# Talen Energy Corp (TLN) FY 2015 MD&A Verbatim Item 7 Management's Discussion and Analysis from Talen Energy Corp's 10-K for fiscal year 2015. SEC filing source: https://www.sec.gov/Archives/edgar/data/1622536/000162253616000111/tln-20151231x10k.htm Accession: 0001622536-16-000111 Filing date: 2016-02-29 Report date: 2015-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/TLN/ All MD&A years: /company/TLN/mda/ Next year: /company/TLN/mda/fy2024/ (FY 2024) Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations This "Item 7. 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 registrant or subsidiary 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. Each disclosure referring to a subsidiary applies to both Talen Energy Corporation and Talen Energy Supply and each disclosure referring to Talen Energy Supply applies to Talen Energy Corporation through consolidation. Talen Energy Corporation's obligation to report under the Securities and Exchange Act of 1934, as amended, commenced on May 1, 2015, the date Talen Energy Corporation's Registration Statement on Form S-1 relating to the spinoff transaction was declared effective by the SEC. Talen Energy Supply is a separate registrant and considered the predecessor of Talen Energy Corporation, and therefore, the financial information prior to June 1, 2015 presented in this Annual Report on Form 10-K 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 Annual Report on Form 10-K for 2015 represents twelve months of legacy Talen Energy Supply information consolidated with seven months of RJS information from June 1, 2015, while 2014 and 2013 represent only legacy Talen Energy Supply information. The following should be read in conjunction with the registrants' Consolidated Financial Statements and accompanying Notes.  Capitalized terms and abbreviations are defined in the glossary.  Dollars are in millions, except per share data, unless otherwise noted. "Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information: [[GREPCENT_TABLE]] [["\u2022","\"Overview,\" which provides Talen Energy's business strategy, key performance measures, an executive summary and a discussion of key competitive power business dynamics."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","\"Results of Operations\" includes \"Statement of Income Analysis,\" which addresses significant changes in principal line items on the Statements of Income comparing 2015 with 2014 and 2014 with 2013 on a GAAP basis. The \"Margins\" discussion, presented by segment, includes a reconciliation of this non-GAAP financial measure to operating income (loss). The \"EBITDA and Adjusted EBITDA\" discussion, also presented by segment, includes a reconciliation of these non-GAAP financial measures to operating income (loss) and consolidated net income (loss)."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","\"Financial Condition - Liquidity and Capital Resources\" provides an analysis of Talen Energy's liquidity positions and credit profiles. This section also includes a discussion of forecasted sources and uses of cash as well as rating agencies and credit considerations."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","\"Financial Condition - Risk Management\" provides an explanation of the risk management policy relating to Talen Energy's market and credit risk."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","\"Application of Critical Accounting Policies\" provides an overview of the accounting policies that are particularly important to the results of operations and financial condition of Talen Energy and that require management to make significant estimates, assumptions and other judgments of inherently uncertain matters."]] [[/GREPCENT_TABLE]] Overview 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 17,400 MW at December 31, 2015, principally located in the Northeast, Mid-Atlantic and Southwest regions of the U.S. See "Item 2. Properties" for additional information on Talen Energy's power plants. For a more detailed description of Talen Energy's business, see "Item 1. Business." 32 Table of Contents Business Strategy Talen Energy seeks to optimize the value from its competitive power generation assets and marketing portfolio 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. 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 years ended December 31 were as follows. [[GREPCENT_TABLE]] [["","2015","","2014","","$ Change"],["Net Income (Loss)","$","(341",")","","$","410","","","$","(751",")"],["Operating Income (Loss)","(39",")","","397","","","(436",")"],["Adjusted EBITDA","1,002","","","759","","","243"],["Margins","1,899","","","1,653","","","246"]] [[/GREPCENT_TABLE]] See "Results of Operations" for a detailed analysis of Talen Energy's results, the definitions of Margins and Adjusted EBITDA and a reconciliation of these non-GAAP measures to related GAAP measures. Executive Summary The increase in Margins, a primary driver to changes in the other three earnings measures reflected above, was primarily due to a $237 million increase related to the RJS and MACH Gen generating facilities acquired in 2015. The declines in operating income (loss) and net income (loss) were substantially due to non-cash goodwill and other asset impairment charges recorded in 2015. Net income (loss) was also negatively impacted by an $80 million after-tax charge related to a debt extinguishment in 2015, and net income (loss) in 2014 benefited from a $206 million after-tax gain on the sale of the hydroelectric generating facilities in Montana. See Note 6 to the Financial Statements for additional information on the sale of the hydroelectric generating facilities. Several of the key financial and operational developments that impacted results for the year ended December 31, 2015 were as follows: [[GREPCENT_TABLE]] [["\u2022","Spinoff from PPL - During 2015, Talen Energy incurred certain restructuring, TSA and other charges in connection with the spinoff from PPL. See Note 1 to the Financial Statements for additional information on the spinoff, acquisition and related charges."]] [[/GREPCENT_TABLE]] 33 Table of Contents [[GREPCENT_TABLE]] [["\u2022","Impairment Charges - During 2015, management considered a number of events and changes in circumstances and concluded that impairment assessments for goodwill and certain long-lived assets were necessary. The charges recorded were as follows:"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","","","Pre-tax","","After-tax"],["","","","Third Quarter","","Fourth Quarter","","Total","","Total"],["","Goodwill","","$","466","","","$","(1",")","","$","465","","","$","444"],["","Sapphire plants and C.P. Crane plant","","122","","","67","","","189","","","113"],["","Total","","$","588","","","$","66","","","$","654","","","$","557"]] [[/GREPCENT_TABLE]] In addition to the impairment assessments that resulted in these charges, management also tested its coal-fired generation facilities located primarily within the PJM market for impairment and concluded that the plants were not impaired at December 31, 2015. The recoverability assessment is very sensitive to forward energy and capacity price assumptions as well as forecasted operation and maintenance and capital spending and further declines could negatively impact future testing results. The carrying value of these coal-fired generation facilities was more than $3 billion as of December 31, 2015. See Notes 14 and 16 to the Financial Statements for additional information on the impairment testing that occurred and the charges recorded in 2015. [[GREPCENT_TABLE]] [["\u2022","Loss on Debt Extinguishment - In conjunction with the termination of a remarketing dealer's right to remarket certain senior unsecured notes, Talen Energy recorded a pre-tax charge of $134 million. See Note 5 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Coal Contract Modification - To mitigate the risk of oversupply of coal due to reduced dispatching of coal-fired generation facilities, primarily as a result of the continued decline in natural gas prices. Talen Energy incurred pre-tax charges of $41 million in the third quarter of 2015 to reduce its contracted coal deliveries in 2015 through 2018."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Acquisition of MACH Gen - In November 2015, Talen Energy obtained 2,344 MW (summer rating) of generating capacity with the completion of the acquisition of all of the membership interests of MACH Gen for cash consideration of approximately $600 million. In addition, $578 million of a MACH Gen subsidiary's debt remained outstanding after the acquisition. See Notes 5 and 6 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Divestiture of Talen Renewable Energy - In November 2015, Talen Energy completed the sale of Talen Renewable Energy for $116 million. See Note 6 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Divestiture of Ironwood, Holtwood, Lake Wallenpaupack and C.P. Crane Power Plants - In October 2015, Talen Energy announced the sale 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. Upon completion of these divestitures, Talen Energy will have generated $1.5 billion in pre-tax cash proceeds. The sales of Ironwood and C.P. Crane were completed in February 2016. See Note 6 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Susquehanna Nuclear Plant - The Susquehanna nuclear plant continues to make modifications to address the causes of turbine blade cracking first identified in 2011. Unit 1 completed its planned refueling and turbine inspection outage in June 2014 and installed newly designed shorter last stage blades on one of the low pressure turbines. The same short blade modifications were installed on two of the three turbines on Unit 2 during the spring 2015 scheduled refueling outage. All remaining turbine blade modifications are scheduled to be performed during planned refueling and maintenance outages. The Susquehanna nuclear plant set a single-year generation record and achieved an annualized capacity factor of over 94 percent."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Brunner Island Co-firing Project - Construction is under way and is expected to be completed by the end of 2016. The project is expected to cost $118 million. At December 31, 2015, $23 million of costs associated with the project have been incurred."]] [[/GREPCENT_TABLE]] Key Competitive Power Business Dynamics Electricity, natural gas and capacity prices are significant contributors to the profitability of Talen Energy's portfolio. A discussion of the general factors and current market conditions affecting these commodities and Talen Energy's operations follows. 34 Table of Contents Electricity Prices Electricity prices impact Talen Energy's operations. The price for electricity varies by region and can be influenced by a host of supply and demand factors including, but not limited to, generator availability, market design, fuel prices for power generators, transmission congestion, demand growth and seasonality. In 2015, delivered prices for electricity fell, relative to 2014 delivered prices, across the competitive power markets in which Talen Energy operates, primarily driven by unusual market and weather volatility in the first quarter of 2014 and a continued decline in natural gas prices, which are discussed below. The table below reflects the average around-the-clock day ahead electricity prices at various pricing points located near Talen Energy's power plants for the years ended December 31. [[GREPCENT_TABLE]] [["","2015 (a)","","2014 (a)","","2013 (a)"],["PJM - West Hub","$","35.82","","","$","51.01","","","$","38.42"],["PJM - PPL Zone","33.01","","","52.13","","","38.01"],["PJM - BGE Hub","43.73","","","60.22","","","41.53"],["ERCOT - North","25.31","","","35.74","","","33.19"],["ERCOT - South","25.85","","","36.02","","","33.76"],["NYISO - Zone F","38.00","","","61.19","","","50.47"],["ISO-NE Mass Hub","41.90","","","64.56","","","56.42"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Source: data obtained from applicable ISO/RTO publications."]] [[/GREPCENT_TABLE]] If a decline in electricity prices driven by declining gas prices persists, Talen Energy will likely experience lower energy Margins at its coal-fired and nuclear generation facilities as higher priced hedges expire. To mitigate the impact of the declining Margins on coal-fired and nuclear generation facilities, as described above, Talen Energy is pursuing opportunities to modify certain of its coal-fired generation facilities to be capable of operating on both coal and natural gas, as well as evaluating cost reduction measures at these facilities. In November 2015, the FERC issued an order on "Price Formation" in the energy and ancillary service markets. These changes and future changes signaled by the FERC in that order may eventually improve pricing and thus compensation for generators in the energy and ancillary services markets, but no assurances can be given that will occur. In December 2015, the FERC accepted a previously submitted PJM proposal that permits cost-based offers to exceed $2,000/MWh in certain circumstances but limits cost-based offers to $2,000/MWh for the purpose of setting locational marginal prices. Under the proposal, market-based offers are permitted to rise along with cost-based offers but are not permitted to exceed $2,000/MWh or the corresponding cost-based offers. Moreover, electricity providers will be permitted to recover actual costs above $2,000MWh through make-whole payments. In addition, electricity prices will be permitted to rise to $3,700/MWh during certain shortage pricing events. The changes became effective in December 2015. However, in January 2016, as a part of the Price Formation efforts, the FERC issued a Notice of Proposed Rulemaking (NOPR) for comment which requires each RTO, including PJM, to cap each resource's incremental electricity offer to the higher of $1,000/MWh or that resource's verified cost-based incremental electricity offer. Under this proposal, verified cost-based incremental electricity offers above $1,000/MWh would be used for purposes of calculating Locational Marginal Prices. Comments on this NOPR are due within 60 days and final FERC action on this proposed ruling could modify the above December 2015 acceptance of the PJM proposal. Capacity Prices Capacity prices are another key source of revenue for Talen Energy’s operations. Currently, about 80% of Talen Energy's generation capacity is located in markets with a capacity product, including assets in PJM, NYISO and ISO-NE. Similar to electricity, capacity prices are affected by supply and demand fundamentals such as power plant additions and retirements, imports/exports of capacity from/to adjacent markets, costs associated with plant retrofits, risk premiums associated with penalties for non-performance, demand response products, ISO demand forecasts and reserve margin targets. Over the past three auction cycles, capacity prices have increased in PJM and ISO-NE, primarily attributable to incentive-based changes in the capacity market structures designed to improve operational availability during periods of peak demand. 35 Table of Contents The table below reflects the cleared capacity prices for the zones in which the majority of Talen Energy's plants are located for the three most recent strip auctions. [[GREPCENT_TABLE]] [["","2015/2016 (a)","","2016/2017 (a)","","2017/2018 (a)"],["PJM - MAAC ($/MW-day)","$","167.46","","","$","119.13","","","$","120.00"],["PJM - SWMAAC ($/MW-day)","167.46","","","119.13","","","120.00"],["PJM - RTO ($/MW-day)","136.00","","","59.37","","","120.00"],["PJM Capacity Performance ($/MW-day) (b)","N/A","","","134.00","","","151.50"],["NYISO - Rest of State ($/kW-month) (c)","1.25","","","N/A","","","N/A"],["ISO-NE - Rest of Pool ($/kW-month)","3.43","","","3.15","","","15.00"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Source: data obtained from applicable ISO/RTO publications."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","The capacity performance product percentage of reliability requirements is being phased in through the 2020/2021 auction as described below."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(c)","Represents the 2015/2016 winter strip auction. Auctions beyond 2015/2016 have not yet been conducted."]] [[/GREPCENT_TABLE]] As a result of unusual market and weather volatility in the first quarter of 2014, PJM determined that changes were necessary to ensure system reliability. In December 2014, PJM proposed to add an enhanced Capacity Performance (CP) product to the capacity market structure to permit additional compensation for generation owners/operators to make the necessary investments to maintain system reliability in exchange for stronger performance requirements, with higher penalties for non-performers. In June 2105, the FERC issued an order approving the PJM CP proposal largely as it was filed and the CP product is being phased in through the 2020/2021 auction based on a percentage of capacity to meet reliability requirements. The phase in percentage was set at 60% for 2016/2017, 70% for 2017/2018 and 80% for both 2018/2019 and 2019/2020. 2020/2021 will be the first auction to procure 100% of the CP product. In August 2015, PJM completed the first base residual auction inclusive of a CP product for the planning year 2018/2019 and subsequently, in late August and September 2015, PJM completed the two CP transitional auctions for planning years 2016/2017 and 2017/2018. The first CP product implementation will begin on June 1, 2016 for the portion procured in the 2016/2017 transitional auction. In December 2015, PJM altered its process for forecasting load beginning with the most recent 2016 "Load Processing Report" to reflect a shorter period for historical weather data, updated end usage data, and the inclusion of distributed solar generation. The revised process lowered the load forecast. This reduction in load is expected to put downward pressure on PJM capacity prices. In January 2016, the U.S. Supreme Court reversed the ruling of the U.S. Court of Appeals for the D.C. Circuit Court and upheld the FERC's jurisdiction over rules regarding DR in organized markets. Therefore, DR will be permitted to continue to participate in future PJM energy and capacity auctions. Natural Gas Prices Natural gas prices are a key aspect of the current competitive power environment. The extensive development of major shale formations in the U.S. over the past few years has caused natural gas prices to decline. Power prices have also declined substantially due to the high degree of correlation with natural gas prices, weak general economic conditions and other factors. As a result, Talen Energy has experienced a shift in the dispatching of its generation fleet from coal-fired to gas-fired generation.   Environmental Regulations Talen Energy is subject to extensive federal, state and local environmental laws, rules and regulations, including those pertaining to CCRs, GHG, effluent limitation guidelines and MATS.  In 2015, the EPA published the final rules related to GHG regulations for new and existing power plants that could have a significant industry-wide impact. Talen Energy is in the process of evaluating these rules. See "Financial Condition - Environmental Matters" below for additional information on these requirements.  In 2015, Talen Energy recorded increases to existing AROs of $41 million as a result of a review of the 2015 CCR rule. Further changes to AROs may be required as estimates are refined and compliance with the rule continues. 36 Table of Contents Other Regulatory Matters 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. 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 (since the date of acquisition) are included in Talen Energy's 2015 results with no comparable amounts in 2014 and 2013. When discussing Talen Energy's results of operations for 2015 compared with 2014, the results of RJS are isolated for purposes of comparability (if significant). At acquisition, the Sapphire operations were classified as discontinued operations. However, in November 2015, when the FERC approved the third mitigation package excluding the Sapphire portfolio, the assets and liabilities and operating results were reclassified to held and used and to continuing operations, as it is no longer probable that the Sapphire portfolio will be sold. As a result of the MACH Gen acquisition on November 2, 2015, results for MACH Gen (since the date of acquisition) are included in Talen Energy's 2015 results with no comparable amounts in 2014 and 2013. When discussing Talen Energy's results of operations for 2015 compared with 2014, the results of MACH Gen are isolated for purposes of comparability (if significant). 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. See Note 2 to the Financial Statements for additional information on Talen Energy's segments and the segment reevaluation. The discussion within "Statement of Income Analysis" addresses significant changes in principal line items on the Statements of Income comparing 2015 with 2014 and 2014 with 2013 on a GAAP basis. The "Margins" discussion, presented by segment, includes a reconciliation of that non-GAAP financial measure to operating income(loss). The "EBITDA and Adjusted EBITDA" discussion, also presented by segment, includes a reconciliation of those non-GAAP financial measures to operating income (loss) and consolidated net income (loss). Earnings in future periods are subject to various risks and uncertainties. See "Forward-Looking Information," "Item 1. Business," "Item 1A. Risk Factors," the rest of this "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 11 to the Financial Statements for a discussion of the risks, uncertainties and factors that may impact future earnings. 37 Table of Contents Statement of Income Analysis, Margins, EBITDA and Adjusted EBITDA Statement of Income Analysis -- [[GREPCENT_TABLE]] [["","For the Years Ended December 31,","","","","For the Years Ended December 31,"],["","2015","","2014","","Change","","2014","","2013","","Change"],["Wholesale energy (a) (b) (c)","$","2,828","","","$","2,653","","","$","175","","","$","2,653","","","$","2,890","","","$","(237",")"],["Wholesale energy to affiliate (b)","14","","","84","","","(70",")","","84","","","51","","","33"],["Retail energy (a) (b)","1,095","","","1,243","","","(148",")","","1,243","","","1,027","","","216"],["Energy-related businesses","544","","","601","","","(57",")","","601","","","527","","","74"],["Total Operating Revenues","4,481","","","4,581","","","(100",")","","4,581","","","4,495","","","86"],["Fuel (a) (b) (c)","1,194","","","1,196","","","(2",")","","1,196","","","1,048","","","148"],["Energy purchases (a) (b) (c)","676","","","1,054","","","(378",")","","1,054","","","1,153","","","(99",")"],["Operation and maintenance","1,052","","","1,007","","","45","","","1,007","","","961","","","46"],["Loss on lease termination","\u2014","","","\u2014","","","\u2014","","","\u2014","","","697","","","(697",")"],["Impairments","657","","","\u2014","","","657","","","\u2014","","","65","","","(65",")"],["Depreciation","356","","","297","","","59","","","297","","","299","","","(2",")"],["Taxes, other than income","65","","","57","","","8","","","57","","","53","","","4"],["Energy-related businesses","520","","","573","","","(53",")","","573","","","512","","","61"],["Total Operating Expenses","4,520","","","4,184","","","336","","","4,184","","","4,788","","","(604",")"],["Operating Income (Loss)","(39",")","","397","","","(436",")","","397","","","(293",")","","690"],["Other Income (Expense) - net","(118",")","","30","","","(148",")","","30","","","32","","","(2",")"],["Interest Expense","211","","","124","","","87","","","124","","","159","","","(35",")"],["Income Taxes","(27",")","","116","","","(143",")","","116","","","(159",")","","275"],["Income (Loss) from Continuing Operations After Income Taxes","(341",")","","187","","","(528",")","","187","","","(261",")","","448"],["Income (Loss) from Discontinued Operations (net of income taxes)","\u2014","","","223","","","(223",")","","223","","","32","","","191"],["Net Income (Loss)","(341",")","","410","","","(751",")","","410","","","(229",")","","639"],["Net Income (Loss) Attributable to Noncontrolling Interests","\u2014","","","\u2014","","","\u2014","","","\u2014","","","1","","","(1",")"],["Net Income (Loss) Attributable to Talen Energy Corporation Stockholders","$","(341",")","","$","410","","","$","(751",")","","$","410","","","$","(230",")","","$","640"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Includes the impact from energy-related economic activity. See \"Commodity Price Risk (Non-trading) - Economic Activity\" in Note 15 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","Amounts included in \"Margins\" and are not discussed separately."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(c)","Amounts for prior years have been reclassified to conform to the current presentation. See \"Reclassifications\" in Note 1 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] 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 acquisition of RJS Power, MACH Gen and several items that management believes are not indicative of ongoing operations. See "EBITDA and Adjusted EBITDA" below for information on the items management does not believe are indicative of ongoing operations. Energy-Related Businesses Net contributions to the East segment's operating income (loss) from energy-related businesses decreased by $4 million in 2015 compared with 2014. Net contributions to the East segment's operating income (loss) increased by $13 million in 2014 compared with 2013. During 2014, Talen Energy recorded a $17 million increase to "Energy-related businesses" revenues on the 2014 Statements of Income related to prior periods and the timing of revenue recognition for a mechanical contracting and engineering subsidiary. See Note 1 to the Financial Statements for additional information. Excluding the impact of the 2014 adjustment, the change in 2015 compared with 2014 was an increase of $13 million due to higher margins on existing construction projects at the mechanical contracting and engineering subsidiaries. The change in 2014 compared with 2013 was primarily due to the $17 million revenue adjustment. 38 Table of Contents Operation and Maintenance The increase (decrease) in operation and maintenance was due to: [[GREPCENT_TABLE]] [["","2015 vs. 2014","","2014 vs. 2013"],["East segment:"],["RJS - Raven and Sapphire (a)","$","104","","","$","\u2014"],["MACH Gen - Athens and Millennium (a)","7","","","\u2014"],["Fossil and Hydro (b)","(51",")","","(9",")"],["Nuclear (c)","(21",")","","33"],["Talen Energy Marketing (d)","(25",")","","4"],["Energy Services (e)","(17",")","","4"],["West segment:"],["RJS - Jade (a)","22","","","\u2014"],["MACH Gen - Harquahala (a)","3","","","\u2014"],["Talen Montana (f)","23","","","(20",")"],["Other:"],["Accelerated stock-based compensation (g)","25","","","\u2014"],["TSA costs","29","","","\u2014"],["Restructuring costs (h)","12","","","\u2014"],["Transaction costs (i)","20","","","\u2014"],["Separation benefits (j)","(17",")","","17"],["Separation costs (k)","(14",")","","16"],["Other (l)","(55",")","","1"],["Total","$","45","","","$","46"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","There are no comparable amounts in the 2014 or 2013 periods as RJS was acquired in June 2015 and MACH Gen was acquired in November 2015."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","The decrease for 2015 compared with 2014 and the decrease for 2014 compared with 2013 was primarily due to lower coal plant outage costs."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(c)","The decrease for 2015 compared with 2014 was primarily due to $11 million of lower outage costs and $13 million of lower contractor costs supporting operations. The increase in 2014 compared with 2013 was primarily due to higher contractor costs supporting operations."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(d)","The decrease for 2015 compared with 2014 was primarily due to lower payroll related costs attributable to restructuring activities."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(e)","The decrease for 2015 compared with 2014 was primarily due to the gain on the sale of Talen Renewable Energy in November 2015."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(f)","The increase for 2015 compared with 2014 was primarily due to $8 million of higher coal plant outage costs and $7 million of costs associated with the retirement of the Corette plant in 2015. The decrease in 2014 compared with 2013 was primarily due to the elimination of $20 million of rent expense associated with the Colstrip lease that was terminated in 2013."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(g)","Related to the spinoff transaction. See Note 1 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(h)","The increase for 2015 compared with 2014 was due to costs recorded in 2015 related to the spinoff transaction, including expenses for the FERC-required mitigation plan and legal and professional fees."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(i)","The increase for 2015 compared with 2014 was due to costs recorded in 2015 related to the RJS, MACH Gen and mitigation asset sale transactions."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(j)","The decrease for 2015 compared with 2014 and the increase in 2014 compared with 2013 was due to bargaining unit one-time voluntary retirement benefits recorded in 2014 as a result of the ratification of the IBEW Local 1600 three-year labor agreement in June 2014."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(k)","The decrease for 2015 compared with 2014 and the increase in 2014 compared with 2013 was primarily due to costs incurred in 2014 related to restructuring in anticipation of the spinoff, which included cash severance compensation, lump sum COBRA reimbursement payments and outplacement services."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(l)","The decrease for 2015 compared with 2014 was primarily due to lower corporate expenses."]] [[/GREPCENT_TABLE]] Loss on Lease Termination A $697 million charge was recorded in 2013 for the termination of the Colstrip operating lease to facilitate the sale of the Montana hydroelectric generating facilities. See Note 6 to the Financial Statements for additional information. Impairments Impairments in 2015 primarily include a $465 million goodwill impairment, a $175 million impairment of the Sapphire plants and a $14 million impairment of the C.P. Crane plant (all included in the East segment). 2013 includes a $65 million impairment of the Corette plant (included in the West segment). These impairments exclude those recorded to "Income (Loss) from Discontinued Operations (net of income taxes)" on the 2014 Statement of Income. See Note 16 to the Financial Statements for additional information. 39 Table of Contents Depreciation Depreciation increased by $59 million in 2015 compared with 2014, primarily due to increases in the East and West segments of $31 million and $25 million, primarily related to the acquisitions of RJS Power and MACH Gen. There are no comparable amounts in 2014 and 2013 for RJS or MACH Gen as their acquisition occurred in 2015. Depreciation decreased by $2 million in 2014 compared with 2013, primarily due to an $8 million increase in the East segment and a $10 million decrease in the West segment. The increase in the East segment was partially due to $13 million from PP&E additions in part due to the completed Holtwood expansion project in 2013. The decrease in the West segment was primarily due to decreases from the impairment of the Corette plant and the write off of leasehold improvement assets in conjunction with the termination of the operating lease at the Colstrip facility, both of which occurred in 2013. See Note 14 to the Financial Statements for additional information on the Corette impairment and Note 6 to the Financial Statements for information on the Colstrip operating lease termination. Taxes, Other Than Income Taxes, other than income increased by $8 million for 2015 compared with 2014. This increase was primarily due to $11 million related to RJS, $7 million impacting the East segment and $4 million impacting the West segment. Taxes other than income increased by $4 million in 2014 compared with 2013, within the East segment. There are no comparable amounts in 2014 and 2013 for RJS as the acquisition occurred in 2015. Other Income (Expense) - net Other income (expense) - net decreased by $148 million in 2015 compared with 2014 and decreased by $2 million in 2014 compared with 2013. The decrease in 2015 compared with 2014 was primarily due to the recording of a $134 million charge for a termination payment to a remarketing dealer related to an October 2015 debt extinguishment and a $9 million decrease in 2015 in net earnings on the NDT funds. See Note 5 for additional information on the debt extinguishment. The decrease in 2014 compared with 2013 resulted from 2013 including a gain of $8 million related to adjustments to liabilities for a former mining subsidiary partially offset by a $5 million increase in 2014 in net earnings on the NDT funds. Interest Expense The increase (decrease) in interest expense was due to: [[GREPCENT_TABLE]] [["","2015 vs. 2014","","2014 vs. 2013"],["Long-term debt interest expense (a)","$","56","","","$","(50",")"],["MACH Gen (b)","6","","","\u2014"],["Short-term debt interest expense","11","","","7"],["Capitalized interest (c)","3","","","14"],["Net amortization of debt discounts, premiums and issuance costs (d)","11","","","(4",")"],["Other","\u2014","","","(2",")"],["Total","$","87","","","$","(35",")"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","The increase in 2015 compared with 2014 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 August 2014. The increase in expense from the RJS Power related debt was $35 million. See Note 6 to the Financial Statements for information on the acquisition. The decrease in 2014 compared with 2013 was primarily due to the repayment of debt in July and December 2013."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","Represents interest on long-term debt. There are no comparable amounts in the 2014 or 2013 periods as MACH Gen was acquired in November 2015. See Note 6 to the Financial Statements for additional information on the acquisition."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(c)","The increase in 2014 compared with 2013 was primarily due to the Holtwood hydroelectric expansion project placed in service in November 2013."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(d)","The increase in 2015 compared with 2014 was due to the write-off of fees associated with Talen Energy Supply's $3 billion syndicated credit facility that was terminated in connection with the spinoff."]] [[/GREPCENT_TABLE]] 40 Table of Contents Income Taxes The increase (decrease) in income taxes was due to: [[GREPCENT_TABLE]] [["","2015 vs. 2014","","2014 vs. 2013"],["Change in pre-tax income at current tax rates (a)","$","(36",")","","$","298"],["RJS (b)","(49",")","","\u2014"],["MACH Gen (b)","(5",")","","\u2014"],["Federal and state uncertain tax benefits recognized (c)","(12",")","","\u2014"],["State deferred tax rate change (d)","(16",")","","(16",")"],["Goodwill impairment (e)","(21",")","","\u2014"],["Federal income tax credits (f)","(9",")","","8"],["Federal and state tax return adjustments","(7",")","","(6",")"],["Other","12","","","(9",")"],["Total","$","(143",")","","$","275"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Excludes income taxes related to RJS and MACH Gen as there are no comparable amounts in 2014 or 2013 as their acquisition occurred in 2015. Also excludes the impact of the goodwill impairment recorded in 2015 because the effective tax rate on the impairment does not bear a customary relationship to the recognized loss as a result of a significant portion of the impairment being related to non-deductible goodwill."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","There are no comparable amounts in the 2014 or 2013 periods as RJS was acquired in June 2015 and MACH Gen was acquired in November 2015."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(c)","In 2015, open audits for the tax years 2008 - 2011 were settled by PPL with the IRS resulting in a tax benefit of $12 million for Talen Energy's portion of the settlement of previously unrecognized tax benefits."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(d)","During 2015, 2014 and 2013, Talen Energy recorded adjustments related to its December 31 state deferred tax liabilities as a result of annual changes in state apportionment and the impact on the future estimated state income tax rate."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(e)","Federal and state tax impacts attributable to the deductible portion of goodwill that was impaired during the third quarter of 2015. See Note 16 to the Financial Statements for additional information on the goodwill impairment."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(f)","During 2015, Talen Energy recorded a benefit primarily related to the recognition of previously unamortized tax credits as a result of the sale of Talen Renewable Energy in November 2015. During 2013, Talen Energy recorded a deferred tax benefit related to investment tax credits on progress expenditures for the Holtwood hydroelectric plant expansion. See Note 6 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] See Note 4 to the Financial Statements for additional information. Income (Loss) from Discontinued Operations (net of income taxes) Income (Loss) from Discontinued Operations (net of income taxes) for 2014 and 2013 includes the Montana hydroelectric generating facilities which were sold in November 2014.  See Note 6 to the Financial Statements for additional information.   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, energy purchases, certain operation and maintenance expenses, primarily ancillary charges, and gross receipts tax, recorded in "Taxes, other than income." 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 "Energy purchases" on the Statements of Income. This performance measure includes PLR revenues from energy sales to PPL Electric by Talen Energy Marketing, which prior to June 1, 2015, are reflected in "Wholesale energy to affiliate" in the reconciliation table below. "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 41 Table of Contents 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 years ended December 31. [[GREPCENT_TABLE]] [["","2015","","2014"],["","East Segment","","West Segment","","Reconciling Items (a)","","Operating Income (b)","","East Segment","","West Segment","","Reconciling Items (a)","","Operating Income (b)"],["Operating Revenues"],["Wholesale energy","$","2,531","","","$","222","","","$","75","(c)","","$","2,828","","","$","2,496","","","$","96","","","$","61","(c)","","$","2,653"],["Wholesale energy to affiliate (d)","14","","","\u2014","","","\u2014","","","14","","","84","","","\u2014","","","\u2014","","","84"],["Retail energy","1,039","","","73","","","(17",") (c)","","1,095","","","1,135","","","81","","","27","(c)","","1,243"],["Energy-related businesses","\u2014","","","\u2014","","","544","","","544","","","\u2014","","","\u2014","","","601","","","601"],["Total Operating Revenues","3,584","","","295","","","602","","","4,481","","","3,715","","","177","","","689","","","4,581"],["Operating Expenses"],["Fuel","1,038","","","120","","","36","(c)","","1,194","","","1,097","","","72","","","27","(c)","","1,196"],["Energy purchases","723","","","34","","","(81",") (c)","","676","","","971","","","26","","","57","(c)","","1,054"],["Operation and maintenance","16","","","\u2014","","","1,036","","","1,052","","","22","","","\u2014","","","985","","","1,007"],["Impairments (Note 16)","\u2014","","","\u2014","","","657","","","657","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Depreciation","\u2014","","","\u2014","","","356","","","356","","","\u2014","","","\u2014","","","297","","","297"],["Taxes, other than income","41","","","\u2014","","","24","","","65","","","43","","","\u2014","","","14","","","57"],["Energy-related businesses","8","","","\u2014","","","512","","","520","","","8","","","\u2014","","","565","","","573"],["Total Operating Expenses","1,826","","","154","","","2,540","","","4,520","","","2,141","","","98","","","1,945","","","4,184"],["Total","$","1,758","","","$","141","","","$","(1,938",")","","$","(39",")","","$","1,574","","","$","79","","","$","(1,256",")","","$","397"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","2013"],["","East Segment","","West Segment","","Reconciling Items (a)","","Operating Income (b)"],["Operating Revenues"],["Wholesale energy","$","3,086","","","$","98","","","$","(294",") (c)","","$","2,890"],["Wholesale energy to affiliate (d)","51","","","\u2014","","","\u2014","","","51"],["Retail energy","933","","","82","","","12","(c)","","1,027"],["Energy-related businesses","\u2014","","","\u2014","","","527","","","527"],["Total Operating Revenues","4,070","","","180","","","245","","","4,495"],["Operating Expenses"],["Fuel","966","","","78","","","4","(c)","","1,048"],["Energy purchases","1,265","","","23","","","(135",") (c)","","1,153"],["Operation and maintenance","20","","","\u2014","","","941","","","961"],["Loss on lease termination","\u2014","","","\u2014","","","697","","","697"],["Impairments","\u2014","","","\u2014","","","65","","","65"],["Depreciation","\u2014","","","\u2014","","","299","","","299"],["Taxes, other than income","37","","","\u2014","","","16","","","53"],["Energy-related businesses","7","","","\u2014","","","505","","","512"],["Total Operating Expenses","2,295","","","101","","","2,392","","","4,788"],["Total","$","1,775","","","$","79","","","$","(2,147",")","","$","(293",")"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Represents amounts excluded from Margins."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","As reported on the Statements of Income."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(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 15 to the Financial Statements. Also includes unrealized gains (losses) on trading activity of $(37) million, $27 million and $(6) million for 2015, 2014 and 2013. Amounts have been adjusted for option premiums of $8 million and $(10) million for 2015 and 2014. To mitigate the risk of oversupply, Talen Energy incurred charges of $41 million during 2015 to reduce its contracted coal deliveries, which is also included in this amount. See Note 11 to the Financial Statements for additional information. 2015 also includes net realized gains on certain derivative contracts that were early-terminated of $13 million and a prior period revenue adjustment of $(7)"]] [[/GREPCENT_TABLE]] 42 Table of Contents million. See Note 1 to the Financial Statements for additional information on the revenue adjustment. 2015, 2014 and 2013 includes OCI amortization on non-active derivative positions of $(11) million, $(11) million and $(13) million. [[GREPCENT_TABLE]] [["(d)","Amounts recorded prior to the spinoff for activity with PPL Electric."]] [[/GREPCENT_TABLE]] Changes in Margins The following table shows Margins by segment for the years ended December 31, as well as the change between periods. Margins do not include operations related to those assets classified as discontinued operations. The factors that gave rise to the changes are described following the table. [[GREPCENT_TABLE]] [["","","","Change"],["","2015","","2014","","2013","","2015 vs. 2014","","2014 vs. 2013"],["East segment","$","1,758","","","$","1,574","","","$","1,775","","","$","184","","","$","(201",")"],["West segment","141","","","79","","","79","","","62","","","\u2014"],["Total","$","1,899","","","$","1,653","","","$","1,854","","","$","246","","","$","(201",")"]] [[/GREPCENT_TABLE]] East Segment East segment Margins increased $162 million in 2015 from the Raven and Sapphire portfolios. There are no comparable amounts in the 2014 or 2013 periods as the acquisition of Raven and Sapphire occurred during 2015. Excluding the impact of the Raven, Sapphire and MACH Gen acquisitions, East segment Margins increased in 2015 compared with 2014 by $22 million primarily due to higher realized energy prices of $68 million, improved spark spreads of $59 million, higher nuclear availability of $51 million and lower average fuel prices of $24 million, substantially offset by lower capacity prices of $55 million, gains realized in 2014 on certain commodity positions of $46 million, the net effect of unusual market and weather volatility in the first quarter of 2014 as discussed below of $38 million, lower volumes on full-requirement sales contracts of $25 million and retail electric activity of $12 million. East segment Margins decreased in 2014 compared with 2013 primarily due to lower realized energy prices of $354 million and lower capacity prices of $34 million, partially offset by favorable asset performance of $70 million, gains realized in 2014 on certain commodity positions of $46 million, unusual market and weather volatility in 2014 as discussed below of $38 million and gas optimization of $26 million. During the first quarter of 2014, the PJM region experienced unusually cold weather conditions, higher demand and congestion patterns, causing rising natural gas and electricity prices in spot and near-term forward markets. Due to these market dynamics, Talen Energy captured opportunities on unhedged generation, which were offset primarily by losses incurred by under-hedged full-requirement sales contracts and retail electric portfolios, which were not fully hedged or able to be fully hedged given the higher load conditions and lack of market liquidity. West Segment West segment Margins increased $68 million in 2015 compared with 2014 from the Jade portfolio. There are no comparable amounts in the 2014 and 2013 periods as the acquisition of Jade occurred during 2015. EBITDA and Adjusted EBITDA In addition to operating income (loss), EBITDA and Adjusted EBITDA, non-GAAP financial measures are other 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, 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 U.S. GAAP as indicators of operating performance and are not necessarily comparable to similarly- 43 Table of Contents 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 tables below provide 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 years ended December 31. [[GREPCENT_TABLE]] [["","2015","","2014"],["","East Segment","","West Segment","","Other","","Total","","East Segment","","West Segment","","Other","","Total"],["Net income (loss)","","","","","","","$","(341",")","","","","","","","","$","410"],["(Income) loss from discontinued operations (net of tax)","","","","","","","\u2014","","","","","","","","","(223",")"],["Interest expense","","","","","","","211","","","","","","","","","124"],["Income taxes","","","","","","","(27",")","","","","","","","","116"],["Other (income) expense - net","","","","","","","118","","","","","","","","","(30",")"],["Operating income (loss)","$","198","","","$","2","","","$","(239",")","","$","(39",")","","$","558","","","$","71","","","$","(232",")","","$","397"],["Depreciation","327","","","26","","","3","","","356","","","296","","","1","","","\u2014","","","297"],["Other income (expense) - net","19","","","(2",")","","(135",")","","(118",")","","29","","","\u2014","","","1","","","30"],["EBITDA","$","544","","","$","26","","","$","(371",")","","$","199","","","$","883","","","$","72","","","$","(231",")","","$","724"],["Unrealized (gain) loss on derivative contracts (a)","(175",")","","25","","","\u2014","","","(150",")","","15","","","(32",")","","\u2014","","","(17",")"],["Stock-based compensation expense (b)","\u2014","","","\u2014","","","40","","","40","","","\u2014","","","\u2014","","","18","","","18"],["(Gain) loss from NDT funds","(15",")","","\u2014","","","\u2014","","","(15",")","","(26",")","","\u2014","","","\u2014","","","(26",")"],["ARO accretion","33","","","1","","","\u2014","","","34","","","32","","","\u2014","","","\u2014","","","32"],["Coal contract adjustment (c)","41","","","\u2014","","","\u2014","","","41","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Impairments (d)","657","","","\u2014","","","\u2014","","","657","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["REPS Remarketing","\u2014","","","\u2014","","","134","","","134","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Mechanical subsidiary revenue adjustment (e)","\u2014","","","\u2014","","","\u2014","","","\u2014","","","(17",")","","\u2014","","","\u2014","","","(17",")"],["TSA costs","\u2014","","","\u2014","","","29","","","29","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Separation benefits (f)","\u2014","","","\u2014","","","2","","","2","","","\u2014","","","\u2014","","","33","","","33"],["Corette closure costs (g)","\u2014","","","4","","","\u2014","","","4","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Terminated derivative contracts (h)","(13",")","","\u2014","","","\u2014","","","(13",")","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Revenue adjustment (i)","7","","","\u2014","","","\u2014","","","7","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Transaction costs","\u2014","","","\u2014","","","20","","","20","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Restructuring costs (j)","\u2014","","","\u2014","","","12","","","12","","","\u2014","","","\u2014","","","1","","","1"],["Other (k)","1","","","\u2014","","","\u2014","","","1","","","11","","","\u2014","","","\u2014","","","11"],["Adjusted EBITDA","$","1,080","","","$","56","","","$","(134",")","","$","1,002","","","$","898","","","$","40","","","$","(179",")","","$","759"]] [[/GREPCENT_TABLE]] 44 Table of Contents [[GREPCENT_TABLE]] [["","2013"],["","East Segment","","West Segment","","Other","","Total"],["Net income (loss)","","","","","","","$","(230",")"],["(Income) loss from discontinued operations (net of tax)","","","","","","","(32",")"],["Noncontrolling interest","","","","","","","1"],["Interest expense","","","","","","","159"],["Income taxes","","","","","","","(159",")"],["Other (income) expense - net","","","","","","","(32",")"],["Operating income (loss)","$","652","","","$","(750",")","","$","(195",")","","$","(293",")"],["Depreciation","288","","","11","","","\u2014","","","299"],["Other income (expense) - net","30","","","\u2014","","","2","","","32"],["Noncontrolling interest","(1",")","","\u2014","","","\u2014","","","(1",")"],["EBITDA","$","969","","","$","(739",")","","$","(193",")","","$","37"],["Unrealized (gain) loss on derivative contracts (a)","133","","","3","","","\u2014","","","136"],["Stock-based compensation expense (b)","\u2014","","","\u2014","","","16","","","16"],["(Gain) loss from NDT funds","(22",")","","\u2014","","","\u2014","","","(22",")"],["ARO accretion","29","","","\u2014","","","\u2014","","","29"],["Impairments (d)","\u2014","","","65","","","\u2014","","","65"],["Loss on lease termination (Note 6)","\u2014","","","697","","","\u2014","","","697"],["Other (k)","13","","","(2",")","","\u2014","","","11"],["Adjusted EBITDA","$","1,122","","","$","24","","","$","(177",")","","$","969"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Represents unrealized gains (losses) on derivatives. See \"Commodity Price Risk (Non-trading) - Economic Activity\" and \"Commodity Price Risk (Trading)\" in Note 15 to the Financial Statements for additional information on derivatives. Amounts have been adjusted for option premiums of $8 million and $(10) million for 2015 and 2014."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","2015 includes a charge for the acceleration of expense as a result of the spinoff. See Note 1 to the Financial Statements for additional information. For periods prior to June 2015, represents the portion of PPL's stock-based compensation cost allocable to Talen Energy. Amounts prior to June 2015 were cash settled with a former affiliate."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(c)","To mitigate the risk of oversupply, Talen Energy incurred pre-tax charges of $41 million in 2015 in connection with an agreement to reduce its contracted coal deliveries. See Note 11 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(d)","2015 includes charges for goodwill and certain long-lived assets. 2013 includes a charge for the Corette plant and related emission allowances. See Notes 14 and 16 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(e)","In 2014, Talen Energy recorded $17 million to \"Energy-related businesses\" revenues related to prior periods and the timing of revenue recognition for a mechanical contracting and engineering subsidiary. See Note 1 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(f)","In June 2014, Talen Energy Supply's largest IBEW local ratified a new three-year labor agreement. In connection with the new agreement, estimated bargaining unit one-time voluntary retirement benefits of $17 million were recorded. In addition, 2014 includes separation costs of $16 million related to the spinoff transaction."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(g)","Operations were suspended and the Corette plant was retired in March 2015."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(h)","Represents net realized gains on certain derivative contracts that were early-terminated due to the spinoff transaction."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(i)","Relates to a prior period revenue adjustment for the receipt of revenue under a transmission operating agreement with Talen Energy Supply's former affiliate, PPL Electric. See Note 1 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(j)","Costs related to the spinoff transaction, including expenses associated with the FERC-required mitigation and legal and professional fees."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(k)","All periods include OCI amortization on non-active derivative positions and 2015 includes a gain on the sale of Talen Renewable Energy."]] [[/GREPCENT_TABLE]] Changes in Adjusted EBITDA The following table shows Adjusted EBITDA by segment for the years ended December 31 as well as the change between periods. The factors that gave rise to the changes are described following the table. [[GREPCENT_TABLE]] [["","","","Change"],["","2015","","2014","","2013","","2015 vs. 2014","","2014 vs. 2013"],["East","$","1,080","","","$","898","","","$","1,122","","","$","182","","","$","(224",")"],["West","56","","","40","","","24","","","16","","","16"],["Other","(134",")","","(179",")","","(177",")","","45","","","(2",")"],["Total","$","1,002","","","$","759","","","$","969","","","$","243","","","$","(210",")"]] [[/GREPCENT_TABLE]] 45 Table of Contents East Segment The increase in the East segment in 2015 compared with 2014 was primarily due to higher Margins driven by the addition of the Raven and Sapphire operations, higher realized energy prices, improved spark spreads, higher nuclear availability and lower average fuel prices. These factors were partially offset by lower capacity prices, gains that were realized in 2014 on certain commodity positions, the net effect of unusual market and weather volatility in the first quarter of 2014, lower volumes on full-requirements sales contracts, and retail electric sales activity. The net improvements in Margins were partially offset by higher operation and maintenance expenses, reflecting the addition of the Raven and Sapphire operations partially offset by lower outage costs for coal-fired units and other cost reductions attributable to the spinoff from PPL. The decrease in the East segment in 2014 compared with 2013 was primarily due to lower Margins driven by lower realized energy and capacity prices, partially offset by favorable asset performance, gains on certain commodity positions and net benefits of unusual market and weather volatility in the first quarter of 2014. West Segment The increase in the West segment in 2015 compared with 2014 was primarily due to the addition of the Jade operations in Texas, partially offset by higher coal-fired plant outage costs. The increase in the West segment in 2014 compared with 2013 was primarily due to the elimination of rent expense associated with the Colstrip lease, which was terminated in December 2013. Other The increase in 2015 compared with 2014 was primarily due to lower corporate expenses, which were primarily a result of cost reductions attributable to 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's cash flows from operations and access to cost effective bank and capital markets are subject to risks and uncertainties. See "Item 1A. Risk Factors" for a discussion of risks and uncertainties that could affect Talen Energy's cash flows. Talen Energy had the following at December 31: [[GREPCENT_TABLE]] [["","2015","","2014","","2013"],["Cash and cash equivalents","$","141","","","$","352","","","$","239"],["Short-term debt","608","","","630","","","\u2014"]] [[/GREPCENT_TABLE]] Net cash provided by (used in) operating, investing, and financing activities for the years ended December 31 and the changes between periods were as follows. [[GREPCENT_TABLE]] [["","2015","","2014","","2013","","2015 vs. 2014","","2014 vs. 2013"],["Operating activities","$","768","","","$","462","","","$","410","","","$","306","","","$","52"],["Investing activities","(915",")","","497","","","(631",")","","(1,412",")","","1,128"],["Financing activities","(64",")","","(846",")","","47","","","782","","","(893",")"]] [[/GREPCENT_TABLE]] 46 Table of Contents Operating Activities The components of the change in cash provided by (used in) operating activities were as follows. [[GREPCENT_TABLE]] [["","2015 vs. 2014","","2014 vs. 2013"],["Change - Cash Provided (Used)"],["Net income","$","(751",")","","$","639"],["Non-cash components","919","","","(656",")"],["Working capital","199","","","(46",")"],["Defined benefit plan funding","(39",")","","78"],["Other operating activities","(22",")","","37"],["Total","$","306","","","$","52"]] [[/GREPCENT_TABLE]] A significant portion of Talen Energy's operating cash flows is derived from its competitive generation activities. Talen Energy employs a formal hedging program for its generation fleet, the objective of which is to provide a reasonable level of near-term cash flow and earnings certainty while preserving upside potential over the medium term to benefit from power price increases. See Note 15 to the Financial Statements for further discussion. Despite Talen Energy's hedging practices, future cash flows from operating activities are influenced by energy and capacity prices and, therefore, will fluctuate from period to period. Talen Energy's contracts for the sale and purchase of electricity and fuel often require cash collateral or cash equivalents (e.g. letters of credit), or reductions or terminations of a portion of the entire contract through cash settlement, in the event of a downgrade of Talen Energy Supply's credit ratings or adverse changes in market prices. For example, in addition to limiting its trading ability, if there was a 10% adverse movement in energy prices or as a result of a downgrade in credit ratings, Talen Energy estimates that, based on its December 31, 2015 positions, it would have been required to post additional collateral of approximately $227 million with respect to electricity and fuel contracts. Talen Energy had adequate liquidity sources at December 31, 2015 if it would have been required to post this additional collateral. Talen Energy has in place risk management programs that are designed to monitor and manage exposure to volatility of cash flows related to changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of generating units. Talen Energy had a $306 million increase in cash provided by operating activities in 2015 compared with 2014. [[GREPCENT_TABLE]] [["\u2022","Net income (loss) decreased by $751 million between the periods. However, the decrease was more than offset by $919 million of non-cash components. The non-cash components consisted primarily of an increase in goodwill and other asset impairments of $642 million, a decrease in gains on the sale of assets of $306 million, an increase in non-cash amortization of $59 million, partially offset by an increase in unrealized gains on hedging and other hedging activities of $123 million. The increase in cash from operating activities from changes in working capital was partially due to a decrease in accounts receivable, fuel, materials and supplies, prepayments and increases in counterparty collateral (due in part to market price movement), partially offset by decreases in accounts payable. The decrease in fuel, materials and supplies related to increases that occurred in 2014 from coal inventory build-up and increases in fuel oil inventory at higher average prices. The decrease to accounts payable was related to the timing of certain plant outage payments, 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 decrease in prepayments was primarily due to income tax payments made in 2014."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Pension funding was $39 million higher in 2015."]] [[/GREPCENT_TABLE]] Talen Energy had a $52 million increase in cash provided by operating activities in 2014 compared with 2013. [[GREPCENT_TABLE]] [["\u2022","Net income improved by $639 million between the periods, however, this included an additional $656 million of net non-cash benefits, including a $315 million pre-tax gain in 2014 on the sale of the Montana hydroelectric generating facilities, a $426 million charge in 2013 to terminate the operating lease arrangement for interests in the Montana Colstrip facility and acquire the previously leased interests, and $167 million of lower unrealized losses on hedging activities. These non-cash benefits were partially offset by a $270 million decrease in deferred income tax benefits. The net $17 million decline from net income and non-cash adjustments in 2014 compared with 2013 reflects lower Margins, higher operation and maintenance expenses and other factors. Cash provided by operating activities in 2014 included a $176 million payment to PPL in November 2014 to satisfy the tax liability related to the gain on the sale of the Talen Montana hydroelectric facilities. Cash provided by operating activities in 2013 included a $271 million"]] [[/GREPCENT_TABLE]] 47 Table of Contents payment in December in connection with terminating the operating lease arrangement for interests in the Montana Colstrip facility and acquiring the previously leased interests. [[GREPCENT_TABLE]] [["\u2022","Pension funding was $78 million lower in 2014."]] [[/GREPCENT_TABLE]] Investing Activities The components of the change in cash provided by (used in) investing activities were as follows [[GREPCENT_TABLE]] [["","2015 vs. 2014","","2014 vs. 2013"],["Change - Cash Provided (Used)"],["Expenditures for PP&E","$","(35",")","","$","167"],["Acquisitions & divestitures, net","(1,387",")","","900"],["Restricted cash and cash equivalent activity","195","","","(86",")"],["Purchase and sale of investments, net","\u2014","","","(1",")"],["Other investing activities","(185",")","","148"],["Total","$","(1,412",")","","$","1,128"]] [[/GREPCENT_TABLE]] In 2015 compared with 2014, "Acquisitions & divestitures, net" primarily reflects the November 2015 purchase of MACH Gen for $603 million and 2014 includes proceeds from the sale of the Talen Montana hydroelectric generating facilities, partially offset by proceeds of $116 million from the sale of the Talen Renewable Energy in November 2015. See Note 6 to the Financial Statements for information on the acquisition and divestitures. The change in "Restricted cash and cash equivalent activity" relates to collateral requirements to support Talen Energy's commodity hedging program. This change is primarily due to changes in forward energy commodity prices. The change in "Other investing activities" was primarily due to the 2014 receipt of $164 million related to a U.S. Department of the Treasury grant for the Rainbow Dam and Holtwood hydroelectric expansion capital projects. In 2014 compared with 2013, the decrease in "Expenditures for PP&E" was partially due to expenditures made in 2013 for the Holtwood hydroelectric expansion project. "Acquisitions & divestitures, net" reflects the 2014 sale of the Talen Montana hydroelectric generating facilities. See Note 6 to the Financial Statements for information on the sale. The change in "Other investing activities" was due to the receipt of $164 million in 2014 from U.S. Department of Treasury grants for the Rainbow Dam and Holtwood hydroelectric expansion capital projects. Financing Activities The components of the change in cash provided by (used in) financing activities were as follows. [[GREPCENT_TABLE]] [["","2015 vs. 2014","","2014 vs. 2013"],["Change - Cash Provided (Used)"],["Capital contributions from/distributions to predecessor member, net","$","1,032","","","$","(2,336",")"],["Debt issuances/redemptions, net","574","","","438"],["Change in short-term debt, net","(792",")","","986"],["Other","(32",")","","19"],["Total","$","782","","","$","(893",")"]] [[/GREPCENT_TABLE]] Talen Energy required $783 million less in financing sources for 2015 compared with 2014. In 2015, as a result of the terms of the spinoff transaction, the improvement in capital contributions/distributions to predecessor member, net resulted from a reduction in activity with PPL Energy Funding Corporation. Changes in cash used related to short-term debt resulted from proceeds from 2014 borrowings of $630 million that were needed at that time to fund increased collateral requirements to support Talen Energy's commodity hedging program that were then repaid in 2015 using the $591 million of net proceeds from the issuance of long-term debt. In addition, in 2015, in connection with the RJS Power acquisition, $38 million of short-term debt borrowings under the then-outstanding RJS Power Holdings, LLC credit facility were repaid and the facility was terminated in connection with the acquisition. In 2014, financing activities included distributions of $836 million to PPL of the proceeds from the Talen Montana hydroelectric generating facilities sale, net of a tax liability payment and proceeds from the U.S. Department of Treasury grant for the Holtwood hydroelectric expansion capital project. 48 Table of Contents In 2013, financing activities included net capital contributions of $1.1 billion from PPL Energy Funding Corporation to Talen Energy Supply to fund debt maturities, repay short-term debt and terminate the operating lease arrangement for interests in the Montana Colstrip facility and acquire the previously leased interests. Debt repayments included a $300 million debt maturity and the $437 million repayment by an unconsolidated trust of outstanding debt related to the acquisition of the previously leased Lower Mt. Bethel facility. See "Long-term Debt and Equity Securities" below for additional information on current year activity. See "Forecasted Sources of Cash" for a discussion of Talen Energy's plans to access the capital markets, as well as a discussion of credit facility capacity available to Talen Energy Supply. Also see "Forecasted Uses of Cash" for a discussion of Talen Energy Supply's and a subsidiary's maturities of long-term debt. Long-term Debt and Equity Securities Talen Energy activity for 2015 included: [[GREPCENT_TABLE]] [["","","Debt","","Stock Issuances"],["","","Issuances (a)","","Retirements"],["Cash Transactions","","$","600","","","$","335","","","$","\u2014"],["Non-cash Transactions (b)","","1,950","","","231","","","902"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Issuances are net of pricing discounts, where applicable and excludes the impact of debt issuance costs."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","\"Debt Issuances\" include long-term debt that remained outstanding as part of the RJS Power and MACH Gen acquisitions and the remarketing and exchange of PEDFA debt. \"Retirements\" represents the remarketing and exchange of PEDFA debt. \"Stock Issuances\" only applies to Talen Energy Corporation and includes common stock issued to the Riverstone Holders in connection with the RJS Power acquisition based on the June 1, 2015 closing \"when-issued\" market price."]] [[/GREPCENT_TABLE]] See Note 5 to the Financial Statements for additional information about long-term debt securities and Note 1 to the Financial Statements for additional information on equity issued as part of the spinoff from PPL and simultaneous acquisition of RJS Power. Forecasted Sources of Cash Talen Energy expects to continue to have adequate liquidity available from operating cash flows, cash and cash equivalents and credit arrangements. Additionally, although Talen Energy currently does not plan to access the capital markets, it may decide to do so based on market conditions. The discussion below regarding credit arrangements of Talen Energy Supply apply to Talen Energy Corporation through consolidation. Revolving Credit Facilities Talen Energy Supply and a subsidiary maintain credit facilities to enhance liquidity and provide credit support.  The amounts "Borrowed" below are recorded as "Short-term debt" on the Balance Sheets.  The total committed borrowing capacity under outstanding credit facilities and the use of this borrowing capacity at December 31, were: [[GREPCENT_TABLE]] [["","2015","","2014"],["","CommittedCapacity","","Borrowed","","Letters of Credit Issued","","UnusedCapacity","","Committed Capacity","","Borrowed","","Letters of Credit Issued","","Unused Capacity"],["Credit Facilities","$","2,010","","","$","608","","","$","194","","","$","1,208","","","$","3,150","","","$","630","","","$","259","","","$","2,261"]] [[/GREPCENT_TABLE]] On June 1, 2015, in connection with the completion of the spinoff transaction, Talen Energy Supply entered into the Talen Energy Supply RCF and replaced Talen Energy Supply's previously existing $3 billion unsecured syndicated credit facility that existed at December 31, 2014. At December 31, 2014, the $630 million of outstanding principal amount under the old facility was repaid prior to the termination of the old facility and any outstanding letters of credit were transferred to the Talen Energy Supply RCF. The Talen Energy Supply RCF provides capacity for letters of credit and short-term borrowings and requires Talen Energy Supply to maintain a senior secured net debt to adjusted EBITDA ratio (as defined in the agreement) of less than or equal to 4.50 to 1.00 as of the last day of any fiscal quarter. Talen Energy Supply pays customary fees on the facility and borrowings bear interest at its option at either a defined base rate or LIBOR-based rates, in each case plus an applicable margin. 49 Table of Contents The commitments at December 31, 2015 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. In February 2016, Talen Energy repaid all $600 million of its then-outstanding short-term debt obligations under the Talen Energy Supply RCF, primarily with cash proceeds from the sale of Ironwood.   The New MACH Gen RCF remained outstanding after the November 2015 MACH Gen acquisition. The New MACH Gen RCF provides capacity for short-term borrowings and up to $120 million of letters of credit. New MACH Gen pays customary fees on the facility and borrowings bear interest at 12-month LIBOR plus an applicable margin. In addition to the financial covenants noted above, the credit agreements governing the above credit facilities contain various other covenants. Failure to comply with the covenants after applicable grace periods could result in acceleration of repayment of borrowings and/or termination of the agreements. Talen Energy monitors compliance with the covenants on a regular basis. At December 31, 2015, Talen Energy was in compliance with these covenants. At this time Talen Energy believes that these covenants and other borrowing conditions will not limit access to these funding sources. Other Facilities Talen Energy Supply maintains a $1.3 billion secured energy marketing and trading facility whereby Talen Energy Supply will receive credit to be applied to satisfy collateral posting obligations related to Talen Energy's energy marketing and trading activities with counterparties participating in the facility. See Note 5 to the Financial Statements for further discussion of Talen Energy's credit and other arrangements. Forecasted Uses of Cash In addition to expenditures required for normal operating activities, such as purchased power, payroll, fuel and taxes, Talen Energy currently expects to incur future cash outflows for capital expenditures, various contractual obligations and could purchase or redeem a portion of its or a subsidiary's outstanding debt securities. Capital Expenditures The table below shows Talen Energy's current capital expenditure projections for the years 2016 through 2020. [[GREPCENT_TABLE]] [["","","","","Projected"],["","","Total","","2016","","2017","","2018","","2019","","2020"],["Sustenance","","$","1,310","","","$","233","","","$","305","","","$","295","","","$","257","","","$","220"],["Nuclear fuel","","608","","","82","","","114","","","132","","","137","","","143"],["Growth","","113","","","108","","","3","","","1","","","1","","","\u2014"],["Information technology","","120","","","54","","","15","","","20","","","17","","","14"],["Environmental","","137","","","17","","","15","","","16","","","50","","","39"],["Regulatory","","61","","","26","","","26","","","8","","","1","","","\u2014"],["Discretionary","","31","","","6","","","6","","","7","","","6","","","6"],["Total (a) (b)","","$","2,380","","","$","526","","","$","484","","","$","479","","","$","469","","","$","422"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(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 or are under an agreement to sell. See Note 6 to the Financial Statements for additional information on the divestitures."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","Includes capitalized interest, which, over all years, is expected to total approximately $60 million."]] [[/GREPCENT_TABLE]] Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. 50 Contractual Obligations Talen Energy Supply and its subsidiaries have assumed various financial obligations and commitments in the ordinary course of business. At December 31, 2015, estimated contractual cash obligations were as follows. [[GREPCENT_TABLE]] [["","","Total","","2016","","2017-2018","","2019-2020","","After 2020"],["Long-term Debt (a)","","$","4,228","","","$","396","","","$","429","","","$","1,423","","","$","1,980"],["Interest on Long-term Debt (b)","","1,560","","","236","","","408","","","306","","","610"],["Operating Leases (c)","","81","","","19","","","26","","","10","","","26"],["Purchase Obligations (d)","","2,703","","","621","","","948","","","319","","","815"],["Other Long-term Liabilities Reflected on the Balance Sheet under GAAP (e)(f)","","40","","","40","","","\u2014","","","\u2014","","","\u2014"],["Total Contractual Cash Obligations","","$","8,612","","","$","1,312","","","$","1,811","","","$","2,058","","","$","3,431"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Reflects principal maturities based on stated maturity dates. 2016 includes the $41 million redemption of the Senior Secured Notes of a Talen Ironwood Holdings, LLC subsidiary. See Note 5 to the Financial Statements for additional information. Talen Energy does not have any significant capital lease obligations."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(b)","Assumes interest payments through stated maturity or earlier put dates. The payments herein are subject to change, as payments for debt that is or becomes variable-rate debt have been estimated. 2016 includes the $14 million make whole premium paid in connection with the redemption of the Senior Secured Notes of a Talen Ironwood Holdings, LLC subsidiary. See Note 5 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(c)","See Note 7 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(d)","The amounts primarily include as applicable, the purchase obligations of electricity, coal, nuclear fuel and limestone as well as certain construction expenditures, which are also included in the \"Capital Expenditures\" table presented above. Financial swaps and open purchase orders that are provided on demand with no firm commitment are excluded from the amounts presented. The amounts also include a $132 million contract related to the Ironwood facility, which was sold in February 2016."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(e)","The amounts include Talen Energy's contributions committed to be made in 2016 for its pension plans."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(f)","At December 31, 2015, total unrecognized tax benefits of $31 million were excluded from this table as management cannot reasonably estimate the amount and period of future payments. See Note 4 to the Financial Statements for additional information."]] [[/GREPCENT_TABLE]] Dividends/Distributions Talen Energy Corporation does not expect to pay dividends in 2016. From time to time, as determined by its Board of Managers, Talen Energy Supply may pay distributions to its member. Certain of Talen Energy Supply's debt agreements include covenants that could effectively restrict the payment of distributions, loans or advances, either directly to Talen Energy Corporation or to Talen Energy Supply or one of its subsidiaries. See "Item 1A. Risk Factors" and Note 5 to the Financial Statements for these and other restrictions related to distributions on capital interests for Talen Energy. Purchase or Redemption of Debt Securities Talen Energy will continue to evaluate outstanding debt securities and may decide to purchase or redeem these securities depending upon prevailing market conditions and available cash. 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 as of December 31, 2015. [[GREPCENT_TABLE]] [["","","Moody's","","S&P"],["Senior Unsecured","","Ba3","","B+"],["Senior Secured","","Baa2","","BB"],["Corporate Issuer Rating","","Ba2","","B+"],["Outlook","","Negative","","Stable"]] [[/GREPCENT_TABLE]] 51 Table of Contents 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 those contracts, upon a downgrade in Talen Energy Supply's credit rating.  See Note 15 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 December 31, 2015. 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. Guarantees for Subsidiaries Talen Energy Supply guarantees certain consolidated affiliate financing arrangements. Some of the guarantees contain financial and other covenants that, if not met, would limit or restrict the consolidated affiliates' access to funds under these financing arrangements, accelerate maturity of such arrangements or limit the consolidated affiliates' ability to enter into certain transactions. See Note 11 to the Financial Statements for additional information about guarantees. Off-Balance Sheet Arrangements Talen Energy has entered into certain agreements that may contingently require payment to a guaranteed or indemnified party. See Note 11 to the Financial Statements for a discussion of these agreements. Risk Management Market Risk See Notes 1, 14 and 15 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 15 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 years ended December 31.  See Notes 14 and 15 to the Financial Statements for additional information. [[GREPCENT_TABLE]] [["","","Gains (Losses)"],["","","2015","","2014"],["Fair value of contracts outstanding at the beginning of the period","","$","53","","","$","107"],["Contracts realized or otherwise settled during the period","","(133",")","","328"],["Fair value of new contracts entered into during the period (a)","","5","","","(12",")"],["Other changes in fair value","","220","","","(370",")"],["Fair value of contracts outstanding at the end of the period","","$","145","","","$","53"]] [[/GREPCENT_TABLE]] 52 Table of Contents [[GREPCENT_TABLE]] [["(a)","Represents the fair value of contracts at the end of the quarter of their inception. Includes the impact of contracts acquired as part of the RJS Power and MACH Gen acquisitions."]] [[/GREPCENT_TABLE]] The following table segregates the net fair value of non-trading commodity derivative contracts at December 31, 2015, based on the observability of the information used to determine the fair value. [[GREPCENT_TABLE]] [["","Net Asset (Liability)"],["","Maturity Less Than 1 Year","","Maturity 1-3 Years","","Maturity 4-5 Years","","Maturity in Excess of 5 Years","","Total Fair Value"],["Source of Fair Value"],["Prices based on significant observable inputs (Level 2)","$","89","","","$","\u2014","","","$","7","","","$","\u2014","","","$","96"],["Prices based on significant unobservable inputs (Level 3)","31","","","17","","","1","","","\u2014","","","49"],["Fair value of contracts outstanding at the end of the period","$","120","","","$","17","","","$","8","","","$","\u2014","","","$","145"]] [[/GREPCENT_TABLE]] Talen Energy subsidiaries sell electricity, capacity and related services and buy fuel on a forward basis to hedge the value of energy from Talen Energy's generation assets.  If these Talen Energy subsidiaries were unable to deliver firm capacity and energy or to accept the delivery of fuel under their agreements, under certain circumstances they could be required to pay liquidated damages.  These damages would be based on the difference between the market price and the contract price of the commodity.  Depending on price changes in the wholesale energy markets, such damages could be significant.  Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their counterparties) with which it has energy contracts and other factors could affect Talen Energy's ability to meet its obligations, and/or cause significant increases in the market price of replacement energy.  Although Talen Energy attempts to mitigate these risks, the company cannot assure that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future. Commodity Price Risk (Trading) Talen Energy's trading commodity derivative contracts range in maturity through 2019.  The following table sets forth changes in the net fair value of trading commodity derivative contracts for the years ended December 31.  See Notes 14 and 15 to the Financial Statements for additional information. [[GREPCENT_TABLE]] [["","Gains (Losses)"],["","2015","","2014"],["Fair value of contracts outstanding at the beginning of the period","$","48","","","$","11"],["Contracts realized or otherwise settled during the period","(68",")","","(60",")"],["Fair value of new contracts entered into during the period (a)","4","","","5"],["Other changes in fair value","25","","","92"],["Fair value of contracts outstanding at the end of the period","$","9","","","$","48"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(a)","Represents the fair value of contracts at the end of the quarter of their inception."]] [[/GREPCENT_TABLE]] The following table segregates the net fair value of trading commodity derivative contracts at December 31, 2015, based on the observability of the information used to determine the fair value. [[GREPCENT_TABLE]] [["","Net Asset (Liability)"],["","Maturity Less Than 1 Year","","Maturity 1-3 Years","","Maturity 4-5 Years","","Maturity in Excess of 5 Years","","Total Fair Value"],["Source of Fair Value"],["Prices based on significant observable inputs (Level 2)","$","6","","","$","\u2014","","","$","(2",")","","$","\u2014","","","$","4"],["Prices based on significant unobservable inputs (Level 3)","5","","","\u2014","","","\u2014","","","\u2014","","","5"],["Fair value of contracts outstanding at the end of the period","$","11","","","$","\u2014","","","$","(2",")","","$","\u2014","","","$","9"]] [[/GREPCENT_TABLE]] VaR Models A VaR model is utilized to measure commodity price risk in competitive margins for the non-trading and trading portfolios.  VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level.  VaR is calculated using a Monte Carlo simulation technique based on a 53 Table of Contents five-day holding period at a 95% confidence level.  Given Talen Energy's hedging program, the non-trading VaR exposure is expected to be limited in the short-term.  The VaR for portfolios using end-of-month results for the year ended December 31, 2015 was as follows. [[GREPCENT_TABLE]] [["","Trading VaR","","Non-Trading VaR"],["95% Confidence Level, Five-Day Holding Period"],["Period End","$","\u2014","","","$","37"],["Average for the Period","1","","","18"],["High","4","","","37"],["Low","\u2014","","","8"]] [[/GREPCENT_TABLE]] 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 December 31, 2015. Interest Rate Risk Talen Energy, directly or through its subsidiaries, issues debt to finance its operations, which exposes 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 December 31, 2015 and 2014. 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 December 31, 2015 would cause an insignificant increase in interest expense and a $119 million increase in the fair value of debt. At December 31, 2014, the estimated impact of a 10% adverse movement in interest rates would cause an insignificant increase in interest expense and a $46 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 December 31, 2015, 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 December 31, 2015, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $74 million reduction in the fair value of the trust assets compared with $73 million at December 31, 2014.  See Notes 14 and 19 to the Financial Statements for additional information regarding the NDT funds. Defined Benefit Plans - Securities Price Risk See "Application of Critical Accounting Policies - Defined Benefits" for additional information regarding the effect of securities price risk on Talen Energy plan assets. Credit Risk Credit risk is the risk that Talen Energy would incur a loss as a result of nonperformance by counterparties of their contractual obligations. Talen Energy maintains credit procedures with respect to counterparty credit (including requirements that counterparties maintain specified credit standards) and require other assurances in the form of credit support or collateral in certain circumstances in order to limit counterparty credit risk. However, Talen Energy has concentrations of suppliers and customers among electric utilities, financial institutions and other energy marketing and trading companies. These 54 Table of Contents concentrations may impact Talen Energy's overall exposure to credit risk, positively or negatively, as counterparties may be similarly affected by changes in economic, regulatory or other conditions. Talen Energy includes the effect of credit risk on its fair value measurements to reflect the probability that a counterparty will default when contracts are out of the money (from the counterparty's standpoint). In this case, Talen Energy would have to sell into a lower-priced market or purchase in a higher-priced market. When necessary, Talen Energy records an allowance for doubtful accounts to reflect the probability that a counterparty will not pay for deliveries Talen Energy has made but not yet billed, which are reflected in "Unbilled revenues" on the Balance Sheets. See Notes 14 and 15 to the Financial Statements for additional information on credit concentration and credit risk. Acquisitions, Development and Divestitures Talen Energy from time to time evaluates opportunities for potential acquisitions, divestitures and development projects.  Development projects are reexamined 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 6 to the Financial Statements for information on the RJS Power acquisition, the MACH Gen acquisition, the Talen Montana hydroelectric sale, and the announced divestitures of assets to satisfy a December 2014 FERC order approving the combination with RJS Power. 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" for additional information on environmental matters. CSAPR Annual and seasonal nitrogen oxide emission allowance trading programs, as well as annual sulfur dioxide emission allowance trading, commenced in 2015 for 28 states under the EPA's CSAPR Rule. In December 2015, the EPA proposed a "CSAPR Update Rule" which recommends more stringent ozone season nitrogen oxide budgets for 23 states, including several where Talen owns affected generation. Additional capital and/or operating and maintenance expenses could be imposed on Talen plants in Maryland, New Jersey, New York, Pennsylvania and Texas as a result of this action. NAAQS Regulations to address more stringent National Ambient Air Quality Standard (NAAQS) for ozone established by the EPA advanced in Pennsylvania and Maryland in 2015. In Pennsylvania, these regulations seek to establish reasonably available control technologies (RACT) for fossil-fuel fired power plants nitrogen oxide and volatile organic compound emissions.  Maryland coal plants operated at reduced nitrogen oxide emission rates during the 2015 ozone season as a result of an emergency action issued by the Governor (which later became a final rule), and in November 2015 the MDE promulgated additional nitrogen oxide regulations for Maryland coal plants that require even more stringent operations starting no later than June 2020. Actions were taken at the federal level in 2015 to tighten the NAAQS for ozone as well. More specifically, in October 2015, the EPA released a final rule establishing a more stringent national standard for ozone. 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. Compliance with these regulations, or those that could be developed to address the EPA's 2010 sulfur dioxide NAAQS and/or 2015 ozone NAAQS, could lead to increased capital and/or operating and maintenance expenses for Talen Energy's fossil-fuel fired power plants. MATS Compliance with the EPA's MATS Rule commenced in April 2015 for those plants that did not receive a compliance extension. The rule has increased capital and operating and maintenance expenses for some of Talen Energy's power plants. The U.S. Supreme Court determined in June 2015 that the EPA acted unreasonably by refusing to consider costs when determining whether the MATS regulation was appropriate and necessary. The EPA responded with a proposed supplemental finding in November 2015 claiming that the regulation was appropriate and necessary based on cost. In December 2015, to address the 55 Table of Contents June 2015 Supreme Court action, the DC Circuit remanded the MATS Rule to the EPA to incorporate a revised appropriate and necessary finding. Regional Haze In September 2015, the Third Circuit Court of Appeals vacated portions of the EPA's approval of Pennsylvania's Regional Haze State Implementation Plan and remanded the Rule to the EPA for further consideration. Talen Energy is unable to determine at this time if the future impacts of Regional Haze on Talen Energy's Pennsylvania fossil-fuel fired power plants will have a material adverse effect on its financial condition or results of operations. 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. EPA's existing plant rule has been stayed by the U.S. Supreme Court until all legal challenges to the rule have been resolved. 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 operating and maintenance costs could be imposed. Exemptions for Startup, Shutdown and Malfunction Events In June 2015, the EPA published a Final Rule which prohibits states from exempting startup, shutdown and malfunction events from compliance requirements in SIPs. Revisions to SIPs or other regulations in states where Talen Energy operates could impact operations and financial conditions. CCRs The EPA's final rule regulating CCRs as non-hazardous wastes, which imposes extensive new self-implementing requirements on CCR impoundments and landfills, became effective in October 2015. Talen Energy expects that its plants using surface impoundments for management and disposal of CCRs, or that previously managed CCRs and continue to manage wastewaters, will be most impacted by this rule. Talen Energy anticipates incurring capital, operating and/or maintenance costs to address other provisions of the rule, such as groundwater monitoring and disposal facility modifications. The final CCR Rule is being challenged in federal court. During 2015, an increase of $41 million was recorded to existing AROs. Further changes to AROs may be required as estimates are refined and compliance with the rule continues. ELGs and Standards The EPA's final ELG regulations that revise discharge limitations for steam electric generation wastewater permits were published in the Federal Register in November 2015. The regulations contain requirements that could significantly impact Talen Energy's coal-fired plants.  At this point, Talen Energy is unable to estimate a range of reasonably possible compliance costs. The regulations are being challenged in federal court. Waters of the United States (WOTUS) In June 2015, the EPA and the U.S. Army Corps of Engineers published their final rule redefining the term WOTUS, and in October 2015, the U.S. Court of Appeals for the Sixth Circuit issued an order preventing the EPA from implementing the rule nationwide. In the event the stay is lifted, and the regulation survives separate legal challenges, the redefinition could impact future development actions, such as plant and gas infrastructure expansions. New Accounting Guidance See Notes 1 and 21 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. The following 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. Changes in the estimates or other judgments included within these accounting policies could result in a 56 Table of Contents significant change to the information presented in the Financial Statements (these accounting policies are also discussed in Note 1 to the Financial Statements). Senior management has reviewed with Talen Energy Corporation's Audit Committee these critical accounting policies, the following disclosures regarding their application and the estimates and assumptions regarding them. Price Risk Management See "Price Risk Management" in Note 1 to the Financial Statements, as well as "Risk Management" above. Defined Benefits Talen Energy Supply and certain of its subsidiaries sponsor or participate in, as applicable, various qualified funded and non-qualified unfunded defined benefit pension plans and both funded and unfunded other postretirement benefit plans. These plans are applicable to the majority of Talen Energy's employees (based on eligibility for their applicable plans). Talen Energy records an asset or liability, with an offsetting entry to AOCI to recognize the funded status of all defined benefit plans that it or its subsidiaries sponsor. Consequently, the funded status of all sponsored defined benefit plans is fully recognized on the Balance Sheets. See Note 9 to the Financial Statements for additional information about the plans and the accounting for defined benefits including a discussion of the newly created pension and other postretirement benefit plans sponsored by Talen Energy Supply that replaced Talen Energy Supply's participation in similar PPL plans effective with the June 1, 2015 spinoff. Management makes certain assumptions regarding the valuation of benefit obligations and the performance of plan assets. When accounting for defined benefits, delayed recognition in earnings of differences between actual results and expected or estimated results is a guiding principle. Annual net periodic defined benefit costs are recorded in current earnings based on estimated results. Any differences between actual and estimated results are recorded in AOCI. These amounts in AOCI are amortized to income over future periods. The delayed recognition allows for a smoothed recognition of costs over the working lives of the employees who benefit under the plans. The primary assumptions are: [[GREPCENT_TABLE]] [["\u2022","Discount Rate - The discount rate is used in calculating the present value of benefits, which is based on projections of benefit payments to be made in the future. The objective in selecting the discount rate is to measure the single amount that, if invested at the measurement date in a portfolio of high-quality debt instruments, would provide the necessary future cash flows to pay the accumulated benefits when due."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Expected Return on Plan Assets - Management projects the long-term rates of return on plan assets that will be earned over the life of each plan. These projected returns reduce the net periodic defined benefit costs currently recorded."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Rate of Compensation Increase - Management projects employees' annual pay increases, which are used to project employees' pension benefits at retirement."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","Health Care Cost Trend Rate - Management projects the expected increases in the cost of health care."]] [[/GREPCENT_TABLE]] In addition to the economic assumptions above that are evaluated annually, management must also make assumptions regarding the life expectancy of employees covered under their defined benefit pension and other postretirement benefit plans. At December 31, 2014 or June 1, 2015, as applicable, the plan sponsors adopted the mortality tables issued by the Society of Actuaries in October 2014 (RP-2014 base tables) for all applicable defined benefit pension and other postretirement benefit plans. At December 31, 2014 or June 1, 2015, as applicable, the plan sponsors also selected the IRS BB 2-Dimensional mortality improvement scale on a generational basis for all applicable defined benefit pension and other postretirement benefit plans. These mortality assumptions reflect the recognition of both improved life expectancies and the expectation of continuing improvements in life expectancies. For the applicable periods ended December 31, 2015, Talen Energy's defined benefit pension and other postretirement benefit plans incurred actuarial losses of $50 million primarily due to lower actual return on plan assets compared to the expected return on plan assets partially offset by an increase in the discount rate. In selecting the discount rates for applicable defined benefit plans, the plan sponsors start with a cash flow analysis of the expected benefit payment stream for their plans. The plan-specific cash flows are matched against the coupons and expected maturity values of individually selected bonds. This bond matching process begins with the full universe of Aa-rated non-callable (or callable with make-whole provisions) bonds, serving as the base from which those with the lowest and highest yields are eliminated to develop an appropriate subset of bonds. Individual bonds are then selected based on the timing of each 57 Table of Contents plan's cash flows and parameters are established as to the percentage of each individual bond issue that could be hypothetically purchased and the surplus reinvestment rates to be assumed. To determine the expected return on plan assets, the plan sponsors project the long-term rates of return on plan assets using a best-estimate of expected returns, volatilities and correlations for each asset class. Each plan's specific current and expected asset allocations are also considered in developing a reasonable return assumption. In selecting a rate of compensation increase, the plan sponsors consider past experience in light of movements in inflation rates. The following table provides the weighted-average assumptions used for discount rate, expected return on plan assets and rate of compensation increase at December 31, 2015. [[GREPCENT_TABLE]] [["Assumption"],["Discount Rate"],["Pension","","4.65","%"],["Other Postretirement","","4.60","%"],["Expected return on plan assets"],["Pension","","7.00","%"],["Other Postretirement","","6.37","%"],["Rate of compensation increase"],["Pension","","3.98","%"],["Other Postretirement","","3.98","%"]] [[/GREPCENT_TABLE]] In selecting health care cost trend rates, the plan sponsors consider past performance and forecasts of health care costs. At December 31, 2015, the health care cost trend rates for all plans were 6.8% for 2016, gradually declining to an ultimate trend rate of 5.0% in 2020. A variance in the assumptions listed above could have a significant impact on accrued pension obligations, reported annual net periodic pension costs and related AOCI. At December 31, 2015, the accrued pension obligations and related items and the portions related to the most significant plan were recorded in the financial statements as follows. [[GREPCENT_TABLE]] [["","","Total","","Most Significant Plan"],["Balance Sheet:"],["Accrued pension obligations","","$","(340",")","","$","(323",")"],["AOCI (pre-tax)","","453","","","390"],["Statement of Income:"],["Pension costs","","$","48","","","$","28"]] [[/GREPCENT_TABLE]] The following table reflects the impact of changes in certain assumptions for Talen Energy's most significant plan. The table reflects either an increase or decrease in each assumption. The inverse of this change would impact the accrued pension obligation, reported annual net periodic defined benefit costs and AOCI by a similar amount in the opposite direction. The sensitivities below reflect an evaluation of the change based solely on a change in that assumption. [[GREPCENT_TABLE]] [["","","","Increase (Decrease)"],["Actuarial assumption","Sensitivity","","Accrued Pension Obligation","","AOCI (pre-tax)","","Pension Costs"],["Discount rate","(0.25",")%","","$","51","","","$","51","","","$","5"],["Expected return on plan assets","(0.25",")%","","n/a","","","n/a","","","3"],["Rate of compensation increase","0.25","%","","7","","","7","","","2"]] [[/GREPCENT_TABLE]] Asset Impairment (Excluding Investments) Impairment analyses are performed for long-lived assets that are subject to depreciation or amortization whenever events or changes in circumstances indicate that a long-lived asset's carrying amount may not be recoverable. For these long-lived assets classified as held and used, such events or changes in circumstances are: [[GREPCENT_TABLE]] [["\u2022","a significant decrease in the market price of an asset;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","a significant adverse change in the extent or manner in which an asset is being used or in its physical condition;"]] [[/GREPCENT_TABLE]] 58 Table of Contents [[GREPCENT_TABLE]] [["\u2022","a significant adverse change in legal factors or in the business climate;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of an asset;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","a current period operating or cash flow loss combined with a history of losses or a forecast that demonstrates continuing losses; or"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["\u2022","a current expectation that, more likely than not, an asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life."]] [[/GREPCENT_TABLE]] For a long-lived asset classified as held and used, an impairment is recognized when the carrying amount of the asset is not recoverable and exceeds its fair value. The carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the asset is impaired, an impairment loss is recorded to adjust the asset's carrying amount to its estimated fair value. Management must make significant judgments to estimate future cash flows, including the useful lives of the assets, the forward prices for energy, capacity and fuel in the markets where the assets are utilized, the amount of capital and operations and maintenance spending and management's intended use of the assets. Alternate courses of action are considered to recover the carrying amount of a long-lived asset, and estimated cash flows from the "most likely" alternative are used to assess impairment whenever one alternative is clearly the most likely outcome. If no alternative is clearly the most likely, then a probability-weighted approach is used, taking into consideration estimated cash flows from the alternatives. For assets tested for impairment as of the balance sheet date, the estimates of future cash flows used in that test consider the likelihood of possible outcomes that existed at the balance sheet date, including an assessment of the likelihood of a future sale of the assets. That assessment is not revised based on events that occur after the balance sheet date. Changes in assumptions and estimates could result in materially different results than those identified and recorded in the financial statements. For a long-lived asset classified as held for sale, an impairment exists when the carrying amount of the asset (disposal group) exceeds its fair value less cost to sell. If the asset (disposal group) is impaired, an impairment loss is recorded to adjust the carrying amount to its fair value less cost to sell. A gain is recognized in future periods for any subsequent increase in fair value less cost to sell, but not in excess of the cumulative impairment previously recognized. If the asset (disposal group) no longer qualifies for classification as held for sale, it must be reclassified as held and used and its carrying value must be adjusted to the lower of its estimated fair value at that time or its carrying value when initially classified as held for sale adjusted for depreciation through the reclassification date. For determining fair value, quoted market prices in active markets are the best evidence. However, when market prices are unavailable, Talen Energy considers all valuation techniques appropriate under the circumstances and for which market participant inputs can be obtained. Generally discounted cash flows are used to estimate fair value, which incorporates market participant inputs when available. Discounted cash flows are calculated by estimating future cash flow streams and determining the present value of the cash flow streams using risk-adjusted discount rates. In 2015, Talen Energy recorded pre-tax impairment charges of $189 million ($113 million after-tax) applicable to certain assets (classified as held and used and held for sale). See Notes 14 and 16 to the Financial Statements for details on the evaluation and charges recorded. Goodwill is tested for impairment at the reporting unit level. Talen Energy has determined its reporting units to be at the same level as its operating segments. At December 31, 2015, Talen Energy is organized in two operating segments/reporting units: East and West, primarily based on geographic location. Prior to the RJS acquisition, Talen Energy operated within a single operating segment/reporting unit. A goodwill impairment test is performed annually or more frequently if events or changes in circumstances indicate that the carrying amount of the reporting unit may be greater than the reporting unit's fair value. Additionally, goodwill is tested for impairment after a portion of goodwill has been allocated to a business to be disposed of. Talen Energy may elect either to initially make a qualitative evaluation about the likelihood of an impairment of goodwill or to bypass the qualitative evaluation and test goodwill for impairment using a two-step quantitative test. If the qualitative evaluation (referred to as "step zero") is elected and the assessment results in a determination that it is not more likely than not that the fair value of a reporting unit is less than the carrying amount, the two-step quantitative impairment test is not necessary. When the two-step quantitative impairment test is elected or required as a result of the step zero assessment, in step one, Talen Energy determines whether a potential impairment exists by comparing the estimated fair value of a reporting unit with its carrying amount, including goodwill, on the measurement date. If the estimated fair value exceeds its carrying amount, goodwill is not considered impaired. If the carrying amount exceeds the estimated fair value, the second step is performed to measure the amount of impairment loss, if any. 59 Table of Contents The second step of the quantitative test requires a calculation of the implied fair value of goodwill, which is determined in the same manner as the amount of goodwill in a business combination. That is, the estimated fair value of a reporting unit is allocated to all of the assets and liabilities of that reporting unit as if the reporting unit had been acquired in a business combination and the estimated fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the estimated fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The implied fair value of the reporting unit's goodwill is then compared with the carrying amount of that goodwill. If the carrying amount exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of the reporting unit's goodwill. In 2015, Talen Energy recorded pre-tax goodwill impairment charges of $465 million ($444 million after-tax), which fully impaired all of the goodwill previously recorded on the balance sheet and assigned to the East segment/reporting unit. See Note 16 to the Financial Statements for details on the evaluation and charges recorded. Asset Retirement Obligations ARO liabilities are required to be recognized for legal obligations associated with the retirement of long-lived assets. The initial obligation is measured at its estimated fair value. An ARO must be recognized when incurred if the fair value of the ARO can be reasonably estimated. An equivalent amount is recorded as an increase in the value of the capitalized asset and amortized to expense over the useful life of the asset. Until the obligation is settled, the liability is increased, through the recognition of accretion expense in the statement of income, for changes in the obligation due to the passage of time. In determining AROs, management must make significant judgments and estimates to calculate fair value. Fair value is developed using an expected present value technique based on assumptions of market participants that considers estimated retirement costs in current period dollars that are inflated to the anticipated retirement date and then discounted back to the date the ARO was incurred. Changes in assumptions and estimates included within the calculations of the fair value of AROs could result in significantly different results than those identified and recorded in the financial statements. Estimated ARO costs and settlement dates, which affect the carrying value of the ARO and the related capitalized asset, are reviewed periodically to ensure that any material changes are incorporated into the latest estimate of the ARO. Any change to the capitalized asset, positive or negative, is generally amortized over the remaining life of the associated long-lived asset. At December 31, 2015, the total recorded balances and information on the most significant recorded AROs were as follows. [[GREPCENT_TABLE]] [["","","Most Significant AROs"],["Total AROs Recorded","","Amount Recorded","","% of Total","","Description"],["$","501","","","$","399","","","79.6","%","","Nuclear decommissioning"]] [[/GREPCENT_TABLE]] The most significant assumptions surrounding AROs are the forecasted retirement costs (including the settlement dates and the timing of cash flows), the discount rates and the inflation rates. At December 31, 2015, a 10% change to retirement costs, a 0.25% decrease in the discount rate or a 0.25% increase in the inflation rate would not have a significant impact on the ARO liabilities and would not cause a significant change to the annual depreciation expense of the ARO asset or the annual accretion expense of the ARO liability. See Note 18 to the Financial Statements for additional information on AROs. Income Taxes Significant management judgment is required in developing the provision for income taxes, primarily due to the uncertainty related to tax positions taken or expected to be taken in tax returns and the valuation allowances that may be required to offset the related deferred tax assets. In order to determine the amount of benefit to be recognized in relation to an uncertain tax position, Talen Energy uses a two-step process to evaluate tax positions. The first step requires an entity to determine whether, based on the technical merits supporting a particular tax position, it is more likely than not (greater than a 50% chance) that the tax position will be sustained. This determination assumes that the relevant taxing authority will examine the tax position and is aware of all the relevant facts surrounding the tax position. The second step requires an entity to recognize in the financial statements the benefit of a tax position that meets the more-likely-than-not recognition criterion. The benefit recognized is measured as the largest amount of benefit that has a likelihood of realization, upon settlement, that exceeds 50%. Management considers a number of factors in assessing the benefit to be recognized, including negotiation of a settlement. 60 Table of Contents At December 31, 2015, Talen Energy had $31 million of unrecognized tax benefits recorded related to deferred tax assets acquired with MACH Gen. Unrecognized tax benefits recorded at December 31, 2014 were settled with taxing authorities and PPL prior to the June 1, 2015 spinoff from PPL. Valuation allowances are initially recorded and reevaluated each reporting period by assessing the likelihood of the ultimate realization of a deferred tax asset. Management considers a number of factors in assessing the realization of a deferred tax asset, including the ability to carryback attributes, the reversal of temporary differences, future taxable income, and prudent and feasible tax planning strategies. Any tax planning strategy utilized in this assessment must meet the recognition and measurement criteria utilized to account for an uncertain tax position. Management also considers the uncertainty posed by political risk and the effect of this uncertainty on the various factors that management takes into account in evaluating the need for valuation allowances. The amount of net deferred tax assets ultimately realized may differ materially from the estimates utilized in the computation of valuation allowances and may materially impact the financial statements in the future. As a result of management's assessment of the realization of deferred tax assets, a valuation allowance of $10 million was recorded at December 31, 2015, primarily related to MACH Gen net operating losses in states where it is expected that a portion of the losses will expire unutilized. See Note 4 to the Financial Statements for additional information on income taxes. Business Combinations - Purchase Price Allocation On June 1, 2015, substantially contemporaneous with the spinoff by PPL to form Talen Energy, RJS Power was contributed by the Riverstone Holders to become a subsidiary of Talen Energy Supply. Additionally, on November 2, 2015, Talen Energy completed the acquisition of the membership interests of MACH Gen. In accordance with accounting guidance on business combinations, the identifiable assets acquired and the liabilities assumed were measured at fair value at the acquisition date. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The excess of the purchase price over the estimated fair value of the identifiable net assets was recorded as goodwill. The determination and allocation of fair value to the identifiable assets acquired and liabilities assumed was based on various assumptions and valuation methodologies requiring considerable management judgment, including estimates based on key assumptions of the acquisition, and historical and current market data. The most significant variables in these valuations were the discount rates, the number of years on which to base cash flow projections, as well as the assumptions and estimates used to determine cash inflows and outflows. Although the assumptions were reasonable based on information available at the dates of the acquisitions, actual results may differ from the forecasted amounts and the difference could be material. The fair value of intangible assets and liabilities (e.g. contracts that have favorable or unfavorable terms relative to market), including coal contracts, a pipeline lease and an ash site permit, have been reflected on the balance sheet. These intangible assets and liabilities are being amortized over the related contracts' terms. Goodwill is measured as the excess of consideration transferred over the net of the acquisition date fair value of the assets acquired and liabilities assumed. Goodwill related to the RJS acquisition of $393 million was assigned to the East segment. There was no goodwill recorded in the provisional purchase price allocation related to the MACH Gen acquisition. During the third quarter of 2015, impairment testing was completed and it was determined that all goodwill was impaired and was written off, including the goodwill recorded related to the RJS acquisition. See Note 16 to the Financial Statements for additional information regarding the goodwill impairment and Note 6 to the Financial Statements for additional information regarding the purchase price allocations. See Note 6 to the Financial Statements for additional information regarding the acquisitions. Other Information Talen Energy Corporation's Audit Committee has approved the independent auditor to provide audit and audit-related services, tax services and other services permitted by Sarbanes-Oxley and SEC rules. The audit and audit-related services include services in connection with statutory and regulatory filings, reviews of offering documents and registration statements, and internal control reviews. 61 Table of Contents