UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

 

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended June 30, 2006

 

 

 

or

 

 

 

o

 

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: 001-32395

 

 

ConocoPhillips

(Exact name of registrant as specified in its charter)

 

Delaware

 

01-0562944

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

600 North Dairy Ashford, 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  ý   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer

ý

 

Accelerated filer

 

o

 

Non-accelerated filer

 

o

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   No  ý

 

The registrant had 1,647,803,761 shares of common stock, $.01 par value, outstanding at June 30, 2006.

 

 



 

CONOCOPHILLIPS

 

TABLE OF CONTENTS

 

 

 

Page

Part I – Financial Information

 

 

 

 

 

Item 1. Financial Statements

 

 

Consolidated Income Statement

 

1

Consolidated Balance Sheet

 

2

Consolidated Statement of Cash Flows

 

3

Notes to Consolidated Financial Statements

 

4

Supplementary Information—Condensed Consolidating Financial Information

 

27

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

36

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

61

 

 

 

Item 4. Controls and Procedures

 

61

 

 

 

Part II – Other Information

 

 

 

 

 

Item 1. Legal Proceedings

 

62

 

 

 

Item 1A. Risk Factors

 

62

 

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

63

 

 

 

Item 4. Submission of Matters to a Vote of Security Holders

 

63

 

 

 

Item 6. Exhibits

 

65

 

 

 

Signature

 

66

 



 

PART I. FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

 

Consolidated Income Statement

 

ConocoPhillips

 

 

 

 

Millions of Dollars

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

2006

 

2005

 

2006

 

2005

 

Revenues and Other Income

 

 

 

 

 

 

 

 

 

Sales and other operating revenues(1)

 

$

47,149

 

41,808

 

94,055

 

79,439

 

Equity in earnings of affiliates

 

1,164

 

701

 

2,124

 

1,754

 

Other income

 

163

 

105

 

224

 

339

 

Total Revenues and Other Income

 

48,476

 

42,614

 

96,403

 

81,532

 

 

 

 

 

 

 

 

 

 

 

Costs and Expenses

 

 

 

 

 

 

 

 

 

Purchased crude oil, natural gas and products

 

29,448

 

28,523

 

62,903

 

54,095

 

Production and operating expenses

 

2,694

 

2,147

 

4,909

 

4,099

 

Selling, general and administrative expenses

 

610

 

539

 

1,176

 

1,078

 

Exploration expenses

 

134

 

121

 

246

 

292

 

Depreciation, depletion and amortization

 

1,965

 

985

 

3,145

 

2,026

 

Property impairments

 

50

 

9

 

50

 

31

 

Taxes other than income taxes(1)

 

4,421

 

4,664

 

8,808

 

9,152

 

Accretion on discounted liabilities

 

73

 

41

 

133

 

89

 

Interest and debt expense

 

360

 

127

 

475

 

265

 

Foreign currency transaction losses

 

18

 

21

 

40

 

18

 

Minority interests

 

21

 

5

 

39

 

15

 

Total Costs and Expenses

 

39,794

 

37,182

 

81,924

 

71,160

 

Income from continuing operations before income taxes

 

8,682

 

5,432

 

14,479

 

10,372

 

Provision for income taxes

 

3,496

 

2,301

 

6,002

 

4,318

 

Income From Continuing Operations

 

5,186

 

3,131

 

8,477

 

6,054

 

Income (loss) from discontinued operations

 

 

7

 

 

(4

)

Net Income

 

$

5,186

 

3,138

 

8,477

 

6,050

 

 

 

 

 

 

 

 

 

 

 

Income Per Share of Common Stock(dollars)

 

 

 

 

 

 

 

 

 

Basic

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

3.13

 

2.24

 

5.58

 

4.33

 

Discontinued operations

 

 

.01

 

 

 

Net Income

 

$

3.13

 

2.25

 

5.58

 

4.33

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

3.09

 

2.21

 

5.49

 

4.26

 

Discontinued operations

 

 

 

 

 

Net Income

 

$

3.09

 

2.21

 

5.49

 

4.26

 

 

 

 

 

 

 

 

 

 

 

Dividends Paid Per Share of Common Stock(dollars)

 

$

.36

 

.31

 

.72

 

.56

 

 

 

 

 

 

 

 

 

 

 

Average Common Shares Outstanding(in thousands)

 

 

 

 

 

 

 

 

 

Basic

 

1,654,758

 

1,396,724

 

1,519,593

 

1,397,305

 

Diluted

 

1,678,445

 

1,419,288

 

1,542,752

 

1,420,022

 

(1) Includes excise taxes on petroleum products sales:

 

$

3,922

 

4,338

 

7,912

 

8,493

 

See Notes to Consolidated Financial Statements.

 

1



 

Consolidated Balance Sheet

 

ConocoPhillips

 

 

 

 

Millions of Dollars

 

 

 

June 30

 

December 31

 

 

 

2006

 

2005

 

Assets

 

 

 

 

 

Cash and cash equivalents

 

$

654

 

2,214

 

Accounts and notes receivable (net of allowance of $77 million in 2006 and $72 million in 2005)

 

11,802

 

11,168

 

Accounts and notes receivable—related parties

 

741

 

772

 

Inventories

 

6,435

 

3,724

 

Prepaid expenses and other current assets

 

2,106

 

1,734

 

Total Current Assets

 

21,738

 

19,612

 

Investments and long-term receivables

 

18,326

 

15,726

 

Net properties, plants and equipment

 

87,920

 

54,669

 

Goodwill

 

32,120

 

15,323

 

Intangibles

 

1,175

 

1,116

 

Other assets

 

638

 

553

 

Total Assets

 

$

161,917

 

106,999

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Accounts payable

 

$

13,839

 

11,732

 

Accounts payable—related parties

 

678

 

535

 

Notes payable and long-term debt due within one year

 

4,571

 

1,758

 

Accrued income and other taxes

 

4,838

 

3,516

 

Employee benefit obligations

 

1,123

 

1,212

 

Other accruals

 

1,971

 

2,606

 

Total Current Liabilities

 

27,020

 

21,359

 

Long-term debt

 

24,939

 

10,758

 

Asset retirement obligations and accrued environmental costs

 

5,728

 

4,591

 

Deferred income taxes

 

20,423

 

11,439

 

Employee benefit obligations

 

2,539

 

2,463

 

Other liabilities and deferred credits

 

2,645

 

2,449

 

Total Liabilities

 

83,294

 

53,059

 

 

 

 

 

 

 

Minority Interests

 

1,246

 

1,209

 

 

 

 

 

 

 

Common Stockholders’ Equity

 

 

 

 

 

Common stock (2,500,000,000 shares authorized at $.01 par value)
Issued (2006—1,700,337,510 shares; 2005—1,455,861,340 shares)

 

 

 

 

 

Par value

 

17

 

14

 

Capital in excess of par

 

41,597

 

26,754

 

Grantor trusts (at cost: 2006—45,876,265 shares; 2005—45,932,093 shares)

 

(815

)

(778

)

Treasury stock (at cost: 2006—6,657,484 shares; 2005—32,080,000 shares)

 

(425

)

(1,924

)

Accumulated other comprehensive income

 

1,759

 

814

 

Unearned employee compensation

 

(158

)

(167

)

Retained earnings

 

35,402

 

28,018

 

Total Common Stockholders’ Equity

 

77,377

 

52,731

 

Total

 

$

161,917

 

106,999

 

See Notes to Consolidated Financial Statements.

 

2



 

Consolidated Statement of Cash Flows

 

ConocoPhillips

 

 

 

Millions of Dollars

 

 

 

Six Months Ended
June 30

 

 

 

2006

 

2005

 

Cash Flows From Operating Activities

 

 

 

 

 

Income from continuing operations

 

$

8,477

 

6,054

 

Adjustments to reconcile income from continuing operations to net cash provided by continuing operations

 

 

 

 

 

Non-working capital adjustments

 

 

 

 

 

Depreciation, depletion and amortization

 

3,145

 

2,026

 

Property impairments

 

50

 

31

 

Dry hole costs and leasehold impairments

 

85

 

156

 

Accretion on discounted liabilities

 

133

 

89

 

Deferred taxes

 

(222

)

492

 

Undistributed equity earnings

 

(754

)

(1,219

)

Gain on asset dispositions

 

(56

)

(242

)

Other

 

(14

)

(191

)

Working capital adjustments

 

 

 

 

 

Decrease in aggregate balance of accounts receivable sold

 

 

(480

)

Decrease in other accounts and notes receivable

 

790

 

221

 

Increase in inventories

 

(2,167

)

(1,280

)

Increase in prepaid expenses and other current assets

 

(436

)

(176

)

Increase in accounts payable

 

564

 

1,509

 

Increase (decrease) in taxes and other accruals

 

49

 

(130

)

Net cash provided by continuing operations

 

9,644

 

6,860

 

Net cash used in discontinued operations

 

 

(3

)

Net Cash Provided by Operating Activities

 

9,644

 

6,857

 

 

 

 

 

 

 

Cash Flows From Investing Activities

 

 

 

 

 

Acquisition of Burlington Resources Inc.*

 

(14,284

)

 

Capital expenditures and investments, including dry hole costs*

 

(7,916

)

(4,947

)

Proceeds from asset dispositions

 

73

 

308

 

Long-term advances/loans to affiliates and other

 

(376

)

(119

)

Collection of advances/loans to affiliates and other

 

110

 

148

 

Net cash used in continuing operations

 

(22,393

)

(4,610

)

Net cash used in discontinued operations

 

 

 

Net Cash Used in Investing Activities

 

(22,393

)

(4,610

)

 

 

 

 

 

 

Cash Flows From Financing Activities

 

 

 

 

 

Issuance of debt

 

15,874

 

333

 

Repayment of debt

 

(3,306

)

(1,332

)

Issuance of company common stock

 

104

 

263

 

Repurchase of company common stock

 

(425

)

(576

)

Dividends paid on company common stock

 

(1,091

)

(780

)

Other

 

(47

)

97

 

Net cash provided by (used in) continuing operations

 

11,109

 

(1,995

)

Net Cash Provided by (Used in) Financing Activities

 

11,109

 

(1,995

)

 

 

 

 

 

 

Effect of Exchange Rate Changes on Cash and Cash Equivalents

 

80

 

(98

)

 

 

 

 

 

 

Net Change in Cash and Cash Equivalents

 

(1,560

)

154

 

Cash and cash equivalents at beginning of period

 

2,214

 

1,387

 

Cash and Cash Equivalents at End of Period

 

$

654

 

1,541

 

*Net of cash acquired.

 

 

 

 

 

See Notes to Consolidated Financial Statements.

 

3



 

Notes to Consolidated Financial Statements

 

ConocoPhillips

 

Note 1—Interim Financial Information

 

The interim-period financial information 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. The acquisition of Burlington Resources Inc. was reflected in our balance sheet beginning at March 31, 2006, and was reflected in our results of operations beginning in the second quarter of 2006.

 

To enhance your understanding of these interim financial statements, see the consolidated financial statements and notes included in our 2005 Annual Report on Form 10-K.

 

Note 2—Accounting Policies

 

Revenue Recognition—Revenues associated with sales 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, either immediately or within a fixed delivery schedule that is reasonable and customary in the industry. Prior to April 1, 2006, revenues included the sales portion of transactions commonly called buy/sell contracts, in which physical commodity purchases and sales were simultaneously contracted with the same counterparty to either obtain a different quality or grade of refinery feedstock supply, reposition a commodity (for example, where we entered into a contract with a counterparty to sell refined products or natural gas volumes at one location and purchase similar volumes at another location closer to our wholesale customer), or both.

 

Effective April 1, 2006, we implemented Emerging Issues Task Force (EITF) Issue No. 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty.” Issue No. 04-13 requires purchases and sales of inventory with the same counterparty, entered into “in contemplation” of one another, be combined and reported net (i.e., on the same income statement line). Exceptions to this are exchanges of finished goods for raw materials or work-in-progress within the same line of business, which are only reported net if the transaction lacks economic substance. The implementation of Issue No. 04-13 did not have a material impact on income from continuing operations or net income.

 

The table below shows the actual three months ended June 30, 2006, sales and other operating revenues, and purchased crude oil, natural gas and products under this new guidance, and the respective pro forma amounts included in this report had this new guidance been effective for all the periods prior to April 1, 2006.

 

 

 

Millions of Dollars

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

Actual

 

Pro Forma

 

Pro Forma

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Sales and other operating revenues

 

$

47,149

 

36,141

 

87,398

 

68,424

 

Purchased crude oil, natural gas and products

 

29,448

 

22,856

 

56,246

 

43,080

 

 

4



 

Revenues from the production of significant natural gas and crude oil 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 to be 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.

 

Stock-Based Compensation—Effective January 1, 2003, we voluntarily adopted the fair-value accounting method prescribed by Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation.”  We used the prospective transition method, applying the fair-value accounting method and recognizing 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 were accounted for under Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations; however, by the end of 2005, all of these awards had vested. Because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant, generally no compensation expense was recognized under APB Opinion No. 25. The following table displays 2005 pro forma information as if provisions of SFAS No. 123 had been applied to all employee stock options granted:

 

 

 

Millions of Dollars

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2005

 

June 30, 2005

 

 

 

 

 

 

 

Net income, as reported

 

$

3,138

 

6,050

 

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

 

29

 

68

 

Deduct: Total stock-based employee compensation expense determined under
fair-value-based method for all awards, net of related tax effects

 

(30

)

(69

)

Pro forma net income

 

$

3,137

 

6,049

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Basic—as reported

 

$

2.25

 

4.33

 

Basic—pro forma

 

2.25

 

4.33

 

Diluted—as reported

 

2.21

 

4.26

 

Diluted—pro forma

 

2.21

 

4.26

 

 

Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” (SFAS No. 123(R)). For information about our adoption of this new accounting standard, see Note 3—Changes in Accounting Principles.

 

5



 

Note 3—Changes in Accounting Principles

 

At its September 2005 meeting, the EITF reached a consensus on Issue No. 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty,” which requires purchases and sales of inventory with the same counterparty, entered into “in contemplation” of one another, be combined and reported net. We adopted Issue No. 04-13 effective April 1, 2006. For additional information, see the Revenue Recognition section of Note 2—Accounting Policies.

 

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), which supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and replaces SFAS No. 123, “Accounting for Stock-Based Compensation.”  SFAS No. 123(R), which was effective January 1, 2006, prescribes the accounting for a wide range of share-based compensation arrangements, including options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans, and generally requires the fair value of share-based awards to be expensed. We adopted SFAS No. 123(R) on January 1, 2006, using the modified-prospective transition method provided under the Statement.

 

SFAS No. 123(R) permits the use of either the accelerated method or the straight-line method of recognizing expense for share-based awards subject to graded vesting (i.e., when portions of the award vest at different dates throughout the vesting period). In the past, we have used the accelerated recognition method for these awards, but concurrent with our adoption of SFAS No. 123(R), we elected to use the straight-line recognition method to account for new awards granted with graded vesting provisions.

 

Generally, our stock-based compensation programs provide accelerated vesting (i.e., a waiver of the remaining period of service required to earn an award) for awards held by employees at the time of their retirement. For awards granted prior to January 1, 2006, we recognize expense over the period of time during which the employee earns the award, accelerating the recognition of expense only when an employee actually retires.

 

For stock-based compensation awards granted after December 31, 2005, our adoption of SFAS No. 123(R) requires us to recognize expense over the shorter of the service period (i.e., the stated period of time required to earn the award), or the period beginning at the start of the service period and ending when an employee first becomes eligible for retirement. This change in recognition method will shorten the period over which we recognize expense for most of our stock-based awards granted to employees who are already age 55 or older.

 

During the first six months of 2006, the company granted 3,124,670 restricted stock units, with an average fair value of $58.47 per unit, under the 2004 Omnibus Stock and Performance Incentive Plan and lifted restrictions on 157,517 restricted stock units.

 

Also during the first six months of 2006, the company granted 1,737,864 stock options, primarily under the 2004 Omnibus Stock and Performance Incentive Plan, with a weighted-average exercise price of $59.09 and a weighted-average fair value of $16.09 per option. The fair values were calculated using the Black-Scholes-Merton option-pricing model, with the following weighted-average assumptions:  a risk-free interest rate of 4.62 percent, an expected dividend yield of 2.50 percent, a volatility factor of 26.1 percent and an expected life of 7.19 years. None of these stock options were exercisable as of June 30, 2006.

 

In addition to the above stock option activity, on March 31, 2006, in exchange for outstanding Burlington Resources Inc. stock options, the company granted approximately 3.6 million vested stock options, with an average exercise price of $23.40 per share, and approximately 1.3 million non-vested stock options, with

 

6



 

an average exercise price of $62.99 per share. The aggregate fair value of these options, as calculated with the Black-Scholes-Merton option-pricing model, was approximately $164 million.

 

During the first six months of 2006, 4,587,518 stock options were exercised with an average exercise price of $24.13 per option, and 6,541,497 options became eligible for exercise.

 

Due in part to our having fully adopted the fair-value accounting method prescribed by SFAS No. 123 on January 1, 2003, the adoption of SFAS No. 123(R) did not have a material impact on our 2006 financial statements, nor do we expect it to have a material impact on our future financial statements.

 

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.”  This Statement clarifies that items such as abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) be recognized as current-period charges. In addition, the Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We adopted this Statement effective January 1, 2006. The adoption did not have a material impact on our financial statements.

 

Note 4—Acquisition of Burlington Resources Inc.

 

On March 31, 2006, we completed the $33.9 billion acquisition of Burlington Resources Inc., an independent exploration and production company that held a substantial position in North American natural gas proved reserves, production and exploratory acreage. We issued approximately 270.4 million shares of our common stock and paid approximately $17.5 billion in cash. We acquired $3.2 billion in cash and assumed $4.3 billion of debt from Burlington Resources in the acquisition. Results of operations attributable to Burlington Resources were included in our consolidated income statement beginning in the second quarter of 2006.

 

The acquisition of Burlington Resources added approximately 2 billion barrels of oil equivalent to our proved reserves.

 

The primary reasons for the acquisition and the principal factors contributing to a purchase price resulting in the recognition of goodwill were expanded growth opportunities in North American natural gas exploration and development, cost savings from the elimination of duplicate activities, and the sharing of best practices in the operations of both companies.

 

The $33.9 billion purchase price was based on Burlington Resources shareholders receiving $46.50 in cash and 0.7214 shares of ConocoPhillips common stock for each Burlington Resources share owned. ConocoPhillips issued approximately 270.4 million shares of common stock and approximately 3.6 million vested employee stock options in exchange for 374.8 million shares of Burlington Resources common stock and 2.5 million Burlington Resources vested stock options. The ConocoPhillips common stock was valued at $59.85 per share, which was the weighted-average price of ConocoPhillips common stock for a five-day period beginning two available trading days before the public announcement of the transaction on the evening of December 12, 2005. The Burlington Resources vested stock options, whose fair value was determined using the Black-Scholes-Merton option-pricing model, were exchanged for ConocoPhillips stock options valued at $146 million. Estimated transaction-related costs were $56 million.

 

Also included in the acquisition was the replacement of 0.9 million non-vested Burlington Resources stock options and 0.4 million shares of non-vested restricted stock with 1.3 million non-vested ConocoPhillips stock options and 0.5 million non-vested ConocoPhillips restricted stock. In addition, 1.2 million Burlington Resources shares of common stock held by a consolidated grantor trust, related to a deferred

 

7



 

compensation plan, were converted into 0.9 million ConocoPhillips common shares and were recorded as a reduction of common stockholders’ equity.

 

The preliminary allocation of the purchase price to specific assets and liabilities was based, in part, upon a preliminary outside appraisal of the fair value of Burlington Resources assets. Over the next few months, we expect to receive the final outside appraisal of the long-lived assets and conclude the fair value determination of all other Burlington Resources assets and liabilities. 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 March 31, 2006:

 

 

 

Millions of
Dollars

 

 

 

 

 

Cash and cash equivalents

 

$

3,238

 

Accounts and notes receivable

 

1,375

 

Inventories

 

242

 

Prepaid expenses and other current assets

 

106

 

Investments and long-term receivables

 

237

 

Properties, plants and equipment

 

28,493

 

Goodwill

 

16,663

 

Intangibles

 

68

 

Other assets

 

79

 

Total Assets

 

$

50,501

 

 

 

 

 

Accounts payable

 

$

1,361

 

Notes payable and long-term debt due within one year

 

1,009

 

Accrued income and other taxes

 

940

 

Employee benefit obligations—current

 

199

 

Other accruals

 

171

 

Long-term debt

 

3,330

 

Asset retirement obligations

 

885

 

Accrued environmental costs

 

19

 

Deferred income taxes

 

7,978

 

Employee benefit obligations

 

334

 

Other liabilities and deferred credits

 

411

 

Common stockholders’ equity

 

33,864

 

Total Liabilities and Equity

 

$

50,501

 

 

We assigned all of the Burlington Resources goodwill to the Worldwide Exploration and Production reporting unit. Of the $16,663 million of goodwill, $8,255 million relates to net deferred tax liabilities arising from differences between the allocated financial bases and deductible tax bases of the acquired assets. None of the goodwill is deductible for tax purposes.

 

Goodwill recorded in the acquisition is not subject to amortization, but will be tested periodically for impairment as required by SFAS No. 142, “Goodwill and Other Intangible Assets.”

 

8



 

The following table presents actual results for the three-month period ended June 30, 2006, and the respective pro forma information as if the acquisition had occurred at the beginning of each year presented.

 

 

 

Millions of Dollars

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

Actual

 

Pro Forma

 

Pro Forma

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Sales and other operating revenues

 

$

47,149

 

43,337

 

95,960

 

82,351

 

Income from continuing operations

 

5,186

 

3,320

 

8,920

 

6,368

 

Net income

 

5,186

 

3,327

 

8,920

 

6,364

 

Income from continuing operations per share of common stock

 

 

 

 

 

 

 

 

 

Basic

 

3.13

 

1.99

 

5.39

 

3.82

 

Diluted

 

3.09

 

1.96

 

5.31

 

3.76

 

Net income per share of common stock

 

 

 

 

 

 

 

 

 

Basic

 

3.13

 

2.00

 

5.39

 

3.82

 

Diluted

 

3.09

 

1.97

 

5.31

 

3.76

 

 

The unaudited pro forma information 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 if the companies had been combined during the periods presented, nor is it intended to be indicative of the results of operations that may be achieved by ConocoPhillips in the future.

 

The pro forma adjustments include estimates and assumptions based on currently available information. Management believes the estimates and assumptions are reasonable, and the significant effects of the transactions are properly reflected. However, actual results may differ materially from this pro forma financial information.

 

Note 5—Restructuring

 

As a result of the acquisition of Burlington Resources Inc., we implemented a restructuring program in March 2006 to capture the synergies of combining the two companies. Under this program, which is expected to be completed by the end of March 2008, we recorded accruals totaling $174 million for employee severance payments, site closings, incremental pension benefit costs associated with the workforce reductions, and employee relocations. Approximately 500 positions have been identified for elimination, most of which are in the United States. Of the total accrual, $169 million is reflected in the Burlington Resources purchase price allocation as an assumed liability, and $5 million ($3 million after-tax) related to ConocoPhillips is reflected in selling, general and administrative expenses. Included in the total accruals of $174 million is $12 million related to pension benefits to be paid in conjunction with other retirement benefits over a number of future years. Benefit payments of $71 million related to the non-pension accrual of $162 million were made through June 2006, resulting in an ending liability balance of $91 million. Of this amount, $54 million is expected to be extinguished within one year.

 

9



 

Note 6—Variable Interest Entities (VIEs)

 

In June 2006, ConocoPhillips acquired a 24 percent interest in West2East Pipeline LLC, a company holding direct interest in Rockies Express Pipeline LLC. Rockies Express plans to construct a 1,633-mile natural gas pipeline from the Cheyenne Hub in Weld County, Colorado, to the Clarington Hub in eastern Ohio. We determined Rockies Express is a VIE because a third party other than ConocoPhillips and our partners holds a significant voting interest in the company until project completion. We currently participate in the management committee of Rockies Express as a non-voting member. We determined we were not the primary beneficiary of Rockies Express. We use the equity method of accounting for our investment in West2East Pipeline. At June 30, 2006, we had made no capital investment in West2East Pipeline.

 

In 2005, ConocoPhillips and OAO LUKOIL (LUKOIL) created the OOO Naryanmarneftegaz (NMNG) joint venture to develop resources in the Timan-Pechora region of Russia. We determined NMNG is a VIE because we and our related party, LUKOIL, have disproportionate interests. We have a 30 percent ownership interest with a 50 percent governance interest in the joint venture. We also determined we are not the primary beneficiary of the VIE. At June 30, 2006, the book value of our investment in the venture was $758 million.

 

Note 7—Inventories

 

Inventories consisted of the following:

 

 

 

Millions of Dollars

 

 

 

June 30

 

December 31

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Crude oil and petroleum products

 

$

5,690

 

3,183

 

Materials, supplies and other

 

745

 

541

 

 

 

$

6,435

 

3,724

 

 

Inventories valued on the last-in, first-out (LIFO) basis totaled $5,367 million and $3,019 million at June 30, 2006, and December 31, 2005, respectively. The remainder of our inventories is valued under various methods, including first-in, first-out and weighted average. The excess of current replacement cost over LIFO cost of inventories amounted to $5,601 million and $3,958 million at June 30, 2006, and December 31, 2005, respectively.

 

Note 8—Investments and Long-Term Receivables

 

LUKOIL

We increased our ownership interest in LUKOIL to 18.0 percent at June 30, 2006, from 17.1 percent at March 31, 2006. We base our ownership interest calculation on the total shares issued by LUKOIL, which was 850.6 million shares, based on latest available public data. We have not reduced the shares-issued amount for shares held by LUKOIL subsidiaries classified as “treasury shares,” pending final determination of whether these “treasury shares” should be classified as outstanding when determining our equity-method ownership interest in LUKOIL. If these shares were excluded from the denominator of our ownership calculation, it would increase our ownership interest by approximately 0.5 percent, based on latest available public data.

 

10



 

At June 30, 2006, the book value of our ordinary share investment in LUKOIL was $7,324 million. Our share of the net assets of LUKOIL was estimated to be $5,380 million. This basis difference of $1,944 million is primarily being amortized on a unit-of-production basis. On June 30, 2006, the closing price of LUKOIL shares on the London Stock Exchange was $83.20 per share, making the aggregate total market value of our LUKOIL investment $12,737 million.

 

Loans to Affiliated Companies

As part of our normal ongoing business operations and consistent with normal industry practice, we invest and enter into numerous agreements with other parties to pursue business opportunities, which share costs and apportion risks among the parties as governed by the agreements. Included in such activity are loans made to certain affiliated companies. Significant loans to affiliated companies at June 30, 2006, include the following:

 

                  $357 million in loan financing, including accrued interest, to Freeport LNG for the construction of a liquefied natural gas (LNG) regasification facility. We expect to provide loan financing of approximately $630 million for the construction of the facility.

 

                  $123 million in loan financing, including accrued interest, to Varandey Terminal Company associated with the costs to expand an existing crude oil terminal operated by LUKOIL. Based on the current estimate from the operator, we assess our total obligation for the terminal expansion to be approximately $345 million at current exchange rates.

 

                  $218 million of project financing, including accrued interest, to Qatargas 3, an integrated project to produce and liquefy natural gas from Qatar’s North field. Our maximum exposure to this financing structure is $1.2 billion.

 

Note 9—Properties, Plants and Equipment

 

Properties, plants and equipment included the following:

 

 

 

Millions of Dollars

 

 

 

June 30, 2006

 

December 31, 2005

 

 

 

Gross
PP&E

 

Accum.
DD&A

 

Net
PP&E

 

Gross
PP&E

 

Accum.
DD&A

 

Net
PP&E

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exploration and Production (E&P)

 

$

87,796

 

19,374

 

68,422

 

53,907

 

16,200

 

37,707

 

Midstream

 

327

 

143

 

184

 

322

 

128

 

194

 

Refining and Marketing (R&M)

 

22,912

 

5,214

 

17,698

 

20,046

 

4,777

 

15,269

 

LUKOIL Investment

 

 

 

 

 

 

 

Chemicals

 

 

 

 

 

 

 

Emerging Businesses

 

915

 

76

 

839

 

865

 

61

 

804

 

Corporate and Other

 

1,273

 

496

 

777

 

1,192

 

497

 

695

 

 

 

$

113,223

 

25,303

 

87,920

 

76,332

 

21,663

 

54,669

 

 

11



 

Suspended Wells

The following table reflects the net changes in suspended exploratory well costs during the first six months of 2006:

 

 

 

Millions of Dollars

 

 

 

Six Months Ended
June 30, 2006

 

 

 

 

 

Beginning balance at January 1

 

$

339

 

Additions pending the determination of proved reserves

 

119

 

Reclassifications to proved properties

 

(8

)

Charged to dry hole expense

 

(3

)

Ending balance at June 30

 

$

447

 

 

The following table provides an aging of suspended well balances at June 30, 2006, and December 31, 2005:

 

 

 

Millions of Dollars

 

 

 

June 30

 

December 31

 

 

 

2006

 

2005

 

Exploratory well costs capitalized for a period of one year or less

 

$

255

 

183

 

Exploratory well costs capitalized for a period greater than one year

 

192

 

156

 

Ending balance

 

$

447

 

339

 

Number of projects with exploratory well costs capitalized for a period greater than one year

 

16

 

15

 

 

The following table provides a further aging of those exploratory well costs that have been capitalized for more than one year since the completion of drilling, as of June 30, 2006:

 

 

 

Millions of Dollars

 

 

 

Suspended Since

 

Project

 

Total

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Alpine satellite—Alaska (1)

 

$

21

 

 

 

 

21

 

 

Kashagan—Republic of Kazakhstan (2)

 

18

 

 

 

9

 

 

9

 

Kairan—Republic of Kazakhstan (2)

 

11

 

 

11

 

 

 

 

Aktote—Republic of Kazakhstan (3)

 

19

 

 

7

 

12

 

 

 

Gumusut—Malaysia (3)

 

30

 

6

 

11

 

13

 

 

 

Malikai—Malaysia (2)

 

10

 

 

10

 

 

 

 

Plataforma Deltana—Venezuela (3)

 

21

 

6

 

15

 

 

 

 

Hejre—Denmark (3)

 

22

 

14

 

 

 

 

8

 

Eight projects of less than $10 million each (2)(3)

 

40

 

11

 

1

 

19

 

9

 

 

Total of 16 projects

 

$

192

 

37

 

55

 

53

 

30

 

17

 

(1)       Development decisions pending infrastructure west of Alpine and construction authorization.

 

(2)       Additional appraisal wells planned.

 

(3)       Appraisal drilling complete; costs being incurred to assess development.

 

 

12



 

Note 10—Goodwill

 

Changes in the carrying amount of goodwill were as follows:

 

 

 

Millions of Dollars

 

 

 

E&P

 

R&M

 

Total

 

 

 

 

 

 

 

 

 

Balance at December 31, 2005

 

$

11,423

 

3,900

 

15,323

 

Acquired (Burlington Resources)

 

16,663

 

 

16,663

 

Acquired (Wilhelmshaven refinery)

 

 

225

 

225

 

Tax and other adjustments

 

(91

)

 

(91

)

Balance at June 30, 2006

 

$

27,995

 

4,125

*

32,120

 

*Consists of two reporting units: Worldwide Refining ($2,225) and Worldwide Marketing ($1,900).

 

 

On March 31, 2006, we acquired Burlington Resources Inc., an independent exploration and production company. As a result of this acquisition, we recorded goodwill of $16,663 million, all of which was aligned with our E&P segment. See Note 4—Acquisition of Burlington Resources Inc., for additional information.

 

On February 28, 2006, we acquired the Wilhelmshaven refinery, located in Wilhelmshaven, Germany. The purchase included the refinery, a marine terminal, rail and truck loading facilities and a tank farm, as well as another entity that provides commercial and administrative support to the refinery. As a result of this acquisition, we recorded goodwill of $225 million, all of which was aligned with our R&M segment. The allocation of the purchase price to specific assets and liabilities was based on a combination of an outside appraiser’s valuation for fixed assets and an internal estimate of the fair values of the various other assets and liabilities acquired. We are finalizing the fair value of certain liabilities, including the pension liability. Over the next few months, the company expects to finalize the allocation of the purchase price to the specific assets and liabilities acquired and the calculations of deferred tax liabilities and goodwill.

 

Note 11—Property Impairments

 

In the second quarter of 2006, we recorded a property impairment of $40 million as a result of our decision to withdraw an application for a license under the federal Deepwater Port Act, associated with a proposed LNG regasification terminal located offshore Alabama. We also impaired properties located offshore Australia due to increased accrued dismantlement and removal costs. In the second-quarter and six-month periods of 2005, we recorded property impairments associated with planned asset dispositions in our Midstream, E&P and R&M segments. The property impairments by segment were:

 

 

 

Millions of Dollars

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

E&P

 

$

50

 

1

 

50

 

1

 

Midstream

 

 

9

 

 

30

 

R&M

 

 

(1

)

 

 

 

 

$

50

 

9

 

50

 

31

 

 

13



 

Note 12—Debt

 

Our balance sheet debt at June 30, 2006, was $29.5 billion, compared with a debt balance of $12.5 billion at year-end 2005 and $32.2 billion at March 31, 2006. The increase in the first quarter of 2006 reflects debt issuances of approximately $15.3 billion during the first quarter related to the acquisition of Burlington Resources Inc., the assumption of $3.9 billion of Burlington Resources debt and the recognition of an incremental debt increase of $406 million to record Burlington Resources debt at its fair value. These increases in the first quarter of 2006 were partly offset by debt repayments during the second quarter of 2006.

 

At June 30, 2006, we had two revolving credit facilities totaling $5 billion, and a $2.5 billion five-year revolving credit facility we entered into in April 2006. These facilities may be used as direct bank borrowings, as support for the ConocoPhillips $7.5 billion commercial paper program, as support for the ConocoPhillips Qatar Funding Ltd. $1.5 billion commercial paper program, or as support for issuances of letters of credit totaling up to $750 million. The facilities are broadly syndicated among financial institutions and do not contain any material adverse change provisions or any covenants requiring maintenance of specified financial ratios or ratings. The credit facilities contain a cross-default provision relating to our, or any of our consolidated subsidiaries’, failure to pay principal or interest on other debt obligations of $200 million or more. At June 30, 2006, and December 31, 2005, we had no outstanding borrowings under these credit facilities, but $62 million in letters of credit had been issued at both dates. Under both commercial paper programs there was $4,052 million of commercial paper outstanding at June 30, 2006, compared with $32 million at December 31, 2005. The commercial paper increase resulted from efforts to reduce the bridge facilities discussed below.

 

In March 2006, we closed on two $7.5 billion bridge facilities with a group of five banks to help fund the Burlington Resources acquisition. These bridge financings were both 364-day loan facilities with pricing and terms similar to our existing revolving credit facilities. These facilities were fully drawn in the funding of the acquisition.

 

In April 2006, we entered into and funded a $5 billion five-year term loan, closed on the previously mentioned $2.5 billion five-year revolving credit facility, increased the ConocoPhillips commercial paper program to $7.5 billion, and issued $3 billion of debt securities. The term loan and new credit facility were executed with a group of 36 banks and have terms and pricing provisions similar to our other existing revolving credit facilities. The proceeds from the term loan, debt securities and issuances of commercial paper, together with our cash balances and cash provided from operations, allowed us to reduce the balance outstanding under the $15 billion bridge facilities to $1 billion at June 30, 2006. The remaining balance under the bridge facilities had been repaid by August 1, 2006.

 

The $3 billion of debt securities were issued under a new shelf registration statement filed with the U.S. Securities and Exchange Commission in early April 2006, allowing for the issuance of various types of debt and equity securities. Of this issuance, $1 billion of Floating Rate Notes due April 11, 2007, were issued by ConocoPhillips, and $1.25 billion of Floating Rate Notes due April 9, 2009, and $750 million of 5.50% Notes due 2013, were issued by ConocoPhillips Australia Funding Company, a wholly owned subsidiary. ConocoPhillips guarantees the obligations of ConocoPhillips Australia Funding Company.

 

14



 

Burlington Resources debt assumed in the acquisition, including increases to record Burlington Resources debt at fair value (see Note 4—Acquisition of Burlington Resources Inc., for additional information about the acquisition), had the following balances at the March 31, 2006, acquisition date:

 

 

 

Millions of
Dollars

 

 

 

 

 

5.60% Notes due 2006

 

$

500

 

6.60% Notes due2007 (1)

 

129

 

5.70% Notes due 2007

 

350

 

9 7/8% Debentures due 2010

 

150

 

6.50% Notes due 2011

 

500

 

6.68% Notes due 2011

 

400

 

6.40% Notes due 2011

 

178

 

7 5/8% Debentures due 2013

 

100

 

9 1/8% Debentures due 2021

 

150

 

7.65% Debentures due 2023

 

88

 

8.20% Debentures due 2025

 

150

 

6 7/8% Debentures due 2026

 

67

 

7 3/8% Debentures due 2029

 

92

 

7.20% Notes due 2031

 

575

 

7.40% Notes due 2031

 

500

 

Capital lease

 

4

 

Unamortized premiums and discounts

 

406

 

Total debt assumed

 

4,339

 

Notes payable and long-term debt due within one year

 

(1,009

)

Long-term debt assumed

 

$

3,330

 

(1) Notes are denominated in Canadian dollars and reported in U.S. dollars.

 

 

 

 

Maturities as of March 31, 2006, on Burlington Resources debt assumed, inclusive of net unamortized premiums and discounts, for the remainder of 2006 through 2010 were:  $650 million, $377 million, $27 million, $25 million and $175 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 5.64 percent.

 

In May 2006, we redeemed our $240 million 7.625% Notes upon their maturity and redeemed our $129 million of 6.60% Notes due in 2007 at a premium of $4 million, plus accrued interest.

 

Note 13—Contingencies and Commitments

 

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 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

 

15



 

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 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.

 

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 for 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 June 30, 2006, our balance sheet included a total environmental accrual of $982 million, compared with $989 million at December 31, 2005. 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.

 

16



 

Legal Proceedings—We apply our knowledge, experience, and professional judgment to the specific characteristics of our cases, employing a litigation management process to manage and monitor the legal proceedings against us. Our process facilitates the early evaluation and quantification of potential exposures in individual cases. This process also enables us to track those cases which have been scheduled for trial, as well as the pace of settlement discussions in individual matters. Based on our professional judgment and experience in using these litigation management tools and available information about current developments in all our cases, we believe there is only a remote likelihood 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.

 

Other Contingencies—We have contingent liabilities resulting from throughput agreements with pipeline and processing companies not associated with financing arrangements. 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. In addition, at June 30, 2006, we had performance obligations secured by letters of credit of $1,194 million (of which $62 million was issued under the provisions of our revolving credit facilities, and the remainder was issued as direct bank letters of credit) and various purchase commitments for materials, supplies, services and items of permanent investment incident to the ordinary conduct of business.

 

Note 14—Guarantees

 

At June 30, 2006, we were liable for certain contingent obligations under various contractual arrangements as described below. We recognize a liability, at inception, for the fair value of our obligation as a guarantor for newly issued or modified guarantees. 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

 

                  In June 2006, we issued a guarantee for 24 percent of the $2.0 billion credit facilities of Rockies Express Pipeline LLC, which will be used to construct a natural gas pipeline across a portion of the United States. The maximum potential amount of future payments to third-party lenders under the guarantee is estimated to be $480 million, which could become payable if the credit facility is fully utilized and Rockies Express Pipeline LLC fails to meet its obligations under the credit agreement. It is anticipated that construction completion will be achieved mid-2009, and refinancing will take place at that time, making the debt non-recourse. At June 30, 2006, the carrying value of the guarantee to third-party lenders was $11 million. For additional information, see Note 6—Variable Interest Entities (VIEs).

 

                  In December 2005, we issued a construction completion guarantee for 30 percent of the $4.0 billion in loan facilities of Qatargas 3, which will be used to construct an LNG train in Qatar. Of the $4.0 billion in loan facilities, ConocoPhillips has committed to provide $1.2 billion. The maximum potential amount of future payments to third-party lenders under the guarantee is estimated to be $850 million, which could become payable if the full debt financing is utilized and completion of the Qatargas 3 project is not achieved. The project financing will be non-recourse upon certified completion, which is expected by December 31, 2009. At June 30, 2006, the carrying value of the guarantee to the third-party lenders was $11 million. For additional information, see Note 8—Investments and Long-Term Receivables.

 

17



 

Guarantees of Joint-Venture Debt

 

                  At June 30, 2006, we had guarantees outstanding for our portion of joint-venture debt obligations, which have terms of up to 12 years. The maximum potential amount of future payments under the guarantees is approximately $160 million. Payment would be required if a joint venture defaults on its debt obligations.

 

Other Guarantees

 

                  The Merey Sweeny, L.P. (MSLP) joint-venture project agreement requires the partners in the venture to pay cash calls to cover operating expenses in the event the venture does not have enough cash to cover operating expenses after setting aside the amount required for debt service over the next 18 years. Although there is no maximum limit stated in the agreement, the intent is to cover short-term cash deficiencies should they occur. Our maximum potential future payments under the agreement are currently estimated to be $100 million, assuming such a shortfall exists at some point in the future due to an extended operational disruption.

 

                  In February 2003, we entered into two agreements establishing separate guarantee facilities of $50 million each for two LNG ships. 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. To the extent we receive any such payments, our actual gross payments over the 20 years could exceed that amount. 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.

 

                  We have other guarantees with maximum future potential payment amounts totaling $260  million, which consist primarily of dealer and jobber loan guarantees to support our marketing business, a guarantee to fund the short-term cash liquidity deficits of a lubricants joint venture, three small construction completion guarantees, a guarantee supporting a lease assignment on a corporate aircraft, a guarantee associated with a pending lawsuit and guarantees of the lease payment obligations of a joint venture. The carrying amount recorded for these other guarantees, as of June 30, 2006, was $50 million. These guarantees generally extend up to 15 years and payment would be required only if the dealer, jobber or lessee goes into default, if the lubricants joint venture has cash liquidity issues, if construction projects are not completed, if guaranteed parties default on lease payments, or if an adverse decision occurs in the lawsuit.

 

Indemnifications

 

Over the years, we have entered into various agreements to sell ownership interests in certain corporations and joint ventures and sold several assets, including 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, 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 June 30, 2006, was $456 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 the liability is essentially relieved or amortize the liability over an appropriate time period as the fair value of our indemnification exposure declines. Although it is reasonably possible future payments may exceed amounts recorded, due to the nature of the indemnifications, it is not possible to

 

18



 

make a reasonable estimate of the maximum potential amount of future payments. Included in the carrying amount recorded were $334 million of environmental accruals for known contamination that is included in asset retirement obligations and accrued environmental costs at June 30, 2006. For additional information about environmental liabilities, see Note 13—Contingencies and Commitments.

 

Note 15—Financial Instruments and Derivative Contracts

 

Derivative assets and liabilities were:

 

 

 

Millions of Dollars

 

 

 

June 30

 

December 31

 

 

 

2006

 

2005

 

Derivative Assets

 

 

 

 

 

Current

 

$

606

 

674

 

Long-term

 

156

 

193

 

 

 

$

762

 

867

 

Derivative Liabilities

 

 

 

 

 

Current

 

$

778

 

1,002

 

Long-term

 

260

 

443

 

 

 

$

1,038

 

1,445

 

 

These derivative assets and liabilities appear as prepaid expenses and other current assets, other assets, other accruals, or other liabilities and deferred credits on the balance sheet.

 

Note 16—Comprehensive Income

 

ConocoPhillips’ comprehensive income was as follows:

 

 

 

Millions of Dollars

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

5,186

 

3,138

 

8,477

 

6,050

 

After-tax changes in:

 

 

 

 

 

 

 

 

 

Minimum pension liability adjustment

 

 

 

 

(1

)

Foreign currency translation adjustments

 

767

 

(336

)

938

 

(592

)

Unrealized loss on securities

 

 

 

 

(1

)

Hedging activities

 

6

 

5

 

7

 

5

 

Comprehensive income

 

$

5,959

 

2,807

 

9,422

 

5,461

 

 

19



 

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

 

 

 

Millions of Dollars

 

 

 

June 30
2006

 

December 31
2005

 

 

 

 

 

 

 

Minimum pension liability adjustment

 

$

(123

)

(123

)

Foreign currency translation adjustments

 

1,883

 

945

 

Deferred net hedging loss

 

(1

)

(8

)

Accumulated other comprehensive income

 

$

1,759

 

814

 

 

Note 17—Supplemental Cash Flow Information

 

 

 

Millions of Dollars

 

 

 

Six Months Ended
June 30

 

 

 

2006

 

2005

 

Non-Cash Investing and Financing Activities

 

 

 

 

 

Acquisition of Burlington Resources Inc. by issuance of stock

 

$

16,343

 

 

Investment in properties, plants and equipment of businesses through the assumption of non-cash liabilities

 

 

261

 

Fair market value of properties, plants and equipment received in a nonmonetary exchange
transaction

 

 

138

 

Cash Payments

 

 

 

 

 

Interest

 

$

327

 

269

 

Income taxes

 

5,835

 

3,681

 

 

Note 18—Employee Benefit Plans

 

Pension and Postretirement Plans

 

 

 

Millions of Dollars

 

 

 

Pension Benefits

 

Other Benefits

 

Three Months Ended

 

June 30

 

June 30

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

U.S.

 

Int’l.

 

U.S.

 

Int’l.

 

 

 

 

 

Components of Net Periodic Benefit Cost

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

44

 

22

 

38

 

19

 

3

 

5

 

Interest cost

 

53

 

34

 

44

 

32

 

12

 

12

 

Expected return on plan assets

 

(43

)

(31

)

(32

)

(28

)

 

 

Amortization of prior service cost

 

3

 

2

 

1

 

2

 

5

 

5

 

Recognized net actuarial loss (gain)

 

22

 

10

 

13

 

8

 

(4

)

(1

)

Net periodic benefit costs

 

$

79

 

37

 

64

 

33

 

16

 

21

 

 

20



 

 

 

Millions of Dollars

 

 

 

Pension Benefits

 

Other Benefits

 

Six Months Ended

 

June 30

 

June 30

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

U.S.

 

Int’l.

 

U.S.

 

Int’l.

 

 

 

 

 

Components of Net Periodic Benefit Cost

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

86

 

43

 

76

 

37

 

7

 

10

 

Interest cost

 

103

 

65

 

87

 

64

 

23

 

25

 

Expected return on plan assets

 

(83

)

(60

)

(63

)

(56

)

 

 

Amortization of prior service cost

 

5

 

4

 

2

 

4

 

10

 

10

 

Recognized net actuarial loss (gain)

 

44

 

20

 

27

 

17

 

(8

)

(2

)

Net periodic benefit costs

 

$

155

 

72

 

129

 

66

 

32

 

43

 

 

During the first six months of 2006, we contributed $215 million to our domestic qualified and non-qualified benefit plans and $59 million to international qualified and non-qualified benefit plans. At the end of 2005, we estimated that, during 2006, we would contribute approximately $415 million to our domestic qualified and non-qualified benefit plans and $115 million to our international benefit plans. We presently expect 2006 contributions to the heritage ConocoPhillips plans to be $410 million for domestic and $120 million for international. For the heritage Burlington Resources plans, we expect to contribute $20 million during the period April through December 2006.

 

The projected benefit obligation and asset value of the pension plans acquired from Burlington Resources were $303 million and $246 million, respectively. The accumulated postretirement benefit obligation of the postretirement medical plans acquired from Burlington Resources was $36 million.

 

Note 19—Related Party Transactions

 

Significant transactions with related parties were:

 

 

 

Millions of Dollars

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

2006

 

2005*

 

2006

 

2005*

 

 

 

 

 

 

 

 

 

 

 

Operating revenues (a)

 

$

2,418

 

1,833

 

4,186

 

3,478

 

Purchases (b)

 

1,731

 

1,619

 

3,225

 

2,939

 

Operating expenses and selling, general and administrative expenses (c)

 

101

 

90

 

182

 

188

 

Net interest income (d)

 

16

 

9

 

31

 

19

 

*Certain amounts reclassified to conform to current year presentation.

 

(a)                                  We sell natural gas to Duke Energy Field Services, LLC (DEFS) and crude oil to the Malaysian Refining Company Sdn. Bhd (MRC), among others, for processing and marketing. Natural gas liquids, solvents and petrochemical feedstocks are sold to Chevron Phillips Chemical Company LLC (CPChem), gas oil and hydrogen feedstocks are sold to Excel Paralubes, and refined products are sold primarily to CFJ Properties and Getty Petroleum Marketing, Inc. (a subsidiary of LUKOIL). 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.

 

21



 

(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 MRC. We also pay fees to various pipeline equity companies for transporting finished refined products and a price upgrade to MSLP for heavy crude processing. We purchase base oils and fuel products from Excel Paralubes for use in our refinery and specialty businesses.

 

(c)                                  We pay processing fees to various affiliates. Additionally, we pay crude oil transportation fees to pipeline equity companies.

 

(d)                                 We pay and/or receive interest to/from various affiliates, including the Phillips 66 Capital II trust. See Note 8—Investments and Long-Term Receivables, for additional information on loans to affiliated companies.

 

Elimination amounts related to our equity percentage share of profit or loss on the above transactions were not material.

 

Note 20—Segment Disclosures and Related Information

 

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

 

1)              E&P—This segment primarily explores for, produces and markets crude oil, natural gas and natural gas liquids on a worldwide basis. At June 30, 2006, our E&P operations were producing in the United States, Norway, the United Kingdom, the Netherlands, Canada, Nigeria, Venezuela, Ecuador, Argentina, offshore Timor Leste in the Timor Sea, Australia, China, Indonesia, Algeria, Libya, 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 and Trinidad. The Midstream segment primarily consists of our equity investment in DEFS. Through June 30, 2005, our equity ownership in DEFS was 30.3 percent. In July 2005, we increased our ownership interest to 50 percent.

 

3)              R&M—This segment purchases, refines, markets and transports crude oil and petroleum products, mainly in the United States, Europe and Asia. At June 30, 2006, we owned 12 refineries in the United States, one in the United Kingdom, one in Ireland, one in Germany, 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)              LUKOIL Investment—This segment represents our investment in the ordinary shares of LUKOIL, an international, integrated oil and gas company headquartered in Russia. At June 30, 2006, our ownership interest was 18.0 percent.

 

5)              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.

 

22



 

6)              Emerging Businesses—This segment includes the development of new businesses outside our traditional operations. These activities include gas-to-liquids (GTL) operations, power generation, technology solutions such as sulfur removal technologies, and emerging technologies, such as renewable fuels and emission management technologies.

 

Corporate and Other includes general corporate overhead, interest income and expense, discontinued operations, certain eliminations, acquisition-related costs, 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 at prices that approximate market.

 

23



 

Analysis of Results by Operating Segment

 

 

 

Millions of Dollars

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

2006

 

2005

 

2006

 

2005

 

Sales and Other Operating Revenues

 

 

 

 

 

 

 

 

 

E&P

 

 

 

 

 

 

 

 

 

United States

 

$

8,798

 

7,493

 

18,117

 

14,525

 

International

 

7,080

 

4,331

 

14,524

 

9,238

 

Intersegment eliminations-U.S.

 

(1,517

)

(979

)

(2,722

)

(1,891

)

Intersegment eliminations-international

 

(2,121

)

(995

)

(3,375

)

(1,992

)

E&P

 

12,240

 

9,850

 

26,544

 

19,880

 

Midstream

 

 

 

 

 

 

 

 

 

Total sales

 

1,179

 

850

 

2,200

 

1,871

 

Intersegment eliminations

 

(247

)

(197

)

(531

)

(427

)

Midstream

 

932

 

653

 

1,669

 

1,444

 

R&M

 

 

 

 

 

 

 

 

 

United States

 

24,900

 

24,021

 

48,441

 

43,976

 

International

 

9,356

 

7,296

 

17,712

 

14,155

 

Intersegment eliminations-U.S.

 

(201

)

(150

)

(401

)

(237

)

Intersegment eliminations-international

 

(5

)

(4

)

(9

)

(6

)

R&M

 

34,050

 

31,163

 

65,743

 

57,888

 

LUKOIL Investment

 

 

 

 

 

Chemicals

 

4

 

4

 

7

 

7

 

Emerging Businesses*

 

 

 

 

 

 

 

 

 

Total Sales

 

135

 

142

 

316

 

286

 

Intersegment eliminations

 

(104

)

(101

)

(228

)

(189

)

Emerging Businesses

 

31

 

41

 

88

 

97

 

Corporate and Other

 

4

 

4

 

4

 

5

 

Other Adjustments*

 

(112

)

93

 

 

118

 

Consolidated sales and other operating revenues

 

$

47,149

 

41,808

 

94,055

 

79,439

 

*       Sales and other operating revenues for the Emerging Businesses segment have been restated to reflect intersegment eliminations on sales from the Immingham power plant (Emerging Businesses segment) to the Humber refinery (R&M segment). Since these amounts were not material to the consolidated income statement, the “other adjustments” line above is required to reconcile the restated Emerging Businesses revenues to the consolidated income statement.

 

 

24



 

 

 

Millions of Dollars

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

2006

 

2005

 

2006

 

2005

 

Net Income (Loss)

 

 

 

 

 

 

 

 

 

E&P

 

 

 

 

 

 

 

 

 

United States

 

$

1,300

 

966

 

2,481

 

1,858

 

International

 

2,004

 

963

 

3,376

 

1,858

 

Total E&P

 

3,304

 

1,929

 

5,857

 

3,716

 

Midstream

 

108

 

68

 

218

 

453

 

R&M

 

 

 

 

 

 

 

 

 

United States

 

1,433

 

936

 

1,730

 

1,506

 

International

 

275

 

174

 

368

 

304

 

Total R&M

 

1,708

 

1,110

 

2,098

 

1,810

 

LUKOIL Investment

 

387

 

148

 

636

 

258

 

Chemicals

 

103

 

63

 

252

 

196

 

Emerging Businesses

 

(12

)

(8

)

(4

)

(16

)

Corporate and Other

 

(412

)

(172

)

(580

)

(367

)

Consolidated net income

 

$

5,186

 

3,138

 

8,477

 

6,050

 

 

 

 

Millions of Dollars

 

 

 

June 30

 

December 31

 

 

 

2006

 

2005

 

Total Assets

 

 

 

 

 

E&P

 

 

 

 

 

United States

 

$

35,486

 

18,434

 

International

 

45,789

 

31,662

 

Goodwill

 

27,995

 

11,423

 

Total E&P

 

109,270

 

61,519

 

Midstream

 

2,277

 

2,109

 

R&M

 

 

 

 

 

United States

 

23,569

 

20,693

 

International

 

9,353

 

6,096

 

Goodwill

 

4,125

 

3,900

 

Total R&M

 

37,047

 

30,689

 

LUKOIL Investment

 

7,506

 

5,549

 

Chemicals

 

2,345

 

2,324

 

Emerging Businesses

 

887

 

858

 

Corporate and Other

 

2,585

 

3,951

 

Consolidated total assets

 

$

161,917

 

106,999

 

 

Note 21—Income Taxes

 

Our effective tax rate for the second quarter and first six months of 2006 was 40 percent and 41 percent, respectively, compared with 42 percent for the same two periods of 2005. The change in the effective tax rate for the second quarter and six months of 2006, versus the same periods of 2005, was due to the impact of reductions in state and international tax rates in 2006, including a favorable $391 million adjustment related to recently enacted tax law changes in Canada, partly offset by a higher proportion of income in

 

25



 

higher-tax-rate jurisdictions. In addition, the first six months of 2005 included a benefit from the utilization of capital loss carryforwards that previously had a full valuation allowance in the restructuring of ConocoPhillips’ ownership in Duke Energy Field Services, LLC. The effective tax rate in excess of the domestic federal statutory rate of 35 percent was primarily due to foreign taxes.

 

On July 19, 2006, the United Kingdom enacted an increase in the rate of supplementary corporation tax applicable to U.K. upstream activity from 10 percent to 20 percent, with retroactive effect from January 1, 2006. This resulted in the U.K. upstream corporation tax rate increasing from 40 percent to 50 percent. The rate of U.K. petroleum revenue tax was unchanged. The earnings impact of these changes will be reflected in our financial statements in the third quarter of 2006 when we expect to record a charge of about $400 million, comprised of approximately $275 million for revaluing the December 31, 2005, deferred tax liability, and approximately $125 million to adjust tax expense to reflect the new rate from January 1, 2006, through June 30, 2006.

 

Note 22—New Accounting Standards

 

In June 2006, the FASB issued FASB Interpretation No.&nb