Notes to Consolidated Financial Statements

A. Accounting Policies
Principles of Consolidation – The consolidated financial statements include the accounts of Bethlehem Steel Corporation and all majority-owned subsidiaries and joint ventures.

Cash and Cash Equivalents – Cash equivalents consist primarily of overnight investments, certificates of deposit and other short-term, highly liquid instruments generally with original maturities at the time of acquisition of three months or less. Cash equivalents are stated at cost plus accrued interest, which approximates market.

Inventories – Inventories are valued at the lower of cost (principally FIFO) or market.

Property, Plant and Equipment – Property, plant and equipment is stated at cost. Maintenance, repairs and renewals that neither materially add to the value of the property nor appreciably prolong its life are charged to expense. Gains or losses on dispositions of property, plant and equipment are recognized in income. Interest is capitalized on significant construction projects and totaled $7 million, $7 million and $5 million in 1997, 1996 and 1995.

Our property, plant and equipment by major classification is:

Depreciation – Depreciation is based upon the estimated useful lives of each asset group. The estimated useful life is 18 years for most steel producing assets. Steel assets, other than blast furnace linings, and most raw material producing assets are depreciated on a straight-line basis adjusted by an activity factor. This factor is based on the ratio of production and shipments for the current year to the average production and shipments for the current and preceding four years at each operating location. Annual depreciation after adjustment for this activity factor is not less than 75% nor more than 125% of straight-line depreciation. Depreciation after adjustment for this activity factor was $5 million, $13 million and $16 million more than straight-line in 1997, 1996 and 1995. Through December 31, 1997, $10 million more accumulated depreciation has been recorded under this method than would have been recorded under straight-line depreciation. The cost of blast furnace linings is depreciated on a unit-of-production basis.

Foreign Currency, Interest Rate and Commodity Price Risk Management – Periodically, we enter into financial contracts to manage risks. We use foreign currency exchange contracts to manage the cost of firm purchase commitments for capital equipment or other purchased goods and services denominated in a foreign currency. We use interest rate swap agreements to fix the interest rate on certain floating rate debt. We use commodity contracts to fix the cost of a portion of our annual requirements for natural gas, zinc and other metals. Generally, foreign currency and commodity contracts are for periods of less than a year. The gains or losses on these contracts are reflected in the cost of goods or services purchased. Net payments or receipts on interest rate swaps are reflected in interest expense. Gains or losses on swaps settled or terminated are deferred and amortized to interest expense over the life of the related debt. Currency and commodity contracts outstanding during the years and at year end were not material. Also, see Note F, Long-term Debt and Capital Lease Obligations.

Use of Estimates – In preparing these financial statements, we make estimates and use assumptions that affect some of the reported amounts and disclosures. See, for example, Note E, Taxes; Note G, Commitments and Contingent Liabilities; Note H, Postretirement Pension Benefits; and Note I, Postretirement Benefits Other Than Pensions. In the future, actual amounts received or paid could differ from those estimates.

B. Industry Segment Information

A general description of our segments and their products and services is contained under the heading “Bethlehem’s Segments” of this Report.

Intersegment sales are generally at market prices. Corporate assets consist primarily of cash and cash equivalents, investments, deferred income tax asset and intangible asset – pensions.

C. Estimated Gain (Loss) on Exiting Businesses
     and Impairment of Long-lived Assets
In the second quarter of 1997, we sold our 37.57% interest in Iron Ore Company of Canada (IOC) for about $145 million. This sale resulted in recognizing a gain of $135 million ($113 million after-tax, or $1.01 per common share).

During 1996, we announced a restructuring plan to improve financial performance and stockholder value. Our plan included exiting our Bethlehem Structural, BethForge, CENTEC and BethShip businesses. Accordingly, we recorded restructuring losses in 1996 totaling $465 million ($382 million after-tax, or $3.43 per share). These losses included $250 million for the net book value of certain assets, $180 million for employee benefit-related costs ($120 million for pensions, $30 million of postretirement benefits other than pensions, and $30 million for severance and other benefits) and $35 million for future contractual and other costs. In 1996, we also sold and leased assets of our Eagle Nest coal mine and wrote down as an impaired asset our Coke Division in Bethlehem, Pennsylvania.

Bethlehem Structural ended operations in March 1997. We have sold all of Bethlehem Structural’s inventory and are in the process of selling its individual assets. BethForge, CENTEC and BethShip were sold during 1997.

In December 1997, we announced plans to discontinue our Bethlehem Coke Division operations by March 31, 1998. The 1996 restructuring charge assumed that our BethForge, CENTEC and BethShip businesses would be shut down and liquidated. Fortunately, we were able to sell those businesses. Also, because of a recent arbitration decision, we can offer employment at our Sparrows Point Division and our Lackawanna Coke operation to certain potential early retirees from the Bethlehem Structural operations. Accordingly, the restructuring charges recognized in prior years are expected to be sufficient to cover the employment and other related charges for closing the Bethlehem Coke Division. We expect to reduce our workforce by about 800 employees as a result of this decision.

The amounts charged to the restructuring liability in 1997, 1996 and 1995, other than employment-related costs, were not material.

D. Acquisition of Lukens Inc.
In January 1998, Bethlehem signed an amended merger agreement to acquire Lukens Inc. in a transaction valued at about $740 million, including the assumption of about $250 million of debt. The equity value of the transaction is about $490 million. Of the total consideration to be paid by Bethlehem, 68% will be in the form of cash, with the remaining 32% to be in the form of Bethlehem Common Stock. The amount of Bethlehem Common Stock to be issued for each Lukens share exchanged for Bethlehem Common Stock will be based on the 15-day average closing price of Bethlehem Common Stock prior to the closing of the transaction. Under the agreement, Bethlehem will issue no more than 22.5 million shares, nor less than 15.1 million shares, of its Common Stock. We expect to complete the transaction in the second quarter of 1998.

E. Taxes
Our benefit (provision) for income taxes consisted of:

The benefit (provision) for income taxes differs from the amount computed by applying the federal statutory rate to pre-tax income (loss). The computed amounts and the items comprising the total differences follow:

The components of our net deferred income tax asset are as follows:

Temporary differences represent the cumulative taxable or deductible amounts recorded in our financial statements in different years than recognized in our tax returns. Our employee benefits temporary difference includes amounts expensed in our financial statements for pensions, health care, life insurance and other post-retirement benefits that become deductible in our tax return upon payment or funding in qualified trusts. The depreciable assets temporary difference represents principally tax depreciation in excess of financial statement depreciation. Other temporary differences represent principally various expenses accrued for financial reporting purposes that are not deductible for tax reporting purposes until paid. At December 31, 1997, we had regular tax net operating loss carryforwards of $1.8 billion and alternative minimum tax loss carryforwards of $800 million. Regular federal tax net operating loss carryforwards of $261 million expire in 1998, with the balance expiring in varying amounts from 1999 through 2011.

FASB Statement No. 109, Accounting for Income Taxes, requires that we record a valuation allowance when it is “more likely than not that some portion or all of the deferred tax assets will not be realized.” It further states, “forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years.” The ultimate realization of this deferred tax asset depends on our ability to generate sufficient taxable income in the future.

Bethlehem reported income before income taxes, restructuring charges and accounting changes in eight of the past ten years. Bethlehem has undergone substantial restructuring and made substantial strategic capital expenditures during the last several years. Also, we have significant tax-planning opportunities to manage taxable income including selection of depreciation methods and timing of contributions to our pension trust fund.

We believe that our deferred tax asset will be realized by future operating results together with tax-planning opportunities. However, our significant net operating loss carryforwards and future tax deductions from temporary differences make it appropriate to record a valuation allowance. Accordingly, we have provided a valuation allowance equal to 50% of the total deferred tax asset related to our operating loss carryforward and our temporary differences exclusive of postretirement benefits other than pensions. If we have a tax loss in any year in which our tax deduction for postretirement benefits other than pensions exceeds our financial statement expense, the tax law currently provides for a 15-year carryforward (20 years beginning in 1998) of that loss against future taxable income. We, therefore, have sufficient time to realize these future tax benefits. We believe, therefore, a valuation allowance is not appropriate for the deferred tax asset related to our temporary difference for postretirement benefits other than pensions.

If we are unable to generate sufficient taxable income in the future through operating results or tax-planning opportunities, we will be required to increase our valuation allowance through a charge to expense (reducing our stockholders’ equity). On the other hand, if we achieve sufficient profitability to use all of our deferred income tax asset, we will reduce the valuation allowance through a decrease to expense (increasing our stockholders’ equity).

In addition to income taxes, we incurred costs for certain other taxes as follows:

F. Long-term Debt and Capital Lease Obligations

Maturities and sinking fund requirements for the next five years are $42 million in 1998, $44 million in 1999, $48 million in 2000, $50 million in 2001 and $11 million in 2002.

The galvanizing lines financing is collateralized by such equipment at our Sparrows Point and Burns Harbor Divisions and will be repaid in equal semiannual installments through 2000.

The 10-3/8% Senior Notes are senior in right of payment to all existing and future subordinated indebtedness of Bethlehem. As unsecured senior obligations, the Notes will effectively be subordinate to secured senior indebtedness of Bethlehem. These Notes contain covenants that impose certain limitations on our ability to incur or repay debt, to pay dividends and make other distributions on or redeem capital stock, or to sell, merge, transfer or encumber assets. See Note L, Stockholders’ Equity.

We have a credit arrangement with a group of 13 domestic and international banks for $525 million, $150 million of which can be used for letters of credit. The arrangement consists of a $300 million receivables sale/purchase agreement through a wholly owned special purpose subsidiary and a $225 million secured credit agreement. During the second quarter of 1997, we amended this agreement by extending its term by about two years, through September 12, 2002, and increasing the facility’s inventory credit arrangement from $200 million to $225 million.

As of December 31, 1997, we had sold to the banks an ownership interest in trade receivables of $175 million in exchange for $78 million in cash, $67 million in letters of credit and required reserves of $30 million. The receivables were sold at a discount, based on defined short-term, investment-grade interest rates and a fixed fee per annum for the letters of credit. The banks are required to pay us cash for the face amount of the letters of credit upon expiration. We pay a .1875% per annum fee on the daily available commitment.

Receivables from banks relate to letters of credit and required reserves that will be collected upon expiration of the letters of credit and liquidation of the banks’ receivable ownership. Supplemental information on the receivable balances at December 31, 1997 and 1996 follows:

Under the secured credit agreement, inventories are pledged as collateral for any borrowings and letters of credit. Borrowings under the agreement are subject to collateral coverage requirements and incur interest based on defined short-term interest rates. No borrowings were outstanding under this agreement at December 31, 1997. We pay a .5% per annum fee on the daily available commitment.

Our secured credit agreement and galvanizing lines financing agreements contain restrictive covenants that require Bethlehem to maintain a minimum adjusted consolidated tangible net worth. At December 31, 1997, our adjusted tangible net worth as defined by these agreements exceeded the more restrictive of these requirements by about $600 million.

At December 31, 1997, outstanding interest rate swap agreements with notional amounts totaling $68 million effectively fix the interest rate on our floating rate financings at 5.75% to 8.70%. These interest rate swap agreements expire in 2000 and 2001. At December 31, 1997 and 1996, the estimated fair value of our debt and interest rate swap agreements was not materially different from the recorded amounts.

Future minimum payments under noncancelable operating leases at December 31, 1997 were $18 million in 1998, $14 million in 1999, $10 million in 2000, $7 million in 2001, $6 million in 2002 and $15 million thereafter. Total rental expense under operating leases was $40 million, $40 million and $42 million in 1997, 1996 and 1995.

G. Commitments and Contingent Liabilities
On April 1, 1997, we sold our interest in IOC and entered into a 14-year agreement to purchase up to 1.8 million tons of iron ore per year through the year 2004 and about 500,000 tons in the years 2005 through 2011. In 1997, we purchased 1.7 million net tons from IOC at a net cost of $53 million.

At December 31, 1997, we had outstanding approximately $57 million of purchase orders for additions and improvements to our properties.

We, as well as other steel companies, are subject to various environmental laws and regulations imposed by federal, state and local governments. Because of the continuing evolution of the specific regulatory requirements and available technology to comply with the requirements, we cannot reasonably estimate the future capital expenditures and operating costs required to comply with these laws and regulations. Although it is possible that our future operating results in a particular quarterly or annual period could be materially affected by the future costs of environmental compliance, we believe that such costs will not have a material adverse effect on our consolidated financial position or on our competitive position with respect to other integrated domestic steelmakers subject to the same environmental requirements.

In the ordinary course of our business, we are involved in various pending or threatened legal actions. In our opinion, adequate reserves have been recorded for losses that are likely to result from these proceedings. If such reserves prove to be inadequate, however, we would incur a charge to earnings that could be material to the results of operations in a particular future quarterly or annual period. Based on the advice of legal counsel, we believe that any ultimate liability arising from these actions will not have a material adverse effect on our consolidated financial position.

H. Postretirement Pension Benefits
We have noncontributory defined benefit pension plans that provide benefits for substantially all our employees. Defined benefits are based on years of service and the five highest consecutive years of pensionable earnings during the last ten years prior to retirement or a minimum amount based on years of service. We fund annually the amount required under ERISA minimum funding standards plus additional amounts as appropriate.

The following sets forth the plans’ actuarial assumptions used and funded status at our valuation date of November 30, together with amounts recognized in our consolidated balance sheets:

The assumptions used in each year and the components of our annual pension cost are as follows:

I. Postretirement Benefits Other Than Pensions
In addition to providing pension benefits, we currently provide health care and life insurance benefits for most retirees and their dependents.

The following sets forth our plans’ actuarial assumptions used and funded status at our valuation date of November 30, together with the amounts recognized in our consolidated balance sheets:

The assumptions used in each year and the components of our postretirement benefit cost follow:

A one percentage point increase or decrease in the assumed health care trend rate would increase or decrease the accumulated postretirement benefit obligation by about $150 million and 1997 expense by about $10 million.

J. Stockholder Rights Plan
We have a Stockholder Rights Plan under which holders of Common Stock have rights to purchase a new series of Preference Stock. When exercisable, each right entitles the holder to purchase one one-hundredth of a share of Series A Junior Participating Preference Stock at an exercise price of $80 per unit. The rights will become exercisable only if a person or group acquires 15% or more of Common Stock or begins a tender offer or exchange offer that would result in that person or group beneficially owning 20% or more of Common Stock. Subsequently, upon the occurrence of certain events, holders of rights will be entitled to purchase Common Stock of Bethlehem or a third-party acquiror worth twice the right’s exercise price. Until the rights become exercisable, we will be able to redeem them at one cent per right. The rights expire on October 18, 1998.

K. Stock Options
At December 31, 1997, we had options outstanding under Plans approved by our stockholders in 1988 and 1994. New options can be granted only under the 1994 Plan, which reserved 4,000,000 shares of Common Stock for such use. At December 31, 1997, options on 826,300 shares of Common Stock were available for granting. The option price is the fair market value of our Common Stock on the date the option is granted. Options issued under the 1994 Plan become exercisable one to four years after the date granted and expire ten years from the date granted. Exercisable options may be surrendered for the difference between the option price and the quoted market price of the Common Stock on the date of surrender. Depending on the circumstances, option holders receive either Common Stock, cash or a combination of Common Stock and cash. Because of the surrender component in our options, related expense is recognized periodically based on the difference between the option price and current quoted market prices. Compensation expense recognized and weighted average fair value for the options granted in 1997, 1996 and 1995 were not material.

Changes in options outstanding during 1997, 1996 and 1995 under the Plans were as follows:

Options exercisable at the end of 1997, 1996 and 1995 were 2,083,250, 1,976,300 and 1,848,375.

Information on our stock options at December 31, 1997 follows:

L. Stockholders' Equity

Each share of $3.50 Cumulative Convertible Preferred Stock issued in 1993 is convertible into 2.39 shares of Common Stock, subject to certain events. Each share of the $5.00 Cumulative Convertible Preferred Stock and the $2.50 Cumulative Convertible Preferred Stock issued in 1983 is convertible into 1.77 and .84 shares of Common Stock, subject to certain events.

In accordance with our labor agreements, we issue Preference Stock to a trustee under the Employee Investment Program. Series "A" and Series "B" of Preference Stock have a cumulative dividend of 5% per annum payable at our option in cash, Common Stock or additional shares of Preference Stock. Each share of Preference Stock is entitled to vote with Common Stock on all matters and is convertible into one share of Common Stock.

Preferred and Preference Stock issued and outstanding:

The following presents the details of our earnings per share calculations:

*Antidilutive

Under the covenants of our 10-3/8% Senior Notes, we can pay future dividends on our common stock, among certain other restrictions, only if such cumulative dividends do not exceed the aggregate net cash proceeds from the sale of capital stock plus 50% of our consolidated net income and minus 100% of our consolidated net loss since the second quarter of 1993, excluding certain restructuring charges and other adjustments. The amount available at December 31, 1996 under this covenant was about $450 million.

M. Quarterly Financial Data (Unaudited)

Asset Impairment - In accordance with FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, Bethlehem periodically evaluates the carrying value of its property, plant and equipment to be held and used when events and circumstances warrant such a review. The carrying value for a logical grouping of separately identifiable property, plant and equipment is considered impaired when the anticipated undiscounted future cash flows from such logical grouping of assets is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the asset. If comparable market values are not available to determine fair market value, fair market value is determined by discounting the anticipated future cash flows at a rate commensurate with the risk involved. Losses, if any, on long-lived assets to be disposed of are determined in a similar manner, except fair market values are reduced for the estimated costs to dispose.

Environmental Expenditures - Bethlehem accounts for environmental expenditures in accordance with FASB Statement No. 5, Accounting for Contingencies, and its related interpretations, including Staff Accounting Bulletins issued by the staff of the Securities and Exchange Commission. Accordingly, environmental expenditures that increase the life or efficiency of property, plant and equipment, or that reduce or prevent environmental contamination are capitalized. Expenditures that relate to existing conditions caused by past operations and which have no significant future economic benefit are expensed. Environmental expenses are accrued at the time the expenditure becomes probable and the costs can be reasonably estimated. Bethlehem's policy is to not discount any recorded obligations for future remediation expenditures to their present value nor to record recoveries of environmental remediation costs from insurance carriers and other third parties, if any, as assets until their receipt is deemed probable.

Revenue Recognition - Bethlehem recognizes substantially all revenues when products are shipped to customers and risks of ownership change. Revenue and estimated profits under long-term contracts (related to the Steel Related Operations - refer to Note B. Industry Segment Information) are recognized using the percentage of completion method; however, losses are recognized when they are probable and can be reasonably estimated. Such long-term contracts have not been material in relation to Bethlehem's total sales and operating income.

2. The following paragraph is added to Note C. Estimated Gain (Loss) on Exiting Businesses and Impairment of Long-lived Assets:

B. To the extent incorporated in this Form 10-K Annual Report, any references in Bethlehem's 1997 Annual Report to Stockholders to cash provided from operating activities means cash provided from operating activities excluding pensions. Any other statement contained in Bethlehem's 1997 Annual Report to Stockholders incorporated by reference in this Report shall be deemed to be modified or superseded for purposes of this Report to the extent that a statement contained in this Report modifies or supersedes such statement.

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