Financial Review and Operating Analysis

Net income for 1997 was $281 million, or $2.13 per common share, compared with a net loss of $309 million, or $3.15 per common share, for 1996 and net income of $180 million, or $1.24 per common share, for 1995. Results for 1997 include an after-tax gain of $113 million related to the sale of our equity interest in Iron Ore Company of Canada (IOC), and results for 1996 include after-tax restructuring charges of $382 million. We recorded the restructuring charges in connection with our decision to exit five businesses and to recognize the Bethlehem Coke Division as an impaired asset. The exited businesses were: Bethlehem Structural, BethForge, CENTEC, BethShip’s Sparrows Point Yard and our Eagle Nest coal mine. See Note C, Estimated Gain (Loss) on Exiting Businesses and Impairment of Long-lived Assets, to the Consolidated Financial Statements. Excluding the effects of these items, net income for 1997 was $168 million ($1.12 per common share), compared with net income for 1996 of $73 million ($.28 per common share). Sales in 1997 declined to $4.63 billion from $4.68 billion in 1996 and $4.87 billion in 1995 principally as the result of exiting the underperforming businesses.

The improvement in 1997 over 1996 was due primarily to lower costs from improved operations at our Sparrows Point Division and Pennsylvania Steel Technologies, Inc. (PST) and exiting Bethlehem Structural. The 1997 results were also affected by higher employment and raw material costs at Burns Harbor. Results for 1996 declined from 1995 principally from lower average realized prices and shipments, which were partially offset by a higher valued product mix.

Lukens Inc.
As discussed elsewhere in this report, Bethlehem will acquire Lukens 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% in the form of Bethlehem Common Stock. The transaction is expected to close by early second quarter 1998, subject to approval by Lukens’ stockholders and regulatory authorities. Bethlehem also entered into agreements with Allegheny Teledyne Corporation under which Bethlehem will provide Allegheny with conversion services for stainless steel hot bands and coiled plate wider than Allegheny can currently produce; Allegheny will purchase certain assets that Lukens uses in the manufacture of stainless steel products; and Allegheny will supply hot rolled bands to Bethlehem for further processing on the stainless steel coil finishing facilities that Lukens currently owns.

Segment Results
Basic Steel Operations. Our Basic Steel Operations segment had income from operations of $264 million in 1997, compared with income from operations of $168 million in 1996, excluding 1997’s gain on the sale of IOC and 1996’s restructuring charges. Income from operations was $311 million in 1995.

The improvement in this segment’s results in 1997 over 1996 was due primarily to lower costs from improved operations at Sparrows Point and PST and exiting Bethlehem Structural. The results were also affected by higher employment and raw material costs at Burns Harbor. Shipments were 8.8 million tons for both 1997 and 1996.

Results for 1996 compared with 1995 declined due to lower realized steel prices and lower structural product shipments, partially offset by an improved product mix from a higher percentage of coated and cold rolled sheet product shipments. Average realized prices were 3% lower in 1996 than they were in 1995 and shipments were 8.8 million tons in 1996, compared with 9.0 million tons in 1995.

The effects of changes in average realized steel prices, shipments (including coal and ore) and product mix on this segment’s sales during the last two years were as follows:

Raw steel production increased to 9.6 million tons in 1997 from 9.4 million tons in 1996 due to improved operations at Sparrows Point. Raw steel production declined from 10.4 million tons in 1995 as a result of closing Bethlehem Structural’s steelmaking facilities.

The Burns Harbor Division shipped 4.8 million tons of steel products in both 1997 and 1996, compared with 4.6 million tons in 1995. Despite improvements in product mix and a slight increase in shipments, Burns Harbor’s 1997 operating results declined principally because of higher employment costs and raw material prices and lower average realized prices.

The Sparrows Point Division shipped 3.2 million tons of steel products in both 1997 and 1996, compared with 3.0 million tons in 1995. Sparrows Point’s 1997 operating results improved due to higher productivity; lower energy, repair and maintenance costs; higher average realized prices; and a higher valued product mix.

Results improved at PST in 1997 due to higher semifinished, rail and large-diameter pipe shipments. Lower steelmaking costs were recognized during 1997 as a result of our modernization program.

Steel Related Operations. Our Steel Related Operations segment (BethForge, CENTEC and BethShip) was sold by early fourth-quarter 1997. It reported a loss from operations of $25 million in 1997, compared with a loss from operations of $31 million in 1996, excluding the 1996 restructuring charge, and a loss of $42 million in 1995.

Liquidity and Capital Structure
At December 31, 1997, total liquidity, comprising cash, cash equivalents and funds available under our bank credit arrangement, totaled $612 million, compared with $446 million at December 31, 1996.

Cash provided from operating activities in 1997 increased to $551 million from $341 million in 1996 due to changes in working capital, principally inventory, and higher earnings. Cash provided from operating activities in 1996 declined to $341 million from $586 million in 1995 from lower earnings and changes in working capital, principally receivables. Other sources of cash in 1997 included about $190 million of proceeds from the sales of IOC, our Steel Related Operations and High Power Mountain.

Principal uses of cash during 1997 included pension funding and capital expenditures. We contributed $425 million to our pension fund in 1997, compared with $170 million in 1996 and $330 million in 1995. As a result of our contributions and better than expected earnings on our pension fund assets in 1997, our pension liability decreased to $440 million at December 31, 1997, from $870 million at December 31, 1996. Over the past four years, our pension liability has been reduced by about $1.2 billion from $1.6 billion at December 31, 1993, and our plan is now about 95% funded.

We have contributed amounts to our pension fund substantially in excess of amounts required under current law and regulations. As a result, we currently have a funding standard credit balance that would allow us to defer pension funding for more than two years, although we presently have no plans to do so.

Major uses of funds for 1998, excluding the potential merger with Lukens Inc., are pension funding, capital expenditures of about $300 million and debt payments of about $40 million. Cash required in connection with the Lukens acquisition is expected to total about $350 million and will be funded with available cash and proceeds from the sale of assets, including Lukens’ stainless business. We expect to maintain an adequate level of liquidity throughout 1998 from cash flow from operations, reductions in working capital and available funds under our credit arrangement.

We have made good progress in improving our capital structure by reducing our debt and increasing our stockholders’ equity. Our ratio of debt to invested capital was 29% at December 31, 1997, compared with 36% a year earlier.

*The principal market for Bethlehem Common Stock is the New York Stock Exchange. Bethlehem Common Stock is also listed on the Chicago Stock Exchange. The high and low sales prices of Bethlehem’s Common Stock as reported in the consolidated transaction system are shown. The trading symbol for Bethlehem Common Stock is BS. Bethlehem has not paid a dividend on its Common Stock since the fourth quarter of 1991.

Status of Restructuring Plan
In 1997, we completed the 1996 Comprehensive Restructuring Plan by exiting five underperforming businesses and eliminating the significant losses they were incurring. We sold BethForge, CENTEC and BethShip’s Sparrows Point Yard. Bethlehem Structural ended operations in March, and we are attempting to sell its individual assets.

We also sold our Eagle Nest coal operation in 1996, and although it was not part of the Plan, in 1997, we sold our High Power Mountain coal assets and our equity interest in IOC.We also announced in 1997 that we intend to discontinue our Bethlehem Coke Division in Bethlehem, Pennsylvania, by March 31, 1998. In 1996, as part of the Comprehensive Restructuring Plan, we wrote off the property, plant and equipment of this Division as an impaired asset.

Capital Expenditures
Capital expenditures were $228 million in 1997, compared with $259 million in 1996 and $267 million in 1995.

In October 1997, we announced a plan to build a new cold rolling mill complex at Sparrows Point. The $300 million complex, which is scheduled to begin production early in 2000, is expected to lower costs, improve quality and enhance capabilities.At December 31, 1997, the estimated cost of completing authorized capital expenditures was about $751 million, compared with $386 million at December 31, 1996. Such authorized capital expenditures are expected to be completed during the 1998-2000 period.

Employment
At the end of 1997, we had about 15,600 employees, compared with about 17,500 employees at the end of 1996 and 18,300 employees at the end of 1995. About three-quarters of our employees are covered by our labor agreements with the United Steelworkers of America (USWA).

Under the terms of our 1993 labor agreements with the USWA, most employees at our steel operations receive profit sharing of 8% of adjusted consolidated annual income before taxes, unusual items and expenses applicable to the plan plus 2% of adjusted profits of certain operations, payable in the following year. Most workers received a $.25 per hour wage increase on August 1, 1997, and will receive a $.25 per hour wage increase on August 1, 1998. Profit sharing is also paid to non-represented employees based on specific Corporate and Business Unit plans and performance. We paid about $40 million in 1997 and expect to pay about $55 million for income-related bonus, profit sharing and shortfall amounts in early 1998.

Under other provisions of the labor agreements, we are required to pay “shortfall amounts” each year up to 10% of the first $100 million and 20% in excess of $100 million of consolidated income before taxes, unusual items and expenses applicable to the shortfall plan. Shortfall amounts arise when employees terminate employment and ESOP Preference Stock, held in trust for employees in reimbursement for wage and benefit reductions in prior years, is converted into Common Stock and sold for amounts less than the stated value of the Preference Stock ($32 for Series A and $40 for Series B). We issued approximately 37,000 shares of Series B Preference Stock in 1997 and approximately 61,000 shares in 1996 to a trustee for the benefit of employees for 1996 and 1995, respectively, and expect to issue about 18,000 shares in early 1998 for the 1997 plan year.

Environmental
We are subject to various federal, state and local environmental laws and regulations concerning among other things, air emissions, waste water discharges, and solid and hazardous waste disposal. During the five years ended December 31, 1997, we spent approximately $160 million for environmental control equipment. Expenditures for new environmental control equipment totaled approximately $15 million in 1997, $29 million in 1996 and $36 million in 1995. The costs incurred in 1997 to operate and maintain existing environmental control equipment were approximately $110 million (excluding interest costs but including depreciation charges of $14 million), compared with $115 million in 1996 and $120 million in 1995.

Bethlehem and federal and state regulatory agencies conduct negotiations to resolve differences in interpretation of certain environmental control requirements. In some instances, those negotiations are being held in connection with the resolution of pending environmental proceedings. We believe that there will not be any significant curtailment or interruptions of any of our important operations as a result of these proceedings and negotiations. We cannot predict the specific environmental control requirements that we will face in the future. Based on existing and anticipated regulations promulgated under presently enacted legislation, we currently estimate that capital expenditures for installation of new environmental control equipment will average about $20 million per year over the next two years. However, estimates of future capital expenditures and operating costs required for environmental compliance are subject to numerous uncertainties, including the evolving nature of regulations, possible imposition of more stringent requirements, availability of new technologies and the timing of expenditures.

Although it is possible that our future results of operations, in particular quarterly or annual periods, could be materially affected by the future costs of environmental compliance, we believe that the future costs of environmental compliance will not have a material adverse effect on our consolidated financial position or on our competitive position with respect to other integrated domestic steelmakers that are subject to the same environmental requirements.

Financial Highlights Chairman's Letter
Bethlehem's Businesses Financial Review and Operating Analysis
Financial Statements   Notes
Report of  Independent Auditors Management Statement
Five-Year Financial and Operating Summaries
Directors/Corporate Officers and Business Unit Presidents
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