PPL is an energy and utility holding company with headquarters in Allentown, PA. Please refer to "Item 1. Business - Background" for descriptions of PPL's reportable segments, which are Supply, International Delivery and Pennsylvania Delivery. Through its subsidiaries, PPL is primarily engaged in the generation and marketing of electricity in two key markets - the northeastern and western U.S. - and in the delivery of electricity in Pennsylvania and the U.K. PPL's overall strategy is to achieve disciplined growth in energy supply margins while limiting volatility in both cash flows and earnings and to achieve stable, long-term growth in its regulated electricity delivery businesses through efficient operations and strong customer and regulatory relations. More specifically, PPL's strategy for its electricity generation and marketing business is to match energy supply with load, or customer demand, under contracts of varying lengths with creditworthy counterparties to capture profits while effectively managing exposure to energy and fuel price volatility, counterparty credit risk and operational risk. PPL's strategy for its electricity delivery businesses is to own and operate these businesses at the most efficient cost while maintaining high quality customer service and reliability.

PPL faces several risks in its generation business, principally electricity and capacity wholesale price risk, fuel supply and price risk, power plant performance, evolving regulatory frameworks and counterparty credit risk. PPL attempts to manage these risks through various means. For instance, PPL operates a portfolio of generation assets that is diversified as to geography, fuel source, cost structure and operating characteristics. PPL expects to expand its generation capacity over the next several years through power uprates at certain of its existing power plants, and is continually evaluating the potential construction of new plants and the potential acquisition of existing plants or businesses. PPL is and will continue to remain focused on the operating efficiency and availability of its existing and any newly constructed or acquired power plants. In addition, PPL has executed and continues to pursue contracts of varying lengths for energy sales and fuel supply, while using other means to mitigate the risks associated with adverse changes in the difference, or margin, between the cost to produce electricity and the price at which PPL sells it. PPL's future profitability will be affected by whether PPL decides to, or is able to, continue to enter into long-term or intermediate-term power sales and fuel purchase agreements or renew its existing agreements and prevailing market conditions. Currently, PPL's commitments for energy sales are satisfied through its own generation assets and supply purchased from third parties. PPL markets and trades around its physical portfolio of generating assets through integrated generation, marketing and trading functions.

PPL has adopted risk management programs that, among other things, are designed to monitor and manage its exposure to earnings and cash flow volatility related to changes in energy and fuel prices, interest rates, foreign currency exchange rates, counterparty credit quality and the operating performance of its generating units.

The principal challenge that PPL faces in its electricity delivery businesses is to maintain high quality customer service and reliability in a cost-effective manner. PPL's electricity delivery businesses are rate-regulated. Accordingly, these businesses are subject to regulatory risk with respect to costs that may be recovered and investment returns that may be collected through customer rates. In particular, uncertainty driven by potential changes in the regulatory treatment of PPL Electric's PLR obligation after 2009, when its full requirements supply contracts with PPL EnergyPlus expire, presents a risk for the Pennsylvania electricity delivery business. The Customer Choice Act requires electricity delivery companies, like PPL Electric, to act as a PLR of electricity supply and provides that electricity supply costs will be recovered by such companies pursuant to regulations to be established by the PUC. As discussed in more detail in Note 15 to the Financial Statements, there are a number of ongoing regulatory and legislative activities that may affect PPL Electric's recovery of supply costs after 2009. In May 2007, the PUC approved PPL Electric's plan to procure default electricity supply in 2007 through 2009 for retail customers who do not choose an alternative competitive supplier in 2010. Pursuant to this plan, PPL Electric has contracted for two-thirds of the 2010 electricity supply it expects to need for residential, small commercial and small industrial customers. In August 2008, the PUC approved a plan proposed by PPL Electric, under which its residential and small commercial customers, beginning in 2008, could begin to pay in advance to smooth the impact of price increases when generation rate caps expire in 2010. Approximately 10% of PPL Electric's customers are participating in the plan. In February 2009, PPL Electric asked the PUC for permission to offer customers a second option for reducing the potential initial impact of higher electricity prices resulting from expiration of the generation rate caps. If approved by the PUC, this option would enable eligible residential and eligible small-business customers to defer payment of any increase greater than 25% in their 2010 electric bills. The 25% will be calculated on an average rate schedule usage basis, and will be based on a comparison of currently estimated 2009 bills to currently estimated 2010 bills. In September 2007, the PUC regulations became effective regarding the obligation of Pennsylvania electric utilities to provide default electricity supply in 2011 and beyond. In August 2008, PPL Electric filed for PUC approval of its post-2010 supply procurement plan under these regulations. In addition to this regulatory activity, in October 2008, the legislature passed and the Pennsylvania Governor signed a bill that, among other things: (i) requires electric utilities to meet specified goals for reduction in use and peak demand;
(ii) establishes procedures and standards for the purchase of PLR supply; and
(iii) requires utilities to install smart metering technology and offer time-of-use rates. Utilities must file with the PUC by July 1, 2009, for approval of plans to meet the conservation and demand side requirements of the legislation. The Governor recently publicly stated that he expects some form of rate mitigation to be passed by the state legislature. In addition, in the last legislative session, certain Pennsylvania legislators introduced legislation to extend generation rate caps or otherwise limit cost recovery through rates for Pennsylvania utilities beyond the end of their transition periods, which in PPL Electric's case is December 31, 2009. It is possible that similar legislation could be reintroduced. If such legislation were introduced and ultimately enacted, PPL Electric could experience substantial operating losses, cash flow shortfalls and other adverse financial impacts. In addition to the activities discussed above relating to PPL Electric's PLR obligations, PPL Electric is engaged in three other major regulatory proceedings. First, in April 2008, the FERC granted PPL Electric's request for incentive rate treatment for the Susquehanna-Roseland 500 kV Transmission Line. Those incentives are: (i) a 1.25% increase to the return on equity previously approved for the project, (ii) inclusion of construction work in progress in rate base, and (iii) recovery of all costs if the line is abandoned. In addition, FERC granted PPL Electric a 0.5% increase to the return on equity previously approved for its continuing membership in PJM. Second, in August 2008, PPL Electric requested permission from FERC to replace its stated rates for transmission service with a formula rate. In October 2008, FERC permitted PPL Electric's proposed formula rate to go into effect, subject to refund. The matter is in settlement discussions before an administrative law judge. Third, in January 2009, PPL Electric filed its application with the PUC requesting permission to site and construct the Susquehanna-Roseland line. PUC review is expected to take approximately one year.

PPL faces additional financial risks in conducting international operations, such as fluctuations in foreign currency exchange rates. PPL attempts to manage these financial risks through its risk management programs.

In order to manage financing costs and access to credit markets, a key objective for PPL's business as a whole is to maintain a strong credit profile. PPL continually focuses on maintaining an appropriate capital structure and liquidity position.

See "Item 1A. Risk Factors" for more information concerning these and other material risks PPL faces in its businesses.

The purpose of "Management's Discussion and Analysis of Financial Condition and Results of Operations" is to provide information concerning PPL's past and expected future performance in implementing the strategies and managing the risks and challenges mentioned above. Specifically:

· "Results of Operations" provides an overview of PPL's operating results in 2008, 2007 and 2006, including a review of earnings, with details of results by reportable segment. It also provides a brief outlook for 2009.

· "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL's liquidity position and credit profile, including its sources of cash (including bank credit facilities and sources of operating cash flow) and uses of cash (including contractual obligations and capital expenditure requirements) and the key risks and uncertainties that impact PPL's past and future liquidity position and financial condition. This subsection also includes a listing and discussion of PPL's current credit ratings.

· "Financial Condition - Risk Management - Energy Marketing & Trading and Other" provides an explanation of PPL's risk management programs relating to market risk and credit risk.

· "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 PPL and that require its management to make significant estimates, assumptions and other judgments.

In 2007, PPL sold its regulated electricity delivery businesses in Latin America, which were included in the International Delivery segment. In October 2008, PPL completed the sale of its natural gas distribution and propane businesses, which were included in the Pennsylvania Delivery segment. See Note 10 to the Financial Statements for information on the sales.

Market Events

The continued downturn in the financial markets has increased the complexity of managing credit risk, responding to liquidity needs, measuring derivatives and other financial instruments at fair value, and managing market price risk. Global bank credit capacity has been reduced dramatically and the cost of renewing or establishing new credit facilities has increased significantly. New bank credit facilities generally are being restricted to less than one-year terms, thereby introducing uncertainties as to businesses' ability to enter into long-term energy commitments or reliably estimate the longer-term cost and availability of credit.

Commodity Price Risk

The volatility of wholesale energy prices due to the continued financial downturn significantly impacted PPL's earnings in 2008. See "Statement of Income Analysis - Domestic Gross Energy Margins - Domestic Gross Energy Margins By Region" for further discussion.

Credit risk

Credit risk is the risk that PPL would incur a loss as a result of nonperformance by counterparties of their contractual obligations. PPL maintains credit policies and procedures to limit counterparty credit risk. The continued volatility and downturn in financial and commodity markets during 2008 have generally increased PPL's exposure to credit risk. See Note 19 to the Financial Statements for additional information about credit concentration and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" for more information on credit risk.

Liquidity Issues

The continued downturn in financial markets has generally made obtaining new sources of bank and capital markets funding more difficult and costly. During this challenging period, PPL expects to continue to have access to adequate sources of liquidity through operating cash flows, cash and cash equivalents, short-term investments and its credit facilities. In 2009, subject to market conditions, PPL plans to issue up to $300 million in long-term debt securities and to remarket to unaffiliated investors $150 million of tax-exempt bonds that were issued by the PEDFA in December 2008 on behalf of PPL Energy Supply and for which a subsidiary of PPL Energy Supply acted as initial purchaser. PPL does not expect to need to issue any commercial paper during 2009, but may do so from time to time to facilitate short-term cash flow needs if commercial paper market conditions improve. See "Financial Condition - Liquidity and Capital Resources" for an expanded discussion of PPL's liquidity position and a discussion of financing transactions.

Valuations in Inactive Markets

The continued downturn in the financial markets has generally made it difficult to determine the fair value of certain assets and liabilities in inactive markets. Management has reviewed the activity in the energy and financial markets in which PPL transacts, concluding that substantially all of these markets were active as of December 31, 2008, with the exception of the market for auction rate securities. See Notes 18 and 23 to the Financial Statements and "Financial Condition - Liquidity and Capital Resources - Auction Rate Securities" for a discussion of these investments.

Securities Price Risk

Declines in the market price of debt and equity securities resulted in unrealized losses that have reduced the asset values of PPL's investments in its nuclear decommissioning trust funds and defined benefit plans. The nuclear plant decommissioning trust funds experienced negative investment returns during 2008. The assets in these funds support the costs to decommission the Susquehanna nuclear plant when its licenses, subject to any extensions, expire in 2022 and 2024. The obligation to decommission the nuclear plant is long-term in nature, exposing the assets held in the funds to price risk. PPL actively monitors the performance of the investments held in the funds and periodically reviews the funds' investment allocations. See "Financial Condition - Risk Management - Energy Marketing & Trading and Other - Nuclear Decommissioning Trust Funds - Securities Price Risk" for additional information on securities price risk.

PPL's defined benefit plans experienced negative investment returns in 2008, impacting the funded status of those plans as disclosed in Note 13 to the Financial Statements. Determination of the funded status of defined benefit plans, contribution requirements and net periodic defined benefit costs for future years are subject to changes in several assumptions, including the performance of the assets in the plans. See "Application of Critical Accounting Policies - Defined Benefits" for a discussion of the assumptions and sensitivities regarding those assumptions.

The information provided in this Item 7 should be read in conjunction with PPL's Consolidated Financial Statements and the accompanying Notes.

Terms and abbreviations are explained in the glossary. Dollars are in millions, except per share data, unless otherwise noted.

Earnings

Net income and the related EPS were:

                                       2008       2007        2006

                      Net income      $  930     $ 1,288     $  865
                      EPS - basic     $ 2.49     $  3.39     $ 2.27
                      EPS - diluted   $ 2.47     $  3.35     $ 2.24

The changes in net income from year to year were, in part, attributable to several special items that management considers significant. Details of these special items are provided within the review of each segment's earnings.

The year-to-year changes in significant earnings components, including domestic gross energy margins by region and significant income statement line items, are explained in the "Statement of Income Analysis."

PPL's earnings beyond 2008 are subject to various risks and uncertainties. See "Forward-Looking Information," "Item 1A. Risk Factors," the rest of this Item 7 and Note 15 to the Financial Statements for a discussion of the risks, uncertainties and factors that may impact PPL's future earnings.

Segment Results

Net income by segment was:

                                             2008       2007       2006

                   Supply                   $ 479     $   568     $ 416
                   International Delivery     290         610       268
                   Pennsylvania Delivery      161         110       181
                   Total                    $ 930     $ 1,288     $ 865

Supply Segment

The Supply segment primarily consists of the domestic energy marketing, domestic generation and domestic development operations of PPL Energy Supply. In August 2007, PPL completed the sale of its domestic telecommunication operations. See Note 9 to the Financial Statements for additional information.

The Supply segment results in 2006 reflect the reclassification of PPL's interest in the Griffith plant's operating revenues and expenses from certain income statement line items to Discontinued Operations. See Note 10 to the Financial Statements for additional information.

Supply segment net income was:

                                                 2008        2007        2006
           Energy revenues
           External (a)                        $ 3,411     $ 1,615     $ 1,659
           Intersegment                          1,826       1,810       1,708
           Energy-related businesses               486         732         580
           Total operating revenues              5,723       4,157       3,947

           Fuel and energy purchases
           External (a)                          3,108       1,419       1,560
           Intersegment                            111         159         160
           Other operation and maintenance         834         715         707
           Depreciation                            196         167         159
           Taxes, other than income                 20          31          35
           Energy-related businesses               467         745         621
           Total operating expenses              4,736       3,236       3,242

           Other Income - net                       (9 )        38           4
           Interest Expense                        204         156         123
           Income Taxes                            293         232         147
           Minority Interest                         2           3           3
           Loss from Discontinued Operations                                20
           Net Income                          $   479     $   568     $   416

(a) Includes unrealized gains and losses from economic activity. See Note 19 to the Financial Statements for additional information.

The after-tax changes in net income between these periods were due to the following factors.

                                       2008 vs. 2007      2007 vs. 2006

               Eastern U.S.
               non-trading margins    $        (62 )     $         63
               Western U.S.
               non-trading margins               5                 16
               Net energy trading
               margins                         (95 )                3
               Energy-related
               businesses                       (4 )               33
               Other operation and
               maintenance                      17                (25 )
               Depreciation                    (17 )               (5 )
               Taxes, other than
               income                            6                  2
               Other income - net               (6 )               14
               Interest expense                (29 )              (19 )
               Income taxes                    (60 )                5
               Discontinued
               operations, net of
               special item (Note
               10)                                                  4
               Other                             4                 (3 )
               Special items                   152                 64
                                      $        (89 )     $        152

· See "Domestic Gross Energy Margins" for an explanation of non-trading margins by geographic region and for an explanation of net energy trading margins.

· The increased contributions from energy-related businesses in 2007 compared with 2006, was primarily due to improved earnings contributions from synfuel projects resulting primarily from higher net gains on options purchased to hedge the risk associated with the phase-out of synthetic fuel tax credits. These net gains were partially offset by higher operating losses due to increased production and by lower utilization of tax credits due to the level of crude oil prices.

· Other operation and maintenance expenses decreased in 2008 compared with 2007, primarily due to lower costs at PPL's coal-fired, hydroelectric and nuclear power plants, and lower defined benefit costs, partially offset by higher bad debt expense. Other operation and maintenance expenses increased in 2007 compared with 2006, primarily due to higher defined benefit costs, and costs at PPL's coal-fired, hydroelectric and nuclear power plants.

· Depreciation expense was higher in 2008 compared with 2007, primarily due to the Montour scrubbers and Susquehanna uprate projects that were placed in-service in 2008.

· Other income - net increased in 2007 compared with 2006, primarily due to an increase in interest income and higher gains on sales of real estate.

· Interest expense increased in 2008 compared with 2007, primarily due to increased interest on long-term debt resulting from new issuances, partially offset by hedging activities. Interest expense increased in 2007 compared with 2006, primarily due to increased interest on long-term debt resulting from new issuances.

· Income taxes increased in 2008 compared with 2007, primarily due to the loss of synfuel tax credits as the projects ceased operation at the end of 2007.

The following after-tax amounts, which management considers special items, also had a significant impact on the Supply segment earnings.

                                          2008        2007       2006

                    MTM adjustments
                    from economic
                    activity (Note
                    19)                 $   251     $   32     $  (11 )
                    Off-site
                    remediation of
                    ash basin leak
                    (Note 15)                 1                     6
                    Impairment of
                    domestic
                    telecommunication
                    operations (Note
                    9)                                 (23 )
                    Settlement of
                    Wallingford
                    cost-based rates
                    (a)                                 33
                    Impairment of
                    transmission
                    rights (b)                         (13 )
                    Sale of interest
                    in the Griffith
                    plant (Note 10)                               (16 )
                    Reduction in
                    Enron reserve (c)                              11
                    Impairment of
                    synfuel-related
                    assets (Note 15)                               (6 )
                    Workforce
                    reduction
                    (Note 13)                           (4 )       (3 )
                    PJM billing
                    dispute (d)                         (1 )      (18 )
                    Montana basin

(a) In 2003, PPL Wallingford and PPL EnergyPlus sought from the FERC cost-based payments based upon the RMR status of four units at the Wallingford, Connecticut generating facility. In 2007, as a result of a settlement agreement, PPL recognized $55 million of revenue and $4 million of interest income related to the settlement agreement.
(b) See "Other Operation and Maintenance" for more information on the $23 million pre-tax impairment recorded in 2007.
(c) In 2006, PPL and PPL Energy Supply sold their Enron Corporation (Enron) bankruptcy claims that related to past due receivables to an independent third party. In conjunction with the sale, PPL Energy Supply reduced the associated allowance for doubtful accounts. The effect of this change was to increase income from continuing operations and net income by $11 million ($0.03 per share, basic and diluted, for PPL). PPL Energy Supply remained liable if any of the claims were disallowed by the bankruptcy court, under certain circumstances. During 2008, this exposure expired.
(d) In 2005, the Pennsylvania Delivery segment recorded a loss accrual, including interest expense, related to a PJM billing dispute. In 2006, the accrual was reduced and it was determined that the Supply segment was responsible for a portion of the loss accrual, including interest.
(e) Includes $13 million related to the cancellation of the Holtwood hydroelectric expansion project. See Note 9 to the Financial Statements for additional information.

2009 Outlook

Excluding special items and the impact of the cost reduction initiative discussed below, PPL projects higher earnings for its Supply business segment in 2009 compared with 2008, driven by higher energy margins, despite higher expected coal expense, as a result of higher baseload generation; higher Western U.S. energy sales prices; and higher expected margins from its marketing and trading activities. The Supply segment also expects to incur higher operation and maintenance expenses, depreciation and financing costs in 2009.

See Note 26 to the Financial Statements for additional information on a cost reduction initiative completed in February 2009. The Supply segment expects to achieve annual pre-tax savings of between $14 and $17 million from the reduction of management and staff positions, including a reduction of costs allocated as a result of the elimination of positions at PPL Services.

International Delivery Segment

The International Delivery segment consists primarily of the distribution of electricity in the U.K. In 2007, PPL completed the sale of its Latin American businesses. In the first quarter of 2008, the International Delivery segment recognized income tax adjustments and other expenses in Discontinued Operations as the dissolution of the remaining Latin American holding companies commenced. See Note 10 to the Financial Statements for additional information.

The International Delivery segment results in 2008, 2007 and 2006 reflect the reclassification of Latin American revenues and expenses to Discontinued . . .