergers and acquisitions.

Changes in, or reinterpretations of, existing laws or regulations, or the imposition of new laws or regulations, may require us to change the way we conduct our operations or may result in substantial costs to us.

Shifting federal and state regulatory policies impose risks on our operations.

Our operations are subject to regulatory policies that are evolving as a result of various initiatives, including initiatives regarding the deregulation of the production and sale of electricity and changes in transmission regulation. Any new requirements arising from these actions could lead to increased operating expenses and capital expenditures, the amount of which cannot be predicted at this time.

Delays, discontinuations or reversals of electricity market restructurings in the markets in which we operate, or may operate in the future, could have a material adverse effect on our results of operations and financial condition. For instance, at this time the PUC has delayed the enactment of final rules that will apply to the default generation service to be provided by Duquesne Light after the expiration of its POLR III arrangements, which currently expire December 31, 2007. At a minimum, these types of actions raise uncertainty concerning the continued development of competitive power markets.

Our financial obligations under the Seams Elimination Charge Adjustment remain uncertain.

In addition to the regulatory risks described above, as a result of the FERC’s regulatory efforts to implement a new long-term rate design for public utilities in the Midwest and Mid-Atlantic regions, and specifically due to the FERC’s elimination of the regional through and out rates (RTOR) for certain transmission services between the Midwest Independent System Operator (MISO) and PJM, our transmission and distribution businesses may have costs shifted to them from other transmission owners. A transitional pricing mechanism called the seams elimination charge adjustment (SECA) was put in place through March 2006 in order to compensate transmission owners for the estimated revenue lost as a result of the elimination of RTOR. The allocation of SECA charges has not yet been fully resolved.

If the FERC ultimately adopts a SECA level and allocation method that differs from the proposed charges initially accepted by the FERC for billing purposes, refunds or surcharges will be used to compensate or charge the appropriate entity for the difference between the amounts initially accepted by the FERC and the amounts ultimately determined to be just and reasonable by the FERC. The final amount of our SECA obligations therefore remains uncertain.

Duquesne Light has recovered from its retail customers the total expected liability of SECA obligations and will refund, if applicable, any over-collection to customers once all SECA obligations are determined.

We are subject to risks associated with our POLR obligations.

Duquesne Light’s customers may choose to receive their electric energy from an alternative generation supplier. If they do not choose an alternative generation supplier, they will be served through Duquesne Light’s POLR arrangements. Customers who select an alternative generation supplier pay for generation charges set by that supplier, and pay Duquesne Light both transmission and distribution charges. In connection with these POLR transactions, Duquesne Light retains the risk that such customers will not pay for the POLR generation supply. Duquesne Light procures the energy and capacity needed to serve POLR III customers under a full-requirements contract with Duquesne Power. Failure or delay by Duquesne Power to provide the energy and capacity anticipated in the contract could require Duquesne Light to incur additional expenses to meet the needs of its POLR customers.

In addition, our proposed POLR IV arrangements, submitted to the PUC in January 2007, remain subject to PUC review and approval. We cannot predict the timing or outcome of the PUC’s review process.

We are subject to risks associated with procuring energy and capacity for Duquesne Light’s customers and DLE’s customers.

In addition to supplying the energy and capacity needs of Duquesne Light’s customers, Duquesne Power also supplies its affiliate DLE. Duquesne Power has entered into wholesale power purchase contracts. The net result of these transactions is that, as of December 31, 2006, Duquesne Power has secured a substantial portion of the combined expected load obligation for its full-requirements contracts with Duquesne Light through 2007.

Actual load may differ from expected load due to weather, customer switching, economic and other factors. If Duquesne Power did not have sufficient

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supplies, Duquesne Power would be required to procure the requirements in the energy markets. If market prices were higher than the rates to be paid by Duquesne Light to Duquesne Power under the full-requirements contracts, Duquesne Power could potentially be acquiring the energy or capacity at a loss, and any such losses could have a material adverse effect on our consolidated results of operations, financial position and cash flows. Likewise, if Duquesne Power has contracted for supplies in excess of its needs, Duquesne Power could potentially be selling energy or capacity at a loss, and any such losses could have a material adverse effect on our consolidated results of operations and financial condition. Duquesne Power’s energy commodity contracts contain provisions designed to provide security for potential losses by requiring that Duquesne Power post collateral depending on changes in energy or capacity prices. Because Holdings guarantees many of these contracts, any such collateral postings would reduce cash and/or the availability under Holdings’ credit facility.

Wholesale power secured under long-term contracts for 2008, 2009 and 2010 may not be permitted to be used to satisfy Duquesne Light’s POLR obligation.

Duquesne Power has secured a significant amount of power under long-term forward contracts for delivery in 2008, 2009 and 2010. Duquesne Light has not received approval from the PUC on its POLR IV plans. Should the PUC not permit an extension of Duquesne Light’s current relationship with Duquesne Power, Duquesne Power will be left with power it would have to sell to another wholesale customer or sell into the spot market at then-current market prices. As discussed above, Duquesne Power could potentially be selling energy at a loss (which could have a material adverse effect on our consolidated results of operations, financial position and cash flows), and Duquesne Power could be required to post collateral depending on changes in prices (which could impact Holdings’ credit facility availability due to its guarantees of these contracts).

In February 2007, the PUC issued an advanced notice of proposed rulemaking that, if made final, would impact the procedures that electric distribution companies such as Duquesne Light must follow in securing generation suppliers for POLR customers. As currently written, the proposal would require Duquesne Light to select a supplier through an auction or request for proposal process, impacting the POLR IV plan to use Duquesne Power as the supplier.

Our interests in the Keystone and Conemaugh power plants subject us to certain risks.

The ownership of interests in power plants involves numerous risks, including:

Any of these factors could give rise to lost revenues and/or increased expenses and/or capital expenditures. In addition, the financial results from our investment in the Keystone and Conemaugh power plants will depend on:

Events or circumstances that adversely affect our financial position could result in defaults under our credit agreements.

Holdings and Duquesne Light are subject to financial covenants contained in their respective credit agreements. For instance, our credit agreement requires us to maintain at all times a ratio of consolidated debt to consolidated capital of not more than 0.65 to 1.0 and an interest coverage ratio, with respect to each twelve-month period ending on the last day of each fiscal quarter, of at least 2.0 to 1.0. Duquesne Light’s credit agreement requires Duquesne Light to maintain at all times a ratio of indebtedness to total capitalization of not more than 0.65 to 1.0. As of December 31, 2006 we were in compliance with those covenants. However, any events or circumstances (including any charges to earnings) which have an effect, directly or indirectly, of reducing our common equity, increasing our indebtedness or reducing interest coverage, in relative terms, could result in non-compliance with these covenants. If we default under our credit agreements, our lenders could elect to declare all amounts borrowed to be immediately due and payable, together with accrued and unpaid interest; and/or terminate their commitments, if any, to make further extensions of credit. Both credit agreements include cross-default provisions that would be triggered if the borrower or any of its subsidiaries defaults on any payment due under any indebtedness exceeding $50 million.

The cost of compliance with environmental laws is significant. The costs of compliance with new environmental laws and the incurrence of environmental liabilities could adversely affect our cash flow and profitability.

The operations of our subsidiaries are subject to extensive federal, state and local environmental statutes, rules and regulations relating to air quality, water quality, waste management, natural resources, site remediation, and health and safety. These statutes, rules and regulations require us to commit significant resources and funds to, among other things,

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conduct site remediation and perform environmental monitoring. We also may be required to pay significant remediation costs with respect to third party sites in connection with previously divested assets. If we fail to comply with applicable environmental statutes, rules and regulations, even if caused by factors beyond our control, such failure could result in the assessment of civil or criminal penalties and liabilities and the need to expend significant sums to come into compliance. Alleged violations of environmental laws and regulations may require us to expend significant resources defending ourselves against these claims.

New environmental statutes, rules and regulations, or amendments to or new interpretations of existing statutes, rules and regulations, could impose additional or more stringent limitations on our operations or require us to incur significant additional costs. Our current compliance strategy may not successfully address the relevant standards and interpretations of the future.

Our operating results fluctuate on a seasonal basis and can be adversely affected by changes in weather.

Our electric utility business is sensitive to variations in weather conditions and significant variations from normal weather patterns can have a material impact on our operating performance. Historically, demand for electricity is generally greater in the summer months associated with cooling compared to other times of the year. Accordingly, we have generated less revenues and income when weather conditions are cooler than usual in the summer.

Severe weather, such as tornadoes, hurricanes, storms, ice and droughts, may cause outages and property damage which may require us to incur additional costs that may not be insured and that may not be recoverable from customers.

We may be adversely affected by economic conditions.

Periods of slowed economic activity generally result in decreased demand for power, particularly as industrial customers reduce production during such economic downturns, resulting in less consumption of electricity. Additionally, a general downturn in overall economic conditions may result in an increased number of bankruptcy filings by our customers, which would restrict our ability to collect revenue from these customers. As a consequence, recessions or other downturns in the economy may result in decreased revenues and cash flows for us.

Our insurance coverage may not be sufficient to cover all casualty losses that we might incur.

We currently have insurance coverage for our facilities and operations in amounts and with deductibles that we consider appropriate. However, there is no assurance that such insurance coverage will be available in the future on commercially reasonable terms. In addition, some risks, such as weather-related casualties, may not be insurable. In the case of loss or damage to property, plant or equipment, there is no assurance that the insurance proceeds, if any, received by us will be sufficient to cover the entire cost of replacement or repair.

Changes in PJM market policies and rules may impact our financial results.

Substantially all of our generation assets and power supply obligations are located within the PJM region. Any changes in PJM policies or market rules, including changes that are currently under consideration by FERC, could adversely affect our financial results.

Our transmission facilities are interconnected with the facilities of other transmission facility owners whose actions may have a negative impact on our operations.

Our transmission facilities are directly interconnected with the transmission facilities of contiguous utilities and as such are part of an interstate power transmission grid. The FERC has approved certain Regional Transmission Organizations (RTOs) that coordinate and have operational control of portions of the interstate transmission grid. PJM and the other regional transmission operators have established sophisticated systems that are designed to ensure the reliability of the operation of transmission facilities and prevent the operations of one utility from having an adverse impact on the operations of the other utilities. The systems put in place by PJM and the other RTOs may not, however, always be adequate to prevent problems at other utilities from causing service interruptions in our transmission facilities. If we were to suffer such a service interruption due to an unexpected or uncontrollable event occurring on the system of another utility, it could have a negative impact on our business.

Physical limitations in the electricity transmission system may give rise to increases in electric transmission congestion charges.

Energy pricing within PJM includes the costs or benefits of transmission congestion experienced at each location within the region. This is known as locational marginal pricing (LMP). LMP recognizes that the marginal price of electricity may be different at

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varying locations on the system and at different times. Differences in prices between two locations in the region at the same time reflect physical limitations in the transmission lines used to move power across the system. These physical limitations may give rise to increases in electric transmission congestion charges.

We are dependent on our ability to cost-effectively access capital markets. Our inability to obtain capital on acceptable terms may adversely affect our business. A reduction in our credit ratings could increase our borrowing costs.

We rely on access to both short-term debt markets and longer-term capital markets as a source of liquidity and to satisfy our capital requirements in excess of cash flow from our operations. Any inability to maintain our current credit ratings could affect, especially during times of uncertainty in the capital markets, our ability to raise capital on favorable terms that, in turn, could impact our ability to manage our business. Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch Ratings periodically assign credit ratings on our debt and preferred securities. We raise capital primarily by issuing senior-unsecured debt (currently rated Baa3, BBB- and BBB-, respectively) and bank borrowings. Duquesne Light raises capital primarily by issuing first mortgage bonds (currently rated Baa1, BBB+ and BBB, respectively), preferred stock (currently rated Ba1, BB+ and BBB-, respectively), senior-unsecured debt (currently rated Baa2, BBB- and BBB-, respectively) and bank borrowings. Any downgrades in these ratings could have a negative impact on our liquidity, our access to capital markets, our costs of financing and could increase the amount of collateral required by energy-contract counterparties. Capital market disruptions could also adversely affect our ability to access one or more financial markets.

In connection with the announcement of the merger, Standard & Poor’s placed us on CreditWatch with negative implications, and Moody’s placed us under review for possible downgrade.

A rating is not a recommendation to buy, sell or hold the notes, inasmuch as such rating does not comment as to market price or suitability for a particular investor. The ratings assigned to the notes address the likelihood of payment of principal and interest on the notes pursuant to their terms. A rating may be subject to revision or withdrawal at any time by the assigning rating agency. Each rating should be evaluated independently of any other rating that may be assigned to our securities.

We may have difficulty retaining our aging utility workforce or finding skilled personnel to replace them.

Workforce demographic issues are a national phenomenon that is of particular concern to the electric utility industry. The median age of utility workers is significantly higher than the national average. Currently, nearly one-half of the utility workforce is age 45 or higher. As of December 31, 2006, the median age of utility workers at Duquesne Light was 51.86. Consequently, the utility industry generally faces, and we specifically face, the difficult challenge of finding ways to retain our aging skilled workforce while recruiting new talent in the hopes of decreasing losses in critical knowledge and skills due to retirements. Mitigating these risks may require additional financial commitments.

Labor disputes may have a material adverse effect on our operations and profitability.

As of December 31, 2006, we, together with our various subsidiaries, had approximately 1,500 employees. Of this total, approximately 1,400 were employed by Duquesne Light. We collectively bargain with a labor union that represents approximately 71% of these Duquesne Light employees. When the current collective bargaining agreement expires September 30, 2010, failure to reach an agreement could result in strikes or other labor protests that could disrupt our operations. In addition, the collective bargaining agreement for employees at the Keystone and Conemaugh power plants expires in September 2007. If we were to experience a strike or work stoppage, it would be difficult for us to find a sufficient number of employees with the necessary skills to replace these employees. We cannot assure you that we will reach any such agreement or that we will not encounter strikes or other types of conflicts with the labor union of our personnel. Such labor disputes could have an adverse effect on our business, financial condition or results of operations, could cause us to lose revenues and customers and might have permanent effects on our business.

Our revenues and results of operations are subject to other risks beyond our control, including, but not limited to, accidents, storms, natural catastrophes and terrorism.

The lost revenues and cost of repairing damage to our facilities due to storms, natural disasters, wars,

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terrorist acts and other catastrophic events may exceed reserves and/or insurance coverage established for repairs necessitated by such events, which may adversely impact our results of operations and financial condition. We cannot assure you that our facilities will not face damage or disruptions from these or other events. In addition, in the current geopolitical climate, enhanced concern regarding the risks of terrorism throughout the economy may impact our operations in unpredictable ways. Insurance coverage may not cover risks of this nature adequately or at all.

Changes in financial or regulatory accounting principles or policies could affect our future earnings or cash flows.

See Item 1, “Recent Accounting Standards,” for further discussion.

We may experience a significant reduction in our earnings as a result of the December 31, 2007 expiration or the earlier phase-out of certain tax credits related to our synthetic fuel projects.

In addition to operating five synthetic fuel plants owned by an unrelated third party, we also hold a limited partnership interest in an entity that owns and operates plants that produce and sell synthetic fuel. These synthetic fuel projects are important contributors to our earnings.

Section 45K tax credits are set to expire on December 31, 2007. Once such tax credits expire we do not believe that there will be a market for the sale of the synthetic fuel.

Section 45K tax credits are subject to a phase-out provision that reduces or eliminates the tax credits when the average annual wellhead price per barrel of domestic crude oil increases into an inflation-adjusted phase-out range. The IRS publishes the phase-out range in April for the previous year. We estimate that for 2006 the tax credits would have begun to phase out when the annual average wellhead price of domestic crude oil exceeded approximately $55 per barrel and would have completely phased out if that price exceeded approximately $69 per barrel. For 2006, the estimated average wellhead price was approximately $60 per barrel. The wellhead price per barrel of domestic crude oil in recent years has averaged approximately 90% of the New York Mercantile Exchange price per barrel of domestic crude oil. We cannot predict the phase-out range for 2007.

If 2007 domestic crude oil prices mimic the high level of 2006, the annual tax credits to be generated from DQE Financial’s investment in a synthetic fuel partnership, as well as DES’ annual after-tax earnings from its synthetic fuel facilities management contract, may be substantially reduced or eliminated.

The level of our indebtedness could adversely affect our business.

At December 31, 2006, Holdings had total indebtedness of approximately $1.2 billion (including approximately $700 million at Duquesne Light), which could have important consequences. For example, it could:

Any of these consequences could have a material adverse effect on our ability to satisfy our indebtedness. The indenture under which Duquesne Light’s first mortgage bonds are issued permits Duquesne Light to issue additional first mortgage bonds from time to time if certain financial requirements are satisfied. The terms of our credit agreements also do not prohibit us or our subsidiaries from incurring additional indebtedness. As of December 31, 2006, approximately $220 million of unused commitments remain under Holdings’ credit agreements (including approximately $80 million at Duquesne Light), and our credit agreements would permit additional borrowings. If new debt is added to our and our subsidiaries’ current debt levels, the leverage-related risks described above could intensify.

Our ability to pay dividends or service indebtedness is largely dependent upon the earnings of our subsidiaries and the distribution of such earnings to us.

We are a holding company, and substantially all of the assets shown on our consolidated balance sheets are held by subsidiaries. Our operating cash flow and our ability to service our indebtedness depend on the operating cash flow of our subsidiaries and the payment of funds by them to us in the form of dividends or advances. Our indebtedness is not guaranteed by our subsidiaries and our subsidiaries are separate and distinct legal entities. We hold no assets and have no sources of revenue other than the

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ownership interests in our subsidiaries and the right to any dividends thereon and the right to receive payments on any existing or future loans made to our subsidiaries.

Our subsidiaries are separate and distinct legal entities and have no obligation to make payments on their common stock, or to make any funds available for such payment. Our subsidiaries’ ability to make dividend payments or other distributions to us may be restricted by their obligations to holders of their outstanding debt, their other creditors and holders of their preferred and preference stock, and the availability of earnings and the needs of their businesses. For instance, no dividends or distributions may be made on Duquesne Light’s common stock if it has not paid dividends on its preferred or preference stock. Dividends on Duquesne Light stock may also be effectively limited by the terms of certain financing arrangements. Further, under Duquesne Light’s articles of incorporation, the aggregate amount of common stock dividend payments or distributions may not exceed certain percentages of net income, if the ratio of total common shareholder’s equity to total capitalization is less than specified percentages. No part of Duquesne Light’s retained earnings was restricted at December 31, 2006.

In addition, as discussed above, Duquesne Light is regulated by the PUC, which generally possesses broad powers to ensure that the needs of the utility customers are being met. To the extent that the PUC attempts to impose restrictions on the ability of Duquesne Light to pay dividends to us, it could adversely affect our ability to make payments on our indebtedness or otherwise meet our financial obligations.

In the event of a bankruptcy, liquidation, winding-up, dissolution, receivership, insolvency, reorganization, administration or similar proceeding relating to one of our subsidiaries, holders of such subsidiaries’ indebtedness, trade creditors of such subsidiaries and holders of such subsidiaries’ preferred and/or preference stock will generally be entitled to payment of their claim from the assets of those subsidiaries before assets are made available for distribution to us.

We cannot assure investors that future dividend payments will be made, or if made, in what amounts they may be paid.

Our Board of Directors regularly evaluates our common stock dividend policy and sets the amount each quarter. The level of dividends will continue to be influenced by many factors, including, among other things, our earnings, financial condition and cash flows from subsidiaries, as well as general economic and competitive conditions. We cannot assure investors that dividends will be paid in the future, or that, if paid, dividends will be at the same amount or with the same frequency as in the past.

Because Duquesne Light is a wholly owned subsidiary of Holdings, Holdings can exercise substantial control over its dividend policy and business and operations.

All of the members of Duquesne Light’s board of directors and its executive officers are also officers of Holdings. Among other decisions, the Duquesne Light board is responsible for decisions regarding financing and capital raising activities, and acquisition and disposition of assets. Within the limitations of applicable law, Duquesne Light’s articles of incorporation and subject to the covenants under its outstanding debt instruments, the Duquesne Light board of directors will base its business decisions on its earnings, cash flow and capital structure, but may also take into account the business plans and financial requirements of Holdings and its other subsidiaries.

Not applicable.

Our principal properties consist of Duquesne Light’s facilities for both transmitting and distributing electricity, and supplemental properties and appurtenances, located substantially in Allegheny and Beaver counties in southwestern Pennsylvania. Substantially all of the electric utility properties are subject to a lien under the Indenture of Mortgage and Deed of Trust dated as of April 1, 1992.

Duquesne Light owns 123 transmission substations (12 of which are located on customer-owned land) and 478 distribution substations, of which over 65% are located on customer-owned land and are used to service that customer. They also own 26 substations that are comprised of both transmission and distribution assets (four are on customer-owned land). Duquesne Light has 672 circuit-miles of transmission lines, comprised of 345,000, 138,000 and 69,000 volt lines. Street lighting and distribution circuits of 23,000 volts and less include approximately 16,420 circuit-miles of lines and cable. These properties are used in the electricity delivery business segment.

Duquesne Generation owns undivided interests in two coal-fired power plants located in Armstrong and Indiana counties in Pennsylvania.

Our total investment in property, plant and equipment (PP&E) and the related accumulated depreciation balances for major classes of property are as follows:

Holdings PP&E and Related Accumulated Depreciation

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Duquesne Light electric plant includes: (1) distribution poles and equipment; (2) lower voltage distribution wires used in delivering electricity to customers; (3) substations and transformers; (4) high voltage transmission wires used in delivering electricity to substations; (5) meters and automated meter reading assets; and (6) internal telecommunication equipment, vehicles and office equipment, primarily used in our electricity delivery business segment. The jointly owned plants’ primary physical assets that are used in the electricity supply segment consist of boilers, turbines, and the supporting structures (including emissions treatment facilities.) The fiber optic network owned by DQE Communications is reported in our Communications business segment. The other energy facilities equipment is used in our Energy Solutions business segment. The other PP&E is comprised of office furniture and fixtures.

On March 17, 2006, our then-subsidiary Monmouth Energy Inc. (Monmouth) received a notice of violation (dated March 10, 2006) and penalty assessment in the amount of $480,000 from the New Jersey Department of Environmental Protection (NJDEP) relating to Monmouth’s landfill gas turbine operation located at the Monmouth County Landfill in Monmouth, New Jersey. The notice of violation alleges non-compliance with the maximum allowable carbon monoxide steady state emission limitation for each of the two turbines operated at the facility during 2003 and 2004. The permit for the facility provides both a maximum emission limitation and a steady state emission limit. Steady state represents 90% of the facility’s rated capacity. The facility has always operated in compliance with the maximum emission limitation, but has not achieved the steady state emission limitation when the facility operates at less than steady state. We believe that the NJDEP is attempting to incorrectly impose the steady state emission limitation during non-steady state conditions, as opposed to the maximum emission limitation which is the only other emission limit in the operating permit that could be applicable.

Monmouth has timely filed a notice of appeal challenging the bases for the alleged violations and the penalty assessment. Pending agreement on a permit modification clearly addressing less than steady state operations (discussed below) Monmouth had also voluntarily constrained its operations to substantially comply with the steady state permit limit at all times. During that time Monmouth engaged in technical discussions with the NJDEP aimed at demonstrating the need for clarification under the permit to account for non-steady state operating conditions, and filed a permit modification request to address this issue. These technical discussions were successful and in December 2006 an acceptable modification to the permit was issued by NJDEP. It appears that, at all times, operations have been consistent and in compliance with the emission limitations that NJDEP in the permit modification has now recognized as being appropriate for this operation. In addition, the right to additional landfill gas supplies associated with the active portions of the landfill has been secured alleviating the gas quality and quantity degradation issues that led to the notice of violation. Although Monmouth was sold with the landfill gas business, we have retained the liabilities regarding this issue. We believe that we have credible defenses to the alleged violations and that the penalty assessment is excessive given all of the circumstances. We will vigorously defend our position in the event it is not possible to reach an acceptable resolution of all issues.

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We are involved in various other routine legal proceedings and environmental matters. We believe that the resolution of such proceedings and matters, in total, will not have a materially adverse effect on our financial position, results of operations or cash flows.

On December 5, 2006, we held a Special Meeting of Stockholders, at which the stockholders voted on the proposed merger with the Macquarie Consortium. We solicited proxies pursuant to Regulation 14 under the Securities and Exchange Act of 1934, as amended. The merger approval was the sole proposal submitted for stockholder vote. The vote on this proposal was as follows:

Pursuant to a written consent of the sole stockholder dated July 24, 2006, the following individuals (all of whom are employees) were elected as the full board of directors of Duquesne Light: Morgan K. O’Brien, Joseph G. Belechak, Maureen L. Hogel and Mark E. Kaplan. Mr. Belechak is no longer a director, as his employment was terminated in January 2007. All 10 outstanding shares of Duquesne Light common stock were voted in favor of each individual.

PART II

Information relating to the market price for Holdings common stock is set forth in Note 22 to the consolidated financial statements hereto, and incorporated herein by reference.

Holdings has continuously paid dividends on its common stock since 1953. Dividends of $0.25 per share were declared and paid quarterly for the last two years. At January 31, 2007 there were approximately 42,000 holders of record of our common stock. Holdings common stock is listed and traded on the New York, Philadelphia and Chicago Stock Exchanges.

Duquesne Light common stock is not publicly traded; Holdings owns all 10 shares outstanding. No quarterly common dividends were declared in 2006 and $13 million were declared in 2005. Duquesne Light paid common stock dividends of zero, $20 million and $71 million in 2006, 2005 and 2004. During 2005 Duquesne Light embarked on a significant capital expenditure program, and therefore has been retaining more of its earnings than in prior years.

We have no program regarding the repurchase of Holdings common stock. However, we repurchase shares in connection with the issuance of so-called “stock swap exercises” of employee stock options or restricted stock in which shares are surrendered or deemed surrendered to Holdings to pay the exercise price and/or to satisfy tax withholding obligations. The following table presents information with respect to such repurchases that occurred during the quarter ended December 31, 2006.

For information regarding equity compensation plans, see Item 12.

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Unless otherwise stated, the terms “earnings” and “loss” used in this Item 7 refer to after-tax amounts.

OVERVIEW OF BUSINESS SE GMENTS

Duquesne Light reports the following business segments: (1) transmission and distribution of electricity (electricity delivery business segment) and (2) supply of electricity by Duquesne Light, which is our POLR business, and, in 2005, included Duquesne Power (Duquesne Light supply business segment).

Holdings reports the following business segments: (1) transmission and distribution of electricity (electricity delivery business segment), (2) supply of electricity, which includes Duquesne Light’s supply segment, DLE, Duquesne Power and, beginning September 1, 2006, the results from the Keystone and Conemaugh power plants (electricity supply business segment), (3) DES’ operation and

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maintenance of energy facilities and, for a single customer, synthetic fuel facilities (Energy Solutions business segment), (4) DQE Financial’s management of structured finance and alternative energy investments (Financial business segment), and (5) DQE Communications’ operation, maintenance and leasing of its fiber optic based network (Communications business segment). We also report an “all other” category to include our other subsidiaries below the quantitative threshold for disclosure. These subsidiaries provide corporate administrative functions, financing, and insurance services for our various affiliates.

In 2005 and 2004, both Holdings and Duquesne Light also reported the CTC business segment, which reported the collection of transition costs that were fully collected as of December 31, 2005.

Note 21 to the consolidated financial statements shows the financial results of each principal business segment in tabular form. Following is a discussion of these results.

Merger Activities. As previously discussed, we entered into a merger agreement with the Macquarie Consortium on July 5, 2006. On August 11, 2006 Holdings sold an aggregate of 8.8 million shares of common stock to members of the Macquarie Consortium for total consideration of $141.4 million. This common stock issuance increased the average number of shares of common stock outstanding for the year ended December 31, 2006. In addition, during the year ended December 31, 2006, we incurred $7.9 million of costs associated with the merger, which have been included in the all other category. We expect to incur additional merger-related costs until such time that the merger closes.

Supply Business. Effective January 1, 2006, the operations of Duquesne Power are reported as part of the Holdings electricity supply segment only. During 2005, Duquesne Power was a wholly owned subsidiary of Duquesne Light, and its financial results were reported in both the Duquesne Light supply business segment and the electricity supply business segment of Holdings. The transfer of Duquesne Power was completed to strategically align our unregulated businesses outside of Duquesne Light in order to provide flexibility to capitalize on future supply opportunities. The transfer has effectively eliminated the net income included in the Duquesne Light supply business segment, as the full-requirements contract between Duquesne Light and Duquesne Power is designed to be income neutral for Duquesne Light. If this transfer had occurred on January 1, 2005, the earnings reported in the Duquesne Light supply business segment would have been $27.3 million lower for the twelve months ended December 31, 2005, but there would have been no change in the earnings reported in the electricity supply business segment of Holdings.

During the twelve months ended December 31, 2006, there was a large decline in the megawatt hours (MWh) supplied to large commercial and industrial customers in the Duquesne Light supply business segment because the two largest industrial customers switched to alternative energy suppliers as their POLR I arrangement ended. The POLR I arrangement featured both a low revenue and purchased power expense per MWh supplied as the pricing under these arrangements was determined years ago. The total MWh supplied in the electricity supply business segment increased in 2006 as compared to 2005, due to the increase in MWh supplied to large commercial and industrial customers by our unregulated retail electric generation supplier, DLE. Both the revenues and purchased power expense recognized during 2006 increased at a greater rate than the increase in MWh supplied as a result of the current pricing associated with the MWh supplied in 2006 compared to the POLR I pricing for the MWh supplied in 2005.

On September 1, 2006, we completed our purchase of undivided interests in two coal-fired power plants for an aggregate purchase price of approximately $177 million, including applicable closing costs and working capital adjustments. The interests acquired represent a 2.47% interest, or 42 megawatts, in the Keystone plant and a 3.83% interest, or 66 megawatts, in the Conemaugh plant, plus related inventories, equipment and other property. The acquisition of the interests in these plants will serve as a physical hedge to our supply portfolio of energy commodity contracts. A $200 million term loan issued by Holdings was used to finance the acquisition.

Section 45K Tax Credits and Synthetic Fuel (Energy Solutions and Financial business segments). Section 45K tax credits are subject to a phase-out provision that reduces tax credits as the average annual wellhead price per barrel of domestic crude oil increases into an inflation-adjusted phase-out range, which is published by the IRS in April for the previous year. In recent years, the wellhead price per barrel of domestic crude oil has averaged approximately 90% of the New York Mercantile Exchange (NYMEX) price per barrel of domestic crude oil. The possible Section 45K phase-out may impact (i) our Financial business segment through our investment in a synthetic fuel partnership and (ii) our Energy Solutions business segment through the fees earned from the operation and maintenance of synthetic fuel facilities for a single customer.

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During 2006, we estimated the average annual wellhead price per barrel of domestic crude oil based on the actual NYMEX price per barrel of domestic crude oil through December. We also estimated the phase-out range for Section 45K tax credits based on the actual 2005 phase-out range, and an estimated inflation factor. This resulted in an annual phase-out of Section 45K tax credits for 2006 at an estimated 34% level as of December 31, 2006.

As a result of the estimated phase-out of Section 45K tax credits, effective July 17, 2006, we elected to temporarily cease participation in the synthetic fuel limited partnership interest held in our Financial business segment. However, due to the subsequent decrease in the estimated phase-out of Section 45K tax credits, we elected, effective October 30, 2006, to resume our participation in the synthetic fuel limited partnership interest. Future participation in the partnership depends on our estimate of future oil prices, potential legislative relief regarding Section 45K tax credits and the probability of production from the partnership.

The estimated Section 45K phase-out also negatively impacted our fees earned from the operation and maintenance of synthetic fuel facilities included in our Energy Solutions business segment. This impact resulted from price concessions granted to the facilities owner for the synthetic fuel processed during August through December 2006. In addition, August production volumes were also reduced, at the owner’s request, to approximately 75% of the aggregate budgeted production levels as a result of the anticipated phase-out. The concessions were agreed to because, without them, the synthetic fuel facilities may have ceased operations. The price concessions also include a true-up provision that could reduce the ultimate price concessions granted to the facility owners. The true-up provisions are based in part on the actual 2006 Section 45K credit information to be published by the IRS in April 2007. We do not, however, anticipate a reduction in the price concessions that were granted to the facility owners. The price and production concessions reduced earnings from the synthetic fuel facilities in 2006 by approximately $7.5 million. (See Recent Developments.)

Income tax settlements. During 2006, two significant tax legacy issues were settled with the IRS and the Pennsylvania Department of Revenue that impacted our results.

In October 2006, we reached a definitive agreement with the Pennsylvania Department of Revenue regarding all of the issues in dispute on Duquesne Light’s 1997 through 2004 Pennsylvania state income tax returns and treatment of the disputed items on our 2005 income tax returns. Pursuant to this settlement agreement, Duquesne Light paid approximately $60 million, which includes interest, and recorded a net charge of $16.1 million in the third quarter. Included in the payment and net charge described above is $13.2 million of taxes other than income taxes which is included in operating expenses in our electricity delivery business segment’s results.

In May 2006, we paid approximately $52.8 million to the IRS related to the 1998-2002 audit cycle. The net charge resulting from this audit, including the impact on state taxes, was $2.9 million.

See Note 10 to the consolidated financial statements for a detailed discussion of the tax settlements.

Discontinued Operations. Effective December 29, 2006, DQE Financial sold its landfill gas business. This is now reported as a discontinued operation.

RESULTS OF OPERATI ONS

Overall Performance

2006 Compared to 2005

Our net income was $54.7 million, or $0.67 basic earnings per share in 2006, compared to $114.2 million, or $1.47 basic earnings per share in 2005. The average shares outstanding increased 4.3 million, or 5.5%, compared to 2005. Our income from continuing operations was $8.7 million, or $0.11 basic earnings per share in 2006, compared to $94.2 million, or $1.21 basic earnings per share in 2005. This decrease of $85.5 million, or 90.8% is primarily due to the following:

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Our income from discontinued operations was $46.0 million, or $0.56 basic earnings per share in 2006, compared to $20.0 million, or $0.26 basic earnings per share in 2005. This increase of $26.0 million is due primarily to the $30.2 million gain recognized in 2006 on the sale of the landfill gas business. This was partially offset by the effect in 2006 of the estimated 34% phase-out of Section 45K tax credits, as there was no phase-out of tax credits in 2005.

Duquesne Light’s loss available for common stock was $3.6 million in 2006, compared to earnings of $65.0 million in 2005, a decrease of $68.6 million, primarily due to the $40.6 million decrease in the earnings from the electricity delivery business segment discussed above, and the December 31, 2005 transfer of Duquesne Power’s operations from Duquesne Light’s supply segment. During the year ended December 31, 2005, Duquesne Power earned $27.3 million.

2005 Compared to 2004

Our net income was $114.2 million, or $1.47 basic earnings per share in 2005, compared to $87.0 million, or $1.14 basic earnings per share in 2004. The average shares outstanding increased 1.3 million, or 1.7%, compared to 2004. Our income from continuing operations was $94.2 million, or $1.21 basic earnings per share in 2005, compared to $73.3 million, or $0.96 basic earnings per share in 2004. This increase of $20.9 million, or 28.5% primarily due to the following:

Our income from discontinued operations was $20.0 million, or $0.26 basic earnings per share in 2005, compared to $13.7 million, or $0.18 basic earnings per share in 2004. This increase of $6.3 million is due primarily to the higher average sales prices for the pipeline quality landfill gas sold in 2005 as compared to 2004.

Duquesne Light’s earnings available for common stock were $65.0 million in 2005, compared to $61.2 million in 2004, an increase of $3.8 million, or 6.2%. Earnings from Duquesne Light’s supply business segment increased $14.7 million from 2005, while earnings from the electricity delivery business segment decreased $10.6 million from the prior year, for the reasons discussed above.

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RESULTS OF OPERATIONS BY BUSINESS SEGMENT

2006 Compared to 2005

Electricity Delivery Business Segment. This segment reported a loss of $4.1 million in 2006, compared to earnings of $36.5 million in 2005, a decrease of $40.6 million or 111.2%. This decrease was primarily due to an after-tax charge of $16.1 million from the state income tax settlement discussed above and $13.6 million of lower after-tax other income consisting of a $6.0 million after-tax charge to increase our reserve for legacy issues associated with our Warwick mine, $4.6 million after-tax less in interest from Holdings due to a repayment of an intercompany loan, and $1.2 million after-tax in lower interest on temporary cash investments. Also contributing to the decrease were lower operating revenues attributable to the milder weather in 2006 as compared to 2005.

Operating revenues are primarily derived from the delivery of electricity, including related excise taxes. Sales to residential and commercial customers are primarily influenced by weather conditions. Warmer summer and colder winter seasons lead to increased customer use of electricity for cooling and heating. Commercial sales also are affected by regional development. Sales to industrial customers are influenced by national and global economic and competitive conditions.

The following table sets forth the MWh delivered to electric utility customers.

Operating revenues decreased $4.3 million, or 1.3%, compared to 2005. A $5.5 million increase in SECA revenues was more than offset by decreases in revenues due to the 2006 summer not being as hot as in 2005 and the 2006 winter being milder than in 2005.

Operating expenses consist primarily of costs of operation and maintenance of the transmission systems and distribution systems; meter reading, billing and collection; customer service; administrative expenses; and non-income taxes such as gross receipts, property, capital stock and payroll taxes. Operating expenses increased $15.1 million, or 8.5%, compared to 2005. The primary reason for the increase in operating expenses was the $13.2 million charge to taxes other than income taxes as a result of the agreement reached with the Pennsylvania Department of Revenue on issues in dispute on the Pennsylvania state income tax returns.

Depreciation and amortization expense includes depreciation on property, plant and equipment and amortization of intangibles. Depreciation and amortization expense increased $7.9 million, or 11.8%, compared to 2005. The increase is primarily the result of an additional $5.2 million of amortization related to SECA revenue, as well as additional depreciation expense attributable to our ongoing infrastructure program.

Other income includes interest as well as income and expenses from legacy operations and activities not directly associated with ongoing utility operations. Other income decreased $23.3 million, or 146.5%. Primary reasons for the decrease were a $10.3 million charge to increase the liability for legacy issues from our Warwick mine including a $9.1 million increase in expected future healthcare costs, $7.9 million less in interest received from Holdings as a result of the repayment of the $250 million intercompany loan in August 2005, and $2.1 million less in interest from temporary investments as cash was deployed in the ongoing infrastructure program.

Interest and other charges include interest on long-term debt and other interest. Interest and other charges decreased $5.5 million, or 11.7%, primarily as a result of $5.7 million of interest incurred in 2005 on pollution control revenue refunding bonds that were no longer outstanding in 2006.

Dividends on all issues of Duquesne Light’s preferred stock are included in interest and other charges in the Holdings presentation of the electricity delivery business segment.

Duquesne Light Supply Business Segment. As previously discussed, the factors impacting this segment in 2006 have changed significantly compared to 2005. The following table summarizes the earnings from this segment.

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The decrease in total earnings reflects the organizational restructuring which moved Duquesne Power from this segment effective January 1, 2006.

Operating revenues are derived primarily from the supply of electricity to POLR retail customers. Retail energy requirements fluctuate as the number of customers choosing alternative generation suppliers changes. Energy requirements for residential and commercial customers are also influenced by weather conditions; temperature extremes lead to changes in customer use of electricity for cooling and heating. Commercial energy requirements are also affected by regional economic development. Energy requirements for industrial customers are primarily influenced by national and global economic conditions.

In addition, operating revenues include, to a lesser extent, the supply of electricity to wholesale customers. In 2006, these sales primarily consisted of short-term sales to other utilities that were made at market rates. In 2005, these sales were primarily comprised of sales to DLE by Duquesne Power under its full-requirements energy supply contract.

The following tables set forth the MWh supplied.

Operating revenues decreased $59.8 million, or 13.5%, compared to 2005. There was an approximately $44 million decrease in wholesale sales of electricity in 2006 related to sales by Duquesne Power to DLE that were included in this segment in 2005. An approximately $28 million decrease in revenue was due to the migration of most of the remaining POLR I customers to alternate suppliers during 2006. The combination of the milder summer and milder winter in 2006 as compared to 2005 caused a further decrease in revenues. Partially offsetting the decreases was a $14.4 million increase in revenue from customers who returned to POLR service.

In 2006, operating expenses consisted primarily of costs to obtain energy and capacity for Duquesne Light’s POLR service and gross receipts tax, both of which fluctuated directly with operating revenues. In 2005, operating expenses consisted of (i) costs to obtain energy and capacity for POLR service and to supply DLE, (ii) certain changes in the fair value of derivative energy contracts, (iii) administrative expenses at Duquesne Power, and (iv) gross receipts tax.

Operating expenses decreased $11.7 million, or 3.0%, compared to 2005. Operating expenses in 2005 included $4.8 million of administrative costs and a $16.1 million benefit from changes in the fair value of the derivative energy contracts, with no corresponding amounts in 2006. Purchased power expenses were $21.5 million lower in 2006 than 2005, due to a decline in the MWh supplied.

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Electricity Supply Business Segment. The following table summarizes the income from this segment.

Operating revenues were $52.4 million, or 11.6%, higher in 2006 primarily due to $55.8 million in higher revenues at DLE and $11.2 million in new revenues from Duquesne Generation (beginning in the third quarter of 2006), partially offset by lower revenues from the Duquesne Light supply segment as discussed above.

The following table sets forth the MWh supplied to the electricity supply business segment customers.

Operating expenses consist primarily of purchased power, capacity and related ancillary services, along with derivative accounting charges and credits. Operating expenses increased $76.0 million, or 18.9% primarily due to a $49.7 million decline in the fair market value of the derivative energy contracts since 2005, increased cost of power to meet the additional supply needs of DLE, and $6.2 million in costs to operate the power plants. On a per MWh basis, Duquesne Power’s cost for power decreased $1.92 per MWh between 2005 and 2006.

Energy Solutions Business Segment. The following table summarizes the income from this segment.

Income from this segment decreased $15.7 million, or 43.4%, in 2006 as compared to 2005. The decrease is primarily due to a $10.0 million decrease in earnings from the management of synthetic fuel facilities mainly from decreased prices, and a $5.9 million decrease in earnings from the energy facility management projects mostly related to the sale of several projects in 2005 and 2006. These decreases were partially offset by the absence in 2006 of a $3.9 million after-tax impairment charge taken in 2005 at an energy facility management project.

Operating revenues are derived primarily from the facility management services for synthetic fuel and industrial customers. Operating revenues for 2006 decreased $11.7 million, or 17.4%, compared to 2005. Revenues for the synthetic fuel facilities decreased $12.9 million from 2005 related primarily to the price concessions granted. There was also a $7.4 million decrease in revenue due to the sale of the energy facility management projects. These decreases were partially offset by an increase in revenue at the remaining energy facility management projects resulting from higher commodity prices and the settlement of a revenue dispute.

Operating expenses consist of the operating and maintenance costs to manage the facilities, as well as general corporate overhead and other gains and losses associated with the operations of the facilities. Operating expenses increased $3.2 million, or 13.3%, compared to 2005, primarily due to the $10.7 million net decrease in pre-tax gains recognized from the 2005 and 2006 sales of several energy facility management projects. This was partially offset by a $4.7 million decrease in expenses in 2006 due to the sale of the energy facility management projects and the $3.9 million impairment charge taken in 2005 associated with a remaining energy facility management project.

Other income consists of various other gains and losses. Other income decreased $18.1 million from 2005 primarily as a result of an $18.0 million pre-tax gain on the sale of an equity investment energy management project in 2005.

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Financial Business Segment. This segment reported income of $11.9 million in 2006, compared to $10.7 million in 2005, an increase of $1.2 million, or 11.2%. This increase was primarily due to a $4.5 million after-tax gain on the sale of a limited partnership investment in 2006 and was partially offset by decreased tax credits related to our synthetic fuel limited partnership investment, which resulted from the 34% estimated tax credit phase-out in 2006.

Operating expenses consist of expenses related to our synthetic fuel limited partnership investment. Operating expenses decreased $2.8 million, or 25.7%, compared to 2005, primarily due to the impact of the estimated tax credit phase-out and our related temporary cessation of operations.

Other income consists of income from structured leases, affordable housing and equity investments, and various other gains and losses. Other income for 2006 increased $7.2 million compared to 2005, primarily due to a $6.9 million pre-tax gain on the sale of a limited partnership investment.

The benefit from limited partners’ interest reflects the portion of the losses related to the affordable housing guarantee funds that are not owned by the DQE Financial subsidiary.

Income taxes consist of our provision for federal income taxes and the tax credits generated from our synthetic fuel limited partnership and affordable housing investments. The income tax benefit for 2006 decreased $7.1 million, or 67.6%, compared to 2005, due to a $4.8 million decrease in tax credits generated in 2006, which resulted from the estimated 34% tax credit phase-out, and a $3.1 million increase in our provision due to the increase in pre-tax earnings in 2006 as compared to 2005.

Communications Business Segment. This segment reported income of $2.5 million in both 2006 and 2005. The increase in revenue from new and existing customers was offset by an increase in both operating and depreciation expenses.

All Other. The all other category reported a loss of $35.3 million in 2006, compared to a loss of $19.6 million in 2005, an increase of $15.7 million, or 80.1%. The increase is primarily due to a $7.1 million after-tax increase in interest expense at Holdings resulting from increased borrowings and $7.9 million of merger-related costs incurred in 2006.

Operating expenses consist of general corporate expenses. Operating expenses increased $10.5 million, or 145.8%, from 2005, primarily due to $7.9 million of merger costs.

Interest and other charges include interest on long-term debt, short-term borrowings and other interest. Interest and other charges increased $10.5 million, or 53.6%, from 2005, primarily due to an $11.4 million increase related to the issuance of $320 million of senior notes in August 2005, an $8.1 million increase related to higher short-term borrowings in 2006 and the entrance into a $200 million term loan facility in September 2006, partially offset by the elimination in 2006 of $7.9 million of interest to Duquesne Light on the $250 million note.

2005 Compared to 2004

Electricity Delivery Business Segment. This segment reported $36.5 million of earnings in 2005, compared to $47.1 million in 2004, a decrease of $10.6 million or 22.5%. This decrease was primarily due to increased operating expenses in 2005.

The following table sets forth the MWh delivered to electric utility customers.

Operating revenues decreased $1.2 million, or 0.3%, compared to 2004. The decrease was primarily due to ancillary services revenue being reported in the Duquesne Light supply segment in 2005. This reclassification of ancillary revenue ($11.8 million in 2004) offset the $3.2 million of revenue collected in 2005 to recover SECA charges. It also offset the increased delivery revenues to residential and commercial customers resulting from the higher MWh sales in 2005 due to the warmer summer weather as compared to 2004.

Operating expenses increased $13.5 million, or 8.2%, compared to 2004. Following the sale of several of Holding’s non-complementary businesses, approximately $6.5 million of additional costs were borne by this segment in 2005 compared to 2004. Included in this amount was $3.4 million related to insurance. Rising energy prices in 2005 placed a strain on the budgets of the elderly and low-income customers. Duquesne Light attempted to balance this impact with sound business practices through increased participation in customer assistance programs. This had the effect of a $7.2 million increase in uncollectible accounts expense. In addition, $4.9 million of increased labor costs were incurred in 2005. These increases were partially offset by a $6.5 million decrease in the costs of ancillary services, because the majority of this cost is now being reported in the Duquesne Light supply segment as a result of the POLR III arrangement.

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Depreciation and amortization expense increased $4.8 million, or 7.7%, compared to 2004. The increase was primarily due to $3.0 million of amortization expense recognized in 2005 relating to SECA, as discussed in the revenue section above.

Preferred dividends increased $1.4 million, or 21.2%, compared to the prior year due to the $75 million of 6.5% preferred stock issued in April 2004. Dividends on all issues of Duquesne Light’s preferred stock are included in interest and other charges in the Holdings presentation of the electricity delivery business segment.

Duquesne Light Supply Business Segment. As previously discussed, the factors that impacted this segment in 2005 changed significantly compared to 2004. The following table summarizes the earnings from this segment.

Under the POLR II arrangement in 2004, the margin on sales to residential and small commercial customers was a fixed dollar amount per MWh supplied, while under the POLR III arrangement in 2005, the margin on these customers is no longer fixed.

The $5.1 million increase in the earnings from the residential and small commercial customers reflects the higher POLR III rates. Under the POLR II arrangement, Duquesne Light earned a margin per MWh on sales to large commercial and industrial customers. However, there is no margin under the POLR III arrangement associated with these customers, which accounts for a $4.6 million decrease in earnings from 2004. In addition, some of the energy contracts entered into by Duquesne Power are derivative instruments, the accounting for which results in certain changes in the fair value of these contracts being recorded currently in earnings. As shown above, there was a $9.4 million increase in earnings in 2005 resulting from certain changes in the fair value of these energy contracts since December 31, 2004. The results for 2004 included the $4.8 million after-tax charge related to the termination of the Sunbury acquisition.

Beginning in 2005, wholesale sales are primarily comprised of sales to DLE by Duquesne Power under its full-requirements energy supply contract. In 2004, these sales primarily consisted of short-term sales to other utilities that were made at market rates, and resulted primarily from excess daily energy deliveries to Duquesne Light’s electricity delivery system.

The following tables set forth the MWh supplied.

Operating revenues increased $9.3 million, or 2.1%, compared to 2004. The combination of the higher average generation rate charged to residential and small commercial customers under the POLR III arrangement and the addition of the ancillary services revenue that is being reported in this segment in 2005 caused an approximate $51 million increase in

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operating revenues in 2005 compared to the prior year. This was augmented by an approximate $12 million increase in retail revenue from increased MWh sales due to the warmer summer weather that occurred in 2005 and an increase in the number of customers being served under the POLR III arrangement. In addition, there was an approximate $39 million increase in wholesale sales of electricity in 2005, due primarily to sales to DLE. As shown in the tables above, there has been a significant decrease in the MWh supplied to large commercial and industrial customers as a higher percentage of these customers chose an alternative generation supplier in 2005. This resulted in an approximate $92 million decrease in operating revenues compared to 2004.

In 2005, operating expenses consisted of (i) costs to obtain energy and capacity for Duquesne Light’s POLR service and to supply DLE, (ii) certain changes in the fair value of derivative energy contracts, (iii) administrative expenses at Duquesne Power, and (iv) gross receipts tax. In 2004, operating expenses consisted primarily of costs to obtain energy for our POLR service and gross receipts tax, both of which fluctuated directly with operating revenues. Beginning in the third quarter of 2004, operating expenses also included administrative expenses at Duquesne Power.

Operating expenses decreased $8.0 million, or 2.0%, compared to 2004. The primary reason for the decrease was a $15.2 million decrease in purchased power expense, primarily due to certain increases in the fair value of the derivative energy contracts. Partially offsetting this decrease was a $2.7 million increase in administrative costs, and increased gross receipts taxes.

CTC Business Segment. Collection of the CTC was completed in the third quarter of 2005. Changes in revenue and expenses between 2005 and 2004 reflect the full collection of this regulatory asset in 2005.

Electricity Supply Business Segment. Earnings from this segment include the results for the Duquesne Light supply segment and, beginning January 1, 2005, the results of Holdings’ unregulated retail electric generation supplier, DLE.

In 2005, the revenues relating to the full-requirements contract between Duquesne Power and DLE (which were included in the Duquesne Light supply segment) were eliminated in this segment’s presentation, and instead DLE’s retail sales to its large commercial and industrial customers are presented. As a result, overall earnings and operating revenues and expenses of this segment are substantially unchanged from corresponding amounts discussed in the Duquesne Light supply segment above.

The following tables set forth the retail MWh supplied to the electricity supply business segment customers.

Energy Solutions Business Segment. This segment reported income of $36.2 million in 2005, compared to $22.3 million in 2004, an increase of $13.9 million, or 62.3%. The increase is primarily due to the $19.4 million of after-tax gains on the sale of investments in certain energy facility management projects partially offset by $6.7 million of charges related to another energy facility management project.

Operating revenues for 2005 increased $0.9 million, or 1.4%, compared to 2004. Revenues for the synthetic fuel facilities increased $3.2 million from 2004 due to an approximate 5% increase in production. This increase was partially offset by a cumulative reduction to revenue recognized in 2005 relating to a contract dispute with the counter-party of another energy facility management project.

Operating expenses decreased $7.2 million, or 23.0%, compared to 2004, primarily due to the $13.2 million pre-tax gain on the sale of two energy facilities in the fourth quarter of 2005, partially offset by a $3.9 million impairment charge associated with another energy facility management project and a $3.3 million increase in energy commodity costs related to the energy facility operations.

Other income increased $17.9 million from 2004 primarily as a result of an $18 million pre-tax gain on the sale of our equity investment as previously discussed.

Financial Business Segment. This segment reported income of $10.7 million in 2005, compared to $12.9 million in 2004, a decrease of $2.2 million, or 17.1%, primarily due to a decrease in tax credits resulting from the October 2004 sale of 50% of our investment in a synthetic fuel partnership.

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Communications Business Segment. This segment reported income of $2.5 million in 2005, compared to $1.7 million in 2004, an increase of $0.8 million, or 47.1%. The increase is primarily due to increases in revenues from new and existing customers.