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

FORM 10-Q

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 679,926,255 shares of common stock, $.01 par value, outstanding at July 31, 2003.

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 the consolidated financial statements and notes included in ConocoPhillips’ 2002 Annual Report on Form 10-K. Certain amounts in the 2002 financial statements have been reclassified to reflect discontinued operations and to conform to ConocoPhillips’ presentation.

The financial statements reflect the August 30, 2002, merger of Conoco Inc. (Conoco) and Phillips Petroleum Company (Phillips). The transaction was accounted for using the purchase method of accounting as required by Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations.” Phillips was designated as the acquirer. Results of operations for the second quarter and first six months of 2002 reflect only Phillips’ activity.

Note 2—Changes in Accounting Principles

Effective January 1, 2003, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,” which applies to legal obligations associated with the retirement and removal of long-lived assets. SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period when it is incurred (typically when the asset is installed at the production location). When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related property, plant and equipment. Over time, the liability is accreted upward for the change in its present value each period, and the initial capitalized cost is depreciated over the useful life of the related asset.

Application of this new accounting standard resulted in an initial increase in net properties, plants and equipment of $1.2 billion and an asset retirement obligation liability increase of $1.1 billion. The cumulative effect of this change in accounting principle increased net income in the first quarter of 2003 by $145 million. The second quarter 2003 effect of adopting this accounting principle increased net income $8 million, $.01 per basic and diluted share. The effect on net income for the first six months of 2003 was an increase of $16 million, or $.02 per basic and diluted share.

We have numerous asset removal obligations that we are required to perform under law or contract once an asset is permanently taken out of service. Most of these obligations are not expected to be paid until several years, or decades, in the future and will be funded from general company resources at the time of removal. Our largest individual obligations are related to fixed-base offshore production platforms around the world and to production facilities and pipelines in Alaska.

SFAS No. 143 calls for measurements of asset retirement obligations to include, as a component of expected costs, an estimate of the price that a third party would demand, and could expect to receive, for bearing the uncertainties and unforeseeable circumstances inherent in the obligations, sometimes referred to as a market-risk premium. To date, the oil and gas industry has no examples of credit-worthy third

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parties who are willing to assume this type of risk, for a determinable price, on major oil and gas production facilities and pipelines. Therefore, because determining such a market-risk premium would be an arbitrary process, we have excluded it from our SFAS No. 143 estimates.

During the first six months of 2003, ConocoPhillips’ overall asset retirement obligation changed as follows:

The pro forma effects of the retroactive application of this change in accounting principle follows:

Also, effective January 1, 2003, we adopted SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” The adoption of SFAS No. 145 requires that gains and losses on extinguishments of debt no longer be presented as extraordinary items in the income statement. Accordingly, a loss from the extinguishment of debt of $15 million (after reduction for income taxes of $6 million), previously reported as an extraordinary item in the second quarter and six months of 2002, has been reclassified as a charge to other income with the appropriate tax benefit to provision for income taxes.

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Note 3—Merger of Conoco and Phillips

On August 30, 2002, Conoco and Phillips combined their businesses by merging with separate acquisition subsidiaries of ConocoPhillips (the merger). As a result, each company became a wholly owned subsidiary of ConocoPhillips. For accounting purposes, Phillips was treated as the acquirer of Conoco, and ConocoPhillips was treated as the successor of Phillips. Conoco’s operating results have been included in ConocoPhillips’ consolidated financial statements since the merger date.

The $16 billion purchase price attributed to Conoco for accounting purposes was based on an exchange of Conoco common shares for ConocoPhillips common shares. 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 Conoco’s assets. ConocoPhillips expects to receive the final outside appraisal of the long-lived assets during the third quarter of 2003 and conclude the fair value determination of all other Conoco assets and liabilities. Subsequent to completion of the final allocation of the purchase price and determination of the ultimate asset and liability tax bases, the deferred tax liabilities will also be finalized in the third quarter. The following table summarizes, based on a June 30, 2003, preliminary purchase price allocation, the fair values of the assets acquired and liabilities assumed as of August 30, 2002:

The allocation of the purchase price, as reflected above, has not been adjusted for the U.S. Federal Trade Commission (FTC)-mandated dispositions described in Note 4—Discontinued Operations. Goodwill, land and certain identifiable intangible assets recorded in the acquisition are not subject to amortization, but the goodwill and intangible assets will be tested periodically for impairment as required by SFAS No. 142, “Goodwill and Other Intangible Assets.”

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ConocoPhillips has not yet determined the assignment of Conoco goodwill to specific reporting units. Currently, Conoco goodwill is being reported as part of the Corporate and Other reporting segment. Included in the $12,841 million of goodwill is $4,026 million attributable to recording a net liability required under purchase accounting for deferred taxes. This and the remaining goodwill of $8,815 million will ultimately be assigned to reporting units based on the benefits received by the units from the synergies and strategic advantages of the merger. None of the goodwill is deductible for tax purposes. During the first six months of 2003, the balance of goodwill was adjusted upward by $762 million, primarily due to revisions to properties, plants and equipment, and assumed contingent liabilities.

Note 4—Discontinued Operations

During 2002 and the first six months of 2003, we disposed of, or had committed to a plan to dispose of, certain U.S. retail and wholesale marketing assets, certain U.S. refining and related assets, and exploration and production assets in the Netherlands. Certain of these planned dispositions were mandated by the FTC as a condition of the merger. For reporting purposes, these operations are classified as discontinued operations, and in Note 17—Segment Disclosures and Related Information, these operations are included in Corporate and Other.

FTC-Mandated Divestitures
In the fourth quarter of 2002, we sold our propane terminal assets at Jefferson City, Missouri, and East St. Louis, Illinois. In the second quarter of 2003 we sold:

In August 2003, we sold our Commerce City, Colorado, refinery, and related crude oil pipelines, and our Colorado Phillips-branded motor fuel marketing operations (both retail and wholesale). This completed our FTC-mandated asset dispositions.

Other Dispositions
In the fourth quarter of 2002, we committed to a plan to dispose of 3,200 marketing sites that do not fit into our long-range plans. Discussions are under way with potential buyers, and we expect to complete the sales of these assets by the end of 2003. The second quarter of 2003 included a $24 million after-tax charge for lease loss provisions expected from lease guaranteed residual value deficiencies that are being recognized as the company operates the sites until sold. The corresponding amount for the first six months of 2003 was $49 million.

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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—Subsidiary Equity Transactions

ConocoPhillips, through various affiliates, and its unaffiliated co-venturers received final approvals from the relevant authorities in June 2003 to proceed with the natural gas development phase of the Bayu-Undan project in the Timor Sea. The natural gas development phase of the project will include a pipeline from the offshore Bayu-Undan field to Darwin, Australia, and a liquefied natural gas facility, also located in Darwin. The pipeline portion of the project is owned and operated by an unincorporated joint venture, while the liquefied natural gas facility is owned and operated by Darwin LNG Pty Ltd (DLNG). Both of these entities are consolidated subsidiaries of ConocoPhillips.

In June 2003, as part of a broad Bayu-Undan ownership interest re-alignment with co-venturers, these entities issued equity and sold interests to the co-venturers (as described below), which resulted in a gain of $28 million before-tax, $25 million after-tax, recorded in the second quarter of 2003. This non-operating gain is shown in the consolidated statement of income in the line item entitled “Gain on subsidiary equity transactions.”

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DLNG—DLNG issued 118.9 million shares of stock, valued at 1 Australian dollar per share, to co-venturers for 118.9 million Australian dollars ($76.2 million U.S. dollars), reducing our ownership interest in DLNG from 100 percent to 56.72 percent. The transaction resulted in a before-tax gain of $21 million in the consolidated financial statements. Deferred income taxes were not recognized as this was an issuance of common stock and therefore not taxable.

Unincorporated Pipeline Joint Venture—The co-venturers purchased pro-rata interests in the pipeline assets held by ConocoPhillips Pipeline Australia Pty Ltd for $26.6 million U.S. dollars and contributed the purchased assets to the unincorporated joint venture, reducing our ownership interest from 100 percent to 56.72 percent. The transaction resulted in a before-tax gain of $7 million in the consolidated financial statements. A deferred tax liability of $1.3 million was recorded in connection with the transaction.

Note 6—Stock-Based Compensation

Effective January 1, 2003, ConocoPhillips adopted the fair-value accounting method of SFAS No. 123, “Accounting for Stock-Based Compensation.” Using the prospective transition method, we recognize compensation expense using the fair-value accounting method for all stock options granted or modified after December 31, 2002, whereas we continue to account for options granted prior to 2003 in accordance with Accounting Principles Board (APB) No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. The following table illustrates the effect on net income and earnings per share as if the fair-value-based method had been applied to all outstanding and unvested awards in each period.

The pro forma total stock-based employee compensation expense determined using the fair-value-based method was higher during the first six months of 2002, compared with the same period in 2003, due to the accelerated vesting of options triggered by the March 2002 shareholder approval of the merger.

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Note 7—Inventories

Inventories consisted of the following:

Inventories valued on a last-in, first-out (LIFO) basis totaled $3,482 million and $3,349 million at June 30, 2003, and December 31, 2002, respectively. The excess of current replacement cost over LIFO cost of inventories amounted to $1,079 million and $1,083 million at June 30, 2003, and December 31, 2002, respectively.

Note 8—Properties, Plants and Equipment

Properties, plants and equipment included the following:

Property Impairments—In the second quarter of 2003, we recorded property impairments totaling $146 million before-tax, $49 million after-tax. The impairments were recorded as a result of asset status changes from held for use to held for sale, unsuccessful development drilling results, and Norway tax law changes dealing with the treatment of asset removal costs. Of the total charges in the second quarter, $141 million before-tax, $46 million after-tax, were related to properties in the Exploration and Production segment, primarily in the North Sea, Canada, and the U.S. Lower 48. The remaining amounts related to the Corporate and Other reporting segment.

Note 9—Restructuring

In 2002, as a result of the merger, we began a restructuring program to capture the benefits of combining Conoco and Phillips by eliminating redundancies, consolidating assets, and sharing common services and functions across regions. As a result, 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 the first six months of 2003, we recorded additional accruals totaling $225 million for severance-related benefits, site closings, Conoco

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employee relocation costs, and pension and other post-retirement benefits. Of this total, $77 million was reflected as a purchase price adjustment in the consolidated financial statements and $148 million was reflected in selling, general and administrative expense and production and operating expense. Included in the total additional accruals of $225 million was an $83 million expense related to pension and other post-retirement 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. A roll-forward of activity during the first six months of 2003 is provided below for the non-pension portion of the accrual, which consists of severance-related benefits to be provided to approximately 3,800 employees worldwide, most of whom are in the United States, as well as other merger related expenses.

The restructuring liability at June 30 of $287 million is expected to be expended by the end of the first quarter of 2004; except for $36 million, classified as long-term. The remaining $251 million is included in other accruals in the current liabilities section of the balance sheet. Approximately 1,550 employees were terminated during the first six months of 2003 and approximately 2,325 employees have been terminated since the restructuring program was implemented.

Note 10—Debt

At June 30, 2003, we had three 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 $2 billion, 364-day revolving credit facility expiring on October 14, 2003, and two revolving credit facilities totaling $2 billion expiring in October 2006. At June 30, 2003, we had no debt outstanding under these credit facilities, but had $801 million in commercial paper outstanding, of which $99 million was denominated in foreign currencies. The commercial paper is supported 100 percent by the credit facilities and the amount approximates fair value. One of our Norwegian subsidiaries has two $300 million revolving credit facilities that expire in June 2004, under which no borrowings were outstanding as of June 30, 2003.

During the first six months of 2003, in addition to reducing our commercial paper from $1,517 million at December 31, 2002, to $801 million at June 30, 2003, we paid the following notes as they were called or matured, and funded the payments with cash from operating activities and proceeds from asset dispositions:

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Note 11—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 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 estimate, 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 consider unasserted claims in our determination of environmental liabilities and we accrue them in the period that they are both probable and reasonably estimable.

Although liability of those potentially responsible for environmental remediation costs is generally joint and several for federal sites and frequently so for state sites, 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 ConocoPhillips were solely responsible, the costs, in some cases, could be material to our, or one of our segment’s, operations, capital resources or liquidity. However, settlements and costs incurred in matters

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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, ConocoPhillips may have no liability or attain a settlement of liability. Where it appears that other potentially responsible parties may be financially unable to bear their proportional share, 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 indemnification agreements and some of the indemnifications are subject to dollar limits 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 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, if assumed in a purchase business combination, we record such costs 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. 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. At June 30, 2003, ConocoPhillips’ balance sheet included a total environmental accrual from continuing operations of $845 million, compared with $743 million at December 31, 2002. The increase in the accrual from year-end 2002, primarily resulted from the continuing assessment of Conoco environmental liabilities during the period allowed by purchase accounting rules. These accrued environmental liabilities assumed in the merger are discounted obligations. These expected expenditures are discounted using a weighted average 5 percent discount factor, resulting in an additional accrued balance of $113 million. The expected inflated expenditures for these additional accruals are: $25 million in 2003, $39 million in 2004, $18 million in 2005, $8 million in 2006, and $7 million in 2007. The remaining expenditures in all future years after 2007 for these additional accruals are expected to total $42 million. Final purchase price adjustments will be recognized in the third quarter of 2003.

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 various purchase commitments for materials, supplies, services and items of permanent investment incident to the ordinary conduct of business.

Note 12—Guarantees

At June 30, 2003, 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.

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Construction Completion Guarantees

Guaranteed Residual Value on Leases

Guarantees of Joint-Venture Debt

Other Guarantees

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Indemnifications

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Note 13—Comprehensive Income

ConocoPhillips’ comprehensive income was as follows: