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ConocoPhillips 10-Q Summary: Period Ended September 30, 2002

Business Context and Reporting Period

This quarterly report covers the three and nine months ended September 30, 2002. The period is defined by the August 30, 2002, merger of Conoco Inc. and Phillips Petroleum Company, creating ConocoPhillips. Phillips was designated the accounting acquirer. Consequently, the third-quarter results include two months of Phillips operations and one month of combined ConocoPhillips operations. The nine-month results include eight months of Phillips and one month of combined operations. The company is currently divesting assets mandated by the U.S. Federal Trade Commission (FTC) as a condition of the merger.

Key Financial Metrics

Balance Sheet Highlights (Sep 30, 2002 vs. Dec 31, 2001):

• Total Assets: $77,484 million (up from $35,217 million).
• Total Liabilities: $46,492 million (up from $20,222 million).
• Long-term Debt: $17,850 million (up from $8,645 million).
• Cash and Cash Equivalents: $517 million (up from $142 million).
• Goodwill: $14,464 million (up from $2,281 million).

Material Changes vs. Prior Period

The financial results are not directly comparable to the prior year due to the merger and the acquisition of Tosco Corporation in September 2001. Key drivers of change include:

• Revenue Surge: Revenues increased 158% in the quarter and 121% year-to-date, driven primarily by the Tosco acquisition and the inclusion of Conoco operations.
• Net Loss: The company reported a net loss of $116 million for the quarter, compared to net income of $364 million in the prior year. This was primarily due to $469 million in merger-related special items, including a $246 million write-off of in-process research and development (R&D) and $335 million in restructuring charges.
• Expense Increases: Purchased crude oil and products rose 208% in the quarter. Production and operating expenses increased 175%, reflecting the merger and the R&D write-off.
• Effective Tax Rate: The effective tax rate was 116% for the quarter and 81% for the nine months, significantly higher than the prior year's 48% and 50%, largely due to the non-deductible R&D write-off.

Guidance, Outlook, and Risks

Management Commentary and Outlook:

• Production: Worldwide production for the full year 2002 is anticipated to be approximately 1.1 million barrels-of-oil-equivalent per day. Fourth-quarter production is expected to be about 1.62 million barrels per day, impacted by a recent earthquake in Alaska that shut down the Trans-Alaska Pipeline System (TAPS) for three days.
• Divestitures: The company is proceeding with FTC-mandated divestitures, including the Woods Cross refinery and Conoco's Commerce City refinery. A sale of propane terminal assets is scheduled to close in the fourth quarter.
• Accounting Changes: Beginning January 1, 2003, the company will expense stock options under FASB Statement No. 123. Pro forma impact for 2001 would have been $52 million after-tax.
• Restructuring: A program to eliminate approximately 2,400 positions is underway, expected to be completed by February 2004.

Risks and Contingencies:

• Commodity Prices: Results remain exposed to volatility in crude oil, natural gas, and refining margins.
• Environmental Liabilities: Total environmental accruals were $826 million at September 30, 2002. The company faces potential liabilities under CERCLA and RCRA at approximately 55 sites.
• Legal Proceedings: Various lawsuits are pending, including a CERCLA cost recovery action in Colorado and penalties related to Clean Air Act violations.
• Integration Risks: Risks associated with realizing expected synergies and cost savings from the Conoco-Phillips merger.

Investor Verification Checklist

• Merger Accounting: Verify the final allocation of the $16 billion purchase price for Conoco, specifically the valuation of goodwill and deferred tax liabilities.
• Special Items: Confirm the non-recurring nature of the $469 million in merger-related charges (R&D write-off, restructuring) to assess underlying operating performance.
• Divestiture Progress: Monitor the completion of FTC-mandated asset sales and the associated impairment charges ($113 million pre-tax recorded for Phillips assets).
• Debt Structure: Review the $2 billion debt offering completed in October 2002 and the company's ability to manage its increased debt load ($20.5 billion total).
• Environmental Accruals: Assess the adequacy of the $826 million environmental reserve given the joint and several liability risks at Superfund sites.
• Alaska Production: Track the impact of the TAPS shutdown and subsequent repairs on fourth-quarter and full-year production volumes.