Talen Energy Corp: Form 10-Q for the period ended Jun 30, 2016

This "Item 2. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" is separately filed by Talen Energy Corporation and Talen Energy Supply. Any information contained herein relating to an individual registrant is filed by such registrant solely on its own behalf, and neither registrant makes any representation as to information relating to the other registrant except that information relating to Talen Energy Supply and its subsidiaries is also attributed to Talen Energy Corporation and information relating to the subsidiaries of Talen Energy Supply is also attributed to Talen Energy Supply. As Talen Energy Corporation is substantially comprised of Talen Energy Supply and its subsidiaries, most disclosures refer to Talen Energy and are intended to be applicable to both registrants. When identification of a particular entity is considered important to understanding the matter being disclosed, the specific entity's name is used, in particular, for those few disclosures that apply only to Talen Energy Corporation.

Talen Energy Supply is considered the accounting predecessor of Talen Energy Corporation. Therefore, the financial information prior to the June 2015 spinoff presented in this Quarterly Report on Form 10-Q for both registrants includes only legacy Talen Energy Supply information. From June 1, 2015, upon completion of the spinoff and acquisition, Talen Energy Corporation's and Talen Energy Supply's consolidated financial information also includes RJS. As such, Talen Energy Corporation's and Talen Energy Supply's consolidated financial information presented in this Quarterly Report on Form 10-Q for the 2015 periods represents three and six months of legacy Talen Energy Supply information consolidated with one month of RJS information from June 1, 2015. See Note 1 in Talen Energy's 2015 Form 10-K for a discussion of the June 2015 spinoff from PPL and formation of Talen Energy.

The following should be read in conjunction with Talen Energy's Condensed Consolidated Financial Statements and accompanying Notes and with Talen Energy's 2015 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, except per share data, unless otherwise noted.

Overview

Introduction

Talen Energy is a North American competitive power generation and marketing company headquartered in Allentown, Pennsylvania. Talen Energy produces and sells electricity, capacity and ancillary services from its fleet of power plants totaling approximately 16,000 MW, principally located in the Northeast, Mid-Atlantic and Southwest regions of the U.S.

Business Strategy

Talen Energy seeks to optimize the value from its competitive power generation assets and marketing portfolios while mitigating near-term volatility in both cash flow and earnings metrics. Talen Energy endeavors to accomplish this by matching projected output from its generation assets with forward power sales in the wholesale and retail markets while effectively managing exposure to fuel price volatility, counterparty credit risk and operational risk. Talen Energy is focused on safe, reliable, and resilient operations, disciplined capital investment, portfolio optimization, cost management and the pursuit of value enhancing growth opportunities.

To manage financing costs and access to credit markets, and to fund capital expenditures and growth opportunities, a key objective of Talen Energy is to maintain adequate liquidity capacity. In addition, Talen Energy has a financial risk management policy and operational procedures that, among other things, are designed to monitor and manage exposure to earnings and cash flow volatility related to, as applicable, changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of generating units. To manage these risks, Talen Energy generally uses contracts such as forwards, options, swaps and insurance contracts primarily focused on mitigating cash flow volatility within the next 12 month period.

Merger Agreement

On June 2, 2016, Talen Energy Corporation entered into an Agreement and Plan of Merger (the Merger Agreement) with RPH Parent LLC, SPH Parent LLC, CRJ Parent LLC (each, an affiliate of Riverstone, and collectively referred to as "Parent"), and RJS Merger Sub Inc. (a wholly owned subsidiary of Parent referred to as "Merger Sub"), pursuant to which Merger Sub will merge with and into Talen Energy Corporation (the Merger), with Talen Energy Corporation continuing as the surviving corporation on the terms and conditions set forth in the Merger Agreement.

At the effective time of the Merger, each share of Talen Energy Corporation common stock outstanding immediately before the effective time of the Merger (excluding shares held by Parent, Merger Sub or certain affiliates of Riverstone and excluding shares pursuant to which dissenting rights under Delaware law have been properly exercised and not withdrawn or lost) will be automatically converted into the right to receive $14.00 in cash, without interest (the Merger Consideration). In addition, affiliates of Riverstone will convert, at the Effective Time, their existing ownership of approximately 35% of the issued and outstanding shares of Talen Energy Corporation common stock into shares of the surviving corporation. Talen Energy Corporation currently expects the transaction to be completed by the end of 2016, subject to regulatory and stockholder approval and satisfaction of other closing conditions.

The Merger Consideration will be funded by Talen Energy's cash on hand and the proceeds of a new $250 million secured term loan. The new secured term loan is fully committed by certain lenders and will rank pari-passu with the Talen Energy Supply RCF, which, in accordance with a consent agreement entered into with the administrative agent and lenders under the Talen Energy Supply RCF, will be reduced from $1.85 billion to $1.4 billion upon closing of the transaction.

The consummation of the Merger is subject to the affirmative vote of (i) a majority of the outstanding shares of Talen Energy Corporation common stock and (ii) a majority of the shares of Talen Energy Corporation common stock (A) not owned by Riverstone, its related entities and any of their respective affiliates and (B) present in person or by proxy at the stockholders meeting to be held with respect to the Merger. Consummation of the Merger also is conditioned on Talen Energy Corporation's satisfaction or receipt of a waiver of certain requirements of the separation agreement entered into in connection with the spinoff of Talen Energy Corporation from PPL (and certain related transactions), generally requiring the delivery of an IRS ruling or a tax opinion from a tax expert to the effect that the Merger will not jeopardize the intended tax-free treatment of the spinoff and certain related transactions. Consummation of the Merger is not subject to a financing condition, but is subject to a condition that Talen Energy Corporation has unrestricted cash and cash equivalents and undrawn revolver capacity equal to at least $350 million at closing, subject to certain exceptions, and after taking into account the proceeds of the new $250 million secured term loan discussed above. Consummation of the Merger is also subject to the condition that immediately prior to the closing, certain specified defaults and events of default under the Talen Energy Supply RCF shall not have occurred. The Merger Agreement contains certain termination rights, including the right of Talen Energy Corporation to terminate the Merger Agreement to accept a superior proposal, subject to specified limitations, and provides that, upon termination of the Merger Agreement by Talen Energy Corporation or Parent upon specified conditions, Talen Energy Corporation will be required to pay Parent a termination fee of $50 million. Upon termination of the Merger Agreement by Talen Energy Corporation or Parent under specified conditions, Parent will be required to pay Talen Energy Corporation a termination fee of $85 million.

The Merger Agreement permitted Talen Energy Corporation and its advisors to actively solicit and negotiate alternative acquisition proposals from third parties during a "go-shop" period that began on June 2, 2016 and expired on July 12, 2016. No alternative proposals were received that would constitute a superior proposal under the Merger Agreement. Talen Energy Corporation is now subject to customary "no shop" restrictions prohibiting Talen Energy Corporation, its subsidiaries, directors, officers, employees and other representatives from soliciting alternative proposals from third parties or providing information to or participating in any discussions or negotiations with third parties regarding alternative proposals. These non-solicitation provisions are subject to a "fiduciary out" provision that allows Talen Energy Corporation to provide non-public information and participate in discussions and negotiations with respect to certain unsolicited written acquisition proposals and upon payment of the termination fee to terminate the Merger Agreement and enter into an alternative acquisition agreement if the Board of Directors determines in good faith after consultation with outside legal and financial advisors that such proposal constitutes a superior proposal under the terms of the Merger Agreement.

In connection with entering into the Merger Agreement, the Riverstone Holders entered into a support agreement pursuant to which such parties have committed to vote their shares of Talen Energy Corporation common stock in favor of, and take certain other actions in furtherance of, the transactions contemplated by the Merger Agreement, including the Merger.

On June 2, 2016, the subsidiaries that guarantee the Talen Energy Supply RCF agreed to unconditionally guarantee, effective upon the closing of the Merger and the other transactions contemplated by the Merger Agreement, all of Talen Energy Supply's obligations with respect to its 6.5% Senior Notes due 2025 and Exempt Facilities Revenue Refunding Bonds, Series 2009A, Series 2009B and Series 2009C.

The Merger Agreement and the above summary of certain of its terms have been included to provide information regarding the terms of the Merger Agreement. Factual disclosures about Talen Energy Corporation contained in this report may supplement, update or modify the factual disclosures about Talen Energy Corporation contained in the Merger Agreement. The representations, warranties and covenants made in the Merger Agreement by Talen Energy Corporation, Parent and Merger Sub were qualified and subject to important limitations agreed to by Talen Energy Corporation, Parent and Merger Sub in connection with negotiating the terms of the Merger Agreement. The representations and warranties contained in the Merger Agreement were negotiated with the principal purposes of establishing the circumstances in which a party to the Merger Agreement may have the right not to close the Merger if the representations and warranties of the other party prove to be untrue due to a change in circumstance or otherwise, and allocating risk between the parties to the Merger Agreement, rather than establishing matters as facts. The representations and warranties may also be subject to a contractual standard of materiality different from those generally applicable to stockholders and reports and documents filed with the SEC. Moreover, information concerning the subject matter of the representations and warranties, which do not purport to be accurate as of the date of this report, (i) is contained, in part, on schedules to the Merger Agreement that have not been filed with the SEC in reliance upon applicable SEC regulations and (ii) may have changed since the date of the Merger Agreement and subsequent developments or new information qualifying a representation or warranty may or may not have been included in this report.

For further information on the Merger, the Merger Agreement, the consent agreement, the support agreement and other Merger related agreements, please refer to the Current Report on Form 8-K filed on June 6, 2016 and the preliminary proxy statement filed on July 1, 2016 by Talen Energy Corporation. The foregoing descriptions of the Merger Agreement, the consent agreement and the support agreement are subject to, and qualified in their entirety by, the full text of those agreements as attached as exhibits to the Form 8-K filed on June 6, 2016, each of which is incorporated by reference herein.

The Merger poses certain risks to Talen Energy during the pendency of the transaction. See "Item 1A. Risk Factors" in Part II of this Form 10-Q for additional information.

Key Performance Measures

In addition to operating income (loss), Talen Energy utilizes Adjusted EBITDA and Margins, both non-GAAP financial measures, as indicators of performance for its business, with Adjusted EBITDA as the primary financial performance measure used by management to evaluate its business and monitor results of operations. Results for the periods ended June 30 were as follows:

See "Results of Operations" and for a detailed analysis of Talen Energy's results, the definitions of Margins and Adjusted EBITDA and reconciliation of these non-GAAP measures to related GAAP measures.

Executive Summary

The changes in net income (loss) and operating income (loss) for the three and six month periods ended June 30, 2016 compared with the prior year were partially due to changes in Margins described below and the positive impact of non-cash net gains from the sales of certain facilities that were partially offset by non-cash impairments recorded in 2016 as described below. Negatively impacting earnings for these periods were unrealized losses on hedging activity of $154 million for the three month period and $116 million for the six month period, and increases in depreciation expense (largely due to the addition of the RJS and MACH Gen generating facilities acquired in 2015) of $22 million for the three month period and $54 million for the six month period. Operation and maintenance expense decreased by $29 million in the three month period for Talen Energy Corporation ($40 million for Talen Energy Supply) and increased by $31 million in the six month period for Talen Energy Corporation ($20 million for Talen Energy Supply).

Net income (loss) for the six month period ended June 30, 2016 compared with the prior year was further reduced due to higher interest expense of $29 million partially as a result of the assumption through consolidation of RJS and MACH Gen related debt, while the three and six month periods were lower due to increases in tax expense primarily from an increase in pre-tax income driven by the sale of the generation assets previously discussed.

The decreases in adjusted EBITDA for the three and six month periods ended June 30, 2016 compared with the prior year were primarily due to changes in Margins described below. The decrease for the six month period was also driven by higher operation and maintenance expense partially due to the RJS and MACH Gen generating facilities acquired in 2015.

The decrease in Margins, a primary driver to changes in the other three earnings measures reflected above, for the three month period ended June 30, 2016 compared with the prior year, was due to a $82 million decrease from Talen Energy's legacy operations, partially offset by a $52 million increase from the RJS and MACH Gen assets acquired in 2015. The increase for the six month period ended June 30, 2016 compared with the prior year was due to a $152 million increase from the RJS and MACH Gen assets acquired in 2015, partially offset by a $119 million decrease from Talen Energy's legacy assets.

The key financial and operational developments that impacted results for 2016 were as follows:

• Merger Agreement- In June 2016, Talen Energy Corporation entered into the Merger Agreement. In connection with the Merger:
• In June 2016, the Antitrust Division of the U.S. Department of Justice and the U.S. Federal Trade Commission granted early termination of the mandatory waiting period under the Hart-Scott Rodino Antitrust Improvements Act of 1976, as amended, expiration or early termination of which was a condition to consummation of the Merger.
• In July 2016, Talen Energy Corporation filed with the SEC a preliminary proxy statement. When completed, a definitive proxy statement and a form of proxy will be filed with the SEC and distributed to the Talen Energy Corporation stockholders.
• For the three and six months ended June 30, 2016, $11 million of costs related to the transaction, primarily for investment banking, legal and other professional services, were recorded in "Operation and maintenance" on Talen Energy Corporation's Statement of Income.
• Divestitures of Ironwood, C.P. Crane, Holtwood and Lake Wallenpaupack Power Plants - In October 2015, Talen Energy announced agreements for the sales of these facilities, with an aggregate generating capacity of approximately 1,400 MW, to satisfy a December 2014 FERC order approving the combination of Talen Energy Supply and RJS Power. The sales of the Ironwood and C.P. Crane plants were completed in February 2016 and the Holtwood and Lake Wallenpaupack sale was completed in April 2016. Talen Energy generated $1.5 billion in pre-tax cash proceeds from these sales. Talen Energy used $600 million of these proceeds during the first quarter of 2016 to repay short-term debt. Talen Energy's operating results for the three and six months ended June 30, 2016 include net pre-tax gains of $423 million ($254 million after-tax) and $563 million ($338 million after-tax) related to the sales. See Note 8 to the Financial Statements for additional information.
• Bell Bend COLA Impairment - For the three and six months ended June 30, 2016, Talen Energy recorded a pre-tax asset impairment charge of $204 million ($122 million after-tax) to fully impair the Bell Bend COLA costs. See Notes 8 and 13 to the Financial Statements for additional information.
• Montour Co-firing Project - The project, announced in June 2016, has an estimated capital cost of $70 million. The project is expected to be completed in the second quarter of 2018. See Note 8 to the Financial Statements for additional information.
• PJM Capacity Auction Results - In May 2016, PJM completed the Base Residual Auction (BRA) for procuring capacity for the 2019/2020 planning year. Talen Energy cleared 6,994 MW (about 67%) of its total PJM capacity compared with 8,378 MW (about 81%) in the prior BRA for the 2018/2019 planning year. This result was primarily driven by lower than expected clearing prices in zones where the majority of Talen Energy's capacity is located. Based on the auction clearing prices and cleared MW in the auction, Talen Energy expects its PJM capacity revenues to be approximately $257 million for the 2019/2020 planning year. The expected capacity revenues do not include any value for capacity that did not clear either the base or Capacity Performance (CP) products. Any uncleared capacity has the capability to be bid into subsequent incremental auctions or sold to third parties in bilateral transactions. Under the CP construct, uncleared capacity also has the potential to provide additional value as portfolio insurance against unit non-performance or through participation in penalty revenues.
• Sierra Club Settlement - In July 2016, settlement was reached in the Sierra Club environmental litigation, pending court approval, which includes a commitment to retire Colstrip Units 1 and 2 no later than July 2022. See Note 10 to the Financial Statements for additional information.

Regulatory Matters

Maryland and New Jersey Capacity Matters

In April 2012, the Maryland Public Service Commission ordered three electric utilities in Maryland to enter into long-term contracts to support the construction of new electricity generating facilities in Maryland, the intent of which, Talen Energy believed, was to encourage the construction of new generation even when, under the FERC-approved PJM economic model, such new generation would not be economic. In April 2012, Talen Energy subsidiaries and several other companies filed a complaint in federal court in Maryland challenging the order on the grounds that it violates the Supremacy and Commerce clauses of the U.S. Constitution and requested declaratory and injunctive relief barring implementation of the order by the Maryland PSC Commissioners. Following certain lower court rulings, in April 2016, the U.S. Supreme Court issued a unanimous decision finding that Maryland's program is preempted by the Federal Power Act because it sets an interstate wholesale rate, contravening the Federal Power Act's division of authority between state and federal regulators.

Also in April 2016, the U.S. Supreme Court denied all petitions for certiorari in a similar case in New Jersey. The effect of the denial was to let stand lower court rulings finding that a similar law enacted by New Jersey was unconstitutional under the Supremacy Clause on the grounds that it infringes upon the FERC's exclusive authority to regulate the wholesale sale of electricity in interstate commerce.

See Note 10 to the Financial Statements for background information on these cases.

Ohio

There have been attempts in Ohio by certain companies to have their utilities be permitted to subsidize several uneconomic merchant generation assets owned by non-utility affiliates. Those attempts are being opposed by many generator and consumer interests both in Ohio and at the FERC. In April 2016, the FERC rescinded waivers it granted to certain Ohio companies that allowed them to purchase power from their affiliate generators. The Ohio companies must seek approval from the FERC that the contracts are consistent with the FERC's affiliate regulations before those contracts can be made effective. Additional efforts to oppose on grounds of federal preemption may also be made in Federal Court. If approved and not reversed, out-of-market subsidies could be disruptive to the market signals for competitive generation and threaten the long-term viability of PJM's markets. It is too early to predict the outcome of these efforts to subsidize uneconomic generators in Ohio.

Talen Energy cannot predict the impact that future economic and market conditions and regulatory requirements may have on its financial condition or results of operations.

Results of Operations

As a result of the RJS Power acquisition on June 1, 2015, results for RJS are included in Talen Energy's results for the three and six months ended June 30, 2016 with only one month of comparable amounts in 2015. As a result of the MACH Gen acquisition on November 2, 2015, results for MACH Gen are included in Talen Energy's results for the three and six months ended June 30, 2016 with no comparable amounts in 2015. When discussing Talen Energy's results of operations for 2016 compared with 2015, when significant, the results of RJS and MACH Gen are isolated for purposes of comparability.

Talen Energy is organized in two segments: East and West, based on geographic location. The East segment includes the generating, marketing and trading activities in PJM, NYISO and ISO-NE. The West segment includes the generating, marketing and trading activities located in ERCOT and WECC. In addition, Talen Energy has an "Other" category that primarily includes wages, benefits, services, certain insurance, rent, financing costs incurred primarily at Talen Energy, which have not been allocated or assigned to the segments and inter-company eliminations, and is presented to reconcile segment information to consolidated results.

The discussion within "Statement of Income Analysis" addresses significant changes in principal line items on the Statements of Income comparing the three and six months ended June 30, 2016 with the same periods in 2015 on a GAAP basis. The "Margins" discussion, presented by segment, includes a reconciliation of that non-GAAP financial measure to operating income. The "EBITDA and Adjusted EBITDA" discussion, also presented by segment, includes a reconciliation of those non-GAAP financial measures to operating income and consolidated net income (loss).

The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.

Earnings in future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this "Item 2. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in Talen Energy's 2015 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

Statement of Income Analysis, Margins, EBITDA and Adjusted EBITDA

Statement of Income Analysis --

(a) Includes the impact from energy-related economic activity. See "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements for additional information. "Wholesale Energy" also includes unrealized gains (losses) on trading activity of insignificant losses for the three and six months ended June 30, 2016 and $(34) million and $(33) million for the same periods in 2015.

(b) Amounts included in "Margins" and are not discussed separately.

(c) Amounts for prior years have been reclassified to conform to the current presentation. See Note 1 to the Financial Statements for additional information.

See below for a discussion of the components of the changes to Net Income (Loss) for the periods. The changes in Net Income (Loss) and Operating Income (Loss) from period to period were, in part, attributable to the acquisitions of RJS Power and MACH Gen and several items that management believes are not indicative of ongoing operations. See "EBITDA and Adjusted EBITDA" discussion below for information on the items management does not believe are indicative of ongoing operations.

Energy-Related Businesses

Net contributions from energy-related businesses decreased by $7 million and $10 million for the three and six months ended June 30, 2016 compared with 2015, primarily due to a decrease in construction projects at the mechanical contracting and engineering subsidiaries in 2016.

Operation and Maintenance

The increase (decrease) in operation and maintenance for the periods ended June 30, 2016 compared with 2015 was due to:

(a) Amounts are not comparable for the three and six months ended June 30, 2015 as RJS was acquired in June 2015 and MACH Gen was acquired in November 2015.

(b) The decrease for the three month period was primarily due to the timing of the refueling outage.

(c) Facilities sold in 2016. See Note 8 to the Financial Statements for additional information.

(d) The decrease for the six month period is primarily due to the timing of outages.

(e) Costs related to the spinoff transaction, including expenses associated with the FERC-required mitigation and legal and professional fees.

(f) See Note 1 to the Financial Statements for additional information on acceleration of expense recorded in connection with the spinoff.

(g) Primarily due to charges under Talen Energy's severance benefits plan recorded in 2016. See Note 9 to the Financial Statements for additional information.

(h) The decrease for the three and six month periods was primarily due to lower corporate expenses, which were primarily a result of cost reductions following the spinoff from PPL.

(i) Primarily represents investment banking, legal and other professional services. See Note 7 for the Financial Statements for additional information on the Merger.

In July 2016, Talen Energy gave notice to Local Union No. 1600 of the International Brotherhood of Electrical Workers (Local 1600) of its intent to eliminate approximately 130 bargaining unit positions at the Susquehanna, Montour, and Brunner Island plants and at Talen Energy's headquarters. Talen Energy and Local 1600 are in the process of identifying impacted employees, some of whom may be eligible to receive enhanced pension and severance benefits in accordance with the terms of the collective bargaining agreement. Talen Energy expects to record a charge related to the elimination of a majority of these positions in the second half of 2016, which is not currently estimable.

(Gain) loss on sale

(Gain) loss on sale for the three and six months ended June 30, 2016 primarily represents the $421 million gain on the sale of the Holtwood and Lake Wallenpaupack hydroelectric facilities. The six month period also includes the $148 million gain on the sale of the Ironwood power plant. See Note 8 to the Financial Statements for additional information.

Impairments

Impairments for the three and six months ended June 30, 2016 primarily includes a $204 million pre-tax charge to fully impair capitalized costs related to the Bell Bend COLA. See Notes 8 and 13 to the Financial Statements for additional information.

Depreciation

The increase (decrease) in depreciation for the periods ended June 30, 2016 compared with 2015 was due to:

(a) Amounts are not comparable for the three and six months ended June 30, 2015 as RJS was acquired in June 2015 and MACH Gen was acquired in November 2015.

(b) Facilities sold in 2016. See Note 8 to the Financial Statements for additional information.

Taxes, Other Than Income

The increase (decrease) in taxes, other than income for the periods ended June 30, 2016 compared with 2015 was primarily due to the acquisitions of RJS Power and MACH Gen. Periods in 2015 include one month of operations for RJS, acquired in June 2015, and no amounts for MACH Gen, acquired in November 2015.

Interest Expense

The increase (decrease) in interest expense for the periods ended June 30, 2016 compared with 2015 was due to:

(a) The increase for both periods was due to a debt issuance in May 2015 and the assumption of an RJS Power subsidiary's debt in June 2015 in connection with the RJS Power acquisition, partially offset by a debt maturity in October 2015. The increase in expense from the RJS Power related debt was $9 million and $24 million for the three and six month periods.

(b) There are no comparable amounts in the 2015 period as MACH Gen was acquired in November 2015.

(c) The decrease for both periods was due to the write-off of fees in 2015 associated with Talen Energy Supply's $3 billion syndicated credit facility that was terminated in connection with the spinoff.

Income Taxes

The increase (decrease) in income taxes for the periods ended June 30, 2016 compared with 2015 was due to:

(a) Excludes income taxes related to RJS and MACH Gen as there are not comparable amounts in the three and six months ended June 30, 2015 as described in (b).

(b) Amounts are not comparable for the three and six months ended June 30, 2015 as RJS was acquired in June 2015 and MACH Gen was acquired in November 2015.

Margins

Management utilizes "Margins," a non-GAAP financial measure, as an indicator of performance for its business.

"Margins" is defined as energy revenues offset by the cost of fuel and energy purchases. Management believes this performance measure is relevant due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs, RTOs and significant fluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy," "Retail energy" or "Fuel and energy purchases" on the Statements of Income. "Margins" excludes unrealized (gains) losses on: energy related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of the competitive generation assets, full-requirement sales contracts and retail activities; and trading activities. These derivatives are subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged or when realized. Energy related economic activity includes premium amortization associated with options. Unrealized gains and losses related to derivatives and premium amortization associated with options are deferred and included in "Margins" over the delivery period of the item that was hedged or upon realization.

This measure is not intended to replace "Operating Income (Loss)," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and report their results of operations. Management believes this measure provides additional useful criteria to make investment decisions. This performance measure is used, in conjunction with other information, by senior management to manage Talen Energy's operations and analyze actual results compared with budget.

Reconciliation of Margins

The following tables contain the components from the Statements of Income that are included in Margins and a reconciliation to "Operating Income (Loss)" for the periods ended June 30.

(a) Represents amounts excluded from Margins.

(b) As reported on the Statements of Income.

(c) Includes unrealized gains (losses) on energy-related economic activity, which is subject to fluctuations in value due to market price volatility. See

"Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. "Wholesale Energy" also includes unrealized gains (losses) on trading activity of insignificant losses for the three and six months ended June 30, 2016 and $(34) million and $(33) million for the same periods in 2015. Amounts have been adjusted for insignificant option premiums for the three months ended June 30, 2016 and 2015, and $6 million and $9 million for the six months ended June 30, 2016 and 2015.

(d) Other includes all Income Statement line items that are fully excluded from Margins, including Operation and maintenance, (Gain) loss on sale, Impairments, Depreciation, Taxes, other than income and Energy-related businesses, net.

Changes in Margins

The following table shows Margins by segments, for the periods ended June 30 as well as the change between the periods. The factors that gave rise to the changes are described following the table. Periods in 2015 include one month of operations for the RJS portfolio, acquired in June 2015, and no amounts for the MACH Gen portfolio, acquired in November 2015.

East Segment

East segment Margins decreased by $24 million for the three month period primarily due to lost energy and capacity revenues from assets sold of $37 million, timing of nuclear outages of $12 million, lower spark spreads of $12 million, and lower other portfolio margins of $9 million. Partially offsetting these amounts is an increase from the Raven and Sapphire portfolios of $30 million, as well as $19 million from the Athens and Millennium portfolios.

East segment Margins increased for the six month period from the Raven and Sapphire portfolios of $109 million, as well as $32 million from the Athens and Millennium portfolios.

Excluding the impact of the Raven, Sapphire, Athens, and Millennium acquisitions, East segment Margins decreased by $101 million for the six month period primarily due to lost energy and capacity revenues from assets sold of $50 million, lower realized energy prices of $35 million, lower nuclear availability of $35 million, and lower spark spreads of $21 million. Partially offsetting these amounts is an increase in capacity prices of $25 million and full-requirement sales contracts of $12 million.

West Segment

West segment Margins decreased for the three month period as the result of a $9 million decrease in the Montana portfolio due to lower realized energy prices and lower generation. This amount was partially offset by the additions of the Jade and Harquahala portfolios of $3 million.

West segment Margins decreased for the six month period as the result of an $18 million decrease in the Montana portfolio due to lower realized energy prices and lower generation. This amount was partially offset by the additions of the Jade and Harquahala portfolios of $11 million.

EBITDA and Adjusted EBITDA

In addition to operating income (loss), management utilizes EBITDA and Adjusted EBITDA, which are both non-GAAP financial measures, as indicators of performance for Talen Energy's business, with Adjusted EBITDA as the primary financial performance measure used by management to evaluate its business and monitor results of operations.

EBITDA represents net income (loss) before interest expense, income taxes, depreciation and certain amortization. Adjusted EBITDA represents EBITDA further adjusted for certain non-cash and other items that management believes are not indicative of ongoing operations including, but not limited to, unrealized gains and losses on derivative contracts, stock-based compensation expense, asset retirement obligation accretion (net of gains (losses) on retirements), impairments, gains and losses on securities in the NDT funds, gains or losses on sales, dispositions or retirements of assets, debt extinguishments and transition, transaction and restructuring costs.

EBITDA and Adjusted EBITDA are not intended to represent cash flows from operations, operating income (loss) or net income (loss) as defined by GAAP as indicators of operating performance and are not necessarily comparable to similarly-titled measures reported by other companies. Management cautions investors that amounts presented in accordance with Talen Energy's definitions of EBITDA and Adjusted EBITDA may not be comparable to similar measures disclosed by other companies because not all companies calculate EBITDA and Adjusted EBITDA in the same manner. Talen Energy believes EBITDA and Adjusted EBITDA are useful to investors and other users of these financial statements in evaluating Talen Energy's operating performance because they provide additional tools to compare business performance across companies and across periods. Talen Energy believes that EBITDA is widely used by investors to measure a company's operating performance without regard to such items as interest expense, income taxes, depreciation and amortization, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired. Additionally, Talen Energy believes that investors commonly adjust EBITDA information to eliminate the effect of restructuring and other expenses, which vary widely from company to company and impair comparability. Talen Energy adjusts for these and other items; as management believes that these items would distort their ability to efficiently view and assess the company's core operating trends. In summary, management primarily uses Adjusted EBITDA as a measure of operating performance to assist in comparing performance from period to period on a consistent basis and to readily view operating trends, as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations, as a measure of certain corporate financial goals used to determine variable compensation and in communications with the Talen Energy Corporation Board of Directors, senior management, shareholders, creditors, analysts and investors concerning Talen Energy's financial performance.

Reconciliations of EBITDA and Adjusted EBITDA

The table below provides reconciliations of EBITDA and Adjusted EBITDA to operating income (loss) on a segment basis and to net income (loss) on a consolidated basis for the periods ended June 30.

57

(a) Represents Merger-related transaction costs, primarily investment banking, legal and other professional services incurred by Talen Energy Corporation. See Note 7 for the Financial Statements for additional information on the Merger.

(b) Represents unrealized (gains) losses on derivatives. See "Commodity Price Risk (Non-trading) - Economic Activity" and "Commodity Price Risk (Trading)" in Note 14 to the Financial Statements for additional information on derivatives. Also includes unrealized (gains) losses on trading activity of insignificant losses for the three and six months ended June 30, 2016 and $34 million and $33 million for the same periods in 2015. Amounts have been adjusted for insignificant option premiums for the three months ended June 30, 2016 and 2015, and $6 million and $9 million for the six months ended June 30, 2016 and 2015.

(c) Represents net realized gains on certain derivative contracts that were terminated due to the spinoff transaction.

(d) Related to a prior period revenue adjustment for the receipt of revenue under a transmission operating agreement with Talen Energy Supply's former affiliate, PPL Electric Utilities Corporation. See Note 1 to the Financial Statements for additional information.

(e) Includes OCI amortization on non-active derivative positions.

(f) For the periods prior to June 2015, represents the portion of PPL's stock-based compensation cost allocable to Talen Energy.

(g) Operations were suspended and the Corette plant was retired in March 2015.

(h) Costs related to the spinoff transaction, including expenses associated with FERC-required mitigation and legal and professional fees. Also see "(a)" above.

(i) Contingency relates to the termination of a gas supply contract. See Note 10 to the Financial Statements for additional information.

Changes in Adjusted EBITDA

The following table shows Adjusted EBITDA by segment for the periods ended June 30 as well as the change between periods. The factors that gave rise to the changes are described following the table. Periods in 2015 include one month of operations for the RJS portfolio, acquired in June 2015, and no amounts for the MACH Gen portfolio, acquired in November 2015.

East Segment

The decrease for the three month period for the East segment was driven by lower margins, primarily due to lost energy and capacity revenue from assets sold, timing of nuclear outages, lower spark spreads and lower other portfolio margins, partially offset by increases in margins from the Raven, Sapphire, Athens and Millennium portfolios acquired in 2015. Also contributing to the decrease were higher operation and maintenance expenses primarily due to the 2015 acquisitions, partially offset by the timing of the nuclear refueling outages.

The decrease for the six month period for the East segment was driven by higher operation and maintenance expenses, primarily due to the Raven, Sapphire, Athens and Millennium operations acquired in 2015. Partially offsetting the decrease were higher margins, primarily from the Raven, Sapphire, Athens and Millennium portfolios, increased capacity prices and full-requirement sales contracts, which were offset by lost energy and capacity revenues from assets sold, lower realized energy prices, lower nuclear availability and lower spark spreads.

West Segment

The decrease for the three and six month periods for the West segment was driven by higher operation and maintenance expenses, primarily due to the addition of the Jade and Harquahala operations in 2015, and lower margins from Montana operations due to lower realized energy prices, partially offset by higher margins from the addition of the Jade and Harquahala portfolios.

Other

The increase for the three and six month periods was primarily due to lower corporate expenses, which were primarily a result of cost reductions following the spinoff from PPL.

See "Margins" and "Statement of Income Analysis" above for a more detailed analysis of the changes.

Financial Condition

Liquidity and Capital Resources

Talen Energy had the following at:

(a) December 31, 2015 includes $108 million related to the New MACH Gen RCF, which at June 30, 2016 is classified as "Long-term debt" on the Balance Sheet based on New MACH Gen's intent to refinance on a long-term basis.

Net cash provided by (used in) operating, investing and financing activities for the six months ended June 30, and the changes between periods were as follows.

Operating Activities

The components of the change in cash provided by (used in) operating activities for the six months ended June 30, 2016 compared with 2015 were as follows.

The change in non-cash components primarily resulted from $595 million of net gains from the sale of certain generation facilities in 2016, an increase in deferred tax credits ($96 million for Talen Energy Corporation and $91 million for Talen Energy Supply), partially offset by $208 million related to asset impairments, a $123 million increase in unrealized losses on hedging and other hedging activities and a $54 million increase in depreciation. The increase in cash from operations from changes in working capital was primarily due to an increase in accrued taxes payable and accounts payable, partially offset by a decrease in counterparty collateral (due in part to market price movement) and increases in accounts receivable, unbilled revenues and prepayments. The increase in accrued taxes payable related to increased taxable income in 2016 primarily resulting from gains on the aforementioned sales of generation facilities. The decrease to accounts payable was related to 2015 changes from the change in market prices of gas and the settlement of the PPL affiliated accounts payable in advance of the June 1, 2015 spinoff. The increases in accounts receivable are primarily related to decreases in 2015 from the settlement of the PPL affiliated accounts receivable in advance of the June 1, 2015 spinoff, while changes in unbilled revenues resulted primarily from decreases in 2015 related to expiring contracts and lower hedging activity. The increase in prepayments was related to 2015 activity, including the receipt of an income tax refund.

The change in defined benefit plan funding is a result of timing of contributions as there have been no 2016 contributions during the six months ended June 30, 2016. Talen Energy made a $20 million contribution in July 2016.

Investing Activities

The $1.4 billion increase in cash provided by investing activities for the six months ended June 30, 2016 compared with 2015 primarily reflects $1.5 billion in in pre-tax cash proceeds received in 2016 from sale of the Ironwood, Holtwood, Lake Wallenpaupak and C.P. Crane power generation facilities. See Note 8 to the Financial Statements for additional information.

Financing Activities

The components of the change in cash provided by (used in) financing activities for the six months ended June 30, 2016 compared with 2015 were as follows.

(a) Includes activity under the New MACH Gen RCF which at June 30, 2016 is classified as "Long-term debt" on the Balance Sheet.

In 2015, Talen Energy made a distribution to its predecessor member prior to the June 2015 spinoff, with no such distributions occurring in 2016. In 2016, Talen Energy used a portion of the proceeds from the February 2016 sales of the Ironwood and C.P. Crane power generation facilities to repay all then outstanding $600 million of short-term borrowings under Talen Energy Supply's RCF and later used borrowings under Talen Energy's Supply's RCF to repay a May 2016 $350 million debt maturity. In 2015, Talen Energy used the proceeds from its May 2015 $600 million debt issuance to repay all then outstanding, $630 million, of short-term borrowings under Talen Energy Supply's RCF.

Talen Energy may from time to time seek to retire or repurchase outstanding debt (including publicly issued debt) through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

See Note 6 to the Financial Statements for information on 2016 short and long-term debt activity. See Note 5 in Talen Energy's 2015 Form 10-K for information on 2015 activity. See "Merger Agreement" below for information on the impact of the Merger on future debt issuances and credit facility capacity.

Revolving Credit Facilities

Talen Energy Supply and a subsidiary maintain credit facilities to enhance liquidity and provide credit support. The total committed borrowing capacity under outstanding credit facilities and the use of this borrowing capacity were:

The amounts "Borrowed" are recorded as either "Short-term debt" or "Long-term debt" on the Balance Sheets depending on the facility utilized and management's ability and intent to repay or refinance borrowings.

The Talen Energy Supply RCF provides capacity for revolving cash borrowings and up to $925 million of letters of credit, which in combination cannot exceed the capacity of the facility at any given time. The commitments at June 30, 2016 under the Talen Energy Supply RCF are provided by a diverse bank group, with no one bank or its affiliates providing an aggregate commitment of more than 8% of the total committed capacity. See "Merger Agreement" below for information on future reduction in the capacity of this facility.

The New MACH Gen RCF provides capacity for revolving cash borrowings and up to $120 million of letters of credit, which in combination cannot exceed the capacity of the facility at any given time.

Other Facilities

Talen Energy Supply is party to a $1.3 billion Amended STF Agreement whereby Talen Energy Supply will receive credit to be applied to satisfy collateral posting obligations related to Talen Energy's energy marketing and trading activities with counterparties participating in the facility.

See Note 6 to the Financial Statements for further discussion of Talen Energy Supply's credit and other agreements.

Merger Agreement

The consideration payable in the Merger with affiliates of Riverstone will be funded by Talen Energy's cash on hand and the proceeds of a yet-to-be issued $250 million new secured term loan. The new secured term loan is fully committed by certain lenders and will rank pari-passu with the Talen Energy Supply RCF. In accordance with a consent agreement entered into with the administrative agent and lenders under the Talen Energy Supply RCF, the Talen Energy Supply RCF will be reduced from $1.85 billion to $1.4 billion upon closing of the transaction. Consummation of the Merger is not subject to a financing condition, but is subject to a condition that Talen Energy Corporation has unrestricted cash and cash equivalents and undrawn revolver capacity equal to at least $350 million at closing, subject to certain exceptions, and after taking into account the proceeds of the new 250 secured term loan discussed above. Consummation of the Merger is also subject to the condition that immediately prior to the Merger, certain specified defaults and events of default under the Talen Energy Supply RCF shall not have occurred. See Note 7 of the Financial Statements for additional information.

Long-term Debt

See Note 6 to the Financial Statements for information on Talen Energy Supply's long-term debt activity.

Rating Agencies and Credit Considerations

A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The ratings issued by rating agencies are not recommendations to buy, sell or hold any debt securities of Talen Energy, and they are often based in part on information provided by Talen Energy and other sources. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities. Talen Energy's credit ratings may affect its liquidity, access to capital markets and cost of borrowing.

The following table sets forth the credit ratings issued by Moody's and Standard & Poor's for outstanding debt securities or credit facilities of Talen Energy Supply at:

In June 2016, following the announced Merger, Moody's placed the ratings of Talen Energy Supply, including its corporate issuer rating, senior secured rating, and the rating on a majority of its senior unsecured debt obligations under review for downgrade. The rating on approximately $830 million of Talen Energy Supply's senior unsecured debt was placed under review for upgrade as a result of guarantees that become effective upon the closing of the Merger as discussed in Note 7.

In June 2016, following the announced Merger, S&P affirmed the ratings of Talen Energy Supply.

Various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage and interest rate instruments contain provisions that require the posting of additional collateral, or permit the counterparty to terminate the contract, upon a downgrade in Talen Energy Supply's credit rating. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral requirements for Talen Energy for derivative contracts in a net liability position at June 30, 2016.

Talen Energy has no credit rating triggers that, by themselves, would result in the reduction of access to capital markets or the acceleration of maturity dates of outstanding debt.

Capital Expenditures

The table below shows Talen Energy's current capital expenditure projections for the years 2016 through 2020.

(a) Does not include the Holtwood and Lake Wallenpaupack hydroelectric projects, the Ironwood natural gas combined-cycle plant, and the C.P. Crane coal-fired power plant, which have been sold. See Note 8 to the Financial Statements for additional information on the divestitures.

(b) Includes capitalized interest, which over all years, is expected to total approximately $55 million.

Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. The above table has been revised from what was presented in the 2015 Form 10-K to reflect additions for the Montour co-fire project and removal of expenditures (including capitalized interest) related to the Bell Bend project. See Note 8 to the Financial Statements for additional information on the Montour co-fire project and the Bell Bend COLA.

Risk Management

Market Risk

See Notes 13 and 14 to the Financial Statements for information about Talen Energy's risk management objectives, valuation techniques and accounting designations.

The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.

Commodity Price Risk (Non-trading)

Talen Energy's non-trading activity includes economic hedge transactions that address a specific risk. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of Talen Energy's competitive generation assets and full-requirement sales and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). See Note 14 to the Financial Statements for additional information.

To hedge the impact of market price volatility on Talen Energy's energy-related assets, liabilities and other contractual arrangements, Talen Energy subsidiaries both sell and purchase physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enter into financial exchange-traded and over-the-counter contracts. Talen Energy's non-trading commodity derivative contracts range in maturity through 2020.

The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.

(a) Represents the fair value of contracts at the end of the quarter of their inception. 2015 includes the impact of contracts acquired as part of the RJS Power acquisition.

The following table segregates the net fair value of non-trading commodity derivative contracts at June 30, 2016, based on the observability of the information used to determine the fair value.

Talen Energy subsidiaries sell electricity, capacity and related services and buy fuel on a forward basis to hedge the value of energy from Talen Energy's generation assets. If these Talen Energy subsidiaries were unable to deliver firm capacity and energy or to accept the delivery of fuel under their agreements, under certain circumstances they could be required to pay liquidated damages. These damages would be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their counterparties) with which it has energy contracts and other factors could affect Talen Energy's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although Talen Energy attempts to mitigate these risks, it cannot be assured that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future.

Commodity Price Risk (Trading)

Talen Energy's trading commodity derivative contracts range in maturity through 2019. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.

(a) Represents the fair value of contracts at the end of the quarter of their inception.

The following table segregates the net fair value of trading commodity derivative contracts at June 30, 2016, based on the observability of the information used to determine the fair value.

VaR Models

A VaR model is utilized to measure commodity price risk in margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given Talen Energy's disciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the six months ended June 30, 2016 was as follows.

The trading portfolio includes all proprietary trading positions, regardless of the delivery period. All positions not considered proprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at June 30, 2016.

Interest Rate Risk

Talen Energy, directly or through its subsidiaries, may issue debt to finance its operations, which would expose it to interest rate risk. Talen Energy may utilize various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio, adjust the duration of its debt portfolio and lock in components of current market interest rates in anticipation of future financing, when appropriate. Risk limits under the risk management policy are designed to mitigate interest rate exposure and volatility in interest expense.

Talen Energy had no interest rate hedges outstanding at June 30, 2016.

Talen Energy is exposed to a potential increase in interest expense and to changes in the fair value of its debt portfolio. The estimated impact of a 10% adverse movement in interest rates at June 30, 2016 would cause an insignificant increase in interest expense and a $108 million increase in the fair value of debt.

NDT Funds - Securities Price Risk

In connection with certain NRC requirements, Susquehanna Nuclear maintains trust funds to fund certain costs of decommissioning the Susquehanna Nuclear plant. At June 30, 2016, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the balance sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna Nuclear's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. Talen Energy actively monitors the investment performance and periodically reviews asset allocation in accordance with its nuclear decommissioning trust policy statement. At June 30, 2016, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $75 million reduction in the fair value of the trust assets. See Notes 13 and 16 to the Financial Statements for additional information regarding the NDT funds.

Credit Risk

See Notes 13 and 14 to the Financial Statements and "Risk Management - Credit Risk" in Talen Energy's 2015 Form 10-K for additional information.

Acquisitions, Development and Divestitures

Talen Energy from time to time evaluates opportunities for potential acquisitions, divestitures and development projects. Development projects are reexamined periodically based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for information on the acquisitions of MACH Gen and RJS Power, the divestitures of the Ironwood, Holtwood, Lake Wallenpaupack and C.P. Crane power plants and the developments regarding the Bell Bend COLA and the Montour co-firing project.

Environmental Matters

The following is a discussion of the more significant environmental matters impacting Talen Energy's business this fiscal year. See "Item 1. Business" in Talen Energy's 2015 Form 10-K for additional information on environmental matters.

NAAQS

Regulations to address more stringent NAAQS for ozone advanced in Pennsylvania in the first quarter of 2016. These regulations became effective in April 2016 and establish reasonably available control technologies (RACT) for nitrogen oxide and volatile organic compound emissions from fossil-fuel fired power plants. Affected sources must comply by January 1, 2017, unless a compliance extension is granted under the conditions of the regulations.

The Delaware Department of Natural Resources and Environmental Control recently petitioned the EPA to find that emissions from the Brunner Island plant are significantly contributing to the nonattainment of the 2008 and 2015 eight-hour NAAQS for ozone. If the EPA grants the petition, Talen Energy would be required to reduce nitrogen dioxide emissions at Brunner Island that significantly contribute to ozone exceedances in Delaware. This petition is similar to one filed recently by the Connecticut Department of Energy & Environmental Protection asking the EPA to find that emissions from Brunner Island are significantly contributing to the nonattainment of the 2008 ozone NAAQS in Connecticut. The Clean Air Act requires the EPA to respond to these petitions within 60 days and after a public hearing. Talen Energy is evaluating the above petitions and is unable to determine at this time, whether either of them will be granted or denied by the EPA or the impact, if any, on Talen Energy's financial condition or operations.

Pertaining to the EPA's 2010 NAAQS for sulfur dioxide, the EPA and Sierra Club entered into an approved consent decree on March 2, 2015 that establishes deadlines for remaining area designations. Several of Talen's affected plants are in undesignated areas and various actions occurred in the second quarter of 2016 to advance these characterizations.

Compliance with Pennsylvania RACT regulations, or other regulations that could be developed to address the NAAQS established by the EPA, including their 2010 sulfur dioxide standard and 2008 and 2015 ozone standards, could lead to increased capital and/or operation and maintenance expenses for Talen Energy's fossil-fuel fired power plants.

GHG Regulations

The EPA's final rules for new and existing power plants were published in the Federal Register in October 2015, along with a proposed federal implementation plan for those states that fail to submit an acceptable state implementation plan for the existing plant rule. The EPA's existing plant rule was stayed by the U.S. Supreme Court in the first quarter of 2016 pending the outcome of other legal challenges to the rule. The new plant rule remains in effect and challenges are also outstanding in federal court. Talen Energy is unable to determine if the rules will have a material adverse effect on Talen Energy's financial condition or results of operations, but increased capital and operation and maintenance costs could be imposed.

ELGs and Standards

The EPA's final ELG regulations (the Regulation) that revise discharge limitations for steam electric generation wastewater permits became effective in January 2016. The Regulation contains requirements that could significantly impact Talen Energy's coal-fired power plants. At this point, Talen Energy is preparing a compliance plan for the new ELG requirements as part of the discharge permit renewals underway with its state permitting agencies. Those compliance plans, if accepted by permitting agencies and incorporated into the renewed permits, may defer any significant compliance costs until 2021 through 2023. The ultimate compliance costs, which could range from approximately $110 million to $135 million, may be lower depending upon the outcome of other plant specific operational changes and other compliance obligations that will impact the plants prior to implementation of the ELG compliance plans. The final ELG Regulation is being challenged in federal court.

New Accounting Guidance

See Notes 2 and 18 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.

Application of Critical Accounting Policies

Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. Certain accounting policies are particularly important to an understanding of the reported financial condition or results of operations, and require management to make estimates or other judgments of matters that are inherently uncertain, including policies for defined benefits, income taxes, asset impairments (excluding investments), AROs, business combinations and price risk management.

See "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations," in Talen Energy's 2015 Form 10-K for a discussion of each critical accounting policy.

TALEN ENERGY CORPORATION

TALEN ENERGY SUPPLY, LLC

Reference is made to "Risk Management" in "Item 2. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations."

(a) Evaluation of Disclosure Controls and Procedures.

Disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their desired control objectives. The registrants' principal executive officers and principal financial officers, based on their evaluation of the registrants' disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) have concluded for their respective companies that, as of June 30, 2016, the registrants' disclosure controls and procedures were effective, at the reasonable assurance level, to ensure that information required to be disclosed by each registrant in the reports filed by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms and that such information is accumulated and communicated to management, including the principal executive and principal financial officers, to allow for timely decisions regarding required disclosure.

(b) Change in Internal Controls over Financial Reporting.

Reference is made to "Item 9A. Controls and Procedures" of Talen Energy's 2015 Form 10-K for a discussion regarding on-going assessments of internal control over financial reporting relating to the RJS Power and MACH Gen acquisitions that occurred during 2015. During the second fiscal quarter of 2016, the registrants continued to transition the processes, information technology systems, and other components of internal control over financial reporting of RJS Power and MACH Gen to the internal control structure of the registrants. The registrants have expanded their consolidation and disclosure controls and procedures related to the acquired companies, and the registrants continue to assess the current internal control over financial reporting at RJS and MACH Gen. Except for those items, there were no changes in the registrants' internal controls over financial reporting that occurred during the second fiscal quarter of 2016 that have materially affected, or are reasonably likely to materially affect, the registrants' internal control over financial reporting.

Talen Energy's 2015 Form 10-K and Form 10-Q for the quarter ended March 31, 2016, including the sections titled "Risk Factors" and "Forward-Looking Information," contain detailed discussions of certain risks and uncertainties that could materially adversely affect Talen Energy's business, operating results, or financial condition.

On June 2, 2016, Talen Energy Corporation entered into an Agreement and Plan of Merger (the Merger Agreement) with RPH Parent LLC, SPH Parent LLC, CRJ Parent LLC (each, an affiliate of Riverstone, and collectively referred to as "Parent"), and RJS Merger Sub Inc. (a wholly owned subsidiary of Parent referred to as "Merger Sub"), pursuant to which Merger Sub will merge with and into Talen Energy Corporation (the Merger), with Talen Energy Corporation continuing as the surviving corporation on the terms and conditions set forth in the Merger Agreement.

The following risk factors, which are related to the Merger, supplement and should be read in conjunction with the risks and uncertainties addressed in those prior filings.

Failure to complete the Merger, as a result of the failure to obtain necessary stockholder or regulatory approvals or otherwise, could negatively impact Talen Energy's business and the market price of Talen Energy Corporation's common stock.

If the Merger is not completed for any reason, Talen Energy will be subject to a number of material risks, including the disruption to its business resulting from the announcement of the signing of the Merger Agreement, the diversion of management's attention from Talen Energy's day-to-day business, expenses incurred in connection with the proposed Merger and the restrictions imposed by the Merger Agreement on the operation of Talen Energy's business during the period before the completion of the Merger, which may make it difficult for Talen Energy to achieve its business goals if the Merger does not occur.

If the Merger is not approved by Talen Energy Corporation's stockholders or if the Merger is not completed for any other reason, Talen Energy Corporation's stockholders will not receive any payment for their shares in connection with the Merger. Instead, Talen Energy Corporation will remain an independent public company, and the shares will continue to be traded on the NYSE. In addition, if the Merger is not completed, Talen Energy expects that management will operate Talen Energy's business in a manner similar to that in which it is being operated today and that Talen Energy Corporation's stockholders will continue to be subject to the same risks and opportunities to which they are currently subject, including, without limitation, risks related to the competitive power generation industry in which Talen Energy operates and adverse economic conditions.

Furthermore, if the Merger is not completed, and depending on the circumstances that would have caused the Merger not to be completed, the price of the shares of Talen Energy Corporation's common stock may decline significantly. If that were to occur, it is uncertain when, if ever, the price of the shares would return to the prices at which the shares currently trade. Accordingly, if the Merger is not completed, there can be no assurance as to the effect of these risks and opportunities on the future value of shares held by Talen Energy Corporation stockholders. If the Merger is not completed, Talen Energy Corporation's board of directors will continue to evaluate and review Talen Energy's business operations, properties and capitalization, among other things, make such changes as it deems appropriate and continue to seek to identify opportunities to enhance stockholder value. If the Merger is not approved by Talen Energy Corporation's stockholders or if the Merger is not completed for any other reason, there can be no assurance that any other transaction acceptable to Talen Energy Corporation will be offered or that Talen Energy's business, prospects or results of operation will not be adversely impacted.

Failure to complete the Merger could trigger the payment of a termination fee.

The Merger Agreement contains certain termination rights, including the right of Talen Energy Corporation to terminate the Merger Agreement to accept a superior proposal, subject to specified limitations, and provides that, upon termination of the Merger Agreement by Talen Energy Corporation or Parent upon specified conditions, Talen Energy Corporation will be required to pay Parent a termination fee of up to $50 million, or less under specified conditions. See "Item 2. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview - Merger Agreement" for additional information.

Uncertainties associated with the Merger may cause Talen Energy to lose key customers or suppliers and make it more difficult to retain and hire key personnel.

As a result of the uncertainty surrounding the conduct of Talen Energy's business following the completion of the Merger, prior to the Merger, Talen Energy may lose key customers and suppliers. In addition, Talen Energy's employees may be uncertain about their future roles and relationships with Talen Energy following the completion of the Merger, which may adversely affect Talen Energy's ability to retain them or to hire new employees.