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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
----------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------------- ----------------
Commission file number 000-49987
------------------------------------------
ConocoPhillips
(Exact name of registrant as specified in its charter)
Delaware 01-0562944
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
600 North Dairy Ashford Road, Houston, TX 77079
(Address of principal executive offices) (Zip Code)
281-293-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The registrant had 676,830,234 shares of common stock, $.01 par
value, outstanding at October 31, 2002.
PART I. FINANCIAL INFORMATION
- ---------------------------------------------------------------------------------------------
Consolidated Statement of Operations ConocoPhillips
Millions of Dollars
-----------------------------------
Three Months Nine Months
Ended Ended
September 30 September 30
-----------------------------------
2002 2001 2002 2001
-----------------------------------
Revenues
Sales and other operating revenues* $15,519 6,021 36,271 16,390
Equity in earnings (losses) of affiliates 89 (15) 138 106
Other income 70 26 104 57
- ---------------------------------------------------------------------------------------------
Total Revenues 15,678 6,032 36,513 16,553
- ---------------------------------------------------------------------------------------------
Costs and Expenses
Purchased crude oil and products 10,219 3,323 23,706 8,056
Production and operating expenses 1,455 603 3,245 1,738
Selling, general and administrative expenses 758 203 1,651 487
Exploration expenses 85 71 315 202
Depreciation, depletion and amortization 580 299 1,412 948
Property impairments 8 - 26 23
Taxes other than income taxes* 2,085 727 4,641 1,872
Accretion on discounted liabilities 7 3 18 7
Interest and debt expense 134 74 347 240
Foreign currency transaction losses (gains) (6) 2 (11) 10
Preferred dividend requirements of capital trusts
and minority interests 9 14 34 41
- ---------------------------------------------------------------------------------------------
Total Costs and Expenses 15,334 5,319 35,384 13,624
- ---------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 344 713 1,129 2,929
Provision for income taxes 398 344 917 1,456
- ---------------------------------------------------------------------------------------------
Income (loss) from continuing operations (54) 369 212 1,473
Income (loss) from operations of discontinued businesses
(net of income taxes of $(34) and $(35) for the three
and nine months ended 2002 and $2 and $4 for the three
and nine months ended 2001) (62) 5 (64) 8
- ---------------------------------------------------------------------------------------------
Income (Loss) Before Extraordinary Item and Cumulative
Effect of Change in Accounting Principle (116) 374 148 1,481
Extraordinary item, net of income taxes of $(6) for 2002
and $(4) for 2001 - (10) (15) (10)
Cumulative effect of change in accounting principle,
net of income taxes of $15 - - - 28
- ---------------------------------------------------------------------------------------------
Net Income (Loss) $ (116) 364 133 1,499
=============================================================================================
Net Income (Loss) Per Share of Common Stock
Basic
Continuing operations $ (.11) 1.33 .51 5.60
Discontinued operations (.13) .02 (.15) .03
- ---------------------------------------------------------------------------------------------
Before extraordinary item and cumulative effect of
change in accounting principle (.24) 1.35 .36 5.63
Extraordinary item - (.04) (.04) (.04)
Cumulative effect of change in accounting principle - - - .11
- ---------------------------------------------------------------------------------------------
Net Income (Loss) $ (.24) 1.31 .32 5.70
=============================================================================================
Diluted
Continuing operations $ (.11) 1.32 .50 5.56
Discontinued operations (.13) .02 (.15) .03
- ---------------------------------------------------------------------------------------------
Before extraordinary item and cumulative effect of
change in accounting principle (.24) 1.34 .35 5.59
Extraordinary item - (.04) (.03) (.04)
Cumulative effect of change in accounting principle - - - .11
- ---------------------------------------------------------------------------------------------
Net Income (Loss) $ (.24) 1.30 .32 5.66
=============================================================================================
Dividends Paid Per Share of Common Stock $ .36 .36 1.08 1.04
- ---------------------------------------------------------------------------------------------
Average Common Shares Outstanding (in thousands)
Basic 480,701 277,822 416,293 263,144
Diluted 484,777 279,767 422,212 264,988
- ---------------------------------------------------------------------------------------------
*Includes excise taxes on petroleum products sales $ 1,897 593 4,114 1,435
See Notes to Financial Statements.
1
- ------------------------------------------------------------------------
Consolidated Balance Sheet ConocoPhillips
Millions of Dollars
-------------------------
September 30 December 31
2002 2001
-------------------------
Assets
Cash and cash equivalents $ 517 142
Accounts and notes receivable 2,848 1,185
Accounts and notes receivable--related parties 1,287 105
Inventories 4,363 2,600
Prepaid expenses and other current assets 871 309
Assets of discontinued operations 781 108
- ------------------------------------------------------------------------
Total Current Assets 10,667 4,449
Investments and long-term receivables 6,647 3,316
Net properties, plants and equipment 43,378 23,716
Goodwill 14,464 2,281
Intangibles 1,807 1,313
Other assets 521 142
- ------------------------------------------------------------------------
Total Assets $77,484 35,217
========================================================================
Liabilities
Accounts payable $ 5,441 2,648
Accounts payable--related parties 875 91
Notes payable and long-term debt due
within one year 2,603 44
Accrued income and other taxes 2,570 938
Other accruals 2,240 796
Liabilities of discontinued operations 227 34
- ------------------------------------------------------------------------
Total Current Liabilities 13,956 4,551
Long-term debt 17,850 8,645
Accrued dismantlement, removal and
environmental costs 1,665 1,142
Deferred income taxes 8,252 4,006
Employee benefit obligations 2,819 953
Other liabilities and deferred credits 1,950 925
- ------------------------------------------------------------------------
Total Liabilities 46,492 20,222
- ------------------------------------------------------------------------
Company-Obligated Mandatorily
Redeemable Preferred Securities of
Phillips 66 Capital Trusts I and II 350 650
- ------------------------------------------------------------------------
Other Minority Interests 651 5
- ------------------------------------------------------------------------
Common Stockholders' Equity
Common stock (2002--2,500,000,000 shares
authorized at $.01 par value;
2001--1,000,000,000 shares authorized
at $1.25 par value)
Issued (2002--703,986,924 shares;
2001--430,439,743 shares)
Par value 7 538
Capital in excess of par 25,228 9,069
Treasury stock (at cost:
2001--20,725,114 shares) - (1,038)
Compensation and Benefits Trust (CBT)
(at cost: 2002--27,256,573 shares;
and 2001--27,556,573 shares) (923) (934)
Accumulated other comprehensive loss (417) (255)
Unearned employee compensation--Long-
Term Stock Savings Plan (LTSSP) (223) (237)
Retained earnings 6,319 7,197
- ------------------------------------------------------------------------
Total Common Stockholders' Equity 29,991 14,340
- ------------------------------------------------------------------------
Total $77,484 35,217
========================================================================
See Notes to Financial Statements.
2
- ------------------------------------------------------------------------
Consolidated Statement of Cash Flows ConocoPhillips
Millions of Dollars
-------------------
Nine Months Ended
September 30
-------------------
2002 2001
-------------------
Cash Flows From Operating Activities
Income from continuing operations $ 212 1,473
Adjustments to reconcile income from continuing
operations to net cash provided by continuing
operations
Non-working capital adjustments
Depreciation, depletion and amortization 1,412 948
Property impairments 26 23
Dry hole costs and leasehold impairments 161 58
Accretion on discounted liabilities 18 7
In-process research and development 246 -
Deferred taxes (33) 361
Other 106 190
Working capital adjustments*
Change in aggregate balance of
accounts receivable sold (140) 26
Decrease in other accounts and notes
receivable 58 880
Increase in inventories (174) (277)
Increase in prepaid expenses and
other current assets (60) (27)
Increase (decrease) in accounts payable 696 (354)
Increase in taxes and other accruals 466 27
- ------------------------------------------------------------------------
Net cash provided by continuing operations 2,994 3,335
Net cash provided by (used in) discontinued
operations (8) 12
- ------------------------------------------------------------------------
Net Cash Provided by Operating Activities 2,986 3,347
- ------------------------------------------------------------------------
Cash Flows From Investing Activities
Acquisitions, net of cash acquired 1,242 58
Capital expenditures and investments,
including dry hole costs (2,513) (2,089)
Proceeds from asset dispositions 100 233
Proceeds from insurance 18 -
Long-term advances to affiliates and
other investments (99) (25)
- ------------------------------------------------------------------------
Net cash used in continuing operations (1,252) (1,823)
Net cash used in discontinued operations (11) (5)
- ------------------------------------------------------------------------
Net Cash Used in Investing Activities (1,263) (1,828)
- ------------------------------------------------------------------------
Cash Flows From Financing Activities
Issuance of debt 525 -
Repayment of debt (1,028) (1,178)
Issuance of company common stock 37 20
Redemption of preferred stock (300) -
Dividends paid on common stock (413) (266)
Other (169) (45)
- ------------------------------------------------------------------------
Net cash used in continuing operations (1,348) (1,469)
- ------------------------------------------------------------------------
Net Cash Used in Financing Activities (1,348) (1,469)
- ------------------------------------------------------------------------
Net Change in Cash and Cash Equivalents 375 50
Cash and cash equivalents at beginning of period 142 149
- ------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 517 199
========================================================================
*Net of acquisition and disposition of businesses.
See Notes to Financial Statements.
3
- -----------------------------------------------------------------
Notes to Financial Statements ConocoPhillips
Note 1--Interim Financial Information
The financial information for the interim periods presented in
the financial statements included in this report is unaudited and
includes all known accruals and adjustments which ConocoPhillips
(hereinafter referred to as ConocoPhillips or the "company")
considers necessary for a fair presentation of the consolidated
financial position of the company and its results of operations
and cash flows for such periods. All such adjustments are of a
normal and recurring nature, except for the restructuring accrual
described in Note 11--Restructuring, and the write-off of
purchased in-process research and development activity costs
described in Note 2--Merger of Conoco and Phillips. Certain
amounts in the financial statements have been reclassified to
conform to ConocoPhillips' presentation.
The financial statements reflect the August 30, 2002, merger of
Conoco Inc. (Conoco) and Phillips Petroleum Company (Phillips).
The transaction has been accounted for using the purchase method
of accounting as required by the Financial Accounting Standards
Board (FASB) Statement No. 141, "Business Combinations."
Phillips was designated the acquirer. As a result, Conoco's
assets and liabilities have been included in the September 30,
2002, balance sheet based on their fair values at the merger
date. Results of operations for the third quarter of 2002
include two months activity for Phillips and one month of
activity for ConocoPhillips. Similarly, results of operations
for the first nine months of 2002 include eight months of
activity for Phillips and one month of activity for
ConocoPhillips. Prior periods reflect only Phillips' assets and
liabilities, and results of operations, which have been
reclassified to reflect discontinued operations as a result of
dispositions required by the U.S. Federal Trade Commission (FTC).
Note 2--Merger of Conoco and Phillips
On August 30, 2002, Conoco and Phillips combined their businesses
by merging with separate acquisition subsidiaries of
ConocoPhillips. As a result, each company became a wholly owned
subsidiary of ConocoPhillips. For accounting purposes, Phillips
was treated as the acquirer of Conoco, and ConocoPhillips was
treated as the successor of Phillips.
4
When the merger was consummated, former Phillips stockholders
held approximately 58 percent of the outstanding shares of
ConocoPhillips common stock, while former Conoco stockholders
held approximately 42 percent. ConocoPhillips common stock,
listed on the New York Stock Exchange under the symbol "COP,"
began trading on September 3, 2002, concurrent with Conoco and
Phillips stocks ceasing to trade.
Prior to the merger, Conoco was a major, integrated global energy
company, with operations in over 40 countries worldwide.
Subsequent to the merger, ConocoPhillips realigned Conoco's and
Phillips' worldwide organizational and operational structure.
The primary reasons for the merger and the principal factors that
contributed to a Conoco purchase price that resulted in the
recognition of goodwill were:
o The merger would transform Conoco and Phillips into a
stronger, major, integrated oil company with the benefits of
increased size and scale, improving the stability of the
combined business' earnings in varying economic and market
climates;
o ConocoPhillips would emerge with a global presence in both
upstream and downstream petroleum businesses, increasing its
overall international presence to over 49 countries while
maintaining a strong domestic base; and
o Combining the two companies' operations would provide
significant synergies and related cost savings, and improve
future access to capital.
Conoco's $16 billion purchase price was based on an exchange of
Conoco shares for ConocoPhillips common shares. ConocoPhillips
issued approximately 293 million shares of common stock and
approximately 23.3 million of employee stock options in exchange
for 627 million shares of Conoco common stock and 49.8 million
Conoco stock options. The common stock was valued at $53.15 per
share, which was Phillips' average common stock price over the
two-day trading period immediately before and after the
November 18, 2001, public announcement of the transaction. The
Conoco stock options, whose fair value was determined using the
Black-Scholes option-pricing model, were exchanged for
ConocoPhillips stock options valued at $384 million. Estimated
transaction-related costs were $82 million.
5
The preliminary allocation of the purchase price to specific
assets and liabilities was based, in part, upon an outside
appraisal of the fair value of Conoco's assets. Over the next
few months ConocoPhillips expects to receive the final outside
appraisal of the long-lived assets and conclude the fair value
determination of all other Conoco assets and liabilities.
Subsequent to the completion of the final allocation of purchase
price and the determination of the ultimate asset and liability
tax bases, the deferred tax liabilities will also be finalized.
The following table summarizes, based on the preliminary purchase
price allocation described above, the fair values of the assets
acquired and liabilities assumed as of August 30, 2002:
Millions
of Dollars
----------
Cash and cash equivalents $ 1,250
Accounts and notes receivable 2,801
Inventories 1,610
Prepaid expenses and other current assets 300
Investments and long-term receivables 3,041
Properties, plants and equipment
(including $300 of land) 19,215
Identifiable intangible assets 795
In-process research and development activities 246
Goodwill 11,839
Deferred charges 367
- -----------------------------------------------------------------
Total assets $41,464
=================================================================
Accounts payable $ 2,879
Notes payable and debt due within one year 3,102
Accrued income and other taxes 1,204
Other accruals 1,482
Long-term debt 8,915
Accrued environmental costs 298
Deferred income taxes 4,188
Employee benefit obligations 1,606
Other liabilities and deferred credits 1,091
Minority interests 648
Common stockholders' equity 16,051
- -----------------------------------------------------------------
Total liabilities and equity $41,464
=================================================================
The allocation of the purchase price, as reflected above, has not
been adjusted for the FTC-mandated dispositions described in Note
4--Discontinued Operations. Goodwill, land and certain
identifiable intangible assets recorded in the acquisition are
not subject to amortization, but will be tested periodically for
impairment as required by FASB Statement No. 142, "Goodwill and
Other Intangible Assets."
6
Of the $795 million allocated to identifiable intangible assets,
$647 million is assigned to marketing trade names which are not
subject to amortization. Of the remaining value assigned to
identifiable intangible assets, $66 million will be amortized
over 11 years and $82 million will be amortized over various
lives ranging between two and 20 years.
ConocoPhillips has not yet determined the assignment of Conoco
goodwill to specific reporting units. Currently, Conoco goodwill
is being reported as part of the Corporate and Other reporting
segment. Of the $11,841 million of goodwill, $4,417 million is
attributable to deferred tax liabilities. This and the remaining
"true" goodwill, or $7,424 million, will ultimately be assigned
to reporting units based on the benefits received by the units
from the synergies and strategic advantages of the merger. None
of the goodwill is deductible for tax purposes.
The purchase price allocation included $246 million of in-process
research and development activity costs related to Conoco's
natural-gas-to-liquids technology. In accordance with FASB
Interpretation No. 4, "Applicability of FASB Statement No. 2 to
Business Combinations Accounted for by the Purchase Method," the
value assigned to the research and development activities was
charged to production and operating expenses at the date of the
consummation of the merger, as the research and development
activity costs had no alternative future use.
In summary, merger-related items that impacted ConocoPhillips'
third-quarter 2002 income (loss) from continuing operations were:
Millions
of Dollars
----------
Write-off of purchased in-process
research and development activity costs $246
Restructuring charges (see Note 11) 200
Incremental seismic contract costs 16
Transition costs 7
- -----------------------------------------------------------------
Total $469
=================================================================
In total, these items reduced third quarter 2002 income (loss)
from continuing operations by $0.97 per share on a diluted basis.
7
The following unaudited pro forma summary presents information as
if the ConocoPhillips merger had occurred at the beginning of
each period presented.
Millions of Dollars
Except Per Share Amounts
--------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Revenues $22,562 21,646 60,760 68,763
Income (loss) from
continuing operations
before extraordinary
item and cumulative
effect of change in
accounting principle (97) 814 436 3,537
Net income (loss) (120) 829 402 3,622
Income (loss) from
continuing operations
before extraordinary
item and cumulative
effect of change in
accounting principle
per share of common stock
Basic (.14) 1.21 .64 5.26
Diluted (.14) 1.20 .64 5.20
Net income (loss) per
share of common stock
Basic (.18) 1.23 .59 5.38
Diluted (.18) 1.22 .59 5.33
- ------------------------------------------------------------------
Included in the pro forma income (loss) numbers for the three and
nine months ended September 30, 2002, are restructuring charges
of $335 million before-tax ($200 million after-tax).
During the nine months ended September 30, 2001, both Phillips
and Conoco entered into other significant transactions that are
not reflected in the companies' historical income statements for
the full three- and nine-month periods ended September 30, 2001.
The unaudited pro forma results have been prepared as if the
Phillips' September 14, 2001, acquisition of Tosco Corporation
(Tosco) (see Note 3--Acquisition of Tosco Corporation) and
Conoco's July 16, 2001, $4.6 billion acquisition of Gulf Canada
Resources Limited occurred on January 1, 2001. Gulf Canada
Resources Limited was a Canadian-based independent exploration
and production company with primary operations in Western Canada,
Indonesia, the Netherlands and Ecuador. In addition to the 2001
transactions mentioned above, in the second quarter of 2002,
8
Conoco committed to a plan to sell its exploration and production
assets in the Netherlands. Accordingly, those assets and results
are reflected as discontinued operations. In addition, the pro
forma amounts incorporate certain other adjustments including:
o Recognition of depreciation and amortization based on the
preliminary allocated purchase price of the properties,
plants and equipment acquired;
o Adjustment of interest for the amortization of the fair-
value adjustment to debt;
o Cessation of the amortization of deferred gains not
recognizable in the purchase price allocation;
o Accretion of discount on environmental accruals recorded at
net present value; and
o Various other adjustments to conform Conoco's accounting
policies to ConocoPhillips'.
Although the unaudited pro forma information contains adjustments
to classify as discontinued operations the assets required to be
disposed of by order of the FTC (see Note 4--Discontinued
Operations), it does not reflect any anticipated synergies that
might be achieved from combining the operations. The pro forma
information is not intended to reflect the actual results that
would have occurred had the companies been combined during the
periods presented. This pro forma information is not intended to
be indicative of the results of operations that may be achieved
by ConocoPhillips in the future.
The pro forma adjustments use estimates and assumptions based on
currently available information. Management believes that the
estimates and assumptions are reasonable, and that the
significant effects of the transactions are properly reflected.
However, actual results may materially differ from this pro forma
financial information.
For more information, see the company's Current Report on
Form 8-K/A filed on October 1, 2002.
9
Note 3--Acquisition of Tosco Corporation
On September 14, 2001, Phillips closed on the $7 billion
acquisition of Tosco. This transaction was accounted for using
the purchase method of accounting.
During the third quarter of 2002, the company concluded:
o The outside appraisal of the long-lived assets;
o The determination of the fair value of all other Tosco
assets and liabilities;
o The tax basis calculation of Tosco's assets and liabilities
and the related deferred tax liabilities; and
o The allocation of Tosco goodwill to reporting units within
the Refining and Marketing (R&M) operating segment.
The Tosco merger agreement required that outstanding Tosco Long-
Term Incentive Plan performance units be converted into
equivalent Phillips (now ConocoPhillips) performance units and
that the program continue over the remaining terms of the units.
At September 30, 2002, there were 2.4 million units outstanding,
held by six former senior executives of Tosco, none of whom were
ConocoPhillips employees. Cash payouts occur on the anniversary
dates of the grants if ConocoPhillips' 15-day rolling average
stock price during any 15-day period of the preceding 365 days
exceeds a stipulated strike price. The units were considered to
be derivative financial instruments tied to ConocoPhillips' stock
price and were marked-to-market each reporting period. The
resulting gains or losses from these mark-to-market adjustments
were reported in other income in the consolidated statement of
operations and discussed as part of Corporate and Other in
Management's Discussion and Analysis. Phillips estimated the
fair value of these units to be $70 million at both September 14,
2001, and March 31, 2002, when this amount was recorded in other
liabilities and deferred credits in the consolidated balance
sheet, with an offsetting increase in goodwill. At September 30,
2002, the estimated fair value of these units had decreased to
$31 million, which resulted in an increase in other income of
$20 million and $39 million during the three- and nine-month
periods ended September 30, 2002, respectively. In October 2002,
the company and the former Tosco executives negotiated and agreed
to a complete cancellation of the performance units in exchange
for a cash payment to the former executives, which will result in
ConocoPhillips' recording a final gain in the fourth quarter of
2002.
10
During the first nine months of 2002, other adjustments to the
purchase price allocation were made, which increased goodwill by
$356 million. The more significant adjustments to goodwill were
a $247 million reduction in the value of refinery air emission
permits to reflect a more appropriate appraisal methodology, the
previously mentioned $70 million for the Tosco Long-Term
Incentive Plan, and a $69 million increase in deferred tax
liabilities, resulting primarily from an updated analysis of the
tax bases of Tosco's assets and liabilities. All other
adjustments in the aggregate reduced goodwill by $30 million. In
addition, tax benefits accruing to the company from the exercise
of stock options by former Tosco employees reduced goodwill by
$12 million during the first nine months of 2002, resulting in a
net increase in goodwill associated with the Tosco acquisition of
$344 million.
The following table summarizes, based on the final purchase price
allocation described above, the fair values of the assets
acquired and liabilities assumed as of September 14, 2001:
Millions
of Dollars
----------
Cash and cash equivalents $ 103
Accounts and notes receivable 718
Inventories 1,965
Prepaid expenses and other current assets 154
Investments and long-term receivables 150
Properties, plants and equipment
(including $1,720 of land) 7,681
Identifiable intangible assets 1,003
Goodwill 2,644
Deferred charges 11
- -----------------------------------------------------------------
Total assets $14,429
=================================================================
Accounts payable $ 1,917
Accrued income and other taxes 350
Other accruals 206
Long-term debt 2,135
Accrued environmental costs 332
Deferred income taxes 1,824
Employee benefit obligations 177
Other liabilities and deferred credits 408
Common stockholders' equity 7,080
- -----------------------------------------------------------------
Total liabilities and equity $14,429
=================================================================
11
Of the $1,003 million allocated to identifiable intangible
assets, marketing trade names comprise $655 million, refinery air
emission and operating permits total $315 million and other
miscellaneous intangible assets amount to $33 million. In
addition, of the $1,003 million of identifiable intangible
assets, $992 million was allocated to intangible assets not
subject to amortization, while $11 million was allocated to
intangible assets with a weighted-average amortization period of
seven years.
ConocoPhillips has finalized the required assignment of Tosco
goodwill to specific reporting units, with $1,944 million
assigned to the refining reporting unit and $700 million assigned
to the marketing reporting unit. The goodwill was assigned to
the reporting units that were deemed to have benefited from the
synergies and strategic advantages of the merger. Based on the
allocations of the Tosco goodwill and the valuation of all
Phillips Refining and Marketing operations, the Tosco goodwill
was not impaired at January 1, 2002. The company plans to update
its goodwill impairment review of these reporting units during
the fourth quarter of 2002.
Note 4--Discontinued Operations
As a condition to the merger of Conoco and Phillips, the FTC
required that ConocoPhillips divest the following assets:
o Phillips' Woods Cross business unit, which includes the
Woods Cross, Utah, refinery and associated motor fuel
marketing operations (both retail and wholesale) in Utah,
Idaho, Wyoming, and Montana, as well as Phillips' 50 percent
interests in two refined products terminals in Boise and
Burley, Idaho;
o Conoco's Commerce City, Colorado, refinery and related crude
oil pipelines;
o Phillips' Colorado motor fuel marketing operations (both
retail and wholesale);
o Phillips' refined products terminal in Spokane, Washington;
o Phillips' propane terminal assets at Jefferson City,
Missouri, and East St. Louis, Illinois, which include the
propane portions of these terminals and the customer
relationships and contracts for the supply of propane
therefrom;
12
o Certain of Conoco's midstream natural gas gathering and
processing assets in southeast New Mexico; and
o Certain of Conoco's midstream natural gas gathering assets
in West Texas.
Further, the FTC required that certain of these assets be held
separately within ConocoPhillips, under the management of a
trustee until sold.
In the second quarter of 2002, Conoco put its Netherlands
exploration and production assets up for sale, as these assets
did not fit into Conoco's long-range plans. These assets were
sold in the fourth quarter of 2002.
Assets and liabilities of the above operations, along with their
earnings and cash flows, are reflected in the financial
statements as discontinued operations.
In connection with the anticipated sales, ConocoPhillips recorded
an impairment of $113 million before-tax, $69 million after-tax,
related to the Phillips assets. Because these operations are
classified as discontinued operations, these impairment charges
are not included in the property impairments line on the
statement of operations, but are included on an after-tax basis
in the discontinued operations line.
Note 5--Extraordinary Item
In the second quarter of 2002, Phillips incurred an extraordinary
loss of $15 million (after reduction for an income tax benefit of
$6 million) attributable to the call premium on early retirement
of its $250 million 8.86% Notes due May 15, 2022, at
104.43 percent and the redemption of all of its outstanding 8.24%
Junior Subordinated Deferrable Interest Debentures due 2036,
which triggered the redemption of $300 million of 8.24% Trust
Originated Preferred Securities of Phillips 66 Capital Trust I.
Phillips funded these redemptions by issuing commercial paper at
a substantially lower interest rate than the interest and
dividend rates of the securities redeemed. See Note 12--Debt,
and Note 13--Company-Obligated Mandatorily Redeemable Preferred
Securities of Phillips 66 Capital Trusts for additional
information about the early debt retirement and debenture
redemption, respectively.
13
Note 6--Derivative Instruments
Derivative Instruments
The company and certain of its subsidiaries may use financial and
commodity-based derivative contracts to manage exposures
to fluctuations in foreign currency exchange rates, commodity
prices, and interest rates, or to exploit market opportunities.
With the completion of the merger of Phillips and Conoco on
August 30, 2002, the derivatives policy adopted during the third
quarter of 2001 is no longer in effect; however, the
ConocoPhillips Board of Directors has approved an "Authority
Limitations" document that prohibits the use of highly leveraged
derivatives, requires all derivative instruments held or issued
to be sufficiently liquid that comparable valuations are
available, and authorizes the Chief Executive Officer to
establish the maximum Value at Risk (VaR) limits for the company.
Compliance with these limits is monitored daily. The function of
the Risk Management Steering Committee was assumed by the Chief
Financial Officer for risks resulting from foreign currency
exchange rates and interest rates, and by the Executive Vice
President of Commercial, a new position that reports to the Chief
Executive Officer, for commodity price risk. ConocoPhillips'
commercial organization manages the commodity flows and
positions, commercial marketing, and related risks of the
company's upstream and downstream businesses.
FASB Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended (Statement No. 133), requires
companies to recognize all derivative instruments as either
assets or liabilities on the balance sheet at fair value. Assets
and liabilities resulting from derivative contracts open at
September 30, 2002, were $389 million and $250 million,
respectively, and appear as receivables or payables on the
balance sheet.
The accounting for changes in fair value (i.e., gains or losses)
of a derivative instrument depends on whether it meets the
qualifications for, and has been designated as, a hedge, and the
type of hedge. At this time, ConocoPhillips does not use hedge
accounting for commodity derivative contracts, but hedge
accounting is used for the company's interest-rate derivatives,
as noted below. All gains and losses, realized or unrealized,
from derivative contracts not designated as hedges have been
recognized in the statement of operations. Gains and losses from
derivative contracts held for trading, whether realized or
unrealized, have been reported net in other income.
14
Statement No. 133 also requires purchase and sales contracts for
commodities that are readily convertible to cash (e.g., crude
oil, natural gas, and gasoline) to be recorded on the balance
sheet as derivatives unless the contracts are for quantities
expected to be used or sold by the company over a reasonable
period in the normal course of business (the normal purchases and
normal sales exception), among other requirements, and the
company has documented its intent to apply this exception.
ConocoPhillips generally applies this exception to eligible
purchase and sales contracts; however, the company may elect not
to apply this exception (e.g., when another derivative instrument
will be used to hedge the risk of the purchase or sale contract
but hedge accounting will not be applied). When this occurs,
both the purchase or sales contract and the derivative contract
hedging the resulting risk will be recorded on the balance sheet
at fair value in accordance with the preceding paragraphs.
Interest Rate Derivative Contracts--On August 30, 2002, the
company obtained the following interest rate derivatives from its
merger with Conoco:
Millions
of Dollars
------------------
Fair Value at
September 30, 2002
------------------
Interest Rate Derivatives
Fixed-to-floating-rate hedges
Notes due 2009 $ 52
Notes due 2029 76
- -----------------------------------------------------------------
Floating-to-fixed-rate swaps
Maturing 2006 $(19)
Maturing 2011 (14)
Maturing in less than one year (4)
- -----------------------------------------------------------------
The floating-to-fixed-rate swaps maturing in 2011 and all of the
fixed-to-floating-rate hedges were liquidated in October 2002. A
portion of the floating-to-fixed-rate swaps maturing in less than
one year settled in October. The remaining floating-to-fixed-
rate swaps maturing in less than one year and the swap maturing
in 2006 were re-designated as cash flow hedges. In accordance
with the hedge accounting provisions of Statement No. 133, any
realized gains or losses will be reflected in future periods as
an adjustment to interest expense over the terms of the hedged
debt instruments.
15
Prior to the merger, these interest rate swaps qualified for the
short-cut method of hedge accounting; however, current generally
accepted accounting principles usually prohibit continuing the
short-cut method for hedges acquired in an acquisition. The
ineffectiveness of the hedge recognized in income for the period
from August 30 to September 30, 2002, for the hedges that have
not been liquidated or settled was not material. No portion of
the gain or loss from the swaps designated as interest rate
hedges has been excluded from the assessment of hedge
effectiveness. The company expects the amount of net unrealized
losses in accumulated other comprehensive loss at September 30,
2002, that will be reclassified to earnings during the next
12 months to be immaterial. ConocoPhillips reports gains,
losses, and ineffectiveness from interest rate derivatives on the
statement of operations in interest and debt expense.
Currency Exchange Rate Derivative Contracts--During the third
quarter of 2001, Phillips used hedge accounting to record the
results of using a forward exchange contract to hedge the
exposure to fluctuations in the exchange rate between the U.S.
dollar and Brazilian real, resulting from a firm commitment to
pay reals to acquire an exploratory lease. The hedge was closed
in August 2001, upon payment of the lease bonus. Results from
the hedge appear in accumulated other comprehensive loss on the
balance sheet and will be reclassified into earnings concurrent
with the amortization or write-down of the lease bonus, but no
portion of this amount is expected to be reclassified during
2003. No component of the hedge results was excluded from the
assessment of hedge effectiveness, and no gain or loss was
recorded in earnings from hedge ineffectiveness.
After merging with Conoco, the company has foreign currency
exchange rate risk resulting from operations in over 40 countries
around the world. ConocoPhillips does not comprehensively hedge
the exposure to currency rate changes, although the company may
choose to selectively hedge exposures to foreign currency rate
risk. Examples include firm commitments for capital projects,
certain local currency tax payments and dividends, and cash
returns from net investments in foreign affiliates to be remitted
within the coming year. Hedge accounting is not currently being
used for any of the company's foreign currency derivatives.
Commodity Derivative Contracts--ConocoPhillips uses energy-
related futures, forwards, swaps and options in various markets:
o To balance physical systems--In addition to being able to
settle exchange traded futures contracts in cash prior to
contract expiry, they also can be settled by physical
delivery of the commodity. These barrels can provide
another source of supply to meet the company's refinery
requirements or marketing demand;
16
o To meet customer needs--Consistent with ConocoPhillips'
policy to generally remain exposed to market prices, the
company uses swap contracts to convert fixed-price sales
contracts (often requested by natural gas and refined
products consumers) to a floating-market basis; and
o To manage the company's price exposure on anticipated crude
oil, natural gas, refined product and electric power
transactions.
ConocoPhillips' policy is generally to be exposed to market
pricing for commodity purchases and sales. From time to time,
management may use derivatives to establish longer-term positions
to change the price risk of the company's equity crude oil and
natural gas production, as well as refinery margins.
ConocoPhillips does a limited amount of trading unrelated to the
company's underlying physical business. For the nine-month
periods ended September 30, 2002, and 2001, the net recognized
gains and losses from this activity were not material to the
company's cash flows or statement of operations.
The fair values of the futures contracts are based on quoted
market prices obtained from the New York Mercantile Exchange or
the International Petroleum Exchange of London. The fair values
of swaps and other over-the-counter instruments are estimated
based on quoted market prices of comparable contracts and
approximate the gain or loss that would have been realized if the
contracts had been closed out at the end of the reporting period.
Note 7--Inventories
Inventories consisted of the following:
Millions of Dollars
-------------------------
September 30 December 31
2002 2001
-------------------------
Crude oil and petroleum products $3,771 2,225
Canadian Syncrude (from mining
operations) 3 -
Merchandise 158 144
Materials, supplies and other 431 231
- -----------------------------------------------------------------
$4,363 2,600
=================================================================
17
Included were inventories valued on a last-in, first-out (LIFO)
basis totaling $3,637 million and $2,194 million at September 30,
2002, and December 31, 2001, respectively. The excess of current
replacement cost over LIFO cost of inventories amounted to
$957 million and $2 million at September 30, 2002, and
December 31, 2001, respectively.
Note 8--Properties, Plants and Equipment
Properties, plants and equipment included the following:
Millions of Dollars
-------------------------
September 30 December 31
2002 2001
-------------------------
Properties, plants and equipment
(at cost) $54,188 35,273
Less accumulated depreciation, depletion
and amortization 10,810 11,557
- -----------------------------------------------------------------
$43,378 23,716
=================================================================
Note 9--Impairments
In connection with the anticipated sale of certain assets as
mandated by the FTC, ConocoPhillips recorded an impairment of
$113 million before-tax, $69 million after-tax, related to the
Phillips assets. Because these operations are classified as
discontinued operations, these impairment charges are not
included in the property impairments line on the statement of
operations, but are included on an after-tax basis in the
discontinued operations line.
Exploration expenses in the first nine months of 2002 included
$77 million for the impairment of a substantial portion of the
company's investment in deepwater block 34, offshore Angola.
Initial results released in early May 2002 indicated that the
first exploratory well drilled in block 34 was a dry hole,
resulting in Phillips' re-assessment of the fair value of the
remainder of the block.
Note 10--Goodwill and Other Intangible Assets
Phillips adopted FASB Statement No. 142, "Goodwill and Other
Intangible Assets," on January 1, 2002. Almost all of
ConocoPhillips' recorded goodwill and other intangible assets
resulted from Phillips' merger with Conoco in August 2002 and
the acquisition of Tosco in September 2001. The Tosco
18
transaction was subject to the special transitional effective
dates of Statement No. 142. See Note 2--Merger of Conoco and
Phillips for additional information about the ConocoPhillips
merger and Note 3--Acquisition of Tosco Corporation for
additional information about the Tosco acquisition.
Other than the goodwill related to the merger of Conoco and
Phillips and the Tosco acquisition, the company had $16 million
of recorded goodwill, which related to the acquisition of Petroz
NL in early 2001, of which $1 million was amortized to expense
during 2001. Under Statement No. 142, the Petroz goodwill
amortization ceased on January 1, 2002. In accordance with the
transition provisions of Statement No. 142, the company has
conducted initial impairment tests of the Petroz goodwill, which
proved not to be impaired. See Note 3--Acquisition of Tosco
Corporation for the status of the impairment review of the Tosco
goodwill as of January 1, 2002.
Other than assets related to Tosco and Conoco, the company has
no recorded intangible assets with indefinite useful lives.
Adoption of Statement No. 142 did not result in any adjustments
of estimated useful lives for other intangible assets that are
being amortized, the aggregate value of which is immaterial.
Note 11--Restructuring
As a result of the merger of Conoco and Phillips, the company
implemented a restructuring program in September 2002 to capture
the synergies of combining Phillips and Conoco by eliminating
redundancies, consolidating assets, and sharing common services
and functions across regions.
The restructuring program that was implemented in September 2002
is expected to be completed by the end of February 2004 and to
date, approximately 2,400 positions worldwide, most of which are
in the United States, have been identified for elimination.
Associated with implementation of this restructuring program,
ConocoPhillips accrued $608 million for merger-related
restructuring and work force reduction liabilities in the third
quarter of 2002. These liabilities primarily represent
anticipated termination payments and related employee benefits
associated with the reduction in positions. These liabilities
include $273 million related to Conoco, which is reflected in
the purchase price allocation, and $335 million related to
Phillips that was charged to selling, general and
administrative, and production and operating expenses in
September 2002. Payments will be made to Conoco and Phillips
employees under each company's respective severance plan.
19
Note 12--Debt
At September 30, 2002, ConocoPhillips, through its Conoco and
Phillips subsidiaries, had four bank credit facilities in place
totaling $5.5 billion, available for use either as support for
the issuance of commercial paper or as direct bank borrowings.
The Phillips facilities included a $1.5 billion revolving credit
facility expiring in October 2006, and a $1.5 billion 364-day
revolving credit facility that expired on October 15, 2002, and
the Conoco facilities included a $650 million revolving credit
facility expiring in May 2004, and a $1.85 billion 364-day
revolving credit facility, expiring on May 1, 2003.
At September 30, 2002, the company had no debt outstanding under
these credit facilities, but had $3,331 million in commercial
paper outstanding, which is supported 100 percent by the credit
facilities. This amount approximates fair value.
In addition to the credit facilities discussed above,
ConocoPhillips' Norwegian subsidiary had no borrowings
outstanding under its two $300 million revolving credit
facilities that expire in June 2004.
Conoco debt assumed in the merger (see Note 2--Merger of Conoco
and Phillips for more information) had the following balances at
September 30, 2002.
Millions
of Dollars
----------
5.90% senior unsecured notes due 2004 $ 1,350
6.35% senior unsecured notes due 2009 750
6.95% senior unsecured notes due 2029 1,900
6.50% senior unsecured notes due 2008 7
5.75% senior unsecured notes due 2026 16
7.443% senior unsecured notes due 2004 171
7.68% senior unsecured notes due 2012 65
6.35% senior unsecured notes due 2011 1,750
5.45% senior unsecured notes due 2006 1,250
7.25% senior unsecured notes due 2031 500
Floating rate notes due 2002 500
Floating rate notes due 2003 500
Commercial paper 1,725
Capitalized lease obligations 23
Industrial development bonds 85
Other 106
Unamortized debt discount and premium (fair
value adjustment) 662
- -----------------------------------------------------------------
Total borrowings and capital lease obligations 11,360
Notes payable and long-term debt due within one year (2,290)
- -----------------------------------------------------------------
Long-term debt $ 9,070
=================================================================
Includes the change in value of fair value hedges from August 30,
2002, to September 30, 2002.
20
Maturities on the Conoco debt assumed for the remainder of 2002
through 2006 are: $581 million (included in current liabilities),
$1,743 million, $1,587 million, $48 million and $1,296 million,
respectively.
The amortization of the fair-value adjustment will result in the
above fixed-rate notes having a weighted average effective
interest rate of 4.9 percent.
In addition to the debt above, in September 2002, ConocoPhillips
assumed debt of $181 million as a result of acquiring the
partner's interest in the SRW Cogeneration Limited Partnership.
On October 9, 2002, ConocoPhillips privately placed $2 billion of
senior unsecured debt securities, consisting of $400 million
3.625% notes due 2007, $1 billion 4.75% notes due 2012, and
$600 million 5.90% notes due 2032, in each case fully and
unconditionally guaranteed by Conoco and Phillips. The
$1,980 million proceeds from the offering were used to reduce
commercial paper, retire Conoco's $500 million floating rate
notes due October 15, 2002, and for general corporate purposes.
Effective October 15, 2002, ConocoPhillips entered into two new
revolving credit facilities and amended and restated a prior
Phillips revolving credit facility to include ConocoPhillips as a
borrower. These credit facilities support the company's
$4 billion commercial paper program. The company now has a
$2 billion 364-day revolving credit facility expiring on
October 14, 2003, and two revolving credit facilities totaling
$2 billion expiring in October 2006. Effective with the
execution of the new facilities, the previously existing
$2.5 billion in Conoco facilities were terminated.
On November 1, 2002, ConocoPhillips sent notice to investors of
the company's intent to redeem the $171 million Conoco 7.443%
senior unsecured notes due 2004. A November 26, 2002, redemption
date has been set.
On May 15, 2002, Phillips redeemed its $250 million 8.86% Notes
due May 15, 2022, at 104.43 percent. An extraordinary loss of
$13 million before-tax, $9 million after-tax, was incurred during
the second quarter of 2002 as a result of this early debt
retirement.
21
Note 13--Company-Obligated Mandatorily Redeemable Preferred
Securities of Phillips 66 Capital Trusts
On May 31, 2002, Phillips redeemed all of its outstanding 8.24%
Junior Subordinated Deferrable Interest Debentures due 2036 held
by the Phillips 66 Capital Trust I. This triggered the
redemption of $300 million of 8.24% Trust Originated Preferred
Securities at par value, $25 per share. An extraordinary loss of
$8 million before-tax, $6 million after-tax, was incurred during
the second quarter of 2002 as a result of the redemption.
Note 14--Condensed Consolidating Financial Information
In connection with the mergers of Conoco and Phillips with
wholly owned subsidiaries of ConocoPhillips, and to simplify the
company's credit structure, the companies have established
various cross guarantees. ConocoPhillips and Conoco have fully
and unconditionally guaranteed the payment obligations of
Phillips with respect to its publicly held debt securities.
Similarly, ConocoPhillips and Phillips have fully and
unconditionally guaranteed the payment obligations of Conoco and
Conoco Funding Company (Conoco Funding), Conoco's wholly owned
finance subsidiary, with respect to the publicly held debt
securities of Conoco and the publicly held debt securities of
Conoco Funding that are fully and unconditionally guaranteed by
Conoco. All guarantees are joint and several. The following
condensed consolidating financial statements present the results
of operations, financial position and cash flows for:
o ConocoPhillips, Phillips, Conoco and Conoco Funding (in
each case, reflecting investments in its consolidated
subsidiaries utilizing the equity method of accounting);
o All other non-guarantor subsidiaries of Conoco and
Phillips; and
o The consolidating adjustments necessary to present
ConocoPhillips' results on a consolidated basis.
These condensed consolidating financial statements should be
read in conjunction with the company's accompanying consolidated
financial statements.
22
Millions of Dollars
------------------------------------------------------------------------------------
Three Months Ended September 30, 2002
------------------------------------------------------------------------------------
Conoco All Other Consolidating Total
Statement of Operations ConocoPhillips Phillips Conoco Funding Subsidiaries Adjustments Consolidated
-------------- -------- ------ ------- ------------ ------------- ------------
Revenues
Sales and other operating
revenues $ - 3,255 - - 12,264 - 15,519
Equity in earnings (losses)
of affiliates (239) 312 (153) (12) 92 89 89
Other income - 33 (1) - 38 - 70
Intercompany revenues - 789 48 32 853 (1,722) -
- -----------------------------------------------------------------------------------------------------------------
Total Revenues (239) 4,389 (106) 20 13,247 (1,633) 15,678
- -----------------------------------------------------------------------------------------------------------------
Costs and Expenses
Purchased crude oil and
products - 2,836 - - 9,034 (1,651) 10,219
Production and operating
expenses - 254 9 - 1,125 67 1,455
Selling, general and
administrative expenses - 240 - - 515 3 758
Exploration expenses - 16 - - 69 - 85
Depreciation, depletion
and amortization - 112 - - 468 - 580
Property impairments - - - - 8 - 8
Taxes other than income
taxes - 760 - - 1,325 - 2,085
Accretion on discounted
liabilities - - - - 7 - 7
Interest and debt expense - 135 26 31 83 (141) 134
Foreign currency transaction
gains - - - - (6) - (6)
Preferred dividend
requirements of capital
trusts and minority
interests - - - - 9 - 9
- -----------------------------------------------------------------------------------------------------------------
Total Costs and Expenses - 4,353 35 31 12,637 (1,722) 15,334
- -----------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (239) 36 (141) (11) 610 89 344
Provision for income taxes - (62) 9 (11) 462 - 398
- -----------------------------------------------------------------------------------------------------------------
Income (loss) from continuing
operations (239) 98 (150) - 148 89 (54)
Income (loss) from operations
of discontinued businesses - (64) - - 2 - (62)
- -----------------------------------------------------------------------------------------------------------------
Net Income (Loss) $(239) 34 (150) - 150 89 (116)
=================================================================================================================
23
Millions of Dollars
------------------------------------------------------------------------------------
Nine Months Ended September 30, 2002
------------------------------------------------------------------------------------
Conoco All Other Consolidating Total
Statement of Operations ConocoPhillips Phillips Conoco Funding Subsidiaries Adjustments Consolidated
-------------- -------- ------ ------- ------------ ------------- ------------
Revenues
Sales and other operating
revenues $ - 8,099 - - 28,172 - 36,271
Equity in earnings (losses)
of affiliates (239) 843 (153) (12) 143 (444) 138
Other income - - (1) - 105 - 104
Intercompany revenues - 1,637 48 32 1,990 (3,707) -
- -----------------------------------------------------------------------------------------------------------------
Total Revenues (239) 10,579 (106) 20 30,410 (4,151) 36,513
- -----------------------------------------------------------------------------------------------------------------
Costs and Expenses
Purchased crude oil and
products - 7,021 - - 20,164 (3,479) 23,706
Production and operating
expenses - 736 9 - 2,508 (8) 3,245
Selling, general and
administrative expenses - 561 - - 1,093 (3) 1,651
Exploration expenses - 53 - - 262 - 315
Depreciation, depletion
and amortization - 303 - - 1,109 - 1,412
Property impairments - - - - 26 - 26
Taxes other than income
taxes - 1,293 - - 3,348 - 4,641
Accretion on discounted
liabilities - (1) - - 19 - 18
Interest and debt expense - 394 26 31 113 (217) 347
Foreign currency
transaction gains - - - - (11) - (11)
Preferred dividend
requirements of capital
trusts and minority
interests - - - - 34 - 34
- -----------------------------------------------------------------------------------------------------------------
Total Costs and Expenses - 10,360 35 31 28,665 (3,707) 35,384
- -----------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (239) 219 (141) (11) 1,745 (444) 1,129
Provision for income taxes - (145) 9 (11) 1,064 - 917
- -----------------------------------------------------------------------------------------------------------------
Income (loss) from continuing
operations (239) 364 (150) - 681 (444) 212
Income (loss) from operations
of discontinued businesses - (66) - - 2 - (64)
- -----------------------------------------------------------------------------------------------------------------
Income (Loss) Before Extraordinary
Item (239) 298 (150) - 683 (444) 148
Extraordinary item - (15) - - - - (15)
- -----------------------------------------------------------------------------------------------------------------
Net Income (Loss) $(239) 283 (150) - 683 (444) 133
=================================================================================================================
24
Millions of Dollars
------------------------------------------------------------------------------------
At September 30, 2002
------------------------------------------------------------------------------------
Conoco All Other Consolidating Total
Balance Sheet ConocoPhillips Phillips Conoco Funding Subsidiaries Adjustments Consolidated
-------------- -------- ------ ------- ------------ ------------- ------------
Assets
Cash and cash equivalents $ - 27 1 - 489 - 517
Accounts and notes receivable 86 1,886 174 400 14,854 (13,265) 4,135
Inventories - 713 - - 3,650 - 4,363
Prepaid expenses and other
current assets 1 109 - - 1,098 (337) 871
Net assets of discontinued
operations - 67 - - 714 - 781
- -----------------------------------------------------------------------------------------------------------------
Total Current Assets 87 2,802 175 400 20,805 (13,602) 10,667
Investments and long-term
receivables 30,070 31,404 24,674 6,691 13,980 (100,172) 6,647
Properties, plants and
equipment (net) - 3,850 - - 39,528 - 43,378
Goodwill - - - - 14,464 - 14,464
Intangibles - 6 - - 1,801 - 1,807
Other assets - 102 77 24 318 - 521
- -----------------------------------------------------------------------------------------------------------------
Total $30,157 38,164 24,926 7,115 90,896 (113,774) 77,484
=================================================================================================================
Liabilities and Stockholders'
Equity
Accounts payable $ 166 3,363 9 325 16,467 (14,014) 6,316
Notes payable and long-term
debt due within one year - 211 2,170 - 222 - 2,603
Accrued income and other taxes - 265 (45) (89) 2,439 - 2,570
Other accruals - 270 126 99 1,745 - 2,240
Net liabilities of discontinued
operations and assets held
for disposition - - - - 227 - 227
- -----------------------------------------------------------------------------------------------------------------
Total Current Liabilities 166 4,109 2,260 335 21,100 (14,014) 13,956
Long-term debt - 7,038 4,775 3,490 2,547 - 17,850
Accrued dismantlement, removal
and environmental costs - 254 - - 1,411 - 1,665
Deferred income taxes - 368 (21) 1 7,912 (8) 8,252
Employee benefit obligations - 968 - - 1,851 - 2,819
Other liabilities and deferred
credits - 11,228 1,494 1,910 36,191 (48,873) 1,950
- -----------------------------------------------------------------------------------------------------------------
Total Liabilities 166 23,965 8,508 5,736 71,012 (62,895) 46,492
Trust Preferred Securities and
other minority interests - - (12) - 1,013 - 1,001
Retained earnings (239) 7,480 (150) - 10,169 (10,941) 6,319
Other stockholders' equity 30,230 6,719 16,580 1,379 8,702 (39,938) 23,672
- -----------------------------------------------------------------------------------------------------------------
Total $30,157 38,164 24,926 7,115 90,896 (113,774) 77,484
=================================================================================================================
25
Millions of Dollars
------------------------------------------------------------------------------------
Nine Months Ended September 30, 2002
------------------------------------------------------------------------------------
Conoco All Other Consolidating Total
Statement of Cash Flows ConocoPhillips Phillips Conoco Funding Subsidiaries Adjustments Consolidated
-------------- -------- ------ ------- ------------ ------------- ------------
Net cash provided by
continuing operations $ - 1,041 (12) - 2,588 (623) 2,994
Net cash used in
discontinued operations - 157 - - (165) - (8)
- -----------------------------------------------------------------------------------------------------------------
Cash Provided by Operating
Activities - 1,198 (12) - 2,423 (623) 2,986
- -----------------------------------------------------------------------------------------------------------------
Cash Flows From Investing
Activities
Acquisitions, net of cash
acquired - (20) - - 1,262 - 1,242
Capital expenditures and
investments, including dry
holes - (562) - - (1,951) - (2,513)
Proceeds from asset
dispositions and insurance - 34 - - 84 - 118
Long-term advances to
Affiliates and other
investments - (193) - - (1,709) 1,803 (99)
- -----------------------------------------------------------------------------------------------------------------
Net cash used for investing
activities in continuing
operations - (741) - - (2,314) 1,803 (1,252)
Net cash used for investing
activities in discontinued
operations - (5) - - (6) - (11)
- -----------------------------------------------------------------------------------------------------------------
Net Cash Used for Investing
Activities - (746) - - (2,320) 1,803 (1,263)
- -----------------------------------------------------------------------------------------------------------------
Cash Flows From Financing
Activities
Issuance of debt - 525 843 - - (843) 525
Repayment of debt - (588) (711) - 271 - (1,028)
Issuance of company common
stock - 37 - - - - 37
Redemption of preferred stock
of subsidiaries - - - - (300) - (300)
Dividends paid on common
stock - (413) - - 337 (337) (413)
Other - (6) (119) - (44) - (169)
- -----------------------------------------------------------------------------------------------------------------
Net Cash Provided by
(Used for) Financing
Activities - (445) 13 - 264 (1,180) (1,348)
- -----------------------------------------------------------------------------------------------------------------
Net Change in Cash and Cash
Equivalents - 7 1 - 367 - 375
Cash and cash equivalents at
beginning of period - 20 - - 122 - 142
- -----------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at
End of Period $ - 27 1 - 489 - 517
=================================================================================================================
26
Note 15--Non-Mineral Operating Leases
The merger of Conoco and Phillips materially increased future
minimum rental payments due under non-cancelable operating
leases. ConocoPhillips' pro forma future minimum rental payments
at December 31, 2001, would have been approximately $3.7 billion,
net of future minimum sublease income of approximately
$650 million. This amount excludes guaranteed residual values of
approximately $1.9 billion, which would be reduced by the fair
value of the leased assets returned. ConocoPhillips' pro forma
capital lease obligations at December 31, 2001, would have been
approximately $120 million.
Note 16--Contingencies
The company is subject to various lawsuits and claims including
but not limited to: actions challenging oil and gas royalty and
severance tax payments; actions related to gas measurement and
valuation methods; actions related to joint interest billings to
operating agreement partners; and claims for damages resulting
from leaking underground storage tanks, with related toxic tort
claims.
In the case of all known contingencies, the company accrues an
undiscounted liability when the loss is probable and the amount
is reasonably estimable. These liabilities are not reduced for
potential insurance recoveries. If applicable, undiscounted
receivables are accrued for probable insurance or other third-
party recoveries. Based on currently available information, the
company believes that it is remote that future costs related to
known contingent liability exposures will exceed current accruals
by an amount that would have a material adverse impact on the
company's financial statements.
As facts concerning contingencies become known to the company,
the company reassesses its position both with respect to accrued
liabilities and other potential exposures. Estimates that are
particularly sensitive to future changes include contingent
liabilities recorded for environmental remediation, tax and legal
matters. Estimated future environmental remediation costs are
subject to change due to such factors as the unknown magnitude of
cleanup costs, the unknown time and extent of such remedial
actions that may be required, and the determination of the
company's liability in proportion to that of other responsible
parties. Estimated future costs related to tax and legal matters
are subject to change as events evolve and as additional
information becomes available during the administrative and
litigation processes.
27
Environmental--The company is subject to federal, state and local
environmental laws and regulations. These may result in
obligations to remove or mitigate the effects on the environment
of the placement, storage, disposal or release of certain
chemical, mineral and petroleum substances at various sites.
When the company prepares its financial statements, accruals for
environmental liabilities are recorded based on Management's best
estimate using all information that is available at the time.
Loss estimates are measured and liabilities are based on
currently available facts, existing technology, and presently
enacted laws and regulations, taking into consideration the
likely effects of inflation and other societal and economic
factors. Also considered when measuring environmental
liabilities are the company's prior experience in remediation of
contaminated sites, other companies' cleanup experience and data
released by the U.S. Environmental Protection Agency (EPA) or
other organizations. Unasserted claims are reflected in
ConocoPhillips' determination of environmental liabilities and
are accrued in the period that they are both probable and
reasonably estimable.
Although liability of those potentially responsible for
environmental remediation costs is generally joint and several
for federal sites and frequently so for state sites, the company
is usually only one of many companies cited at a particular site.
Due to the joint and several liabilities, the company could be
responsible for all of the cleanup costs related to any site at
which it has been designated as a potentially responsible party.
If ConocoPhillips were solely responsible, the costs, in some
cases, could be material to its, or one of its segments',
operations, capital resources or liquidity. However, settlements
and costs incurred in matters that previously have been resolved
have not been materially significant to the company's results of
operations or financial condition. The company has been
successful to date in sharing cleanup costs with other
financially sound companies. Many of the sites at which the
company is potentially responsible are still under investigation
by the EPA or the state agencies concerned. Prior to actual
cleanup, those potentially responsible normally assess the site
conditions, apportion responsibility and determine the
appropriate remediation. In some instances, ConocoPhillips may
have no liability or attain a settlement of liability. Where it
appears that other potentially responsible parties may be
financially unable to bear their proportional share, this
inability has been considered in estimating the company's
potential liability and accruals have been adjusted accordingly.
28
Upon Phillips' acquisition of Tosco on September 14, 2001, the
assumed environmental obligations of Tosco, some of which are
mitigated by indemnification agreements, became contingencies
reportable on a consolidated basis by Phillips. Beginning with
the acquisition of the Bayway refinery in 1993, but excluding the
Alliance refinery acquisition, Tosco negotiated, as part of its
acquisitions, environmental indemnification from the former
owners for remediating contamination that occurred prior to the
respective acquisition dates. Some of the environmental
indemnifications are subject to caps and time limits. No
accruals have been recorded for any potential contingent
liabilities that will be funded by the prior owners under these
indemnifications.
As part of Tosco's acquisition of Unocal's West Coast petroleum
refining, marketing, and related supply and transportation assets
in March 1997, Tosco agreed to pay the first $7 million per year
of any environmental remediation liabilities at the acquired
sites arising out of, or relating to, the period prior to the
transaction's closing, plus 40 percent of any amount in excess of
$7 million per year, with Unocal paying the remaining 60 percent
per year. The indemnification agreement with Unocal has a
25-year term from inception, and, at September 30, 2002, had a
maximum cap of $134 million for environmental remediation costs
that ConocoPhillips has to fund during the remainder of the
agreement period. This maximum has been adjusted for amounts
paid through September 30, 2002.
The company is currently participating in environmental
assessments and cleanups at federal Superfund and comparable
state sites. After an assessment of environmental exposures for
cleanup and other costs, the company makes accruals on an
undiscounted basis (except, if assumed in a purchase business
combination, such costs are recorded on a discounted basis) for
planned investigation and remediation activities for sites where
it is probable that future costs will be incurred and these costs
can be reasonably estimated. At September 30, 2002,
ConocoPhillips' balance sheet included a total environmental
accrual of $826 million, compared with $539 million at
December 31, 2001. The majority of these expenditures are
expected to be incurred within the next 30 years. These accruals
have not been reduced for possible insurance recoveries. In the
future, the company may be involved in additional environmental
assessments, cleanups and proceedings.
At September 30, 2002, the Conoco environmental liabilities that
were assumed as a result of the merger totaled $263 million and
were discounted at 5 percent. The accrual for Conoco's estimated
environmental liabilities was reflected on the balance sheet as
part of the purchase price allocation, and thus is subject to
adjustment as additional facts become known.
29
Other Legal Proceedings--ConocoPhillips is a party to a number of
other legal proceedings pending in various courts or agencies for
which, in some instances, no provision has been made.
Other Contingencies--ConocoPhillips has contingent liabilities
resulting from throughput agreements with pipeline and processing
companies in which it holds stock interests. Under these
agreements, ConocoPhillips may be required to provide any such
company with additional funds through advances and penalties for
fees related to throughput capacity not utilized by
ConocoPhillips.
ConocoPhillips has various purchase commitments for materials,
supplies, services and items of permanent investment incident to
the ordinary conduct of business. Such commitments are not at
prices in excess of current market. Additionally, the company
has obligations under international contracts to purchase natural
gas over periods of up to 17 years. Due to weakening market
prices since year-end, these long-term purchase obligations are
at prices in excess of September 30, 2002, quoted market prices.
No material annual gain or loss is expected from these long-term
commitments.
Note 17--Comprehensive Income (Loss)
ConocoPhillips' comprehensive income (loss) was as follows:
Millions of Dollars
-------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Net income (loss) $(116) 364 133 1,499
After-tax changes in:
Minimum pension liability
adjustment (119) - (119) -
Foreign currency
translation adjustments (73) 21 (23) (6)
Unrealized losses
on derivatives (5) (4) (5) (4)
Unrealized losses
on securities (1) (2) (3) (3)
Equity affiliates:
Foreign currency
translation 10 3 22 -
Derivatives related (10) 3 (34) 6
- -----------------------------------------------------------------
$(314) 385 (29) 1,492
=================================================================
30
Accumulated other comprehensive loss in the equity section of the
balance sheet included:
Millions of Dollars
-------------------------
September 30 December 31
2002 2001
-------------------------
Minimum pension liability adjustment $(262) (143)
Foreign currency translation adjustments (107) (84)
Unrealized losses on derivatives (9) -
Unrealized gain on securities 1 4
Deferred net hedging loss - (4)
Equity affiliates:
Foreign currency translation (17) (39)
Derivatives related (23) 11
- -----------------------------------------------------------------
$(417) (255)
=================================================================
Note 18--Supplemental Cash Flow Information
Non-cash investing and financing activities for the nine-month
periods ended September 30 were as follows:
Millions of Dollars
-------------------
2002 2001
-------------------
Non-Cash Investing and Financing Activities
Acquisition of Conoco by issuance of stock $15,974 -
Acquisition of Tosco by issuance of stock - 7,049
Investment in properties, plants and
equipment of businesses through the
assumption of non-cash liabilities 181 124
- -----------------------------------------------------------------
Note 19--Sales of Receivables
On August 30, 2002, Conoco and Phillips completed their merger
forming ConocoPhillips, and consequently ConocoPhillips assumed
Conoco's agreement with a bank-sponsored entity for the revolving
sale of senior, undivided interests in a pool of up to
$400 million of credit card and trade receivables and Phillips'
two agreements with bank-sponsored entities for the revolving
sale of senior, undivided interests in a pool of up to
$1.2 billion of credit card and trade receivables.
ConocoPhillips retains interests in the pool of receivables,
which are subordinate to the interests sold to the bank-sponsored
entities. ConocoPhillips also retains the servicing
responsibility for the sold receivables. At September 30, 2002,
and December 31, 2001, respectively, ConocoPhillips' retained
interests amounted to approximately $1 billion and $450 million,
reported on the balance sheet in accounts and notes receivable.
31
Total cash flows received from and paid to the bank-sponsored
entities in the first nine months of 2002 and 2001 were as
follows:
Millions of Dollars
-------------------
2002 2001
-------------------
Receivables sold at beginning of year $ 940 500
Conoco receivables sold at August 30, 2002 400 -
Tosco receivables sold at September 14, 2001 - 613
New receivables sold 15,328 5,472
Cash collections remitted (15,468) (5,445)
- -----------------------------------------------------------------
Receivables sold at September 30 $ 1,200 1,140
=================================================================
Discounts and other fees paid on
revolving balances $ 14 17
- -----------------------------------------------------------------
Note 20--Related Party Transactions
ConocoPhillips' third-quarter and nine-month related party
transactions include one month of Conoco and its affiliated
companies' transactions. Significant transactions with related
parties were:
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------
2002 2001 2002 2001
---------------------------------------
Operating revenues (a) $343 195 693 762
Purchases (b) 336 219 690 828
Operating expenses (c) 43 43 96 203
Selling, general and
administrative
expenses (d) 66 22 170 54
Net interest (income)
expense (1) 2 3 6
- -----------------------------------------------------------------
(a) ConocoPhillips' Exploration and Production (E&P) segment
sells natural gas to Duke Energy Field Services, LLC (DEFS)
and crude oil to the Malaysian Refining Company Sdn. Bhd
(Melaka), among others, for processing and marketing.
Natural gas liquids, solvents and petrochemical feedstocks
are sold to Chevron Phillips Chemical Company LLC (CPChem)
and refined products are sold to CFJ Properties and GKG
Mineraloelhandel GMbH & Co. KG. Also, the company charges
several of its affiliates including CPChem; Merey Sweeny,
L.P. (MSLP); Hamaca Holding LLC; and Venture Coke Company
for the use of common facilities, such as steam generators,
waste and water treaters, and warehouse facilities.
32
(b) ConocoPhillips purchases natural gas and natural gas
liquids from DEFS and CPChem for use in its refinery
processes and other feedstocks from various affiliates.
ConocoPhillips purchases crude oil from Petrozuata C.A. and
refined products from Melaka and Ceska rafinerska, a.s.
located in the Czech Republic.
(c) ConocoPhillips pays processing fees to various affiliates,
the most significant being MSLP. Additionally,
ConocoPhillips pays contract drilling fees to two deepwater
drillship affiliates.
(d) ConocoPhillips pays fees to its pipeline equity companies
for transporting finished refined products and pays
commissions to the receivable monetization companies (see
Note 19--Sales of Receivables for more information). These
expenses are reduced by fees charged for corporate services
provided to DEFS and CPChem under ongong service
agreements.
Elimination of the company's equity percentage share of profit
or loss on the above transactions was not material.
Note 21--Segment Disclosures and Related Information
With the merger of Conoco and Phillips, ConocoPhillips' operating
segments were realigned in the third quarter of 2002. Although
similar to the segments reported by Phillips in its 2001
Form 10-K, the following changes were made:
o The natural gas liquids fractionation and marketing business
was transferred from the Refining and Marketing segment to
the Midstream segment.
o The fuels technology business was transferred from the
Refining and Marketing segment to the newly created Emerging
Businesses segment.
o Businesses classified as discontinued operations are
included in Corporate and Other.
Amounts reported for 2001 have been reclassified to reflect these
changes.
33
The merger between Conoco and Phillips materially increased the
reported total assets in all segments. At December 31, 2001,
Conoco had proved worldwide oil and gas reserves of 3.3 billion
barrels of oil equivalent; had five wholly owned refineries (one
of which is held for sale), and four partially owned refineries;
and had a marketing network of approximately 7,900 retail outlets
in the United States, Europe and Asia Pacific. Because there was
only one month's income from the Conoco businesses, the merger's
impact on the statement of operations was less significant, but
is expected to increase markedly in the fourth quarter of 2002.
ConocoPhillips has organized its reporting structure based on the
grouping of similar products and services, resulting in five
operating segments:
(1) E&P--This segment explores for and produces crude oil,
natural gas, natural gas liquids, and Syncrude on a
worldwide basis. At September 30, 2002, E&P was producing
in the United States; the Norwegian and U.K. sectors of the
North Sea; Canada; Nigeria; Venezuela; the Timor Sea;
offshore Australia and China; Indonesia; the United Arab
Emirates; Vietnam; Russia; and Ecuador. Activities in the
Netherlands are classified as discontinued operations and
reported in Corporate and Other. The E&P segment's U.S. and
international operations are disclosed separately for
reporting purposes.
(2) Midstream (formerly Gas Gathering, Processing and
Marketing)--Through both consolidated and equity interests,
this segment gathers and processes natural gas produced by
ConocoPhillips and others, primarily in the United States
and Canada. The Midstream segment also fractionates and
markets natural gas liquids, also principally in the United
States and Canada. The Midstream segment includes
ConocoPhillips' 30.3 percent equity investment in DEFS.
(3) R&M--This segment refines, markets and transports crude oil
and petroleum products, mostly in the United States, Europe
and Asia. At September 30, 2002, ConocoPhillips owned
12 refineries in the United States (excluding two refineries
treated as discontinued operations and reported in Corporate
and Other); one in the United Kingdom; one in Ireland; and
had equity interests in one refinery in Germany, two in the
Czech Republic, and one in Malaysia. The R&M segment's U.S.
and international operations are disclosed separately for
reporting purposes.
34
(4) Chemicals--This segment manufactures and markets
petrochemicals and plastics on a worldwide basis. The
Chemicals segment consists primarily of ConocoPhillips'
50 percent equity investment in CPChem.
(5) Emerging Businesses--This segment includes the development
of new businesses beyond the company's traditional
operations. Emerging Businesses includes:
o Carbon fibers;
o Natural-gas-to-liquids technology;
o Fuels technology; and
o Power generation.
Corporate and Other includes general corporate overhead; all
interest income and expense; preferred dividend requirements of
capital trusts; discontinued operations; restructuring charges
and goodwill resulting from the merger of Conoco and Phillips;
certain eliminations; and various other corporate activities,
such as captive insurance subsidiaries and tax items not directly
attributable to the operating segments. Corporate assets include
all cash and cash equivalents.
The company evaluates performance and allocates resources based
on, among other items, net income. Intersegment sales are
recorded at prices that approximate market value.
35
Analysis of Results by Operating Segment
Millions of Dollars
------------------------------
Three Months Nine Months
Ended Ended
September 30 September 30
------------------------------
2002 2001 2002 2001
------------------------------
Sales and Other Operating Revenues
E&P
United States $ 1,687 1,346 4,047 4,794
International 1,133 495 2,100 1,757
Intersegment eliminations-U.S. (356) (113) (886) (353)
Intersegment eliminations-
international (105) - (105) -
- -----------------------------------------------------------------
E&P Outside Sales 2,359 1,728 5,156 6,198
- -----------------------------------------------------------------
Midstream
Total sales 417 171 772 624
Intersegment eliminations (74) - (230) -
- -----------------------------------------------------------------
Midstream Outside Sales 343 171 542 624
- -----------------------------------------------------------------
R&M
United States 11,749 4,037 29,490 9,482
International 1,215 84 1,223 84
Intersegment eliminations-U.S. (34) (1) (38) (4)
Intersegment eliminations-
international (118) - (118) -
- -----------------------------------------------------------------
R&M Outside Sales 12,812 4,120 30,557 9,562
- -----------------------------------------------------------------
Chemicals Outside Sales 3 - 9 -
Emerging Businesses Outside Sales 1 2 4 5
Corporate and Other Outside Sales 1 - 3 1
- -----------------------------------------------------------------
Consolidated Outside Sales $15,519 6,021 36,271 16,390
=================================================================
Net Income (Loss)
E&P
United States $ 311 305 752 1,162
International 149 66 189 293
- -----------------------------------------------------------------
Total E&P 460 371 941 1,455
- -----------------------------------------------------------------
Midstream 11 30 35 101
- -----------------------------------------------------------------
R&M
United States 65 88 83 352
International 12 1 12 1
- -----------------------------------------------------------------
Total R&M 77 89 95 353
- -----------------------------------------------------------------
Chemicals 3 (36) (1) (75)
Emerging Businesses (262) (2) (270) (9)
Corporate and Other (405) (88) (667) (326)
- -----------------------------------------------------------------
Consolidated Net Income (Loss) $ (116) 364 133 1,499
=================================================================
36
Millions of Dollars
---------------------------
September 30 December 31
2002 2001
---------------------------
Total Assets
E&P
United States $15,732 9,506
International 17,031 5,290
- -----------------------------------------------------------------
Total E&P 32,763 14,796
- -----------------------------------------------------------------
Midstream 1,958 198
- -----------------------------------------------------------------
R&M
United States 22,383 16,820
International 3,467 183
- -----------------------------------------------------------------
Total R&M 25,850 17,003
- -----------------------------------------------------------------
Chemicals 2,061 1,934
Emerging Businesses 677 9
Corporate and Other 14,175* 1,277
- -----------------------------------------------------------------
Consolidated Total Assets $77,484 35,217
=================================================================
*Includes $11.8 billion of goodwill not yet allocated to
reporting units.
Note 22--Income Taxes
The company's effective tax rates for the third quarter and first
nine months of 2002 were 116 percent and 81 percent,
respectively, and 48 percent and 50 percent for each of the same
periods in the prior year. The effective tax rate in excess of
the domestic federal statutory rate of 35 percent is primarily
due to foreign taxes in excess of the domestic federal statutory
rate. In addition, the 2002 periods were impacted by a write-off
of purchased in-process research and development costs without a
corresponding tax benefit.
Note 23--New Accounting Standards
In June 2001, the FASB issued Statement No. 143, "Accounting for
Asset Retirement Obligations." Statement No. 143 is required to
be adopted by the company no later than January 1, 2003, and will
require major changes in the accounting for asset retirement
obligations, such as required decommissioning of oil and gas
production platforms, facilities and pipelines. Statement
No. 143 requires entities to record the fair value of a liability
for an asset retirement obligation in the period when it is
incurred (typically when the asset is installed at the production
location). When the liability is initially recorded, the entity
capitalizes the cost by increasing the carrying amount of the
related property, plant and equipment. Over time, the liability
is accreted for the change in its present value each period, and
the initial capitalized cost is depreciated over the useful life
of the related asset. Upon adoption of Statement No. 143, the
company will adjust its recorded asset retirement obligations to
the new requirements using a cumulative-effect approach. All
37
transition amounts are to be measured using the company's current
information, assumptions, and credit-adjusted, risk-free interest
rates.
While the original discount rates used to establish an asset
retirement obligation will not change in the future, changes in
cost estimates or the timing of expenditures will result in
immediate adjustments to the recorded liability, with an
offsetting adjustment to properties, plants and equipment. The
company is currently assessing and quantifying the potential
impact of adopting Statement No. 143. The preliminary cumulative
after-tax effect of adoption is currently expected to be a gain
with substantial increases in both recorded asset retirement
obligation liabilities and properties, plants and equipment. The
majority of the liability increase is expected to be attributable
to Conoco assets. Following prevalent oil and gas industry
practice for acquisitions, ConocoPhillips did not record an
initial liability for the estimated cost of removing Conoco's
properties, plants and equipment at the end of their useful
lives. Instead, estimated removal costs would be accrued on a
unit-of-production basis as an additional component of
depreciation, building the removal cost liability over the
remaining useful lives of the properties plants and equipment.
However, upon adoption of Statement No. 143, these asset
retirement obligations will be required to be recorded,
significantly increasing asset retirement liabilities on the
balance sheet with an offsetting increase to properties, plants
and equipment.
38
- -----------------------------------------------------------------
Management's Discussion and ConocoPhillips
Analysis of Financial Condition
and Results of Operations
Management's Discussion and Analysis contains forward-looking
statements including, without limitation, statements relating to
the company's plans, strategies, objectives, expectations,
intentions, and resources, that are made pursuant to the "safe
harbor" provisions of the Private Securities Litigation Reform
Act of 1995. The words "intends," "believes," "expects,"
"plans," "scheduled," "anticipates," "estimates," and similar
expressions identify forward-looking statements. The company
does not undertake to update, revise or correct any of the
forward-looking information. Readers are cautioned that such
forward-looking statements should be read in conjunction with the
company's disclosures under the heading: "CAUTIONARY STATEMENT
FOR THE PURPOSES OF THE 'SAFE HARBOR' PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995" beginning on page 79.
RESULTS OF OPERATIONS
Unless otherwise indicated, discussion of results for the three-
and nine-month periods ending September 30, 2002, are based on a
comparison with the corresponding periods of 2001. The merger of
Conoco Inc.(Conoco) and Phillips Petroleum Company (Phillips) on
August 30, 2002, and the acquisition of Tosco Corporation (Tosco)
on September 14, 2001, impacts the comparability of the 2002
periods with the corresponding 2001 periods.
Conoco and Phillips Merger
On August 30, 2002,Conoco and Phillips closed on the merger of
the two companies, creating a new company named ConocoPhillips.
The merger was accounted for using purchase accounting. Although
the business combination of Conoco and Phillips was a merger of
equals, generally accepted accounting principles required that
one of the two companies in the transaction be designated as the
acquirer for accounting purposes. Phillips was designated as the
acquirer based on the fact that its common stockholders initially
held more than 50 percent of the ConocoPhillips common stock
after the merger. Because Phillips was designated as the
acquirer, its operations and results are presented in this Form
10-Q for all periods prior to the close of the merger. From
September 1, 2002, forward, the operations and results of
ConocoPhillips reflect the combined operations of the two
companies.
39
In connection with the merger, the U.S. Federal Trade Commission
(FTC) required the divestiture of specified Conoco and Phillips
assets, which included Phillips' Woods Cross, Utah, refinery and
associated motor fuel marketing operations; Conoco's Commerce
City, Colorado, refinery and related crude oil pipelines and
Phillips' Colorado motor fuel marketing operations. All assets
and operations that are required by the FTC to be divested are
included in Corporate and Other as discontinued operations.
Included in discontinued operations for the third quarter of 2002
was a $69 million after-tax charge for the write-down to fair
value of the Phillips operations to be disposed of. Because the
Conoco assets to be disposed of were recorded at fair value in
the purchase price allocation, no further write-downs were
required. See Note 4--Discontinued Operations in the Notes to
Financial Statements for additional information, including a
complete list of assets required to be divested.
As a result of the merger of Conoco and Phillips, the company
implemented a restructuring program in September 2002 to capture
the synergies of combining Phillips and Conoco by eliminating
redundancies, consolidating assets, and sharing common services
and functions across regions. The restructuring program that was
implemented in September 2002 is expected to be completed by the
end of February 2004 and to date, approximately 2,400 positions
worldwide, most of which are in the United States have been
identified for elimination. Associated with implementation of
the restructuring program, ConocoPhillips accrued $608 million
for merger-related restructuring and work force reduction
liabilities in the third quarter of 2002. These liabilities
primarily represent anticipated termination payments and related
employee benefits associated with the reduction in positions.
These liabilities include $273 million related to Conoco, which
is reflected in the purchase price allocation, and $335 million
related to Phillips that was charged to selling, general and
administrative, and production and operating expenses in
September 2002. Payments will be made to Conoco and Phillips
employees under each company's respective severance plan.
Also related to the merger and recorded in the third quarter was
a $246 million write-off of purchased in-process research and
development activity costs related to Conoco's natural-gas-to-
liquids technology. In accordance with Financial Accounting
Standards Board (FASB) Interpretation No. 4, "Applicability of
FASB Statement No. 2 to Business Combinations Accounted for by
the Purchase Method," value assigned to research and development
activities in the purchase price allocation that have no
alternative future use should be charged to expense at the date
of the consummation of the combination. The $246 million charge
40
was recorded in the Emerging Businesses segment and was the same
on both a before-tax and after-tax basis, as there was no tax
basis to the assigned value prior to its write-off.
ConocoPhillips also accrued $16 million, after-tax, for increased
costs associated with seismic contracts as a result of the
merger. Due to the corporate nature of the transaction, the
expense was recorded in Corporate and Other and did not impact
exploration expenses. In addition, the third quarter also
included transition costs of $7 million, bringing total merger-
related costs to $469 million in the quarter. See Note 2--Merger
of Conoco and Phillips in the Notes to Financial Statements for
additional information on the merger.
Consolidated Results
A summary of the company's net income (loss) by business segment
follows:
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Exploration and
Production (E&P) $ 460 371 941 1,455
Midstream 11 30 35 101
Refining and Marketing
(R&M) 77 89 95 353
Chemicals 3 (36) (1) (75)
Emerging Businesses (262) (2) (270) (9)
Corporate and Other (405) (88) (667) (326)
- -----------------------------------------------------------------
Net income (loss) $(116) 364 133 1,499
=================================================================
Net income is affected by transactions, defined by Management and
termed "special items," which are not representative of the
company's ongoing operations. These special items can obscure
the underlying operating results for a period and affect
comparability of operating results between periods. The
following table summarizes the gains (losses), on an after-tax
basis, from special items included in the company's net income:
41
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Merger-related costs $(469) - (473) -
Discontinued operations (62) 5 (64) 8
Impairments (5) - (94) (23)
Net gain (loss) on
asset sales (5) 13 (5) 16
Cumulative effect of
accounting change - - - 28
Extraordinary item - (10) (15) (10)
Pending claims and
settlements (3) 5 (12) 2
Equity companies'
special items (2) (34) 4 (7)
Other items (26) 12 (28) 11
- -----------------------------------------------------------------
Total special items $(572) (9) (687) 25
=================================================================
See Notes to Financial Statements for additional information.
Excluding the special items listed above, the company's net
operating income (loss) by business segment was:
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
E&P $ 499 360 1,069 1,449
Midstream 11 30 35 101
R&M 79 100 100 340
Chemicals 5 (27) - (89)
Emerging Businesses (16) (2) (24) (9)
Corporate and Other (122) (88) (360) (318)
- -----------------------------------------------------------------
Net operating income $ 456 373 820 1,474
=================================================================
ConocoPhillips' net loss in the third quarter of 2002 was
$116 million, compared with net income of $364 million in the
third quarter of 2001. Special items decreased net income by
$572 million in the third quarter of 2002 and $9 million in the
third quarter of 2001. After excluding special items, net
operating income in the third quarter of 2002 was $456 million,
compared with $373 million in the third quarter of 2001.
42
The increase in net operating income in the third quarter of 2002
was primarily attributable to the contribution of one month's
earnings from Conoco operations, as well as higher realized crude
oil prices and increased crude oil production. However,
ConocoPhillips' operations were affected by interruptions at the
Prudhoe Bay field in Alaska and at the Britannia field in the
U.K. North Sea; maintenance turnarounds at the Borger and Bayway
refineries; and tropical storms in the Gulf of Mexico.
ConocoPhillips' net income in the first nine months of 2002 was
$133 million, compared with $1,499 million in the nine-month
period of 2001. Special items decreased net income by
$687 million in the 2002 period and benefited net income by
$25 million in the 2001 period. Excluding special items, net
operating income in the first nine months of 2002 was
$820 million, compared with $1,474 million in the prior year.
The decline was primarily attributable to lower crude oil and
natural gas prices, as well as lower refining and marketing
margins.
Statement of Operations Analysis
In addition to the merger between Conoco and Phillips discussed
above, on September 14, 2001, Phillips closed on the $7 billion
acquisition of Tosco. These transactions significantly increased
operating revenues, purchase costs, operating expenses and other
income statement line items. See Note 2--Merger of Conoco and
Phillips, and Note 3--Acquisition of Tosco Corporation, in the
Notes to Financial Statements for additional information.
Sales and other operating revenues increased 158 percent in the
third quarter of 2002 and 121 percent in the nine-month period
ended September 30, 2002. The increase in both periods reflects
the impact of the Tosco acquisition and, to a lesser extent, the
merger of Conoco and Phillips. These items were partially offset
by lower crude oil and natural gas revenues in the nine-month
period of 2002.
Equity in earnings of affiliates was $89 million in the third
quarter of 2002, compared with a loss of $15 million in the third
quarter of 2001. Equity in earnings of affiliates increased
30 percent in the nine-month period. Equity earnings from Duke
Energy Field Services, LLC (DEFS) and Merey Sweeny, L.P. (MSLP)
declined in both the third quarter and first nine months of 2002.
DEFS' decline was primarily attributable to higher operating
expenses, hedging losses, gas imbalance adjustments, and lower
natural gas liquids prices and MSLP's decline was mainly due to
lower crude oil heavy-light differentials. Results from Chevron
43
Phillips Chemical Company LLC (CPChem) improved in both the third
quarter and nine-month period of 2002, but remain depressed due
to a weak industry-wide market environment. Equity companies
from Conoco operations contributed positively to equity earnings
for both the three- and nine-month periods of 2002.
Other income increased 169 percent in the third quarter of 2002
and 82 percent in the first nine months. The increase in both
periods reflects a favorable revaluation of long-term incentive
performance units held by six former senior Tosco executives, as
well as increased interest income from Conoco activities. See
Note 3--Acquisition of Tosco Corporation, in the Notes to
Financial Statements, for more information about the long-term
incentive performance units. In exchange for a cash settlement,
these units were cancelled in October 2002. As a result,
ConocoPhillips expects to record a before-tax gain in the fourth
quarter of 2002.
Purchased crude oil and products increased 208 percent in the
third quarter of 2002 and 194 percent in the nine-month period.
The increase in both periods reflects the impact of the Tosco
acquisition and, to a lesser extent, the merger of Conoco and
Phillips.
Production, operating, selling, general and administrative
expenses increased 175 percent in the third quarter of 2002 and
120 percent in the nine-month period. The increase in both
periods was attributable to the Tosco acquisition and the Conoco
and Phillips merger. In conjunction with the merger,
ConocoPhillips wrote-off $246 million of purchased in-process
research and development activity costs related to Conoco's
natural-gas-to-liquids technology. ConocoPhillips also expensed
$335 million related to planned work force reductions of Phillips
personnel. These items were partially offset by lower refining
expenses in Phillips' operations.
Exploration expenses increased 20 percent in the third quarter of
2002 and 56 percent in the nine-month period. Both periods
reflect the impact of one month of exploration activities
associated with the Conoco operations. The nine-month period
also included a $77 million leasehold impairment of deepwater
block 34, offshore Angola, recorded in the first quarter of 2002.
Dry hole costs were $4 million in the third quarter of 2002,
compared with $10 million in the third quarter of 2001.
Depreciation, depletion and amortization (DD&A) increased
94 percent in the third quarter of 2002 and 49 percent in the
first nine months. The increase in both periods was primarily
the result of the Conoco and Phillips merger as well as the Tosco
acquisition.
44
In the third quarter of 2002, ConocoPhillips recorded a property
impairment of $8 million in connection with the third-quarter
sale of its Point Arguello assets, offshore California. In the
nine-month 2002 period, the company also recorded property
impairments on its Janice field, in the U.K. North Sea, sold in
the second quarter of 2002, and on a non-producing field in
Alaska, together totaling $18 million. There were no property
impairments recorded in the third quarter of 2001, but the nine-
month 2001 period included a $23 million impairment of the Siri
field, offshore Denmark.
Taxes other than income taxes increased 187 percent in the third
quarter of 2002 and 148 percent in the nine-month period. The
increase in both periods reflects the Conoco and Phillips merger,
as well as the Tosco acquisition, and the corresponding increase
in excise taxes due to higher petroleum products sales; and
increased property and payroll taxes.
Accretion on discounted liabilities increased 133 percent in the
third quarter of 2002 and 157 percent in the first nine months.
These amounts relate to discounted environmental liabilities
assumed in acquisitions and mergers.
Interest expense increased 81 percent in the third quarter of
2002 and 45 percent in the nine-month period. The increase in
both periods was primarily due to higher debt levels following
the Tosco acquisition and the merger of Conoco and Phillips.
Foreign currency gains were recorded in the third quarter and
first nine months of 2002, compared with losses in the
corresponding periods of the previous year. Preferred dividend
requirements decreased in both the third quarter and nine-month
period of 2002, reflecting the redemption of $300 million of
preferred securities in late-May 2002.
The company's effective tax rates for the third quarter and first
nine months of 2002 were 116 percent and 81 percent,
respectively, compared with 48 percent and 50 percent for each of
the same periods in the prior year. The increase in the
effective tax rates in the 2002 periods was primarily the result
of the write-off of in-process research and development activity
costs without a corresponding tax benefit, and a higher
proportion of income in higher-tax-rate jurisdictions.
45
Segment Results
E&P
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Millions of Dollars
---------------------------------------
Operating Results
Net income $ 460 371 941 1,455
Less special items (39) 11 (128) 6
- -----------------------------------------------------------------
Net operating income $ 499 360 1,069 1,449
=================================================================
Dollars Per Unit
---------------------------------------
Average Sales Prices
Crude oil (per barrel)
United States $25.94 24.41 22.98 25.21
International 26.98 25.19 24.55 26.04
Total consolidated 26.37 24.65 23.54 25.48
Equity affiliates 20.29 - 19.88 -
Worldwide 25.96 24.65 23.43 25.48
Natural gas--lease (per
thousand cubic feet)
United States 2.60 2.48 2.39 4.08
International 2.38 2.48 2.34 2.60
Total consolidated 2.49 2.48 2.37 3.57
Equity affiliates 1.78 - 1.78 -
Worldwide 2.49 2.48 2.37 3.57
- -----------------------------------------------------------------
Millions of Dollars
---------------------------------------
Worldwide Exploration
Expenses
General administrative;
geological and
geophysical; and lease
rentals $ 66 53 154 143
Leasehold impairment 15 8 124 34
Dry holes 4 10 37 25
- -----------------------------------------------------------------
$ 85 71 315 202
=================================================================
46
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Thousands of Barrels Daily
---------------------------------------
Operating Statistics
Crude oil produced
United States
Alaska 310 325 334 337
Lower 48 38 34 34 34
- -----------------------------------------------------------------
348 359 368 371
Norway 156 98 131 114
United Kingdom 35 20 24 19
Nigeria 29 29 26 30
China 12 10 12 11
Canada 14 1 5 1
Other 26 9 11 13
- -----------------------------------------------------------------
Total consolidated 620 526 577 559
Equity affiliates 44 - 18 -
- -----------------------------------------------------------------
664 526 595 559
=================================================================
Natural gas liquids
produced
United States* 30 24 28 26
Norway 6 4 5 5
Other areas 7 4 5 4
- -----------------------------------------------------------------
43 32 38 35
=================================================================
*Includes 13,000 and 14,000 barrels per day in the third quarter
and nine-month period of 2002, respectively, that were sold from
the Prudhoe Bay lease to the Kuparuk lease for reinjection to
enhance crude oil production. The corresponding periods of
2001 included 13,000 and 15,000 barrels per day, respectively.
Millions of Cubic Feet Daily
---------------------------------------
Natural gas produced*
United States 1,105 946 953 911
Norway 183 105 150 128
United Kingdom 347 165 237 177
Canada 172 18 72 18
Indonesia 68 - 23 -
Other 105 100 106 95
- -----------------------------------------------------------------
Total consolidated 1,980 1,334 1,541 1,329
Equity affiliates 4 - 1 -
- -----------------------------------------------------------------
1,984 1,334 1,542 1,329
=================================================================
*Represents quantities available for sale. Excludes gas
equivalent of natural gas liquids shown above.
Thousands of Barrels Daily
---------------------------------------
Mining operations
Syncrude produced 8 - 3 -
- -----------------------------------------------------------------
47
Net operating income from ConocoPhillips' E&P segment increased
39 percent in the third quarter of 2002, while declining
26 percent in the nine-month period. For the quarter, the
improved results were primarily attributable to the inclusion of
one month's results from Conoco operations, along with higher
crude oil prices and sales volumes. In the first nine months,
lower crude oil and natural gas prices were partially offset by
the benefit of one month's results from Conoco operations.
U.S. E&P
- --------
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Operating Results
Net income $311 305 752 1,162
Less special items (15) (2) (20) 5
- -----------------------------------------------------------------
Net operating income $326 307 772 1,157
=================================================================
Alaska $252 228 606 713
Lower 48 74 79 166 444
- -----------------------------------------------------------------
$326 307 772 1,157
=================================================================
Net operating income from ConocoPhillips' U.S. E&P operations
increased 6 percent in the third quarter of 2002, while declining
33 percent in the nine-month period. Both periods benefited from
the inclusion of one month's activity from Conoco operations.
The improvement in the third quarter was also due to higher crude
oil prices. The nine-month period of 2002 was negatively
impacted by lower crude oil and natural gas prices.
The company's U.S. crude oil production decreased 3 percent in
the third quarter of 2002, compared with the third quarter of the
previous year. The decline was predominantly in Alaska, which
experienced normal field declines, as well as operating
interruptions at the Prudhoe Bay field in the third quarter of
2002. These items were partially offset in the Lower 48 states
by one month's production from Conoco fields. U.S. natural gas
production increased 17 percent in the third quarter of 2002,
mainly reflecting one month's production from Conoco fields.
Special items in the third quarter of 2002 included an impairment
charge associated with the Point Arguello field, offshore
California, and a loss on its disposition, together totaling
$10 million after-tax. In addition, the nine-month period of
48
2002 included a property impairment charge on a field in Alaska,
as well as merger-related costs. Special items in the third
quarter of 2001 consisted of work force reduction charges. The
first nine months of 2001 also included a net favorable result
from claims and settlements.
International E&P
- -----------------
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Operating Results
Net income $149 66 189 293
Less special items (24) 13 (108) 1
- -----------------------------------------------------------------
Net operating income $173 53 297 292
=================================================================
Net operating income from ConocoPhillips' international E&P
operations increased 226 percent in the third quarter of 2002 and
2 percent in the nine-month period. The increase in the third
quarter was principally attributable to one month's earnings from
Conoco operations, as well as higher crude oil prices and
production, and income from the Hamaca project in Venezuela,
which became operational in the fourth quarter of 2001. In the
nine-month period, the benefit of Conoco's contribution was
offset by lower crude oil and natural gas prices, as well as
lower crude oil production volumes.
International crude oil production increased 89 percent in the
third quarter of 2002, while international natural gas production
increased 127 percent. Both increases reflect the impact of
production from Conoco operations for the month of September.
Special items in the third quarter of 2002 consisted of a
$24 million charge relating to tax law changes in the United
Kingdom. On April 17, 2002, the U.K. government announced
proposed changes to corporate tax laws specifically impacting the
oil and gas industry and production from the U.K. sector of the
North Sea. The proposed changes became law on July 24, 2002. A
10 percent supplementary charge to corporation taxes is now
assessed on profits, which is expected to be partially offset by
the elimination of royalties and an increase in first-year
deduction allowances for capital investments. The $24 million
represents a one-time change in deferred taxes upon enactment of
the new laws. Special items in the nine-month period of 2002
also included after-tax property impairment charges to the Janice
49
field in the U.K. North Sea totaling $9 million, and a
$77 million leasehold impairment of deepwater block 34, offshore
Angola, due to an unsuccessful initial exploratory well in this
block.
Special items in the third quarter of 2001 consisted of a net
gain on asset dispositions. The 2001 nine-month period also
included an impairment of the Siri field, offshore Denmark.
Midstream
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Millions of Dollars
-------------------------------------
Operating Results
Net income $ 11 30 35 101
Less special items - - - -
- -----------------------------------------------------------------
Net operating income $ 11 30 35 101
=================================================================
Dollars Per Barrel
-------------------------------------
Average Sales Prices
U.S. natural gas liquids*
Consolidated $18.57 - 18.57 -
Equity 16.32 16.37 14.91 20.66
- -----------------------------------------------------------------
Operating Statistics Thousands of Barrels Daily
-------------------------------------
Natural gas liquids
extracted 153 125 129 120
- -----------------------------------------------------------------
Natural gas liquids
fractionated 139 95 117 94
- -----------------------------------------------------------------
*Prices are based on index prices from the Mont Belvieu and
Conway market hubs that are weighted by natural gas liquids
component and location mix.
The Midstream segment consists of ConocoPhillips' 30.3 percent
interest in DEFS, as well as company-owned natural gas gathering
and processing operations and natural gas liquids fractionation
and marketing businesses. The 2001 periods have been restated to
reflect the inclusion of the Phillips natural gas liquids
business. Net operating income from the Midstream segment
declined 63 percent in the third quarter of 2002 and 65 percent
in the nine-month period.
50
DEFS' results were reduced by lower natural gas liquids prices,
gas imbalance accruals and other adjustments, losses incurred on
hedging activities, and higher operating expenses. Benefiting
both 2002 periods was the inclusion of one month's results for
Conoco operations.
There were no special items in Midstream for the first nine
months of 2002 or 2001.
51
R&M
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Millions of Dollars
---------------------------------------
Operating Results
Net income $ 77 89 95 353
Less special items (2) (11) (5) 13
- -----------------------------------------------------------------
Net operating income $ 79 100 100 340
=================================================================
Dollars Per Gallon
---------------------------------------
U.S. Average Sales Prices
Automotive gasoline
Wholesale $ .93 .89 .86 .94
Retail 1.02 1.06 .95 1.09
Distillates .81 .83 .73 .85
- -----------------------------------------------------------------
Thousands of Barrels Daily
---------------------------------------
Operating Statistics
Refining operations*
United States
Rated crude oil
capacity 1,825 571 1,710 420
Crude oil runs 1,643 516 1,546 394
Capacity utilization
(percent) 90% 90 90 94
Refinery production 1,795 614 1,702 486
International
Rated crude oil
capacity 192 13 112 4
Crude oil runs 170 12 100 4
Capacity utilization
(percent) 89% 92 89 100
Refinery production 183 12 103 4
Worldwide
Rated crude oil
capacity 2,017 584 1,822 424
Crude oil runs 1,813 528 1,646 398
Capacity utilization
(percent) 90% 90 90 94
Refinery production 1,978 626 1,805 490
- -----------------------------------------------------------------
*Includes ConocoPhillips share of equity affiliates.
52
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Thousands of Barrels Daily
---------------------------------------
Petroleum products
outside sales
United States
Automotive gasoline 1,264 458 1,168 346
Distillates 476 200 444 146
Aviation fuels 212 43 187 44
Other products 350 145 362 112
- -----------------------------------------------------------------
2,302 846 2,161 648
International 202 6 102 2
- -----------------------------------------------------------------
2,504 852 2,263 650
=================================================================
Net operating income from the R&M segment declined 21 percent in
the third quarter of 2002 and 71 percent in the first nine
months. Results for 2001 have been restated to reflect the
transfer of the natural gas liquids business to the Midstream
segment, the transfer of the fuels technology business to the
Emerging Businesses segment, and the classification of certain
refining and marketing operations as discontinued, and their
subsequent alignment with Corporate and Other for reporting
purposes.
The lower earnings in both periods were primarily attributable to
lower refinery and marketing margins and volumes from Phillips'
R&M operations. These items were partially offset by one month's
earnings from Conoco R&M operations, the impact of including
Tosco's earnings in 2002, versus including only the last two
weeks of September in 2001, and lower operating and
administrative costs from the Phillips operations.
53
U.S. R&M
- --------
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Operating Results
Net income $65 88 83 352
Less special items (2) (11) (5) 13
- -----------------------------------------------------------------
Net operating income $67 99 88 339
=================================================================
Net operating income from U.S. R&M operations declined 34 percent
in the third quarter of 2002 and 73 percent in the nine-month
period. One month's results from Conoco operations and the
impact of including Tosco's earnings for 2002, versus including
only the last two weeks of September in 2001, benefited earnings
in both periods. However, both periods were negatively impacted
by lower refinery and marketing margins and volumes from the
Phillips operations. These items were mitigated by lower
operating costs and general and administrative expenses.
The crude oil utilization rate for ConocoPhillips' U.S.
refineries was 90 percent in the third quarter of 2002, the same
as the third quarter of 2001, but down from 95 percent in the
second quarter of 2002. The lower rate compared with the second
quarter was due to maintenance turnarounds at the Borger and
Bayway refineries, located in Texas and New Jersey, respectively.
Tropical storms also impacted the company's Gulf Coast refineries
during the quarter.
Special items in the third quarter of 2002 included merger-
related transition costs, while the nine-month period also
included work force reduction charges unrelated to the merger.
Special items in the third quarter of 2001 consisted of work
force reduction charges, and the first nine months of 2001 also
included a cumulative effect of a change in accounting method.
54
International R&M
- -----------------
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Operating Results
Net income $12 1 12 1
Less special items - - - -
- -----------------------------------------------------------------
Net operating income $12 1 12 1
=================================================================
Net operating income from international R&M operations increased
from $1 million in both the third quarter and nine-month period
of 2001 to $12 million in the third quarter and nine-month period
of 2002. The increases reflect the impact of one month of Conoco
international operations in the 2002 results.
Crude oil capacity utilization in the third quarter of 2002 for
ConocoPhillips' international operations was 89 percent. In
October 2002, the Humber refinery had 28 days of unscheduled
downtime, which will impact international R&M capacity
utilization rates in the fourth quarter. The impact of the
shutdown was partially mitigated by performing maintenance
activities during the downtime that were originally planned for
future periods.
There were no special items in international R&M in the third-
quarter and nine-month periods of 2002 and 2001.
55
Chemicals
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Millions of Dollars
---------------------------------------
Operating Results
Net income (loss) $ 3 (36) (1) (75)
Less special items (2) (9) 1 14
- -----------------------------------------------------------------
Net operating income
(loss) $ 5 (27) - (89)
=================================================================
Millions of Pounds
---------------------------------------
Operating Statistics*
Production
Ethylene 831 769 2,422 2,425
Polyethylene 492 466 1,525 1,443
Styrene 194 83 645 276
Normal alpha olefins 139 155 444 410
- -----------------------------------------------------------------
*ConocoPhillips' 50 percent share of Chevron Phillips Chemical
Company LLC.
The company's Chemicals segment consists primarily of its
50 percent interest in CPChem. The Chemicals segment reported
net operating income of $5 million in the third quarter of 2002,
compared with a net operating loss of $27 million in the third
quarter of the prior year. In the first nine months of 2002, the
Chemicals segment posted breakeven results, compared with a net
operating loss of $89 million in the nine-month period of 2002.
Although the 2002 periods were improved over 2001, this business
remains depressed due to weak economic and market conditions,
which has resulted in low margins across most product lines, as
well as production cutbacks. The improvement in the 2002 periods
was primarily the result of improved performance in the aromatics,
styrenics and polyethylene business lines. In addition, the third
quarter benefited from improved olefins results.
Special items in the third quarter of 2002 consisted of a
property impairment due to a plant closure. In addition, the
nine-month period of 2002 also included a partial reversal of a
previous lower-of-cost-or-market inventory write-down, as well as
contingency accruals and severance charges. Special items in the
third quarter of 2001 consisted of property and deferred tax
asset impairments related to CPChem's aromatics manufacturing
facility in Puerto Rico, which was partially offset by a
favorable deferred tax adjustment recorded by ConocoPhillips that
resulted from the CPChem impairments. In addition, the nine-
month period of 2001 included business interruption insurance
settlements.
57
Emerging Businesses
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Operating Results
Net loss $(262) (2) (270) (9)
Less special items (246) - (246) -
- -----------------------------------------------------------------
Net operating loss $ (16) (2) (24) (9)
=================================================================
Carbon fibers $ (4) - (4) -
Fuels technology (4) (2) (12) (9)
Gas-to-liquids (7) - (7) -
Power (1) - (1) -
- -----------------------------------------------------------------
$ (16) (2) (24) (9)
=================================================================
The Emerging Businesses segment posted net operating losses of
$16 million and $24 million in the third quarter and nine-month
period of 2002, respectively, compared with losses of $2 million
and $9 million in the corresponding 2001 periods.
Prior to September 2002, Emerging Businesses only included
Phillips' fuels technology business. After the ConocoPhillips
merger, Conoco's emerging businesses were added to this segment,
which included carbon fibers, natural-gas-to-liquids technology,
and power generation. The increased number of developing
businesses after the merger accounts for the larger losses in
both 2002 periods.
Special items in the third-quarter and nine-month periods of 2002
represented a $246 million write-off of purchased in-process
research and development activity costs related to Conoco's
natural-gas-to-liquids technology. In accordance with FASB
Interpretation No. 4, "Applicability of FASB Statement No. 2 to
Business Combinations Accounted for by the Purchase Method,"
value assigned to research and development activities in the
purchase price allocation that have no alternative future use
should be charged to expense at the date of the consummation of
the combination. The $246 million charge was the same on both a
before-tax and after-tax basis, as there was no tax basis to the
assigned value prior to its write-off. There were no special
items in the 2001 periods.
57
Corporate and Other
Millions of Dollars
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
------------------ -----------------
Operating Results
Corporate and Other $(405) (88) (667) (326)
Less special items (283) - (307) (8)
- -----------------------------------------------------------------
Adjusted Corporate and
Other $(122) (88) (360) (318)
=================================================================
Adjusted Corporate and Other includes:
Net interest $ (83) (58) (237) (188)
Corporate general and
administrative expenses (32) (22) (106) (77)
Other (7) (8) (17) (53)
- -----------------------------------------------------------------
Adjusted Corporate and
Other $(122) (88) (360) (318)
=================================================================
Net interest represents interest expense, net of interest income
and capitalized interest. Interest expense increased in both
2002 periods due to higher debt levels following the Tosco
acquisition and the merger of Conoco and Phillips.
Corporate general and administrative expenses increased
45 percent in the third quarter of 2002 and 38 percent in the
first nine months, chiefly due to the impact of having one month
of Conoco operations included in this year's results. In
addition, the nine-month period of 2002 also included higher
benefit-related costs, mainly from the accelerated vesting of
awards under certain long-term compensation plans that occurred
at the time of stockholder approval of the merger.
The category "Other" consists primarily of captive insurance
operations, certain foreign currency transaction gains and
losses, income tax and other items that are not directly
associated with the operating segments on a stand-alone basis,
and dividends on the preferred securities of the Phillips 66
Capital Trusts I and II. Results from Other were about the same
in the third quarter of 2002 as in the third quarter of 2001, but
were improved in the 2002 nine-month period. The improvement in
the nine-month period was primarily due to more favorable foreign
currency transaction gains and losses and a favorable mark-to-
market revaluation of certain Tosco long-term incentive units
58
that were converted into Phillips performance units held by
former senior executives of Tosco, none of whom are now employees
of ConocoPhillips. See Note 3--Acquisition of Tosco Corporation
in the Notes to Financial Statements for additional information
on these performance units.
Special items in the third quarter and nine-month period of 2002
primarily included $221 million of merger-related costs and
losses of $62 million from discontinued operations. See the
disclosures under the "Conoco and Phillips Merger" heading on
pages 39 through 41 for detailed information on these items.
Special items in the third quarter of 2001 primarily consisted of
an extraordinary loss on the early retirement of debt, offset by
favorable insurance recoveries. In addition, the nine-month
period of 2001 also included unfavorable claims and settlements,
as well as a loss on property dispositions.
59
CAPITAL RESOURCES AND LIQUIDITY
Financial Indicators
Millions of Dollars
---------------------------------------
At At At
September 30 December 31 September 30
2002 2001 2001
---------------------------------------
Current ratio .8 1.0 .8
Notes payable and
long-term debt due
within one year $ 2,603 44 43
Total debt $20,453 8,689 7,881
Company-obligated
mandatorily redeemable
preferred securities $ 350 650 650
Common stockholders' equity $29,991 14,340 14,422
Percent of total debt to
capital* 40% 37 34
Percent of floating-rate
debt to total debt 33% 20 12
- -----------------------------------------------------------------
*Capital includes total debt, company-obligated mandatorily
redeemable preferred securities and common stockholders' equity.
During the first nine months of 2002, funds of $2,986 million
were provided by operating activities, a decrease of $361 million
from the same period of 2001, chiefly due to a $1,261 million
decrease in income from continuing operations due to lower
upstream commodity prices, lower refining and marketing margins,
and merger-related special item charges. Non-working capital
adjustments increased cash flow by $349 million from the prior
year. Included in the increase in non-working capital
adjustments was a decrease in deferred taxes, offset by an
increase in depreciation, depletion, and amortization, due
primarily from one month's activity of Conoco and the late third-
quarter 2001 acquisition of Tosco; an increase in dry hole and
lease impairments, due principally to the impairment of the
company's investment in the offshore Angola exploratory block 34;
and in-process research and development activity costs. Non-cash
working capital items accounted for a net $571 million increase
to cash flow from the prior period. Contributing to this
increase was a smaller increase in inventories over the prior
year, increased accounts payable, and other accruals offset by a
lower decrease in accounts receivables, compared with the prior
period. Also offsetting the increase above by $166 million were
reduced levels of revolving sales of accounts receivable under
the company's receivables sales program. In addition,
discontinued operations provided a decrease of cash flow between
the two periods.
60
ConocoPhillips' debt-to-capital ratio was 40 percent at
September 30, 2002, up from December 31, 2001, and September 30,
2001, primarily as a result of the merger with Conoco. In
addition to the $11.5 billion of Conoco debt assumed, purchase
accounting required that debt be recorded at fair value at the
time of the merger, increasing total debt by an additional
$546 million.
On May 15, 2002, Phillips redeemed its $250 million 8.86% Notes
due May 15, 2022, at 104.43 percent. On May 31, 2002, Phillips
also redeemed all of its outstanding 8.24% Junior Subordinated
Deferrable Interest Debentures due 2036 held by the Phillips 66
Capital Trust I. This triggered the redemption of $300 million
of 8.24% Trust Originated Preferred Securities at par value,
$25 per share. Both redemptions were funded by the issuance of
commercial paper. Together, these redemptions are estimated to
reduce pretax costs by approximately $30 million per year. Notes
payable and long-term debt due within one year increased
significantly due to the company's redemption of the above debt
and preferred securities, and to the increased issuance of
commercial paper supported by the company's 364-day credit
facility.
On October 9, 2002, ConocoPhillips privately placed $2 billion of
senior unsecured debt securities, consisting of $400 million
3.625% notes due 2007, $1 billion 4.75% notes due 2012, and
$600 million 5.90% notes due 2032, in each case fully and
unconditionally guaranteed by Conoco and Phillips. The
$1,980 million proceeds of the offering were used to reduce
commercial paper, retire Conoco's $500 million floating rate
notes due October 15, 2002, and for general corporate purposes.
On November 1, 2002, ConocoPhillips sent notice to investors of
the company's intent to redeem the $171 million Conoco 7.443%
senior unsecured notes due 2004. A November 26, 2002, redemption
date has been set.
To meet its liquidity requirements, including funding its capital
program, paying dividends and repaying debt, the company looks to
a variety of funding sources, primarily cash generated from
operating activities. Over the next two years, however, the
company anticipates also raising funds from the sale of assets
from its R&M and E&P segments, including those assets required by
the FTC to be sold.
In November 2002, ConocoPhillips closed the sale of its
exploration and production assets in the Netherlands to
Wintershall AG, a unit of BASF AG.
61
While the stability of ConocoPhillips' cash flows from operating
activities benefits from geographic diversity and the effects of
upstream and downstream integration, the company's operating cash
flows remain exposed to the volatility of commodity crude oil and
natural gas prices and downstream margins, as well as to periodic
cash needs to fund tax payments and purchase crude oil, natural
gas and petroleum products. The company's primary swing funding
source for short-term working capital needs is its commercial
paper program supported by revolving bank credit facilities.
At September 30, 2002, ConocoPhillips had four bank credit
facilities in place through its Conoco and Phillips subsidiaries,
totaling $5.5 billion, available for use either as support for
the issuance of commercial paper or as direct bank borrowings.
The Phillips facilities included a $1.5 billion revolving credit
facility expiring in October 2006, and a $1.5 billion 364-day
revolving credit facility that expired on October 15, 2002, and
the Conoco facilities included a $650 million revolving credit
facility expiring in May 2004, and a $1.85 billion 364-day
revolving credit facility, which expires on May 1, 2003. There
were no outstanding borrowings under any of these facilities at
September 30, 2002. ConocoPhillips had $3,331 million of
commercial paper outstanding at September 30, 2002, supported by
the $5.5 billion in credit facilities, compared with
$1,081 million outstanding at December 31, 2001. At
September 30, 2002, ConocoPhillips' Norwegian subsidiary had no
borrowings outstanding under its two $300 million revolving
credit facilities that expire in June 2004. The increase in
commercial paper outstanding was primarily due to the merger with
Conoco, the redemption of the 8.24% preferred securities, early
retirement of the 8.86% notes, oil and gas property acquisitions
in Kazakhstan and the Timor Sea, and the timing of tax payments.
Effective October 15, 2002, ConocoPhillips entered into two new
revolving credit facilities and amended and restated a prior
Phillips revolving credit facility to include ConocoPhillips as a
borrower. These credit facilities support the company's
$4 billion commercial paper program. The company now has a
$2 billion 364-day revolving credit facility expiring on
October 14, 2003, and two revolving credit facilities totaling
$2 billion expiring in October 2006. Effective with the
execution of the new facilities, the previously existing
$2.5 billion in Conoco facilities were terminated.
In addition to the bank credit facilities, ConocoPhillips sells
certain credit card and trade receivables under revolving sales
agreements with six unrelated bank-sponsored entities. These
agreements provide for ConocoPhillips to sell up to $1.6 billion
of senior, undivided interests in pools of the credit card or
trade receivables to the bank-sponsored entities.
62
On October 1, 2002, ConocoPhillips, the seller, and the
sponsoring bank agreed to terminate an agreement that provided
for the sale of up to $100 million of ConocoPhillips trade
receivables.
At September 30, 2002, and December 31, 2001, the company had
sold undivided interests in pools of receivables of $1.2 billion
and $940 million, respectively. ConocoPhillips retains interests
in the pools of receivables, which are subordinate to the
interests sold to the bank-sponsored entities. ConocoPhillips
also retains the servicing responsibility for the sold
receivables. At September 30, 2002, and December 31, 2001,
ConocoPhillips' retained interests amounted to approximately
$1 billion and $450 million, respectively, reported on the
balance sheet in accounts and notes receivable. See Note 19--
Sales of Receivables in the Notes to Financial Statements for
additional information.
The following table summarizes the maturities of the drawn
balances of the company's various debt instruments, as well as
other non-cancelable, fixed or minimum, contractual commitments:
Millions of Dollars
---------------------------------------
Payments Due by Period
---------------------------------------
Debt and other non- Fourth-
cancelable cash Quarter 2003- 2005- After
commitments Total 2002 2004 2006 2006
- ------------------------------------------------------------------
Total debt $20,453 584 3,725 2,770 13,374
Above-market capital lease
obligations 67 - 2 3 62
Mandatorily redeemable
preferred stock 350 - - - 350
Operating leases
Minimum rental payments* 3,767 190 1,156 756 1,665
Sublease offsets (531) (39) (234) (115) (143)
Guaranteed residual
values 1,909 - 459 1,016 434
Unconditional throughput
processing fee and
purchase commitments** 1,733 70 429 311 923
- ------------------------------------------------------------------
*Excludes $383 million in lease commitments that begin upon
delivery of five crude oil tankers currently under construction.
Delivery is expected in the third and fourth quarters of 2003.
**Represents non-market purchase commitments and obligations to
transfer funds in the future for fixed or minimum amounts at
fixed or minimum prices under various throughput or tolling
agreements with pipeline and processing companies in which the
company holds stock interests.
63
In addition to the above contractual commitments, the company has
various guarantees that have the potential for requiring cash
outflows resulting from a contingent event that could require
company performance pursuant to a funding commitment to a third
or related party.
At September 30, 2002, ConocoPhillips had construction completion
guarantees of $474 million related to Phillips' ownership share
of the utilized portion of debt and bond financing arrangements
secured by the Hamaca and Merey Sweeny joint-venture projects in
Venezuela and Texas, respectively. The debt is non-recourse to
ConocoPhillips upon completion/startup certification of the
projects and represents the company's portion due in the event
completion/startup certification is not achieved. The MSLP debt
is joint and several. At September 30, 2002, in addition to the
Hamaca Holding LLC and MSLP debt guarantees, ConocoPhillips had
other guarantees of $512 million related to obligations directly
guaranteed by the company in the event a third party or related
party does not perform.
Financial Instrument Market Risk
ConocoPhillips and certain of its subsidiaries hold and issue
derivative contracts and financial instruments that expose cash
flows or earnings to changes in commodity prices, foreign
exchange rates or interest rates. The company may use financial
and commodity-based derivative contracts to manage the risks
produced by changes in the prices of electric power, natural gas,
crude oil, and related products, and fluctuations in interest
rates and foreign currency exchange rates, or to exploit market
opportunities.
With the completion of the merger of Phillips and Conoco on
August 30, 2002, the derivatives policy adopted during the third
quarter of 2001 is no longer in effect; however, the
ConocoPhillips Board of Directors has approved an "Authority
Limitations" document that prohibits the use of highly leveraged
derivatives, requires all derivative instruments held or issued
to be sufficiently liquid that comparable valuations are
available, and authorizes the Chief Executive Officer to
establish the maximum Value at Risk (VaR) limits for the company.
Compliance with these limits is monitored daily. The function of
the Risk Management Steering Committee was assumed by the Chief
Financial Officer for risks resulting from foreign currency
exchange rates and interest rates, and by the Executive Vice
President of Commercial, a new position that reports to the Chief
Executive Officer, for commodity price risk. ConocoPhillips'
commercial organization manages the commodity flows and
positions, commercial marketing, and related risks of the
company's upstream and downstream businesses.
64
The following quantitative disclosures about foreign currency
exchange rate and interest rate risk pertain only to the
incremental exposures the company assumed from the merger with
Conoco and should be read in conjunction with the Financial
Instrument Market Risk section contained in Item 7a of Phillips'
Form 10-K for the year ended December 31, 2001, as amended. The
VaR calculation discussed in the Commodity Price Risk section
includes all of ConocoPhillips derivative contracts, as defined,
and not just the derivative contracts assumed from the merger.
Interest Rate Risk
The following tables provide information about the financial
instruments acquired in the merger that are sensitive to changes
in interest rates. These tables present principal cash flows and
related weighted-average interest rates by expected maturity
dates. Weighted-average variable rates are based on implied
forward rates in the yield curve at the reporting date. The fair
value of the fixed-rate financial instruments is estimated based
on quoted market prices.
Millions of Dollars Except as Indicated
---------------------------------------
Debt at September 30, 2002
---------------------------------------
Fixed Average Floating Average
Rate Interest Rate Interest
Expected Maturity Date Maturity Rate Maturity Rate
- ---------------------- -------- -------- -------- --------
Fourth-quarter 2002 $ 1 7.68% $ 500 2.63%
2003 5 7.68 1,649 2.47
2004 1,526 6.08 654 3.45
2005 13 8.07 4 5.26
2006 1,260 5.47 5 5.86
2007 6 7.68 5 6.39
Remaining years 4,962 6.68 244 6.39
- -----------------------------------------------------------------
Total $7,773 $3,061
=================================================================
Fair value $8,579 $3,061
=================================================================
65
Interest Rate Derivatives
at September 30, 2002*
----------------------------
Variable-to-Fixed
----------------------------
Average Average
Pay Receive
Expected Maturity Date Notional Rate Rate
- ---------------------- -------- ------- -------
Fourth-Quarter 2002 $109 2.60% 1.66%
2003 500 3.41 2.43
2004 - - -
2005 - - -
2006 169 5.85 4.61
2007 - - -
Remaining years - - -
- -----------------------------------------------------------------
Total $778
=================================================================
Fair value $ 23
=================================================================
*Does not include derivatives that terminated in October 2002,
either through maturity or liquidation.
Foreign Currency Risk
After merging with Conoco, the company has foreign currency
exchange rate risk resulting from operations in over 40 countries
around the world. ConocoPhillips does not comprehensively hedge
the exposure to currency rate changes, although the company may
choose to selectively hedge exposures to foreign currency rate
risk. Examples include firm commitments for capital projects,
certain local currency tax payments and dividends, and cash
returns from net investments in foreign affiliates to be remitted
within the coming year.
At September 30, 2002, ConocoPhillips had the following
significant foreign currency derivative contracts:
o Foreign currency swaps for 53 million euros, associated with
the company's European commercial paper program, with a fair
value of $238 thousand;
o Collars (i.e., a purchased call and a written put) on
200 million euros, associated with an inter-company loan
denominated in euros, with a negative fair value of
$866 thousand; and
o Approximately $22 million in foreign currency swaps,
associated with firm purchase and sales commitments for
gasoline in Germany, with a negative fair value of
$1.9 million.
66
Assuming an adverse hypothetical 10 percent change in the
September 30, 2002 exchange rates, the potential foreign currency
remeasurement loss in non-cash pretax earning from these
contracts would be approximately $15 million. This does not
include forward exchange contracts related to a U.K. construction
contract, with an aggregate fair value of $5.3 million on
September 30, 2002, that were liquidated in October.
Commodity Price Risk
ConocoPhillips uses energy-related futures, forwards, swaps and
options in various markets:
o To balance physical systems--In addition to being able to
settle exchange traded futures contracts in cash prior to
contract expiry, they also can be settled by physical
delivery of the commodity. These barrels can provide
another source of supply to meet the company's refinery
requirements or marketing demand;
o To meet customer needs--Consistent with ConocoPhillips'
policy to generally remain exposed to market prices, the
company uses swap contracts to convert fixed price sales
contracts (often requested by natural gas and refined
product consumers) to a floating market-basis; and
o To manage the company's price exposure on anticipated crude
oil, natural gas, refined product and electric power
transactions.
ConocoPhillips' policy is generally to be exposed to market
pricing for commodity purchases and sales. From time to time,
management may use derivatives to establish longer-term positions
to change the price risk of the company's equity crude oil and
natural gas production, as well as refinery margins.
ConocoPhillips does a limited amount of trading unrelated to the
company's underlying physical business. For the nine-month
periods ended September 30, 2002, and 2001, the net recognized
gains and losses from this activity were not material to the
company's cash flows or operating income.
ConocoPhillips used a VaR model to estimate the loss that could
potentially result on a single day from the effect of adverse
changes in market conditions on the derivative financial
instruments and derivative commodity instruments held or issued,
including commodity purchase and sales contracts recorded on the
balance sheet at September 30, 2002, as derivative instruments in
accordance with Financial Accounting Standards Board Statement
67
No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended. Using a 95 percent confidence level,
the VaR analysis indicated the hypothetical loss would not be
material to ConocoPhillips' consolidated financial position,
operating income, or cash flows.
For additional information about the company's use of derivative
instruments, see Note 6--Derivative Instruments in the Notes to
Financial Statements.
Capital Expenditures and Investments
Millions of Dollars
-------------------
Nine Months Ended
September 30
-------------------
2002 2001
-------------------
E&P
United States-Alaska $ 532 688
United States-Lower 48 234 295
International 1,167 840
- -----------------------------------------------------------------
1,933 1,823
- -----------------------------------------------------------------
Midstream 2 -
- -----------------------------------------------------------------
R&M
United States 421 215
International 38 (1)
- -----------------------------------------------------------------
459 214
- -----------------------------------------------------------------
Chemicals 29 6
Emerging Businesses 35 -
Corporate and Other 55 46
- -----------------------------------------------------------------
$2,513 2,089
=================================================================
United States $1,283 1,250
International 1,230 839
- -----------------------------------------------------------------
$2,513 2,089
=================================================================
On May 30, 2002, the Polar Resolution, the second of five double-
hulled Endeavour Class tankers which ConocoPhillips is having
built for use in transporting Alaskan crude oil to the U.S. West
Coast, completed sea trials and entered service. The third
tanker, the Polar Discovery, was christened on April 13, 2002,
and is expected to enter service in 2003. ConocoPhillips expects
to add a new Endeavour Class tanker to its fleet each year
through 2005.
On June 28, 2002, ConocoPhillips and its co-venturers, in
conjunction with the government of the Republic of Kazakhstan,
declared the Kashagan field on the Kazakhstan shelf in the north
68
Caspian Sea to be commercial. This declaration of commerciality
enabled preparation of a development plan for the Kashagan field.
Drilling and testing of appraisal wells by ConocoPhillips and its
co-venturers continued during the first nine months of 2002. On
October 10, 2002, ConocoPhillips and its co-venturers announced a
new hydrocarbon discovery in the Kazakhstan sector of the Caspian
Sea. An initial test well, the Kalamkas-1, flowed oil. This
well is located adjacent to Kashagan field.
In early September 2002, ConocoPhillips began production from the
Hawksley field in the southern sector of the U.K. North Sea. The
Hawksley discovery well, 44/17a-6y, was completed in July 2002 in
one of five natural gas reservoirs currently being developed by
ConocoPhillips as a single, unitized project. ConocoPhillips is
the operator and holds a 59.5 percent interest.
In the first half of 2002, Phillips continued pursuing the goal
of increasing its presence in high-potential deepwater areas. On
June 14, 2002, Phillips signed the Nigeria block 318 production
sharing contract with the Nigerian Petroleum Development Company,
the exploration and production unit of the state-run Nigerian
National Petroleum Corporation. ConocoPhillips is operator of
the deepwater block with a 50 percent interest. Phillips was
also the high bidder in the central Gulf of Mexico sale for the
Lorien prospect located in Green Canyon block 199 and was
officially awarded the block during the second quarter of 2002.
In early May 2002, initial results showed that the first
exploratory well drilled in block 34, offshore Angola, was a dry
hole. In view of this information, Phillips re-assessed the fair
value of the remainder of the block and determined that its
investment in the block was impaired by $77 million, both before-
and after-tax. Further technical analysis of the results of this
first well continues. The second of three commitment wells in
this block is scheduled for drilling in 2003.
Development activity associated with the Bayu-Undan gas recycle
project continued in the third quarter of 2002. In the Timor
Sea, this involved the drilling of future production wells and
the installation of facilities. Fabrication and assembly of
platform decks continues in Korea. The project is approximately
65 percent complete and full commercial production is expected to
occur as planned in the first quarter of 2004.
Activity associated with the Bayu-Undan pipeline and liquefied
natural gas plant currently is focused on preparation of approval
documentation and project design. Construction is expected to
start in early 2003, following the Timor Sea Treaty ratification.
69
On July 1, 2002, Phillips purchased 50 percent, or $125 million,
of Preferred LLC Interests securities issued by CPChem, the
company's 50 percent-owned joint venture which comprises
ConocoPhillips' chemicals segment.
Contingencies
Legal and Tax Matters
ConocoPhillips accrues for contingencies when a loss is probable
and the amounts can be reasonably estimated. Based on currently
available information, the company believes that it is remote
that future costs related to known contingent liability exposures
will exceed current accruals by an amount that would have a
material adverse impact on the company's financial statements.
On June 23, 1999, a flash fire occurred in a reactor vessel at
Phillips' K-Resin styrene-butadiene copolymer (SBC) plant at the
Houston Chemical Complex. Two individuals employed by a
subcontractor, Zachry Construction Corporation (Zachry), were
killed and other workers were injured. Ten lawsuits were filed
in Texas in connection with the incident, including two actions
for wrongful death. All significant litigation arising from this
incident has now been resolved.
On March 27, 2000, an explosion and fire occurred at the K-Resin
SBC plant due to the overpressurization of an out-of-service
butadiene storage tank. One employee was killed and several
individuals, including employees of both Phillips and its
contractors, were injured. Additionally, individuals who were
allegedly in the area of the Houston Chemical Complex at the time
of the incident have claimed they suffered various personal
injuries due to exposure to the event. The wrongful death claim
and the claims of the most seriously injured workers have been
resolved. Currently, there are 11 lawsuits pending on behalf of
121 primary plaintiffs. Under the indemnification provisions of
subcontracting agreements with Zachry and Brock Maintenance,
Inc., Phillips sought indemnification from these subcontractors
with respect to claims made by their employees. Although that
plant was contributed to CPChem under the Contribution Agreement,
ConocoPhillips retains liability for damages arising out of the
incident.
70
Environmental
ConocoPhillips and each of its various businesses are subject to
the same numerous international, federal, state, and local
environmental laws and regulations as are other companies in the
petroleum exploration and production; and refining, marketing and
transportation of crude oil and refined products businesses. The
most significant of these environmental laws and regulations
include, among others, the:
o Federal Clean Air Act, which governs air emissions;
o Federal Clean Water Act, which governs discharges to water
bodies;
o Federal Comprehensive Environmental Response, Compensation
and Liability Act (CERCLA), which imposes liability on
generators, transporters, and arrangers of hazardous
substances at sites where hazardous substance releases have
occurred or are threatened to occur;
o Federal Resource Conservation and Recovery Act (RCRA), which
governs the treatment, storage, and disposal of solid waste;
o Federal Oil Pollution Act of 1990 (OPA90) under which owners
and operators of onshore facilities and pipelines, lessees
or permittees of an area in which an offshore facility is
located, and owners and operators of vessels are liable for
removal costs and damages that result from a discharge of
oil into navigable waters of the United States;
o Federal Emergency Planning and Community Right-to-Know Act
(EPCRA) which requires facilities to report toxic chemical
inventories with local emergency planning committees and
responses departments;
o Federal Safe Drinking Water Act which governs the disposal
of wastewater in underground injections wells; and
o U.S. Department of the Interior regulations, which relate to
offshore oil and gas operations in U.S. waters and impose
liability for the cost of pollution cleanup resulting from
the lessee's operations and potential liability for
pollution damages.
These laws and their implementing regulations set limits on
emissions and, in the case of discharges to water, establish
water quality limits. They also, in most cases, require permits
in association with new or modified operations. These permits
can require an applicant to collect substantial information in
connection with the application process, which can be expensive
71
and time-consuming. In addition, there can be delays associated
with notice and comment periods and the agency's processing of
the application. Many of the delays associated with the
permitting process are beyond the control of the applicant.
Many states and foreign countries where ConocoPhillips operates
also have, or are developing, similar environmental laws and
regulations governing the same types of activities. While
similar, in some cases these regulations may impose additional,
or more stringent, requirements that can add to the cost and
difficulty of marketing or transporting products across state and
international borders.
The ultimate financial impact arising from environmental laws and
regulations is neither clearly known nor easily determinable as
new standards, such as air emission standards, water quality
standards and stricter fuel regulations, continue to evolve.
However, environmental laws and regulations are expected to
continue to have an increasing impact on ConocoPhillips'
operations in the United States and in most of the countries in
which the company operates. Notable areas of potential impacts
include air emission compliance and remediation obligations in
the United States. Under the Clean Air Act, the EPA has
promulgated a number of stringent limits on air emissions and
established a federally mandated operating permit program.
Violations of the Clean Air Act are enforceable with civil and
criminal sanctions.
The EPA has also promulgated specific rules governing the sulfur
content of gasoline, known generically as the "Tier II Sulfur
Rules," which become applicable to ConocoPhillips' gasoline as
early as 2004. The company is implementing a compliance strategy
for meeting the requirements, including the use of
ConocoPhillips' proprietary technology known as S Zorb. The
company expects to use a combination of technologies to achieve
compliance with these rules and has made preliminary estimates of
its cost of compliance. These costs will be included in future
budgeting for refinery compliance. The EPA has also promulgated
sulfur content rules for highway diesel fuel that become
applicable in 2006. ConocoPhillips is currently developing and
testing an S Zorb system for removing sulfur from diesel fuel.
It is anticipated that S Zorb will be used as part of
ConocoPhillips' strategy for complying with these rules. Because
the company is still evaluating and developing capital strategies
for compliance with the rule, ConocoPhillips cannot provide
precise cost estimates at this time, but will do so and report
these compliance costs as required by law.
72
Additional areas of potential air-related impacts to
ConocoPhillips are the proposed revisions to the National Ambient
Air Quality Standards (NAAQS) and the Kyoto Protocol. In July
1997, the EPA promulgated more stringent revisions to the NAAQS
for ozone and particulate matter. Since that time, final
adoption of these revisions has been the subject of litigation
(American Trucking Association, Inc. et al. v. United States
Environmental Protection Agency) that eventually reached the
U.S. Supreme Court during fall 2000. In February 2001, the
U.S. Supreme Court remanded this matter, in part, to the EPA to
address the implementation provisions relating to the revised
ozone NAAQS. If adopted, the revised NAAQS could result in
substantial future environmental expenditures for ConocoPhillips.
In 1997, an international conference on global warming concluded
an agreement, known as the Kyoto Protocol, which called for
reductions of certain emissions that contribute to increases in
atmospheric greenhouse gas concentrations. The United States has
not ratified the treaty codifying the Kyoto Protocol but may in
the future. In addition, other countries where ConocoPhillips
has interests, or may have interests in the future, have made
commitments to the Kyoto Protocol and are in various stages of
formulating applicable regulations. It is not, however, possible
to accurately estimate the costs that could be incurred by
ConocoPhillips to comply with such regulations, but such
expenditures could be substantial.
ConocoPhillips also is subject to certain laws and regulations
relating to environmental remediation obligations associated with
current and past operations. Such laws and regulations include
CERCLA and RCRA and their state equivalents. Remediation
obligations include cleanup responsibility arising from petroleum
releases from underground storage tanks located at numerous past
and present ConocoPhillips owned and/or operated petroleum-
marketing outlets throughout the United States. Federal and
state laws require that contamination caused by such underground
storage tank releases be assessed and remediated to meet
applicable standards. In addition to other cleanup standards,
many states have adopted cleanup criteria for methyl tertiary
butyl ether (MTBE) for both soil and groundwater. MTBE standards
continue to evolve, and future environmental expenditures
associated with the remediation of MTBE-contaminated underground
storage tank sites could be substantial.
RCRA requires permitted facilities to undertake an assessment of
environmental conditions at the facility. If conditions warrant,
ConocoPhillips may be required to remediate contamination caused
by prior operations. In contrast to CERCLA, which is often
referred to as "Superfund," the cost of corrective action
73
activities under RCRA corrective action program typically is
borne solely by ConocoPhillips. Over the next decade,
ConocoPhillips anticipates that significant ongoing expenditures
for RCRA remediation activities may be required, but such annual
expenditures for the near term are not expected to vary
significantly from the range of such expenditures Conoco and
Phillips have experienced over the past few years. Longer term,
expenditures are subject to considerable uncertainty and may
fluctuate significantly.
ConocoPhillips from time to time receives requests for
information or notices of potential liability from the EPA and
state environmental agencies alleging that we are a potentially
responsible party under CERCLA or an equivalent state statute.
On occasion, ConocoPhillips also has been made a party to cost
recovery litigation by those agencies or by private parties.
These requests, notices and lawsuits assert potential liability
for remediation costs at various sites that typically are not
owned by ConocoPhillips but allegedly contain wastes attributable
to the company's past operations. As of December 31, 2001,
Phillips reported it had been notified of potential liability
under CERCLA at 29 sites around the United States. Phillips also
had been notified of potential liability under comparable state
laws at about 11 sites around the United States. At August 30,
2002, the date of the merger between Conoco and Phillips, Conoco
had been notified of potential liability under CERCLA and
comparable state laws on 24 sites around the United States. At
seven of these sites both Conoco and Phillips have been notified
of potential liability. The resulting total for both Conoco and
Phillips was 57 sites. At September 30, 2002, ConocoPhillips had
resolved two of these sites and received no new notices of
potential liability leaving approximately 55 sites where
ConocoPhillips has been notified of potential liability.
For most Superfund sites, ConocoPhillips' potential liability
will be significantly less than the total site remediation costs
because the percentage of waste attributable to ConocoPhillips
versus that attributable to all other potentially responsible
parties is relatively low. Although liability of those
potentially responsible is generally joint and several for
federal sites and frequently so for state sites, other
potentially responsible parties at sites where ConocoPhillips is
a party typically have had the financial strength to meet their
obligations, and where they have not, or where potentially
responsible parties could not be located, ConocoPhillips' share
of liability has not increased materially. Many of the sites at
which the company is potentially responsible are still under
investigation by the EPA or the state agencies concerned. Prior
to actual cleanup, those potentially responsible normally assess
74
site conditions, apportion responsibility and determine the
appropriate remediation. In some instances, ConocoPhillips may
have no liability or attain a settlement of liability. Actual
cleanup costs generally occur after the parties obtain EPA or
equivalent state agency approval. There are relatively few sites
where ConocoPhillips is a major participant, and neither the cost
to ConocoPhillips of remediation at those sites nor such cost at
all CERCLA sites in the aggregate is expected to have a material
adverse effect on the competitive or financial condition of
ConocoPhillips.
Remediation Accruals
ConocoPhillips accrues for remediation activities when it is
probable that a liability has been incurred and reasonable
estimates of the liability can be made. These accrued
liabilities are not reduced for potential recoveries from
insurers or other third parties and are not discounted (except,
if assumed in a purchase business combination, such costs are
recorded on a discounted basis). Many of these liabilities
result from CERCLA, RCRA and similar state laws that require the
company to undertake certain investigative and remedial
activities at sites where it conducts, or once conducted,
operations or at sites where ConocoPhillips-generated waste was
disposed. The accrual also includes a number of sites identified
by ConocoPhillips that may require environmental remediation, but
which are not currently the subject of CERCLA, RCRA or state
enforcement activities. If applicable, undiscounted receivables
are accrued for probable insurance or other third-party
recoveries. In the future, ConocoPhillips may incur significant
costs under both CERCLA and RCRA. Considerable uncertainty
exists with respect to these costs, and under adverse changes in
circumstances, potential liability may exceed amounts accrued as
of September 30, 2002.
Remediation activities vary substantially in duration and cost
from site to site, depending on the mix of unique site
characteristics, evolving remediation technologies, diverse
regulatory agencies and enforcement policies, and the presence or
absence of potentially liable third parties. Therefore, it is
difficult to develop reasonable estimates of future site
remediation costs.
At September 30, 2002, ConocoPhillips' balance sheet included a
total environmental accrual of $826 million, compared with
$539 million at December 31, 2001, an increase of $287 million,
primarily resulting from the merger with Conoco. The majority of
these expenditures are expected to be incurred within the next
30 years.
75
Notwithstanding any of the foregoing and as with other companies
engaged in similar businesses, environmental costs and
liabilities are inherent in ConocoPhillips' operations and
products, and there can be no assurance that material costs and
liabilities will not be incurred. However, ConocoPhillips
currently does not expect any material adverse affect upon its
results of operations or financial position as a result of
compliance with environmental laws and regulations.
OUTLOOK
As part of the ConocoPhillips merger, the FTC required that both
Conoco and Phillips divest certain assets, including the Phillips
Woods Cross refinery in Salt Lake City, Utah, plus associated
assets; Conoco's Commerce City, Colorado refinery and related
crude oil pipelines; Phillips' Colorado motor fuel marketing
operations; Phillips' refined products terminal in Spokane,
Washington; Phillips' propane terminal assets at Jefferson City,
Missouri, and at East St. Louis, Illinois; certain of Conoco's
midstream natural gas gathering and processing assets in
southeast New Mexico; and certain of Conoco's Midstream natural
gas gathering assets in West Texas. To date, none of these
assets have been sold; however, a potential buyer has been
identified for Phillips' propane terminal assets at Jefferson
City, Missouri, and East St. Louis, Illinois. The FTC has
approved this sale and the transaction is scheduled to close in
the fourth quarter of 2002.
Beginning January 1, 2003, ConocoPhillips plans to expense stock
options under the guidelines of FASB Statement No. 123,
"Accounting for Stock-Based Compensation." ConocoPhillips
currently follows Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," with related
interpretations, in accounting for its employee stock options.
If ConocoPhillips had expensed stock options under Statement
No. 123 in 2001, the pro forma after-tax expense associated with
stock grants made in that year would have been approximately
$52 million, or $.08 diluted earning per share. This pro forma
result is based on the assumption that Statement No. 123 was
adopted at the beginning of 2001, that vesting periods and grant
dates were conformed, and that there were 684 million diluted
shares.
Effective January 1, 2002, the Norwegian authorities implemented
a production curtailment on the Norwegian Continental shelf to
support the efforts of OPEC to stabilize crude prices.
ConocoPhillips incurred only minimal impacts to its Norway
production volumes during the first nine months of 2002 as a
76
result of these curtailments--less than 1 percent, compared with
budgeted volumes. The voluntary curtailments were lifted
effective July 1, 2002, and no significant changes are expected
during the remainder of the year. In Nigeria, curtailment of oil
production from the company's joint-venture operations is
expected for the remainder of 2002, in support of OPEC
curtailment recommendations.
The Trans-Alaska Pipeline System (TAPS), an 800-mile pipeline
system that ties the North Slope of Alaska to the port of Valdez
in south-central Alaska, was shut down in early November
following a major earthquake in Alaska. No oil leaks, spills or
pipeline ruptures were located. Damage was sustained on the
structures that support the pipeline. North Slope producers
reduced crude oil production to 3 percent of normal volumes
during the shutdown, and this limited production was taken into
storage facilities on the North Slope. TAPS remained shutdown
for approximately 3 days, and was then restarted after all
necessary inspections and temporary repairs were made and the
pipeline was leak tested. Crude oil inventory levels at Valdez
were low when the earthquake occurred so there was not enough
inventory at Valdez to maintain regularly scheduled marine vessel
loadings. ConocoPhillips estimates that its fourth-quarter 2002
Alaskan production will be reduced by approximately
10,000 barrels per day as a result of the pipeline shut down.
The company now expects its worldwide fourth-quarter 2002
production to be about 1.62 million barrels-of-oil-equivalent per
day including the impact of the recent earthquake in Alaska and
slight delays in obtaining full production in the United Kingdom.
For the full year 2002, with continued curtailments, production
of approximately 1.1 million barrels-of-oil-equivalent per day is
anticipated.
Crude oil and natural gas prices are subject to external factors
over which the company has no control, such as global economic
conditions, political events, demand growth, inventory levels,
weather, competing fuels prices and availability of supply.
Crude oil prices continued to improve during the third quarter
due to oil inventory reductions resulting from the seasonal
increase in demand in the face of production restraint by major
exporting countries, supply concerns resulting from Middle East
tensions, and tropical storms in the U.S. Gulf of Mexico
temporarily shutting in oil production and shipping. Global oil
demand is starting to recover on a year-over-year basis, compared
with the declines that resulted from the U.S. recession and the
events of September 11, 2001. However, the pace of improvement
will depend on a continuation of the economic recovery in the
United States and globally. U.S. natural gas prices declined
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slightly in the third quarter, versus the second quarter, due to
concerns in the market that the U.S. economic recovery would not
occur and constrain natural gas demand growth. However, natural
gas prices strengthened considerably at the end of the third
quarter due to supply concerns exacerbated by tropical storms
temporarily shutting in production in the Gulf of Mexico, and
rising oil prices.
Refining margins are subject to movements in the price of crude
oil and other feedstocks, and the prices of petroleum products,
which are subject to market factors over which the company has no
control, such as the U.S. and global economies; government
regulations; seasonal factors that affect demand, such as the
summer driving months; and the levels of refining output and
product inventories. Global refining margins remained depressed
during the third quarter of 2002 due to weak oil demand,
relatively high levels of gasoline and distillate inventories and
strengthening crude prices, which increase feedstock costs. As a
result of tropical storms in the Gulf of Mexico, industry
refining crude oil runs were reduced which caused product
inventory draws in the United States and improved refining
margins modestly at the end of the third quarter. Marketing
margins in the third quarter weakened from the second quarter due
to surplus product. Refining and marketing margins can be
expected to improve when the U.S. and global economies recover.
78
CAUTIONARY STATEMENT FOR THE PURPOSES OF THE "SAFE HARBOR"
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995
This report includes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. You can
identify our forward-looking statements by the words "expects,"
"anticipates," "intends," "plans," "projects," "believes,"
"estimates" and similar expressions.
We have based the forward-looking statements relating to
ConocoPhillips' operations on its current expectations, estimates
and projections about ConocoPhillips and the industries in which
it operates in general. We caution you that these statements are
not guarantees of future performance and involve risks,
uncertainties and assumptions that we cannot predict. In
addition, we have based many of these forward-looking statements
on assumptions about future events that may prove to be
inaccurate. Accordingly, ConocoPhillips' actual outcomes and
results may differ materially from what we have expressed or
forecast in the forward-looking statements. Any differences
could result from a variety of factors, including the following:
o fluctuations in crude oil, natural gas and natural gas
liquids prices, refining and marketing margins and margins
for ConocoPhillips' chemicals business;
o changes in the business, operations, results and prospects
of ConocoPhillips;
o the operation and financing of ConocoPhillips' mid-stream
and chemicals joint ventures;
o potential failure to realize fully or within the expected
time frame the expected cost savings and synergies from the
combination of Conoco and Phillips;
o costs or difficulties related to the integration of the
businesses of Conoco and Phillips, as well as the continued
integration of businesses recently acquired by each of them;
o potential failure or delays in achieving expected reserve or
production levels from existing and future oil and gas
development projects due to operating hazards, drilling
risks and the inherent uncertainties in predicting oil and
gas reserves and oil and gas reservoir performance;
79
o unsuccessful exploratory drilling activities;
o failure of new products and services to achieve market
acceptance;
o unexpected cost increases or technical difficulties in
constructing or modifying facilities for exploration and
production projects, manufacturing or refining;
o unexpected difficulties in manufacturing or refining
ConocoPhillips' refined products, including synthetic crude
oil, and chemicals products;
o lack of, or disruptions in, adequate and reliable
transportation for ConocoPhillips' crude oil, natural gas
and refined products;
o inability to timely obtain or maintain permits, comply with
government regulations or make capital expenditures required
to maintain compliance;
o potential disruption or interruption of ConocoPhillips'
facilities due to accidents, political events or terrorism;
o international monetary conditions and exchange controls;
o liability for remedial actions, including removal and
reclamation obligations, under environmental regulations;
o liability resulting from litigation;
o general domestic and international economic and political
conditions, including armed hostilities and governmental
disputes over territorial boundaries;
o changes in tax and other laws or regulations applicable to
ConocoPhillips' business; and
o inability to obtain economical financing for exploration and
development projects, construction or modification of
facilities and general corporate purposes.
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CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report,
ConocoPhillips carried out an evaluation, under the supervision,
and with the participation of, the company's Management,
including the company's President and Chief Executive Officer,
and its Executive Vice President Finance and Chief Financial
Officer, of the effectiveness of ConocoPhillips' disclosure
controls and procedures pursuant to Rule 13a-14 under the
Securities Exchange Act of 1934, as amended. Based upon that
evaluation, the company's President and Chief Executive Officer
and its Executive Vice President Finance and Chief Financial
Officer concluded that ConocoPhillips' disclosure controls and
procedures are effective, in all material respects, with respect
to the recording, processing, summarizing and reporting, within
the time periods specified in the Securities and Exchange
Commission's rules and forms, of information required to be
disclosed by the issuer in the reports that it files or submits
under the Exchange Act.
There were no significant changes in ConocoPhillips' internal
controls or in other factors that could significantly affect
internal controls subsequent to the date of the evaluation
referred to above.
81
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The following is a description of legal proceedings involving
governmental authorities under federal, state and local laws
regulating the discharge of materials into the environment during
this reporting period. The following proceedings include those
matters previously reported in Conoco's and Phillips' respective
2001 Forms 10-K, and first- and second- quarter 2002 Forms 10-Q
that have not yet been resolved. While it is not possible to
predict the outcome of such proceedings, if it were decided
adversely to ConocoPhillips, there would be no material effect on
the company's consolidated financial position. Nevertheless,
such proceedings are reported pursuant to the United States
Securities and Exchange Commission's regulations.
On September 27, 2002, the Montana Department of Environmental
Quality (MDEQ) issued a Notice of Violation (NOV) to
ConocoPhillips. The NOV alleges that on December 13, 2000,
Conoco discharged 52,374 gallons of gasoline from Tank 32 at
Conoco's Helena, Montana, product storage terminal. The NOV
seeks a penalty in the amount of $114,000.
On September 26, 2002, the United States Environmental Protection
Agency (EPA) Region 5 filed an Administrative Complaint against
Phillips Pipe Line Company styled: In The Matter Of: Phillips
Pipe Line Company East St Louis Terminal, Cahokia, Illinois-
Proceeding to Assess a Civil Penalty under Section 113(d) of the
Clean Air Act, 42 U.S.C. Section 7413(d). The complaint alleges
federal clean air act compliance violations associated with a
product tank roof seal during the period December 15, 1997
through October 1, 2001. The Complaint seeks a penalty in the
amount of $140,570.
On July 15, 2002 the United States filed a Comprehensive
Environmental Response, Compensation and Liability Act (CERCLA)
cost recovery action against Conoco and others styled: United
States v. City and County of Denver, et al.; U.S. District Court
for the District of Colorado. The lawsuit alleges that the
United States has incurred unreiumbursed oversight costs at the
Lowry Superfund Site located in Arapahoe County, Colorado. The
United States seeks recovery of approximately $12.3 million in
past oversight costs and a declaratory judgment for future CERCLA
response cost liability. Pursuant to the terms of a prior
settlement agreement between Conoco, Waste Management and others,
Waste Management has assumed Conoco's defense for this matter and
it is Conoco's position that Waste Management should indemnify it
for any liability arising from this action.
82
On June 28, 2002, Tosco Corporation, a wholly owned subsidiary of
the company, received an administrative civil complaint from the
EPA, alleging violation of Emergency Planning and Community Right
to Know Act found during an audit of the Los Angeles refinery in
March 2000. The complaint seeks a $528,000 penalty.
Approximately $176,000 of the proposed penalty is, in Tosco's
opinion, attributable to operations of the refinery when it was
owned by Unocal, and Unocal has been notified that Tosco would
seek reimbursement of such amount under the indemnity provisions
in the refinery sale agreement.
On June 24, 2002, Phillips Petroleum Company received a Proposed
Agreed Order from the Texas Natural Resource Conservation
Commission (TNRCC) proposing a penalty of $400,402 in connection
with alleged air emission violations at the company's Borger,
Texas, refinery as a result of an inspection conducted by the
TNRCC in October 2000.
Conoco conducted negotiations with the EPA and the states of
Colorado, Louisiana, Montana, and Oklahoma throughout 2001 as
part of EPA's nationwide initiative to enforce federal air
regulations at petroleum refineries. In December 2001, Conoco
entered into a Consent Decree with the United States, Colorado,
Louisiana, Montana, and Oklahoma to reduce emissions from
Conoco's Billings, Denver, Lake Charles and Ponca City refineries
by a total of 7,500 tons per year over the subsequent seven
years. Conoco expects to spend an estimated $95 million to
$110 million over that time period to install control technology
and equipment to reduce emissions from stacks, vents, valves,
heaters, boilers and flares. The Consent Decree required and
Conoco has paid a civil penalty of $1.5 million, in addition to
requiring $5.1 million to be spent on supplemental environmental
projects in Colorado, Louisiana, Montana and Oklahoma. This
Consent Decree also resolves certain refinery air compliance
issues previously self-disclosed to the state environmental
agencies for Colorado, Montana and Oklahoma. Other self-
disclosed air compliance issues that were outside the scope of
the Consent Decree have been or will be resolved by consent
orders entered directly with the appropriate state agency.
During August 2001, the EPA and the U.S. Department of Justice
(DOJ) notified Conoco of their intent to seek sanctions for
alleged violations of the Clean Air Act arising from a 1998
Maximum Achievable Control Technology (MACT) compliance test of a
flare at Conoco's Denver refinery. The EPA and DOJ seek a cash
penalty of $38,775 and the performance of a Supplemental
Environmental Project valued at $130,000.
83
In June of 1997, Conoco experienced pipeline spills on its Seminoe
pipeline at Banner, Wyoming, and Lodge Grass, Montana. In response
to these spills, the DOJ advised Conoco in August 2000 that the
United States is contemplating a legal proceeding under the Clean
Water Act against Conoco. Conoco and DOJ are currently in
negotiations to resolve these matters.
Additionally, we are subject to various lawsuits and claims
including, but not limited to: actions challenging oil and gas
royalty and severance tax payments; actions related to gas
measurement and valuation methods; actions related to joint
interest billings to operating agreement partners; claims for
damages resulting from leaking underground storage tanks; and
toxic tort claims. As a result of Conoco's separation agreement
with DuPont, we also have assumed responsibility for current and
future claims related to certain discontinued chemicals and
agricultural chemicals businesses operated by Conoco in the past.
In general, the effect on future financial results is not subject
to reasonable estimation because considerable uncertainty exists.
The ultimate liabilities resulting from such lawsuits and claims
may be material to results of operations in the period in which
they are recognized.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
- --------
3.1 Restated Certificate of Incorporation of ConocoPhillips
(incorporated by reference to Exhibit 3.1 to the Current
Report of ConocoPhillips on Form 8-K filed with the SEC on
August 30, 2002, SEC File No. 000-49987).
3.2 By-laws of ConocoPhillips (incorporated by reference to
Exhibit 3.3 to the Current Report of ConocoPhillips on
Form 8-K filed with the SEC on August 30, 2002, SEC File
No. 000-49987).
10.1 Letter Agreement between Conoco Inc. and Robert E.
McKee III.
10.2 Letter Agreement between Conoco Inc. and Jim W. Nokes.
12 Computation of Ratio of Earnings to Fixed Charges.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
84
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
ConocoPhillips and its subsidiaries are parties to several long-
term debt instruments not registered pursuant to the Securities
Exchange Act of 1934. No instrument with respect to such debt is
being filed since the total amount of the securities authorized
under any such instrument did not exceed 10 percent of the total
assets of the company on a consolidated basis. The company
hereby agrees to furnish to the U.S. Securities and Exchange
Commission upon its request a copy of such instrument defining
the rights of the holders of such debt.
Reports on Form 8-K
- -------------------
During the three months ended September 30, 2002, Phillips filed
two reports on Form 8-K and ConocoPhillips filed one report on
Form 8-K.
The first report filed by Phillips was on August 13, 2002, to
report in Item 9 the filing of sworn statements with the U.S.
Securities and Exchange Commission by Phillips' chief executive
and chief financial officers with copies of each sworn statement
furnished as Exhibits 99.1 and 99.2.
The second report filed by Phillips was on August 30, 2002, to
report in Item 5 the business combination of Phillips and Conoco
with and into separate acquisition subsidiaries of ConocoPhillips
and included Phillips' press release as Exhibit 99.1.
The third report, filed by ConocoPhillips, was on August 30,
2002, to report the acquisition of Conoco by Phillips in Item 2
and the expected filing date of the Conoco financial statements
and the pro forma financial information related to the
acquisition in Item 7.
85
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
ConocoPhillips
/s/ Rand C. Berney
-----------------------------
Rand C. Berney
Vice President and Controller
(Chief Accounting and Duly
Authorized Officer)
November 13, 2002
86
CERTIFICATIONS
I, J.J. Mulva, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
ConocoPhillips;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-
14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
87
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 13, 2002
/s/ J. J. Mulva
-------------------------------------
J. J. Mulva
President and Chief Executive Officer
88
I, John A. Carrig, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
ConocoPhillips;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not
misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-
14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
89
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 13, 2002
/s/ John A. Carrig
--------------------------------
John A. Carrig
Executive Vice President Finance
and Chief Financial Officer
90