Summary of WESTLAKE CHEMICAL CORP

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
We are a vertically integrated manufacturer and marketer of petrochemicals, polymers and fabricated building products. Our two principal business segments are Olefins and Vinyls. We use the majority of our internally-produced basic chemicals to produce higher value-added chemicals and building products. Consumption of the basic chemicals that we manufacture in the commodity portions of our olefins and vinyls processes has increased significantly since we began operations in 1986. Our olefins and vinyls products are some of the most widely used chemicals in the world and are upgraded into a wide variety of higher value-added chemical products used in many end-markets. Petrochemicals are typically manufactured in large volume by a number of different producers using widely available technologies. The petrochemical industry exhibits cyclical commodity characteristics, and margins are influenced by changes in the balance between supply and demand and the resulting operating rates, the level of general economic activity and the price of raw materials. The cycle is generally characterized by periods of tight supply, leading to high operating rates and margins, followed by a decline in operating rates and margins primarily as a result of significant capacity additions. Due to the significant size of new plants, capacity additions are built in large increments and typically require several years of demand growth to be absorbed.
Beginning in 2009 and continuing through 2012, a cost advantage for ethane-based ethylene producers over naphtha-based ethylene producers allowed a strong export market and higher margins for North American chemical producers, including Westlake. Increased global demand for polyethylene since 2010 has resulted in improved operating margins and cash flow for our Olefins segment. However, some olefins industry consultants predict that a significant increase in worldwide ethylene and ethylene derivative capacity may occur within the next decade, with the largest increases in Asia and North America. As a result, our Olefins segment operating margins may be negatively impacted.
Weakness in the U.S. construction markets, which began in the third quarter of 2006, and the subsequent budgetary constraints in municipal spending, have contributed to lower domestic demand for our vinyls products. In addition, increases in feedstock costs, combined with the industry's inability to sufficiently raise domestic prices for PVC resin and building products in order to offset cost increases, affected our Vinyls segment's operating results in 2010 and 2011. However, since late 2010, the PVC industry has experienced an increase in PVC resin export demand, driven largely by more competitive feedstock and energy cost positions in North America. As a consequence, domestic PVC resin industry operating rates have improved since 2010, largely due to higher PVC resin export shipments. However, looking forward, our Vinyls segment operating rates and margins may continue to be negatively impacted by the slow recovery of U.S. construction markets.
While the economic environment continues to be challenging for our customers, we believe our customer base remains generally healthy. As we continue to manage our business in this environment, including the slowdown in construction activity, we have taken steps designed to address the changes in demand and margins in our Vinyls segment and its resulting impact on our operations by matching production with sales demand and continuing to operate our plants in an efficient manner. We continue to monitor our cost management programs and discretionary capital spending. The impact of the global economic environment has been challenging to our business and, depending on the performance of the global economy in 2013 and beyond, could have a negative effect on our financial condition, results of operations or cash flows.
We purchase significant amounts of ethane and propane feedstock, natural gas, ethylene, chlorine and salt from external suppliers for use in production of basic chemicals in the olefins and vinyls chains. We also purchase significant amounts of electricity to supply the energy required in our production processes. While we have agreements providing for the supply of ethane and propane feedstocks, natural gas, ethylene, chlorine, salt and electricity, the contractual prices for these raw materials and energy vary with market conditions and may be highly volatile. Factors that have caused volatility in our raw material prices in the past, and which may do so in the future include:
• the availability of feedstock from shale gas and oil drilling;

• shortages of raw materials due to increasing demand;

• ethane, propane and liquefied natural gas exports;

• capacity constraints due to construction delays, strike action or involuntary shutdowns;

• the general level of business and economic activity; and

• the direct or indirect effect of governmental regulation.

Significant volatility in raw material costs tends to put pressure on product margins as sales price increases could lag behind raw material cost increases. Conversely, when raw material costs decrease, customers may seek immediate relief in the form of lower sales prices. We currently use derivative instruments to reduce price volatility risk on feedstock commodities and

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lower overall costs. Normally, there is a pricing relationship between a commodity that we process and the feedstock from which it is derived. When this pricing relationship deviates from historical norms, we have from time to time entered into derivative instruments and physical positions in an attempt to take advantage of this relationship.
Our historical results have been significantly affected by our plant production capacity, our efficient use of the capacity and our ability to increase our capacity. Since our inception, we have followed a disciplined growth strategy that focuses on plant acquisitions, new plant construction and internal expansion. We evaluate each expansion project on the basis of its ability to produce sustained returns in excess of our cost of capital and its ability to improve efficiency or reduce operating costs.
As noted above in Item 1A, "Risk Factors," we are subject to extensive environmental regulations, which may impose significant additional costs on our operations in the future. Further, concern about GHG emissions and their possible effects on climate change has led to the enactment of regulations, and to proposed legislation and additional regulations that could affect us in the form of increased cost of feedstocks and fuel, other increased costs of production and decreased demand for our products. While we do not expect any of these enactments or proposals to have a material adverse effect on us in the near term, we cannot predict the longer-term effect of any of these regulations or proposals on our future financial condition, results of operations or cash flows.
Recent Developments
We previously announced an expansion program to increase the ethane-based ethylene capacity of both of the ethylene units at our Lake Charles complex. In January 2013, we commenced the expansion of the Petro 2 ethylene unit. This expansion is expected to be completed in the first quarter of 2013 in conjunction with a planned maintenance turnaround and is expected to increase ethane-based ethylene capacity by approximately 230 - 240 million pounds annually in support of our ethylene integration strategy. The Petro 2 ethylene unit is expected to be down for approximately 60 days for the planned maintenance turnaround. In addition, we plan to expand the ethane-based ethylene capacity of the second ethylene unit at our Lake Charles complex, but we are still evaluating plans for this expansion.
In October 2012, we announced a project to convert the feedstock for our Calvert City ethylene plant from propane to ethane and the planned increase in ethylene capacity from 450 million pounds annually to 630 million pounds annually. This expansion and feedstock conversion project is expected to enhance our vinyl chain integration and leverage low cost ethane being developed in the Marcellus shale area. The ethylene expansion and feedstock conversion project is targeted for start-up in the second quarter of 2014. In addition, we announced an expansion of the existing PVC plant in Calvert City, which should allow us to take advantage of the increased ethylene production at our Calvert City complex and to provide additional PVC resin to meet the growing demands of our global customers. The expansion of the Calvert City PVC plant is expected to increase PVC resin capacity by approximately 200 million pounds annually and is targeted for completion by late 2014.
On July 17, 2012, we issued $250.0 million aggregate principal amount of 3.60% senior notes due 2022 (the "3.60% Notes Due 2022"). On July 30, 2012, we voluntarily redeemed all $250.0 million aggregate principal amount of our outstanding 6 5/8% senior notes due 2016 (the "2016 Notes"), at a redemption price of 102.208% of the principal amount, plus accrued and unpaid interest to the redemption date. We used the net proceeds from the issuance of the 3.60% Notes Due 2022, plus cash on hand, to pay the redemption price of the 2016 Notes. As a result of the early redemption of the 2016 Notes, we recognized $7.1 million in non-operating expense in 2012 consisting primarily of a pre-payment premium of $5.5 million and a write-off of $1.3 million in previously capitalized debt issuance costs.
On March 22, 2012, a fire occurred at the VCM unit at our Geismar vinyls complex, resulting in an unscheduled shut down of our Geismar complex. VCM is an intermediate product used in the production of PVC at that complex. We restarted the PVC and VCM plants at our Geismar complex in late April and mid May, respectively, but operated both plants at reduced capacity until we returned them to normal operations in June 2012. In addition to the lost production resulting from the shut down, we incurred repair costs and unabsorbed fixed manufacturing costs in connection with the shutdown, which negatively impacted our Vinyls segment's income from operations in 2012.

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Results of Operations
Segment Data
                                                            Year Ended December 31,
                                                   2012                 2011               2010
                                                 (dollars in thousands, except per share data)
Net external sales
Olefins
Polyethylene                                $     1,658,551       $     1,772,144     $  1,656,203
Styrene, feedstock and other                        841,427               795,698          605,009
Total olefins                                     2,499,978             2,567,842        2,261,212
Vinyls
PVC, caustic soda and other                         743,275               757,314          558,156
Building products                                   327,788               294,692          352,419
Total vinyls                                      1,071,063             1,052,006          910,575
Total                                       $     3,571,041       $     3,619,848     $  3,171,787

Income (loss) from operations
Olefins                                     $       552,762       $       459,266     $    460,027
Vinyls                                               85,942                 4,012          (62,429 )
Corporate and other                                 (23,353 )             (16,482 )        (19,234 )
Total income from operations                        615,351               446,796          378,364
Interest expense                                    (43,049 )             (50,992 )        (39,875 )
Debt retirement costs                                (7,082 )                   -                -
Gain from sales of equity securities                 16,429                     -                -
Other income, net                                     3,520                 5,628            4,471
Provision for income taxes                          199,614               142,466          121,567
Net income                                  $       385,555       $       258,966     $    221,393
Earnings per diluted share                  $          5.75       $          3.87     $       3.34


                                                             Year Ended December 31,
                                                       2012                           2011
                                            Average Sales                  Average Sales
                                                Price          Volume          Price          Volume
Product sales price and volume
percentage change
  from prior year
Olefins                                         -6.9  %          +4.3 %         +16.1 %         -2.6  %
Vinyls                                          -3.3  %          +5.1 %         +19.2 %         -3.7  %
Company average                                 -5.9  %          +4.5 %         +17.0 %         -2.9  %


                                  Year Ended December 31,
                                   2012         2011     2010
Average industry prices (1)
Ethane (cents/lb)                13.4           25.8     20.2
Propane (cents/lb)               23.7           34.6     27.6
Ethylene (cents/lb) (2)          56.9           55.7     44.5
Polyethylene (cents/lb) (3)      94.3           97.3     88.7
Styrene (cents/lb) (4)           77.0           71.9     62.7
Caustic ($/short ton) (5)       607.5          547.5    365.4
Chlorine ($/short ton) (6)      264.8          330.2    322.9
PVC (cents/lb) (7)               55.3           52.0     43.3

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(1) Industry pricing data was obtained through IHS Chemical. We have not independently verified the data.

(2) Represents average North American spot prices of ethylene over the period as reported by IHS Chemical.

(3) Represents average North American contract prices of polyethylene low density film over the period as reported by IHS Chemical.

(4) Represents average North American contract prices of styrene over the period as reported by IHS Chemical.

(5) Represents average North American acquisition prices of caustic soda (diaphragm grade) over the period as reported by IHS Chemical.

(6) Represents average North American contract prices of chlorine (into chemicals) over the period as reported by IHS Chemical.

(7) Represents average North American contract prices of PVC over the period as reported by IHS Chemical. During the first quarter of 2012, IHS Chemical made a 23 cents per pound non-market downward adjustment to PVC resin prices. For comparability, we adjusted both prior year periods' PVC resin price downward by 23 cents per pound consistent with the IHS Chemical non-market adjustment.

Summary
For the year ended December 31, 2012, we had net income of $385.6 million, or $5.75 per diluted share, on net sales of $3,571.0 million. This represents an increase in net income of $126.6 million, or $1.88 per diluted share, from 2011 net income of $259.0 million, or $3.87 per diluted share, on net sales of $3,619.8 million. Net sales for the year ended December 31, 2012 decreased $48.8 million to $3,571.0 million compared to net sales for 2011 of $3,619.8 million, primarily due to lower sales prices for most of our major products, offset by higher sales volumes of feedstock, building products and caustic. Income from operations was $615.4 million for the year ended December 31, 2012 as compared to $446.8 million for 2011, an increase of $168.6 million. Income from operations benefited mainly from a significant decrease in feedstock and energy costs. Industry ethane prices decreased 48.1% and industry propane prices decreased 31.5% in 2012 as compared to 2011. The 2011 income from operations was negatively impacted by the lost production, lost sales and higher operating costs associated with four separate events: an unscheduled outage at one of our ethylene units in Lake Charles caused by a weather related power supply failure from a third party power provider, the turnaround of our Calvert City facility, the closure of our Springfield, Kentucky PVC pipe production facility and higher operating costs resulting from a reduction in our ethylene operating rates in Lake Charles in the first quarter of 2011 due to a fire at a third party storage facility in Mont Belvieu.
2012 Compared with 2011
Net Sales. Net sales decreased by $48.8 million, or 1.3%, to $3,571.0 million in 2012 from $3,619.8 million in 2011. This decrease was mainly attributable to lower sales prices for most of our major products, offset by higher feedstock, building products and caustic sales volumes as compared to 2011. Average sales prices for 2012 decreased by 5.9% as compared to 2011. Overall sales volume increased by 4.5% in 2012 as compared to 2011.
Gross Profit. Gross profit margin percentage increased to 20.6% in 2012 from 15.4% in 2011. The improvement in gross profit margin percentage was predominantly due to significantly lower feedstock and energy costs, which were only partially offset by lower sales prices. Our raw material costs in both segments normally track industry prices, which experienced a decrease of 48.1% for ethane and 31.5% for propane in 2012 as compared to 2011. Sales prices decreased an average of 5.9% for 2012 as compared to 2011. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $9.4 million, or 8.4%, in 2012 as compared to 2011. The increase was mainly attributable to expenses associated with our terminated proposal to acquire Georgia Gulf Corporation and an increase in payroll and related labor costs, including incentive compensation, partially offset by a decrease in the facility fee for our senior secured revolving credit facility.
Interest Expense. Interest expense decreased by $8.0 million to $43.0 million in 2012 from $51.0 million in 2011, largely due to increased capitalized interest on major capital projects in 2012 and lower interest rates for the 3.60% Notes Due 2022 as compared to the 2016 Notes. Debt balances during 2012 remained relatively unchanged compared to 2011.
Debt Retirement Costs. We recognized $7.1 million in non-operating expense in 2012 consisting primarily of a pre-payment premium of $5.5 million and a write-off of $1.3 million in previously capitalized debt issuance costs as a result of the early redemption of the 2016 Notes.
Gain from Sales of Equity Securities. We liquidated our holdings of available-for-sale securities, including shares of Georgia Gulf Corporation common stock, in the second and third quarters of 2012. As a result of the dispositions, we recognized a gain of $16.4 million in non-operating income in 2012.

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Other Income, Net. Other income, net decreased by $2.1 million to $3.5 million in 2012 from $5.6 million in 2011, as lower equity in income from our joint ventures and higher foreign exchange currency losses were partially offset by higher interest income in 2012.
Income Taxes. The effective income tax rate was 34.1% in 2012 as compared to 35.5% in 2011. The effective income tax rate for 2012 was below the U.S. federal statutory rate of 35.0% primarily due to the domestic manufacturing deduction and state income tax credits, offset by state income taxes. The effective income tax rate for 2011 was above the U.S. federal statutory rate of 35.0% primarily due to state income taxes, offset by state tax credits and the domestic manufacturing deduction.
Olefins Segment
Net Sales. Net sales decreased by $67.8 million, or 2.6%, to $2,500.0 million in 2012 from $2,567.8 million in 2011 as higher feedstock sales volumes were more than offset by lower sales prices for most of our major products. Average sales prices for the Olefins segment decreased by 6.9% in 2012 as compared to 2011, while average sales volumes increased by 4.3% in 2012 as compared to 2011. Income from Operations. Income from operations was $552.8 million in 2012 as compared to $459.3 million in 2011. This increase was mainly attributable to higher olefins integrated product margins as compared to 2011. Margins improved as a result of significantly lower feedstock and energy costs, which were only partially offset by lower sales prices. Trading activity for 2012 resulted in a loss of $11.6 million as compared to a gain of $2.0 million for 2011. Results for 2011 were negatively impacted by lost ethylene production, repair costs and unabsorbed fixed manufacturing costs incurred in connection with the unscheduled outage at one of our ethylene units in Lake Charles and the fire at a third party storage facility at Mont Belvieu.
Vinyls Segment
Net Sales. Net sales increased by $19.1 million, or 1.8%, to $1,071.1 million in 2012 from $1,052.0 million in 2011. This increase was primarily attributable to higher building products and caustic sales prices and sales volumes, partially offset by lower PVC resin sales prices as compared to 2011. Average sales prices for the Vinyls segment decreased by 3.3% in 2012 as compared to 2011, while average sales volumes increased by 5.1% in 2012 as compared to 2011. Income from Operations. Income from operations was $85.9 million in 2012, an increase of $81.9 million when compared to the 2011 income from operations of $4.0 million. This increase was predominantly driven by lower feedstock and energy costs and higher caustic and building products sales volumes as compared to 2011. The income from operations for 2012 was negatively impacted by an unscheduled shut down of our Geismar vinyls complex and lower operating rates at that complex as a result of operational issues related to a March 2012 fire at the complex. We expensed approximately $10.5 million of costs associated with that event in 2012. The Vinyls segment's operating results for 2011 were negatively impacted by the turnaround at the Calvert City facility and the closure of the Springfield PVC pipe facility. 2011 Compared with 2010
Net Sales. Net sales increased by $448.0 million, or 14.1%, to $3,619.8 million in 2011 from $3,171.8 million in 2010. This increase was mainly driven by higher sales prices for all major products and higher sales volume for PVC resin, partially offset by lower building products and ethylene sales volume as compared to 2010. Average sales prices for 2011 increased by 17.0% as compared to 2010. Overall sales volume decreased by 2.9% in 2011 as compared to 2010, primarily caused by lower building products sales volume attributable to weakness in the U.S. construction markets.
Gross Profit. Gross profit margin percentage improved slightly to 15.4% in 2011 from 15.2% in 2010. The improvement in gross profit percentage was primarily due to improved Vinyls margins resulting from higher PVC resin, building products and caustic sales prices and higher PVC resin sales volume, mostly offset by higher feedstock costs, the unscheduled Lake Charles outage, the Calvert City turnaround, the closure of our Springfield PVC pipe facility and the fire at a third-party storage facility in Mont Belvieu. Our raw material costs in both segments normally track industry prices, which experienced an increase of 27.7% for ethane and 25.4% for propane in 2011 as compared to 2010. Average sales prices for 2011 increased by 17.0% as compared to 2010. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $7.9 million, or 7.6%, in 2011 as compared to 2010. The increase was mainly attributable to an increase in payroll and related labor costs, including incentive compensation, partially offset by a decrease in legal and consulting fees.
Interest Expense. Interest expense increased by $11.1 million to $51.0 million in 2011 from $39.9 million in 2010, primarily due to higher average debt outstanding for 2011 as a result of the issuance of our senior notes in July 2010 and December 2010.

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Other Income, Net. Other income, net increased by $1.1 million to $5.6 million in 2011 from $4.5 million in 2010, mainly due to higher interest income earned from higher cash balances and higher equity in income from our joint ventures, partially offset by foreign exchange currency losses.
Income Taxes. The effective income tax rate was 35.5% in 2011 as compared to 35.4% in 2010. The effective income tax rate for 2011 was above the statutory rate of 35.0% primarily due to state income taxes, offset by state tax credits and the domestic manufacturing deduction. The effective income tax rate for 2010 was above the statutory rate of 35.0% primarily due to state income taxes, offset by state tax credits and the domestic manufacturing deduction. Olefins Segment
Net Sales. Net sales increased by $306.6 million, or 13.6%, to $2,567.8 million in 2011 from $2,261.2 million in 2010. This increase was primarily due an increase in sales prices for all major products, partially offset by lower ethylene and polyethylene sales volumes. Average sales prices for the Olefins segment increased by 16.1% in 2011 as compared to 2010, while average sales volumes decreased by 2.6% in 2011 as compared to 2010.
Income from Operations. Income from operations was $459.3 million in 2011 as compared to $460.0 million in 2010 as higher polyethylene and styrene sales prices were mostly offset by higher feedstock costs as compared to 2010. In addition, income from operations for 2011 was negatively impacted by the unscheduled outage at one of our ethylene units in Lake Charles and the fire at a third-party storage facility at Mont Belvieu. Trading activity for 2011 resulted in a gain of $2.0 million as compared to a gain of $0.1 million for 2010. Results for 2010 were negatively impacted by the unscheduled outage at one of our ethylene units in Lake Charles caused by severe weather. Vinyls Segment
Net Sales. Net sales increased by $141.4 million, or 15.5%, to $1,052.0 million in 2011 from $910.6 million in 2010. This increase was primarily driven by higher sales prices for all major products and an increase in sales volume for PVC resin, partially offset by lower building products sales volume as compared to 2010. Average sales prices for the Vinyls segment increased by 19.2% in 2011 as compared to 2010, while average sales volumes decreased by 3.7% in 2011 as compared to 2010, primarily caused by lower building products sales volume. Income (Loss) from Operations. Income from operations improved by $66.4 million to $4.0 million in 2011 as compared to a loss from operations of $62.4 million in 2010. This change was primarily attributable to improved caustic, PVC resin and building products margins and higher PVC resin sales volume as compared to 2010, partially offset by the negative impact of the turnaround at our Calvert City facility and the closure of our Springfield PVC pipe facility. PVC resin sales volume benefited from a stronger export market in 2011. In addition, income from operations benefited from a change in the intersegment market pricing methodology used to account for intersegment sales of ethylene. Additional information appears in Note 19 to the audited consolidated financial statements appearing elsewhere in this Form 10-K. Overall, Vinyls margins remained under pressure in 2011 due to the continued weakness in the U.S. construction markets and budgetary constraints in municipal spending. Cash Flows
Operating Activities
Operating activities provided cash of $624.1 million in 2012 compared to $362.3 million in 2011. The $261.8 million increase in cash flows from operating activities was mainly due to an increase in income from operations and a decrease in working capital requirements, as compared to 2011. Income from . . .