UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

OR

ConocoPhillips

600 North Dairy Ashford, Houston, TX 77079
(Address of principal executive offices)

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      

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  X  No      

The registrant had 685,834,267 shares of common stock, $.01 par value, outstanding at March 31, 2004.

CONOCOPHILLIPS

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

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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 that, in the opinion of management, are necessary for a fair presentation of the consolidated financial position of ConocoPhillips and its results of operations and cash flows for such periods. All such adjustments are of a normal and recurring nature. These interim financial statements should be read in conjunction with Management’s Discussion and Analysis and the consolidated financial statements and notes included in ConocoPhillips’ 2003 Annual Report on Form 10-K. Certain amounts in the 2003 financial statements included in this report on Form 10-Q have been reclassified to conform to ConocoPhillips’ 2004 presentation and restated for the adoption of Financial Accounting Standards Board (FASB) Interpretation No. 46, “Consolidation of Variable Interest Entities,” (FIN 46).

Note 2—Revenue Recognition Policy

Revenues associated with the sale of crude oil, natural gas, natural gas liquids, petroleum and chemical products, and other items are recognized when title passes to the customer, which is when the risk of ownership passes to the purchaser and physical delivery of goods occurs immediately or within a fixed delivery schedule that is reasonable and customary in the industry. Revenues include the sales portion of contracts involving purchases and sales necessary to reposition supply to address location, quality or grade requirements (e.g., when we reposition crude by entering into a contract with a counterparty to sell crude in one location and purchase it in a different location) and sales related to purchase for resale activity. Revenues from the production of natural gas properties, in which we have an interest with other producers, are recognized based on the actual volumes we sold during the period. Any differences between volumes sold and entitlement volumes, based on our net working interest, which are deemed non-recoverable through remaining production, are recognized as accounts receivable or accounts payable, as appropriate. Cumulative differences between volumes sold and entitlement volumes are generally not significant. Revenues associated with royalty fees from licensed technology are recorded based either upon volumes produced by the licensee or upon the successful completion of all substantive performance requirements related to the installation of licensed technology.

Note 3—Changes in Accounting Principles

Accounting for Asset Retirement Obligations
Effective January 1, 2003, we adopted Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations,” which applied to legal obligations associated with the retirement and removal of long-lived assets. The cumulative effect of the change increased 2003 net income by $145 million (after reduction of income taxes of $21 million).

Consolidation of Variable Interest Entities
In January 2003, the FASB issued FIN 46 to expand existing accounting guidance about when a company should include in its consolidated financial statements the assets, liabilities and activities of another entity. In December 2003, the FASB issued a revision to FIN 46 to clarify some of the provisions and to exempt certain entities from its guidance. The consolidation requirements of FIN 46, as revised, apply to all

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special purpose entities for periods ending after December 15, 2003. For all other types of variable interest entities the consolidation requirement applies for periods ending after March 15, 2004.

In the third quarter of 2003, with retroactive application to January 1, 2003, we adopted FIN 46 for variable interest entities (VIEs) involving synthetic leases and certain other financing structures, and accordingly, our financial statements for the first quarter of 2003 have been restated from amounts previously reported in the financial statements included in our Form 10-Q for the quarter ended March 31, 2003. The cumulative effect of this adoption of FIN 46 decreased 2003 net income $240 million (after an income tax benefit of $145 million). We consolidated all VIEs created prior to February 1, 2003 (except as noted below), in which we concluded we were the primary beneficiary. In addition, we deconsolidated an entity where we determined we were not the primary beneficiary. The provisions of FIN 46, which became effective for periods ending after March 15, 2004, did not change our analysis on any of the entities we consolidated or deconsolidated in 2003.

In February 2003, we entered into two agreements establishing separate guarantee facilities of $50 million each for two liquefied natural gas ships that were then under construction. Subject to the terms of each facility, we will be required to make payments should the charter revenue generated by the respective ship fall below certain specified minimum thresholds, and we will receive payments to the extent that such revenues exceed those thresholds. The net maximum future payments over the 20-year terms of the two agreements could be up to an aggregate of $100 million. Actual gross payments over the 20 years could exceed that amount to the extent revenues are received by us. In September 2003, the first ship was delivered to its owner and the second ship is scheduled for delivery to its owner in 2005. At December 31, 2003, we reported these two entities could potentially be VIEs, but that we had been unable to obtain sufficient information to confirm that the entities are VIEs or to determine if we were the primary beneficiary. In the first quarter of 2004, we received the required information related to the entity associated with the first ship and determined that it is a VIE; however, we are not the primary beneficiary and therefore will not consolidate the entity. With regard to the second ship, we will have a variable interest in the associated entity once the ship is delivered to its owner in 2005. At that time, we will determine if the entity is a VIE, and if we are the primary beneficiary. We will continue to account for these agreements as guarantees and contingent liabilities. See Note 10—Guarantees for additional information.

Note 4—Discontinued Operations

During 2003 and the first quarter of 2004, we disposed of or held for sale certain midstream, refining and marketing assets, which are classified as discontinued operations. In January 2004, we signed agreements to sell our Mobil-branded marketing assets on the East Coast in two separate transactions. The closing for one of these transactions took place in April 2004. Closing of the other transaction is subject to customary government and regulatory reviews and other closing conditions and is expected to close in the second quarter of 2004. Discussions are under way with potential buyers for the remaining marketing assets held for sale, and we expect to complete the sale of these assets in 2004.

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Sales and other operating revenues and income from discontinued operations were as follows:

The major classes of assets and liabilities of discontinued operations held for sale were as follows:

Note 5—Inventories

Inventories consisted of the following:

Inventories valued on a last-in, first-out (LIFO) basis totaled $3,699 million and $3,224 million at March 31, 2004, and December 31, 2003, respectively. The remainder of our inventories are valued under various methods, including first-in, first-out and weighted average. The excess of current replacement cost over LIFO cost of inventories was $1,665 million and $1,421 million at March 31, 2004, and December 31, 2003, respectively.

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Note 6—Properties, Plants and Equipment

Properties, plants and equipment included the following:

In June 2001, the FASB issued SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets,” which became effective on July 1, 2001, and January 1, 2002, respectively. The Securities and Exchange Commission (SEC) requested the Emerging Issues Task Force (EITF) to consider the issue of whether SFAS Nos. 141 and 142 require interests held under oil, gas and mineral leases to be separately classified as intangible assets on the balance sheets of companies in the extractive industries. Historically, in accordance with SFAS No. 19, “Financial Accounting and Reporting by Oil and Gas Producing Companies,” we have capitalized the cost of oil and gas leasehold interests and, consistent with industry practice, reported these assets as part of tangible Exploration and Production (E&P) properties, plants and equipment.

At its March 2004 meeting, the EITF reached a consensus that all mineral rights should be considered tangible assets for accounting purposes. The EITF acknowledged that this consensus would require an amendment to SFAS Nos. 141 and 142 to remove mineral rights as an example of an intangible asset. In April 2004, the FASB issued FASB Staff Position Nos. FAS 141-1 and FAS 142-1, which amended SFAS Nos. 141 and 142 to remove mineral rights as an example of an intangible asset consistent with the EITF’s consensus.

E&P properties, plants and equipment at March 31, 2004, and December 31, 2003, included approximately $10.0 billion and $10.5 billion, respectively, of mineral rights to extract oil and gas, net of accumulated depletion.

Property Impairments—In the first quarter of 2004, we recorded property impairments of $31 million related to planned dispositions in our Midstream, E&P and Refining and Marketing (R&M) segments. In the first quarter of 2003, property impairments of $28 million were recorded in our E&P segment, also mainly related to planned dispositions.

Note 7—Restructuring

As a result of the 2002 merger of Conoco Inc. and Phillips Petroleum Company that formed ConocoPhillips, we recognized an estimated restructuring liability for anticipated employee severance payments and incremental pension and medical plan benefit costs associated with work force reductions, site closings, and Conoco employee relocations. In connection with this program, we recorded accruals in 2002 of $770 million and in 2003, as individual components of the restructuring program were finalized, we recorded an additional $350 million, of which $46 million was accrued in the first quarter. Included in the total 2002 and 2003 accruals of $1,120 million was a $290 million expense related to pension and other postretirement benefits that will be paid in conjunction with other retirement benefits over a number of future years. This is reported as part of our employee benefit plan obligations. Of the $46 million

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accrued in the first quarter of 2003, $44 million was reflected as a purchase price adjustment in the consolidated financial statements and $2 million was reflected in selling, general and administrative expense and production and operating expense. Included in the total accruals of $46 million was a $7 million expense related to pension and other postretirement benefits. In the first three months of 2004, we recorded additional accruals totaling $18 million, which were reflected in the consolidated financial statements as selling, general and administrative expense and production and operating expense. Included in the total accruals of $18 million was a $4 million expense related to pension and postretirement benefits. A roll-forward of activity during the first quarter of 2004 is provided below for the nonpension portion of the accruals, which primarily consists of severance-related benefits to be provided based on agreed upon payment schedules to approximately 3,900 employees worldwide, most of whom are in the United States, as well as other merger-related expenses.

The ending accrual balance at March 31, 2004, is expected to be extinguished within one year, except for $49 million, which is classified as long-term. Approximately 900 employees were terminated during the first quarter of 2004 and approximately 3,900 employees have been terminated since the restructuring program was implemented.

Note 8—Debt

At March 31, 2004, we had four bank credit facilities in place, totaling $4 billion, available for use either as direct bank borrowings or as support for the issuance of up to $4 billion in commercial paper, a portion of which may be denominated in other currencies (limited to euro 3 billion equivalent). The facilities included a $1.5 billion, 364-day revolving credit facility expiring on October 13, 2004, a $500 million five-year facility expiring in October 2008, and two revolving credit facilities totaling $2 billion expiring in October 2006. At March 31, 2004, we had no debt outstanding under these credit facilities, and no commercial paper outstanding, compared with $709 million at December 31, 2003. The commercial paper is supported 100 percent by the credit facilities and the amount approximates fair value. In addition, one of our Norwegian subsidiaries has two $300 million revolving credit facilities that expire in June 2004, under which no borrowings were outstanding at March 31, 2004.

In April 2004, we paid off the $1,350 million aggregate principal amount of our 5.90% Notes due 2004 at maturity by using the proceeds from issuing commercial paper.

Note 9—Contingencies

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; and claims for damages resulting from leaking underground storage tanks, or other accidental releases, with related toxic tort claims. As a result of Conoco’s separation agreement with DuPont, we also have assumed responsibility for current and future

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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.

In the case of all known contingencies, we accrue a liability when the loss is probable and the amount is reasonably estimable. We do not reduce these liabilities for potential insurance or third-party recoveries. If applicable, we accrue receivables for probable insurance or other third-party recoveries. Based on currently available information, we believe 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 our financial statements.

As we learn new facts concerning contingencies, we reassess our 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 uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our 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.

Environmental—We are 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 we prepare our financial statements, we record accruals for environmental liabilities based on management’s best estimates, using all information that is available at the time. We measure estimates and base liabilities on currently available facts, existing technology, and presently enacted laws and regulations, taking into consideration the likely effects of societal and economic factors. When measuring environmental liabilities, we also consider our 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. We also consider unasserted claims in our determination of environmental liabilities and we accrue them in the period that they become 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, we are usually only one of many companies cited at a particular site. Due to the joint and several liabilities, we could be responsible for all of the cleanup costs related to any site at which we have been designated as a potentially responsible party. If we were solely responsible, the costs, in some cases, could be material to our, or one of our segments’, results of operations, capital resources or liquidity. However, settlements and costs incurred in matters that previously have been resolved have not been material to our results of operations or financial condition. We have been successful to date in sharing cleanup costs with other financially sound companies. Many of the sites at which we are 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, we may have no liability or may attain a settlement of liability. Where it appears that other potentially responsible parties may be financially unable to bear their proportional share, we consider this inability in estimating our potential liability and we adjust our accruals accordingly.

As a result of various acquisitions in the past, we assumed certain environmental obligations. Some of these environmental obligations are mitigated by indemnifications made by others for our benefit and some of the indemnifications are subject to dollar and time limits. We have not recorded accruals for any potential contingent liabilities that we expect to be funded by the prior owners under these indemnifications.

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We are currently participating in environmental assessments and cleanups at numerous federal Superfund and comparable state sites. After an assessment of environmental exposures for cleanup and other costs, we make accruals on an undiscounted basis (except those assumed in a purchase business combination, which we record 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 March 31, 2004, ConocoPhillips’ balance sheet included a total environmental accrual of $1,117 million, compared with $1,119 million at December 31, 2003. We expect to incur the majority of these expenditures within the next 30 years. We have not reduced these accruals for possible insurance recoveries. In the future, we may be involved in additional environmental assessments, cleanups and proceedings.

Other Legal Proceedings—We are 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—We have contingent liabilities resulting from throughput agreements with pipeline and processing companies. Under these agreements, we 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. In addition, we have performance obligations that are secured by unused letters of credit and various purchase commitments for materials, supplies, services and items of permanent investment incident to the ordinary conduct of business.

Note 10—Guarantees

At March 31, 2004, we were liable for certain contingent obligations under various contractual arrangements as described below. We are required to recognize a liability at inception for the fair value of our obligation as a guarantor for guarantees issued or modified after December 31, 2002. Unless the carrying amount of the liability is noted, we have not recognized a liability either because the guarantees were issued prior to December 31, 2002, or because the fair value of the obligation is immaterial.

Construction Completion Guarantees

	•		We have a construction completion guarantee related to debt and bond financing arrangements secured by the Merey Sweeny, L.P. (MSLP) joint-venture project at the Sweeny refinery in Old Ocean, Texas. The maximum potential amount of future payments under the guarantee, including joint-and-several debt at its gross amount, is estimated to be $400 million, assuming that completion certification is not achieved. Of this amount, $200 million is attributable to Petroleos de Venezuela S.A., which has an indirect 50 percent interest in MSLP, and which is jointly-and-severally liable for the debt. If completion certification is not achieved by June 18, 2004, the full debt balance could be called. However, MSLP has received the required permit for the new waste water pipeline and has resolved issues in placing its insurance program, and therefore, expects to achieve completion certification in the second quarter. If completion certification is achieved the debt becomes nonrecourse.
	•		We also issued a construction completion guarantee related to debt financing arrangements for the Hamaca Holding LLC joint-venture project in Venezuela. The maximum potential amount of future payments under the guarantee is estimated to be $440 million, which could be payable if the full debt financing capacity is utilized and startup and completion of the Hamaca project is not achieved by October 1, 2005. The project financing debt will be nonrecourse upon startup and completion certification.

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Guarantees of Joint-Venture Debt

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At March 31, 2004, we had guarantees of about $330 million outstanding for our portion of joint-venture debt obligations, which have terms of up to 22 years. Included in these outstanding guarantees was $140 million associated with the Polar Lights Company joint venture in Russia. Payment will be required if the joint venture defaults on its debt obligations.

Other Guarantees

	•		In addition to the construction completion guarantee explained above, the MSLP agreement also requires the partners in the venture to pay cash calls as required to meet the minimum operating requirements of the venture, in the event revenues do not cover expenses over the next 20 years. Our maximum potential future payments under the agreement are estimated to be $300 million, assuming MSLP does not earn any revenue over the entire period and fixed costs cannot be reduced. To the extent revenue is generated by the venture or fixed costs are reduced, future required payments would be reduced accordingly.
	•		In February 2003, we entered into two agreements establishing separate guarantee facilities for $50 million each for two liquefied natural gas vessels. Subject to the terms of each such facility, we will be required to make payments should the charter revenue generated by the respective ship fall below certain specified minimum thresholds, and we will receive payments to the extent that such revenues exceed those thresholds. The net maximum future payments that we may have to make over the 20-year terms of the two agreements could be up to an aggregate of $100 million. Actual gross payments over the 20 years could exceed that amount to the extent cash is received by us. In the event either ship is sold or a total loss occurs, we also may have recourse to the sales or insurance proceeds to recoup payments made under the guarantee facilities. In April 2003, based on the then current market view of both long-term and short-term shipping capacity, rates, and utilization probability, we estimated the fair value of the liability under these guarantee facilities to be immaterial. In September 2003, the first ship was delivered to its owner and the second ship is scheduled for delivery to its owner in 2005. With respect to the first ship, the amount drawn under the guarantee facility at March 31, 2004, was less than $1 million.
	•		We have other guarantees totaling $190 million, which consist primarily of dealer and jobber loan guarantees to support our marketing business, a guarantee supporting a lease assignment on a corporate aircraft, a guarantee associated with a pending lawsuit and guarantees of lease payment obligations for a joint venture. The carrying amount recorded for these other guarantees as of March 31, 2004, was $13 million. These guarantees generally extend up to 15 years and payment would only be required if the dealer, jobber or lessee goes into default, or if an adverse decision occurs in the lawsuit.

Indemnifications

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Over the years, we have entered into various agreements to sell ownership interests in certain corporations and joint ventures. In addition, we entered into a Tax Sharing Agreement in 1998 related to Conoco’s separation from DuPont. These agreements typically include indemnifications for additional taxes determined to be due under the relevant tax law, in connection with operations for years prior to the sale or separation. Generally, the obligation extends until the related tax years are closed. The maximum potential amount of future payments under the indemnifications is the amount of additional tax determined to be due under relevant tax law and the various agreements. Amounts estimated to be due under the agreements have been accrued and we believe it is remote that settlement of the ultimate obligations would exceed the current accruals by an amount that would have a material adverse impact on our financial statements.

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	•		During 2003 and in the first quarter of 2004, we sold several assets, including FTC-mandated sales of downstream and midstream assets, certain exploration and production assets, and downstream retail and wholesale sites, giving rise to qualifying indemnifications. Agreements associated with these sales include indemnifications for taxes, environmental liabilities, underground storage tank repairs or replacements, permits and licenses, employee claims, real estate indemnity against tenant defaults, and litigation. The terms of these indemnifications vary greatly. The majority of these indemnifications are related to environmental issues, the term is generally indefinite and the maximum amount of future payments is generally unlimited. The carrying amount recorded for these indemnifications as of March 31, 2004, was $214 million. We amortize the indemnification liability over the relevant time period, if one exists, based on the facts and circumstances surrounding each type of indemnity. In cases where the indemnification term is indefinite, we will reverse the liability when we have information that the liability is essentially relieved or amortize over an appropriate time period as the fair value of our indemnification exposure declines over time. Although it is reasonably possible that future payments may exceed amounts recorded, due to the nature of the indemnifications, it is not possible to make a reasonable estimate of the maximum potential amount of future payments. Included in the carrying amount recorded was $86 million of environmental accruals for known contamination that is included in asset retirement obligations and accrued environmental costs at March 31, 2004. For additional information about environmental liabilities, see Note 9—Contingencies.
	•		As part of our normal ongoing business operations and consistent with industry practice, we enter into numerous agreements with other parties, which apportion future risks among the parties to the transaction or relationship governed by the agreements. One method of apportioning risk is the inclusion of provisions requiring one party to indemnify the other against losses that might otherwise be incurred by the other party in the future. Many of our agreements contain an indemnity or indemnities that require us to perform certain acts, such as remediation, as a result of the occurrence of a triggering event or condition. In some instances we indemnify third parties against losses resulting from certain events or conditions that arise out of the operations of our equity affiliates.
			The nature of these numerous indemnity obligations are diverse and each has different terms, business purposes, and triggering events or conditions. Consistent with customary business practice, any particular indemnity obligation incurred is the result of a negotiated transaction or contractual relationship for which we have accepted a certain level of risk in return for a financial or other type of benefit. In addition, the indemnities in each agreement vary widely in their definitions of both triggering events and the resulting obligations contingent on those triggering events.
			With regard to indemnifications, our risk management philosophy is to limit risk in any transaction or relationship to the maximum extent reasonable in relation to commercial and other considerations. Before accepting any indemnity obligation, we make an informed risk management decision considering, among other things, the remoteness of the possibility that the triggering event will occur, the potential costs to perform under any resulting indemnity obligation, possible actions to reduce the likelihood of a triggering event or to reduce the costs of performing under the indemnity obligation, whether we are indemnified by an unrelated third party, insurance coverage that may be available to offset the cost of the indemnity obligation, and the benefits from the transaction or relationship.

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Because many of our indemnity obligations are not limited in duration or potential monetary exposure, we cannot calculate a reasonable estimate of the maximum potential amount of future payments that could be paid under our indemnity obligations stemming from all our existing agreements. The carrying amount recorded for these indemnifications as of March 31, 2004, was $224 million, which is for known contamination and is included in asset retirement obligations and accrued environmental costs. For additional information about environmental liabilities and contingencies, see Note 9—Contingencies.

Note 11—Other Comprehensive Income

ConocoPhillips’ other comprehensive income was as follows:

Accumulated other comprehensive income in the equity section of the balance sheet included:

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Note 12—Supplemental Cash Flow Information

Note 13—Sales of Receivables

At March 31, 2004, certain credit card and trade receivables had been sold to a Qualifying Special Purpose Entity (QSPE) in a revolving-period securitization arrangement. This arrangement provides for us to sell, and the QSPE to purchase, certain receivables, and for the QSPE to then issue beneficial interests of up to $1.2 billion to five bank-sponsored entities. All five bank-sponsored entities are multi-seller conduits with access to the commercial paper market and purchase interests in similar receivables from numerous other companies unrelated to us. We have no ownership interests, nor any variable interests, in any of the bank-sponsored entities. As a result, we do not consolidate any of these entities. Furthermore, we do not consolidate the QSPE because it meets the requirements of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to be excluded from the consolidated financial statements of ConocoPhillips.

At March 31, 2004, and December 31, 2003, the QSPE had issued beneficial interests to the bank-sponsored entities of $450 million and $1.2 billion, respectively. The receivables transferred to the QSPE meet the isolation requirements and other requirements of SFAS No. 140 to be accounted for as sales and were accounted for accordingly.

We retain beneficial interests in the QSPE that are subordinate to the beneficial interests issued to the bank-sponsored entities. These retained interests, which are reported on the balance sheet in accounts and notes receivable—related parties, were $2.3 billion at March 31, 2004, and $1.3 billion at December 31, 2003. We also retain servicing responsibility related to the sold receivables, which gives us certain rights and abilities, the fair value of which approximates the fair value of the liability incurred for continuing to service the receivables. The carrying value of our subordinated beneficial interests in the QSPE approximates fair market value due to the very short term of the underlying assets, which makes fair value stress testing for disclosure purposes unnecessary.

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Total cash flows received from and paid under the securitization arrangements were as follows:

The decrease in cash flow activity in 2004 was primarily due to reductions in the average level of beneficial interests issued to the bank-sponsored entities.

At December 31, 2003, we had sold $226 million of receivables under factoring arrangements. We retain servicing responsibility related to these sold receivables, which gives us certain benefits, the fair value of which approximates the fair value of the liability incurred for continuing to service the receivables. At March 31, 2004, we had no receivables outstanding under similar arrangements.

Note 14—Employee Benefit Plans

Pension and Postretirement Plans

We recognized pension settlement losses of $4 million and $9 million in the first quarters of 2004 and 2003, respectively, due to high levels of lump sum elections by new retirees in certain plans.

We have elected to defer financial recognition of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 until the FASB issues final accounting guidance. When issued, that final guidance could require us to change previously reported information. This deferral is permitted under FASB Staff Position No. FAS 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.”

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Stock-Based Compensation

Effective January 1, 2003, we voluntarily adopted the fair-value accounting method provided under SFAS No. 123, “Accounting for Stock-Based Compensation.” Using the SFAS No. 123 prospective transition method, we apply the fair-value accounting method and recognize compensation expense equal to the fair-market value on the grant date for all stock options granted or modified after December 31, 2002.

Employee stock options granted prior to 2003 continue to be accounted for under Accounting Principles Board (APB) No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is generally recognized under APB No. 25. The following table displays pro forma information as if provisions of SFAS No. 123 had been applied to all employee stock options granted:

Note 15—Related Party Transactions

Significant transactions with related parties were:

(a)

Our 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

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		are sold to Chevron Phillips Chemical Company LLC (CPChem) and refined products are sold primarily to CFJ Properties. Also, we charge several of our affiliates including CPChem, MSLP, and Hamaca Holding LLC for the use of common facilities, such as steam generators, waste and water treaters, and warehouse facilities.
(b)		We purchase natural gas and natural gas liquids from DEFS and CPChem for use in our refinery processes and other feedstocks from various affiliates. We purchase upgraded crude oil from Petrozuata C.A. and refined products from Melaka. We also pay fees to various pipeline equity companies for transporting finished refined products.
(c)		We pay processing fees to various affiliates, the most significant being MSLP. Additionally, we pay crude oil transportation fees to pipeline equity companies, and commissions to the receivable monetization QSPE.
(d)		We pay and/or receive interest to/from various affiliates including the receivable monetization QSPE.

Elimination of our equity percentage share of profit or loss on the above transactions was not material.

Note 16—Segment Disclosures and Related Information

We have organized our reporting structure based on the grouping of similar products and services, resulting in five operating segments:

(1)		Exploration and Production (E&P)—This segment primarily explores for and produces crude oil, natural gas and natural gas liquids on a worldwide basis. At March 31, 2004, E&P was producing in the United States, Norway, the United Kingdom, Canada, Nigeria, Venezuela, offshore Timor Leste in the Timor Sea, Australia, China, Indonesia, the United Arab Emirates, Vietnam, and Russia. The E&P segment’s U.S. and international operations are disclosed separately for reporting purposes.
(2)		Midstream—Through both consolidated and equity interests, this segment gathers and processes natural gas produced by ConocoPhillips and others, and fractionates and markets natural gas liquids, primarily in the United States, Canada and Trinidad. The Midstream segment includes our 30.3 percent equity investment in DEFS.
(3)		Refining and Marketing (R&M)—This segment purchases, refines, markets and transports crude oil and petroleum products, mainly in the United States, Europe and Asia. At March 31, 2004, we owned 12 refineries in the United States; 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.
(4)		Chemicals—This segment manufactures and markets petrochemicals and plastics on a worldwide basis. The Chemicals segment consists of our 50 percent equity investment in CPChem.
(5)		Emerging Businesses—This segment encompasses the development of new businesses beyond our traditional operations. Emerging Businesses includes new technologies related to natural gas conversion into clean fuels and related products (gas-to-liquids), technology solutions, power generation and emerging technologies.

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Corporate and Other includes general corporate overhead, all interest income and expense, discontinued operations, restructuring charges resulting from the merger, certain eliminations, and various other corporate activities. Corporate assets include all cash and cash equivalents.

We evaluate performance and allocate resources based on net income. Intersegment sales are recorded at prices that approximate market value.

Analysis of Results by Operating Segment

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Note 17—Income Taxes

Our effective tax rate for the first quarter of 2004 was 46 percent, compared with 51 percent for the same period a year ago. Contributing to the lower tax rate in the first quarter of 2004, compared with the corresponding period in 2003, was the impact of a lower portion of income being earned in higher tax-rate jurisdictions. The effective tax rate in excess of the domestic federal statutory rate of 35 percent was primarily due to foreign taxes in excess of the domestic federal statutory rate.

Note 18—Preferred Share Purchase Rights

Our Board of Directors authorized and declared a dividend of one preferred share purchase right for each common share outstanding, and authorized and directed the issuance of one right per common share for any newly issued shares. The rights have certain anti-takeover effects. The rights will cause substantial dilution to a person or group that attempts to acquire ConocoPhillips on terms not approved by the Board of Directors. However, since the rights may either be redeemed or otherwise made inapplicable by ConocoPhillips prior to an acquiror obtaining beneficial ownership of 15 percent or more of ConocoPhillips’ common stock, the rights should not interfere with any merger or business combination approved by the Board of Directors prior to that occurrence. The rights, which expire June 30, 2012, will be exercisable only if a person or group acquires 15 percent or more of the company’s common stock or commences a tender offer that would result in ownership of 15 percent or more of the common stock. Each right would entitle stockholders to buy one one-hundredth of a share of preferred stock at an exercise price of $300. If an acquiror obtains 15 percent or more of ConocoPhillips’ common stock, then each right will be adjusted so that it will entitle the holder (other than the acquiror, whose rights will become void) to purchase, for the then exercise price, a number of shares of ConocoPhillips’ common stock equal in value to two times the exercise price of the right. In addition, the rights enable holders to purchase the stock of an acquiring company at a discount, depending on specific circumstances. We may redeem the rights in whole, but not in part, for one cent per right.

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Note 19—New Accounting Standards

In December 2003, the FASB revised and reissued SFAS No. 132 (revised 2003), “Employer’s Disclosures about Pensions and Other Postretirement Benefits—an amendment of FASB Statements No. 87, 88 and 106.” While requiring certain new disclosures, the new Standard does not change the measurement or recognition of employee benefit plans. We adopted the provisions of this Standard effective December 2003, except for certain provisions regarding disclosure of information about estimated future benefit payments which are not required until the fourth quarter of 2004.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Liabilities and Equity,” to address the balance sheet classification of certain financial instruments that have characteristics of both liabilities and equity. The statement is already effective for all contracts created or modified after May 31, 2003, and was originally intended to become effective July 1, 2003, for all previously existing contracts. However, on November 7, 2003, the FASB issued an indefinite deferral of certain provisions of SFAS No. 150. We will continue to monitor and assess the FASB’s modifications to SFAS No. 150, but do not anticipate that it will have a material impact on our financial statements.

In April 2004, the FASB issued FASB Staff Position Nos. FAS 141-1 and FAS 142-1, which amended SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets,” to remove mineral rights as an example of an intangible asset. See Note 6—Properties, Plants and Equipment for more information.

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Supplementary Information—Condensed Consolidating Financial Information

We have various cross guarantees between ConocoPhillips, ConocoPhillips Holding Company, and ConocoPhillips Company. ConocoPhillips Company is wholly owned by ConocoPhillips Holding Company, which is wholly owned by ConocoPhillips. ConocoPhillips and ConocoPhillips Holding Company have fully and unconditionally guaranteed the payment obligations of ConocoPhillips Company with respect to its publicly held debt securities. Similarly, ConocoPhillips and ConocoPhillips Company have fully and unconditionally guaranteed the payment obligations of ConocoPhillips Holding Company with respect to the publicly held debt securities of ConocoPhillips Holding Company. In addition, ConocoPhillips Company and ConocoPhillips Holding Company have fully and unconditionally guaranteed the payment obligations of ConocoPhillips with respect to its publicly held debt securities. All guarantees are joint and several. The following condensed consolidating financial information presents the results of operations, financial position and cash flows for:

	•		ConocoPhillips, ConocoPhillips Holding Company, and ConocoPhillips Company (in each case, reflecting investments in subsidiaries utilizing the equity method of accounting);
	•		All other non-guarantor subsidiaries of ConocoPhillips Holding Company and ConocoPhillips Company; and
	•		The consolidating adjustments necessary to present ConocoPhillips’ results on a consolidated basis.

This condensed consolidating financial information should be read in conjunction with the accompanying consolidated financial statements and notes.

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