PSX-2013/9/30-10Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
September 30, 2013

 
 
or
 

[    ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
to
 
Commission file number:
001-35349
Phillips 66
(Exact name of registrant as specified in its charter)
 
Delaware
 
45-3779385
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

3010 Briarpark Drive, Houston, Texas 77042
(Address of principal executive offices) (Zip Code)
281-293-6600
(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  [X]    No  [    ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer   [X]        Accelerated filer  [    ]        Non-accelerated filer   [    ]        Smaller reporting company  [    ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  [    ]    No  [X]
The registrant had 599,536,436 shares of common stock, $.01 par value, outstanding as of September 30, 2013.


Table of Contents

PHILLIPS 66

TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
 
Consolidated Statement of Income
Phillips 66
 
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2013

2012

 
2013

2012

Revenues and Other Income
 
 
 
 
 
Sales and other operating revenues*
$
44,201

42,945

 
128,704

135,475

Equity in earnings of affiliates
647

959

 
2,304

2,508

Net gain (loss) on dispositions
8

(1
)
 
50

189

Other income (loss)
(7
)
4

 
65

82

Total Revenues and Other Income
44,849

43,907

 
131,123

138,254

 
 
 
 
 
 
Costs and Expenses
 
 
 
 
 
Purchased crude oil and products
38,746

36,189

 
111,287

116,915

Operating expenses
987

884

 
2,998

2,960

Selling, general and administrative expenses
354

432

 
1,060

1,261

Depreciation and amortization
236

229

 
712

669

Impairments
1

248

 
26

566

Taxes other than income taxes*
3,624

3,410

 
10,450

10,305

Accretion on discounted liabilities
6

7

 
18

18

Interest and debt expense
68

74

 
207

170

Foreign currency transaction (gains) losses
1

(15
)
 
(16
)
(22
)
Total Costs and Expenses
44,023

41,458

 
126,742

132,842

Income before income taxes
826

2,449

 
4,381

5,412

Provision for income taxes
286

848

 
1,471

1,991

Net income
540

1,601

 
2,910

3,421

Less: net income attributable to noncontrolling interests
5

2

 
10

5

Net Income Attributable to Phillips 66
$
535

1,599

 
2,900

3,416

 
 
 
 
 
 
Net Income Attributable to Phillips 66 Per Share of Common Stock (dollars)**
 
 
 
 
 
Basic
$
0.88

2.53

 
4.69

5.43

Diluted
0.87

2.51

 
4.65

5.37

 
 
 
 
 
 
Dividends Paid Per Share of Common Stock (dollars)
$
0.3125

0.2000

 
0.9375

0.2000

 
 
 
 
 
 
Average Common Shares Outstanding (in thousands)**
 
 
 
 
 
Basic
608,934

630,672

 
617,654

628,940

Diluted
614,519

637,913

 
623,846

636,585

* Includes excise taxes on petroleum products sales:
$
3,568

3,312

 
10,254

10,022

**See Note 10—Earnings Per Share.
 
 
 
 
 
See Notes to Consolidated Financial Statements.
 
 
 
 
 

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Table of Contents

Consolidated Statement of Comprehensive Income
Phillips 66
 
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2013

2012

 
2013

2012

 
 
 
 
 
 
Net Income
$
540

1,601

 
2,910

3,421

Other comprehensive income (loss)
 
 
 
 
 
Defined benefit plans
 
 
 
 
 
Prior service cost:
 
 
 
 
 
Amortization to net income of prior service cost


 

1

Actuarial gain/loss:
 
 
 
 
 
Actuarial gain arising during the period


 

90

Amortization to net income of net actuarial loss
22

22

 
72

37

Plans sponsored by equity affiliates
6

6

 
(2
)
14

Income taxes on defined benefit plans
(11
)
(10
)
 
(25
)
(52
)
Defined benefit plans, net of tax
17

18

 
45

90

Foreign currency translation adjustments
186

210

 
(98
)
151

Income taxes on foreign currency translation adjustments
(4
)

 
(1
)
48

Foreign currency translation adjustments, net of tax
182

210

 
(99
)
199

Hedging activities by equity affiliates

1

 
1

1

Income taxes on hedging activities by equity affiliates


 


Hedging activities by equity affiliates, net of tax

1

 
1

1

Other Comprehensive Income (Loss), Net of Tax
199

229

 
(53
)
290

Comprehensive Income
739

1,830

 
2,857

3,711

Less: comprehensive income attributable to noncontrolling interests
5

2

 
10

5

Comprehensive Income Attributable to Phillips 66
$
734

1,828

 
2,847

3,706

See Notes to Consolidated Financial Statements.

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Table of Contents

Consolidated Balance Sheet
Phillips 66
 
 
Millions of Dollars
 
September 30
2013

 
December 31
2012

Assets
 
 
 
Cash and cash equivalents*
$
5,942

 
3,474

Accounts and notes receivable (net of allowance of $40 million in 2013 and $50 million in 2012)
7,618

 
8,593

Accounts and notes receivable—related parties
2,126

 
1,810

Inventories
4,737

 
3,430

Prepaid expenses and other current assets
662

 
655

Total Current Assets
21,085

 
17,962

Investments and long-term receivables
10,728

 
10,471

Net properties, plants and equipment
15,077

 
15,407

Goodwill
3,228

 
3,344

Intangibles
713

 
724

Other assets
152

 
165

Total Assets
$
50,983

 
48,073

 
 
 
 
Liabilities
 
 
 
Accounts payable
$
11,236

 
9,731

Accounts payable—related parties
1,508

 
979

Short-term debt
24

 
13

Accrued income and other taxes
889

 
901

Employee benefit obligations
332

 
441

Other accruals
691

 
417

Total Current Liabilities
14,680

 
12,482

Long-term debt
6,132

 
6,961

Asset retirement obligations and accrued environmental costs
687

 
740

Deferred income taxes
5,633

 
5,444

Employee benefit obligations
1,286

 
1,325

Other liabilities and deferred credits
571

 
315

Total Liabilities
28,989

 
27,267

 
 
 
 
Equity
 
 
 
Common stock (2,500,000,000 shares authorized at $.01 par value)
     Issued (2013—633,785,385 shares; 2012—631,149,613 shares)
 
 
 
Par value
6

 
6

Capital in excess of par
18,839

 
18,726

Treasury stock (at cost: 2013—34,248,949 shares; 2012—7,603,896 shares)
(1,958
)
 
(356
)
Retained earnings
5,030

 
2,713

Accumulated other comprehensive loss
(367
)
 
(314
)
Total Stockholders’ Equity
21,550

 
20,775

Noncontrolling interests
444

 
31

Total Equity
21,994

 
20,806

Total Liabilities and Equity
$
50,983

 
48,073

* The September 30, 2013, balance includes $422 million of cash and cash equivalents held by Phillips 66 Partners LP.
 
 
See Notes to Consolidated Financial Statements.

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Table of Contents

Consolidated Statement of Cash Flows
Phillips 66

 
Millions of Dollars
 
Nine Months Ended
September 30
 
2013

 
2012

Cash Flows From Operating Activities
 
 
 
Net income
$
2,910

 
3,421

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation and amortization
712

 
669

Impairments
26

 
566

Accretion on discounted liabilities
18

 
18

Deferred taxes
281

 
111

Undistributed equity earnings
(76
)
 
(928
)
Net gain on dispositions
(50
)
 
(189
)
Other
34

 
81

Working capital adjustments
 
 
 
Decrease (increase) in accounts and notes receivable
535

 
(677
)
Decrease (increase) in inventories
(1,352
)
 
(2,253
)
Decrease (increase) in prepaid expenses and other current assets
(90
)
 
(266
)
Increase (decrease) in accounts payable
2,018

 
1,912

Increase (decrease) in taxes and other accruals
164

 
526

Net Cash Provided by Operating Activities
5,130

 
2,991

 
 
 
 
Cash Flows From Investing Activities
 
 
 
Capital expenditures and investments
(1,170
)
 
(827
)
Proceeds from asset dispositions
1,188

 
259

Advances/loans—related parties
(65
)
 
(100
)
Collection of advances/loans—related parties
100

 

Net Cash Provided by (Used in) Investing Activities
53

 
(668
)
 
 
 
 
Cash Flows From Financing Activities
 
 
 
Distributions to ConocoPhillips

 
(5,255
)
Issuance of debt

 
7,794

Repayment of debt
(1,015
)
 
(206
)
Issuance of common stock
(4
)
 
23

Repurchase of common stock
(1,602
)
 
(111
)
Dividends paid on common stock
(575
)
 
(125
)
Net proceeds from issuance of Phillips 66 Partners LP common units
404

 

Other
(5
)
 
(40
)
Net Cash Provided by (Used in) Financing Activities
(2,797
)
 
2,080

 
 
 
 
Effect of Exchange Rate Changes on Cash and Cash Equivalents
82

 
27

 
 
 
 
Net Change in Cash and Cash Equivalents
2,468

 
4,430

Cash and cash equivalents at beginning of period
3,474

 

Cash and Cash Equivalents at End of Period
$
5,942

 
4,430

See Notes to Consolidated Financial Statements.

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Table of Contents

Consolidated Statement of Changes in Equity
Phillips 66
 
 
Millions of Dollars
 
Attributable to Phillips 66
 
 
 
Common Stock
 
 
 
 
 
 
Par
Value

Capital in Excess of Par

Treasury Stock

Retained
Earnings

Net Parent
Company
Investment

Accum. Other Comprehensive Income (Loss)

Noncontrolling
Interests

Total

 
 
 
 
 
 
 
 
 
December 31, 2011
$




23,142

122

29

23,293

Net income



2,291

1,125


5

3,421

Net transfers to ConocoPhillips




(5,707
)
(541
)

(6,248
)
Other comprehensive income





290


290

Reclassification of net parent company
















 investment to capital in excess of par

18,560



(18,560
)



Issuance of common stock at the Separation
6

(6
)






Cash dividends paid on common stock



(125
)



(125
)
Repurchase of common stock


(111
)




(111
)
Benefit plan activity

89


(2
)



87

Distributions to noncontrolling interests and other






(1
)
(1
)
September 30, 2012
$
6

18,643

(111
)
2,164


(129
)
33

20,606

 
 
 
 
 
 
 
 
 
December 31, 2012
$
6

18,726

(356
)
2,713


(314
)
31

20,806

Net income



2,900



10

2,910

Other comprehensive loss





(53
)

(53
)
Cash dividends paid on common stock



(575
)



(575
)
Repurchase of common stock


(1,602
)




(1,602
)
Benefit plan activity

116


(8
)



108

Issuance of Phillips 66 Partners LP common units






404

404

Distributions to noncontrolling interests and other

(3
)




(1
)
(4
)
September 30, 2013
$
6

18,839

(1,958
)
5,030


(367
)
444

21,994

 
 
Shares in Thousands
 
Common Stock Issued

Treasury Stock

December 31, 2012
631,150

7,604

Repurchase of common stock

26,645

Shares issued—stock-based compensation
2,635


September 30, 2013
633,785

34,249

See Notes to Consolidated Financial Statements.

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Table of Contents

Notes to Consolidated Financial Statements
Phillips 66
 
Note 1—Separation and Basis of Presentation

The Separation
On April 4, 2012, the ConocoPhillips Board of Directors approved the separation of its downstream businesses (as defined below) into an independent, publicly traded company named Phillips 66. In accordance with the Separation and Distribution Agreement, the two companies were separated by ConocoPhillips distributing to its stockholders all 625,272,302 shares of common stock of Phillips 66 after the market closed on April 30, 2012 (the Separation). Each ConocoPhillips stockholder received one share of Phillips 66 stock for every two shares of ConocoPhillips stock. Following the Separation, ConocoPhillips retained no ownership interest in Phillips 66, and each company has had separate public ownership, boards of directors and management.

Basis of Presentation
Prior to the Separation, our results of operations, financial position and cash flows consisted of ConocoPhillips' refining, marketing and transportation operations; its natural gas gathering, processing, transmission and marketing operations, primarily conducted through its equity investment in DCP Midstream, LLC (DCP Midstream); its petrochemical operations, conducted through its equity investment in Chevron Phillips Chemical Company LLC (CPChem); its power generation operations; and an allocable portion of its corporate costs (together, the “downstream businesses”). These financial statements have been presented as if the downstream businesses had been combined for all periods presented prior to the Separation. All intercompany transactions and accounts within the downstream businesses were eliminated. The statement of income for the period prior to the Separation includes expense allocations for certain corporate functions historically performed by ConocoPhillips and not allocated to its operating segments, including allocations of general corporate expenses related to executive oversight, accounting, treasury, tax, legal, procurement and information technology. These allocations were based primarily on specific identification of time and/or activities associated with the downstream businesses, employee headcount or capital expenditures, and our management believes the assumptions underlying the allocations were reasonable. The combined financial statements may not necessarily reflect all of the actual expenses that would have been incurred had we been a stand-alone company during the period presented prior to the Separation. All financial information presented after the Separation represents the consolidated results of operations, financial position and cash flows of Phillips 66. Accordingly:

Our consolidated statements of income and comprehensive income for the three and nine months ended September 30, 2013, consist entirely of the consolidated results of Phillips 66. Our consolidated statements of income and comprehensive income for the three months ended September 30, 2012, consist entirely of the consolidated results of Phillips 66. Our consolidated statements of income and comprehensive income for the nine months ended September 30, 2012, consist of the consolidated results of Phillips 66 for the five months ended September 30, 2012, and of the combined results of the downstream businesses for the four months ended April 30, 2012.

Our consolidated balance sheet at September 30, 2013, and December 31, 2012, consists of the consolidated balances of Phillips 66.

Our consolidated statement of cash flows for the nine months ended September 30, 2013, consists entirely of the consolidated results of Phillips 66. Our consolidated statement of cash flows for the nine months ended September 30, 2012, consists of the consolidated results of Phillips 66 for the five months ended September 30, 2012, and the combined results of the downstream businesses for the four months ended April 30, 2012.

Our consolidated statement of changes in equity for the nine months ended September 30, 2013, consists entirely of the consolidated results of Phillips 66. Our consolidated statement of changes in equity for the nine months ended September 30, 2012, consists of both the combined activity for the downstream businesses prior to April 30, 2012, and the consolidated activity for Phillips 66 completed at and subsequent to the Separation on April 30, 2012.


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Table of Contents

Effective January 1, 2013, we changed the organizational structure of the internal financial information reviewed by our chief executive officer, and determined this resulted in a change in the composition of our operating segments. The primary effects of this reporting reorganization were:

We disaggregated the former Refining and Marketing (R&M) segment into two separate operating segments titled "Refining" and "Marketing and Specialties."

We moved our Transportation and power businesses from the former R&M segment to the Midstream and Marketing and Specialties (M&S) segments, respectively.

The new segment alignment is presented for the three- and nine-month periods ended September 30, 2013, with the prior periods recast for comparability.


Note 2—Interim Financial Information

The interim financial information presented in the financial statements included in this report is unaudited and includes all known accruals and adjustments necessary, in the opinion of management, for a fair presentation of the consolidated financial position of Phillips 66 and its results of operations and cash flows for the periods presented. Unless otherwise specified, all such adjustments are of a normal and recurring nature. Certain notes and other information have been condensed or omitted from the interim financial statements included in this report. Therefore, these interim financial statements should be read in conjunction with the consolidated financial statements and notes included in our 2012 Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2013, are not necessarily indicative of the results to be expected for the full year.


Note 3—Variable Interest Entities (VIEs)

In February 2013, we formed Phillips 66 Partners LP, a master limited partnership, to own, operate, develop and acquire primarily fee-based crude oil, refined petroleum product and natural gas liquids pipelines and terminals, as well as other transportation and midstream assets. We consolidate Phillips 66 Partners as we determined that Phillips 66 Partners is a VIE and we are the primary beneficiary. As general partner, we have the ability to control the financial interests, as well as the ability to direct the activities of Phillip 66 Partners that most significantly impact its economic performance. See Note 23—Phillips 66 Partners LP for additional information.

We hold significant variable interests in VIEs that have not been consolidated because we are not considered the primary beneficiary. Information on these VIEs follows:

Merey Sweeny, L.P. (MSLP) is a limited partnership that owns a delayed coker and related facilities at the Sweeny Refinery. As discussed more fully in Note 6—Investments, Loans and Long-Term Receivables, in August 2009 a call right was exercised to acquire the 50 percent ownership interest in MSLP of the co-venturer, Petróleos de Venezuela S.A. (PDVSA). That exercise has been challenged, and the dispute is being arbitrated. Because the exercise has been challenged by PDVSA, we continue to use the equity method of accounting for MSLP, and the VIE analysis below is based on the ownership and governance structure in place prior to the exercise of the call right. MSLP is a VIE because, in securing lender consents in connection with the Separation, we provided a 100 percent debt guarantee to the lender of the 8.85% senior notes issued by MSLP. PDVSA did not participate in the debt guarantee. In our VIE assessment, this disproportionate debt guarantee, plus other liquidity support provided jointly by us and PDVSA independently of equity ownership, results in MSLP not being exposed to all potential losses. We have determined we are not the primary beneficiary while our call exercise is in dispute because under the partnership agreement the co-venturers jointly direct the activities of MSLP that most significantly impact economic performance. At September 30, 2013, our maximum exposure to loss represented the outstanding principal debt balance of $224 million. The book value of our investment in MSLP at September 30, 2013, was $78 million.

We have a 50 percent ownership interest with a 50 percent governance interest in Excel Paralubes (Excel). Excel is a VIE because, in securing lender consents in connection with the Separation, ConocoPhillips provided a 50 percent debt guarantee to the lender of the 7.43% senior secured bonds issued by Excel. We provided a full indemnity to ConocoPhillips for this debt guarantee. Our co-venturer did not participate in the debt guarantee. In our assessment of the VIE, this debt guarantee, plus other liquidity support up to $60 million provided jointly by us and our co-venturer independently of equity ownership, results in Excel not being exposed to all potential losses. We have determined we are not the primary beneficiary because we and our co-venturer jointly direct the activities of Excel that most significantly impact economic performance. We continue to use

7

Table of Contents

equity method accounting for this investment. At September 30, 2013, our maximum exposure to loss represented 50 percent of the outstanding principal debt balance of $140 million, or $70 million, plus half of the $60 million liquidity support, or $30 million. The book value of our investment in Excel at September 30, 2013, was $135 million.

During October 2013, we entered into a multi-year consignment fuels agreement with a marketer who we currently support with debt guarantees. Pursuant to the consignment fuels agreement, we will purchase the marketer’s fuels inventory, control the fuel marketing at each site and pay a fixed monthly fee to the marketer. We determined the consignment fuels agreement and the debt guarantees together create a variable interest in the marketer with the marketer not being exposed to all potential losses. We determined we are not the primary beneficiary because we do not have the power to direct the activities that most significantly impact the economic performance of the marketer or its service stations. We have no ownership interest in the marketer. Our maximum exposure to loss represented the outstanding debt balance of $190 million and the fixed annual contractual payments under the consignment fuels agreement of $80 million.


Note 4—Inventories

Inventories consisted of the following:

 
Millions of Dollars
 
September 30
2013

 
December 31
2012

 
 
 
 
Crude oil and petroleum products
$
4,470

 
3,138

Materials and supplies
267

 
292

 
$
4,737

 
3,430



Inventories valued on the last-in, first-out (LIFO) basis totaled $4,341 million and $2,987 million at September 30, 2013, and December 31, 2012, respectively. The estimated excess of current replacement cost over LIFO cost of inventories amounted to approximately $8,000 million and $7,700 million at September 30, 2013, and December 31, 2012, respectively.

Our planned year-to-date reductions in inventory caused liquidations of LIFO inventory values. These liquidations increased net income by approximately $2 million and $19 million during the three- and nine-month periods ended September 30, 2013, and $1 million and $86 million, respectively, for the comparable periods of 2012.


Note 5—Assets Held for Sale or Sold

In July 2013, we completed the sale of the Immingham Combined Heat and Power Plant (ICHP), which was included in our M&S segment. At the time of the disposition, ICHP had a net carrying value of $762 million, which primarily included $724 million of net properties, plants and equipment (PP&E), $110 million of allocated goodwill, and $111 million of deferred tax liabilities. A before-tax gain of $323 million was deferred due to an indemnity provided to the buyer. Absent claims under the indemnity, the deferred gain will be recognized into earnings as our exposure under this indemnity declines.

In May 2013, we sold our E-Gas™ Technology business. The business was included in our M&S segment and at the time of disposition had a net carrying value of approximately $13 million, including a goodwill allocation. A $48 million before-tax gain is included in the "Net gain (loss) on dispositions" line of our consolidated statement of income.

In June 2012, we sold our refinery located on the Delaware River in Trainer, Pennsylvania with a net carrying value of $38 million, including a goodwill allocation. The refinery and associated terminal and pipeline assets were included in our Refining segment. The $189 million before-tax gain is included in the “Net gain (loss) on dispositions” line of our consolidated statement of income.



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Note 6—Investments, Loans and Long-Term Receivables

Equity Investments
Summarized 100 percent financial information for WRB Refining LP and CPChem was as follows:
 
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2013

 
2012

 
2013

 
2012

 
 
 
 
 
 
 
 
Revenues
$
8,742

 
8,347

 
24,954

 
25,409

Income before income taxes
821

 
1,498

 
3,587

 
4,074

Net income
801

 
1,449

 
3,526

 
3,982



Loans and Long-Term Receivables
In 2012, we entered into a market-based shareholder financing agreement for up to $100 million with the Malaysian Refining Company Sdn. Bhd. (MRC), all of which was drawn as of December 31, 2012. MRC repaid this advance during the first half of 2013, and subsequently drew additional funds during the third quarter of 2013. As of September 30, 2013, the balance on the facility was $65 million. The advances to MRC are recorded as short-term related party advances with interest income recorded in equity earnings to offset the corresponding interest expense by MRC.

Other
MSLP owns a delayed coker and related facilities at the Sweeny Refinery. MSLP processes long residue, which is produced from heavy sour crude oil, for a processing fee. Fuel-grade petroleum coke is produced as a by-product and becomes the property of MSLP. Prior to August 28, 2009, MSLP was owned 50/50 by ConocoPhillips and PDVSA. Under the agreements that govern the relationships between the partners, certain defaults by PDVSA with respect to supply of crude oil to the Sweeny Refinery triggered the right to acquire PDVSA’s 50 percent ownership interest in MSLP, which was exercised on August 28, 2009. PDVSA has initiated arbitration with the International Chamber of Commerce challenging the exercise of the call right and claiming it was invalid. The arbitral tribunal held hearings on the merits of the dispute in December 2012, and post-hearing briefs were exchanged in March 2013. We expect a final ruling in the fourth quarter of 2013. We continue to use the equity method of accounting for our investment in MSLP.

On July 1, 2013, we increased our ownership interest in WRB to 50 percent by purchasing ConocoPhillips' 0.4 percent interest.


Note 7—Properties, Plants and Equipment

Our investment in PP&E, with the associated accumulated depreciation and amortization (Accum. D&A), was:

 
Millions of Dollars
 
September 30, 2013
 
December 31, 2012
 
Gross
PP&E

 
Accum.
D&A

 
Net
PP&E

 
Gross
PP&E

 
Accum.
D&A

 
Net
PP&E

 
 
 
 
 
 
 
 
 
 
 
 
Midstream
$
2,642

 
1,081

 
1,561

 
2,460

 
1,016

 
1,444

Chemicals

 

 

 

 

 

Refining
18,894

 
6,557

 
12,337

 
17,989

 
5,913

 
12,076

Marketing and Specialties
1,425

 
738

 
687

 
2,500

 
1,078

 
1,422

Corporate and Other
930

 
438

 
492

 
880

 
415

 
465

 
$
23,891

 
8,814

 
15,077

 
23,829

 
8,422

 
15,407





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Note 8—Goodwill

Effective January 1, 2013, we realigned our operating segments and determined that goodwill (which, prior to the realignment, had been assigned 100 percent to our former R&M segment) should now be assigned to three of the realigned operating segments—Midstream, Refining and M&S. We further determined that, for the Midstream segment, Transportation constituted a reporting unit. For the Refining and M&S segments, we determined the goodwill reporting unit was at the operating segment level, due to the economic similarities of the components of those segments.

Goodwill was reassigned to the realigned reporting units using a relative fair value approach. Goodwill impairment testing was completed and no impairment recognition was required.

In May 2013, $110 million of goodwill within the M&S segment was allocated to an asset held for sale. The associated sale was completed in July 2013. See Note 5—Assets Held for Sale or Sold for additional information.

The carrying amount of goodwill was as follows:

 
Millions of Dollars
 
September 30
2013

 
December 31
2012

 
 
 
 
Midstream
$
518

 
518

Refining
1,933

 
1,934

Marketing and Specialties
777

 
892

 
$
3,228

 
3,344



Note 9—Impairments

The three- and nine-month periods ended September 30, 2013 and 2012, included the following before-tax impairment charges:

 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2013

 
2012

 
2013

 
2012


 
 
 
 
 
 
 
Midstream
$

 
248

 

 
524

Refining
1

 

 
2

 
42

Marketing and Specialties

 

 
15

 

Corporate and Other

 

 
9

 

 
$
1

 
248

 
26

 
566



During the nine-month period of 2013, we recorded a $15 million held-for-use impairment in our M&S segment, primarily related to PP&E associated with our planned exit from the composite graphite business.

During the third quarter of 2012, we recorded an impairment of $43 million on the Riverhead Terminal in our Midstream segment. During the same period, we recorded an incremental impairment of $205 million in our Midstream segment related to our investment in Rockies Express Pipeline LLC. The total impairment charges related to this investment during the nine-month period of 2012 were $480 million. In addition, the nine-month period of 2012 included a $42 million held-for-sale impairment in our Refining segment related to equipment formerly associated with the canceled Wilhelmshaven Refinery upgrade project.



10

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Note 10—Earnings Per Share

The numerator of basic earnings per share (EPS) is net income attributable to Phillips 66, reduced by noncancelable dividends paid on unvested share-based employee awards during the vesting period (participating securities). The denominator of basic EPS is the sum of the daily weighted-average number of common shares outstanding during the periods presented and fully vested stock and unit awards that have not yet been issued as common stock. The numerator of diluted EPS is also based on net income attributable to Phillips 66, which is reduced only by dividend equivalents paid on participating securities for which the dividends are more dilutive than the participation of the awards in the earnings of the periods presented. To the extent unvested stock, unit or option awards and vested unexercised stock options are dilutive, they are included with the weighted-average common shares outstanding in the denominator. Treasury stock is excluded from the denominator in both basic and diluted EPS.

On April 30, 2012, 625.3 million shares of our common stock were distributed to ConocoPhillips stockholders in conjunction with the Separation. For comparative purposes, and to provide a more meaningful calculation of weighted-average shares outstanding, we have assumed this amount to be outstanding as of the beginning of each period prior to the Separation presented in the calculation of weighted-average shares. In addition, we have assumed the fully vested stock and unit awards outstanding at April 30, 2012, were also outstanding for each of the periods presented prior to the Separation; and we have assumed the dilutive securities outstanding at April 30, 2012, were also outstanding for each period prior to the Separation.

 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2013

 
2012

 
2013

 
2012

Basic EPS Calculation
 
 
 
 
 
 
 
Allocation of earnings (millions):
 
 
 
 
 
 
 
Net income attributable to Phillips 66
$
535

 
1,599

 
2,900

 
3,416

Income allocated to participating securities
(2
)
 
(1
)
 
(4
)
 
(1
)
Income available to common stockholders
$
533

 
1,598

 
2,896

 
3,415

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding (thousands):
Basic
608,934

 
630,672

 
617,654

 
628,940

 
 
 
 
 
 
 
 
Basic EPS (dollars)
$
0.88

 
2.53

 
4.69

 
5.43

 
 
 
 
 
 
 
 
Diluted EPS Calculation
 
 
 
 
 
 
 
Allocation of earnings (millions):
 
 
 
 
 
 
 
Net income attributable to Phillips 66
$
535

 
1,599

 
2,900

 
3,416

Income allocated to participating securities

 

 

 

Income available to common stockholders
$
535

 
1,599

 
2,900

 
3,416

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding (thousands):
Basic
608,934

 
630,672

 
617,654

 
628,940

Dilutive effect of stock-based compensation
5,585

 
7,241

 
6,192

 
7,645

Weighted-average diluted common shares outstanding
614,519

 
637,913

 
623,846

 
636,585

 
 
 
 
 
 
 
 
Diluted EPS (dollars)
$
0.87

 
2.51

 
4.65

 
5.37




11

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Note 11—Debt

During the second quarter of 2013, we amended our revolving credit agreement by entering into the First Amendment to Credit Agreement (Amendment). The Amendment increased the borrowing capacity from $4.0 billion to $4.5 billion, extended the maturity from February 2017 to June 2018, reduced the margin applied to interest and fees accruing on and after the Amendment effective date, and made certain amendments with respect to Phillips 66 Partners.

Also during the second quarter of 2013, we amended our trade receivables securitization facility by entering into the First Amendment to Receivables Purchase Agreement (Securitization Amendment). The Securitization Amendment decreased the borrowing capacity from $1.2 billion to $696 million and made certain amendments with respect to Phillips 66 Partners.

On June 7, 2013, Phillips 66 Partners entered into a senior unsecured $250 million revolving credit agreement (Revolver) with a syndicate of financial institutions. On July 26, 2013, Phillips 66 Partners, in connection with its initial public offering of common units, closed on the facility. Phillips 66 Partners has the option to increase the overall capacity of the Revolver by up to an additional $250 million, subject to certain conditions. The Revolver has an initial term of five years. As of September 30, 2013, no amount had been drawn under this facility.

During the third quarter of 2013, we entered into a capital lease which resulted in $177 million of debt being included on the balance sheet at September 30, 2013. For additional information, see Note 16—Leases.

We have no material scheduled debt maturities in 2013; however, in June 2013 we made a $500 million prepayment on our term loan and, in September 2013, prepaid the remaining balance of $500 million.

At both September 30, 2013, and December 31, 2012, we had no direct outstanding borrowings under our revolving credit agreement or our trade receivables securitization facility. However, as of both September 30, 2013, and December 31, 2012, $51 million in letters of credit had been issued that were supported by our revolving credit agreement. As of September 30, 2013, and December 31, 2012, $26 million and $166 million, respectively, in letters of credit had been issued that were collateralized by trade receivables held by a subsidiary under our trade receivables securitization facility. Accordingly, as of September 30, 2013, we had an aggregate $5.1 billion of total capacity available under these facilities.


Note 12—Guarantees

At September 30, 2013, 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 below, 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. In addition, unless otherwise stated, we are not currently performing with any significance under the guarantee and expect future performance to be either immaterial or have only a remote chance of occurrence.

Guarantees of Joint Venture Debt
In April 2012, in connection with the Separation, we issued a guarantee for 100 percent of the 8.85% senior notes issued by MSLP in July 1999. At September 30, 2013, the maximum potential amount of future payments to third parties under the guarantee is estimated to be $224 million, which could become payable if MSLP fails to meet its obligations under the senior notes agreement. The senior notes mature in 2019.

At September 30, 2013, we had other guarantees outstanding for our portion of certain joint venture debt obligations, which have terms of up to 12 years. The maximum potential amount of future payments under the guarantees is approximately $105 million. Payment would be required if a joint venture defaults on its debt obligations.

Other Guarantees
We have residual value guarantees associated with leases with maximum future potential payments totaling approximately $246 million. We have other guarantees with maximum future potential payment amounts totaling $293 million, which consist primarily of guarantees to fund the short-term cash liquidity deficits of certain joint ventures, guarantees of third parties related to prior asset dispositions, and guarantees of the lease payment obligations of a joint venture. These guarantees generally extend up to 11 years or life of the venture.


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Table of Contents

Indemnifications
Over the years, we have entered into various agreements to sell ownership interests in certain corporations, joint ventures and assets that gave rise to qualifying indemnifications. Agreements associated with these sales include indemnifications for taxes, litigation, environmental liabilities, permits and licenses, supply arrangements, and employee claims; and real estate indemnities against tenant defaults. 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 indemnifications at September 30, 2013, was $270 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 make a reasonable estimate of the maximum potential amount of future payments. Included in the recorded carrying amount were $121 million of environmental accruals for known contamination that are included in asset retirement obligations and accrued environmental costs at September 30, 2013. For additional information about environmental liabilities, see Note 13—Contingencies and Commitments.

Indemnification and Release Agreement
In conjunction with, and effective as of, the Separation, we entered into the Indemnification and Release Agreement with ConocoPhillips. This agreement governs the treatment between ConocoPhillips and us of aspects relating to indemnification, insurance, litigation responsibility and management, and litigation document sharing and cooperation arising in connection with the Separation. Generally, the agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of ConocoPhillips’ business with ConocoPhillips. The agreement also establishes procedures for handling claims subject to indemnification and related matters.


Note 13—Contingencies and Commitments

A number of lawsuits involving a variety of claims that arose in the ordinary course of business have been filed against us or are subject to indemnifications provided by us. We also may be required 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 active and inactive sites. We regularly assess the need for accounting recognition or disclosure of these contingencies. In the case of all known contingencies (other than those related to income taxes), we accrue a liability when the loss is probable and the amount is reasonably estimable. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the minimum of the range is accrued. We do not reduce these liabilities for potential insurance or third-party recoveries. If applicable, we record receivables for probable insurance or other third-party recoveries. In the case of income-tax-related contingencies, we use a cumulative probability-weighted loss accrual in cases where sustaining a tax position is less than certain.

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 consolidated financial statements. As we learn new facts concerning contingencies, we reassess our position both with respect to accrued liabilities and other potential exposures. Estimates 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 international, federal, state and local environmental laws and regulations. When we prepare our consolidated financial statements, we record accruals for environmental liabilities based on management’s best estimates, using all information available at the time. We measure estimates and base liabilities on currently available facts, existing technology, and presently enacted laws and regulations, taking into account stakeholder and business considerations. 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 they are both probable and reasonably estimable.


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Table of Contents

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 alleged to have liability at a particular site. Due to the joint and several liabilities, we could be responsible for all cleanup costs related to any site at which we have been designated as a potentially responsible party. We have been successful to date in sharing cleanup costs with other financially sound companies. Many of the sites at which we are potentially responsible are still under investigation by the EPA or the state agencies concerned. Prior to actual cleanup, those potentially responsible normally assess the site conditions, apportion responsibility and determine the appropriate remediation. In some instances, we may have no liability or may attain a settlement of liability. Where it appears that other potentially responsible parties may be financially unable to bear their proportional share, we consider this inability in estimating our potential liability, and we adjust our accruals accordingly. As a result of various acquisitions in the past, we assumed certain environmental obligations. Some of these environmental obligations are mitigated by indemnifications made by others for our benefit and some of the indemnifications are subject to dollar and time limits.

We are currently participating in environmental assessments and cleanups at numerous federal Superfund and comparable state sites. After an assessment of environmental exposures for cleanup and other costs, we make accruals on an undiscounted basis (except those acquired in a purchase business combination, which we record on a discounted basis) for planned investigation and remediation activities for sites where it is probable future costs will be incurred and these costs can be reasonably estimated. At September 30, 2013, our consolidated balance sheet included a total environmental accrual of $505 million, compared with $530 million at December 31, 2012. We expect to incur a substantial amount 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.

Legal Proceedings
Our legal organization applies its 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 that have been scheduled for trial and/or mediation. Based on professional judgment and experience in using these litigation management tools and available information about current developments in all our cases, our legal organization regularly assesses the adequacy of current accruals and determines if adjustment of existing accruals, or establishment of new accruals, is required.

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.

At September 30, 2013, we had performance obligations secured by letters of credit of $1,337 million (of which $26 million were issued under the trade receivables securitization facility, $51 million were issued under the provisions of our revolving credit facility, and the remainder were issued as direct bank letters of credit) related to various purchase and other commitments incident to the ordinary conduct of business.


Note 14—Derivatives and Financial Instruments

Derivative Instruments
We use financial and commodity-based derivative contracts to manage exposures to fluctuations in foreign currency exchange rates and commodity prices or to capture market opportunities. Since we are not currently using cash-flow hedge accounting, all gains and losses, realized or unrealized, from commodity derivative contracts have been recognized in the consolidated statement of income. Gains and losses from derivative contracts held for trading not directly related to our physical business, whether realized or unrealized, have been reported net in “Other income (loss)” on our consolidated statement of income. Cash flows from all derivative activity for the periods presented appear in the operating section of the consolidated statement of cash flows.

Purchase and sales contracts with fixed minimum notional volumes for commodities that are readily convertible to cash (e.g., crude oil and gasoline) are recorded on the balance sheet as derivatives unless the contracts are eligible for, and we elect, the normal purchases and normal sales exception (i.e., contracts to purchase or sell quantities we expect to use or sell over a reasonable period in the normal course of business). We generally apply this normal purchases and normal sales exception to eligible crude oil, refined product, natural gas and power commodity purchase and sales contracts; however, we may elect not to apply this exception (e.g., when another derivative instrument will be used to mitigate the risk of the purchase or sales

14

Table of Contents

contract but hedge accounting will not be applied, in which case both the purchase or sales contract and the derivative contract mitigating the resulting risk will be recorded on the balance sheet at fair value).

Our derivative instruments are held at fair value on our consolidated balance sheet. For further information on the fair value of derivatives, see Note 15—Fair Value Measurements.

Commodity Derivative Contracts—We operate in the worldwide crude oil, refined products, natural gas liquids (NGL), natural gas and electric power markets and are exposed to fluctuations in the prices for these commodities. These fluctuations can affect our revenues, as well as the cost of operating, investing and financing activities. Generally, our policy is to remain exposed to the market prices of commodities; however, we use futures, forwards, swaps and options in various markets to balance physical systems, meet customer needs, manage price exposures on specific transactions, and do a limited, immaterial amount of trading not directly related to our physical business. We also use the market knowledge gained from these activities to capture market opportunities such as moving physical commodities to more profitable locations, storing commodities to capture seasonal or time premiums, and blending commodities to capture quality upgrades. Derivatives may be used to optimize these activities, which may move our risk profile away from market average prices.

The following table indicates the balance sheet line items that include the fair values of commodity derivative assets and liabilities presented net (i.e., commodity derivative assets and liabilities with the same counterparty are netted where the right of setoff exists); however, the balances in the following table are presented gross. For information on the impact of counterparty netting and collateral netting, see Note 15—Fair Value Measurements.
 
 
Millions of Dollars
 
September 30
2013

 
December 31
2012

Assets
 
 
 
Prepaid expenses and other current assets
$
1,026

 
767

Other assets
11

 
3

Liabilities
 
 
 
Other accruals
1,038

 
766

Other liabilities and deferred credits
8

 
3

Hedge accounting has not been used for any items in the table.


The gains (losses) from commodity derivatives incurred, and the line items where they appear on our consolidated statement of income, were:
 
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2013

 
2012

 
2013

 
2012

 
 
 
 
 
 
 
 
Sales and other operating revenues
$
(44
)
 
(232
)
 
74

 
(48
)
Equity in earnings of affiliates
(12
)
 
5

 
(13
)
 
5

Other income (loss)
(24
)
 
(9
)
 
3

 
44

Purchased crude oil and products
(78
)
 
(86
)
 
85

 
7

Hedge accounting has not been used for any item in the table.



15

Table of Contents

The table below summarizes our material net exposures resulting from outstanding commodity derivative contracts. These financial and physical derivative contracts are primarily used to manage price exposure on our underlying operations. The underlying exposures may be from non-derivative positions such as inventory volumes. Financial derivative contracts may also offset physical derivative contracts, such as forward sales contracts. As of September 30, 2013, and December 31, 2012, the percentage of our derivative contract volume expiring within the next 12 months was 99 percent for both periods.
 
 
Open Position
Long/(Short)
 
September 30
2013

 
December 31
2012

Commodity
 
 
 
Crude oil, refined products and NGL (millions of barrels)
(25
)
 
(8
)


Credit Risk
Financial instruments potentially exposed to concentrations of credit risk consist primarily of over-the-counter (OTC) derivative contracts and trade receivables.

The credit risk from our OTC derivative contracts, such as forwards and swaps, derives from the counterparty to the transaction. Individual counterparty exposure is managed within predetermined credit limits and includes the use of cash-call margins when appropriate, thereby reducing the risk of significant nonperformance. We also use futures, swaps and option contracts that have a negligible credit risk because these trades are cleared with an exchange clearinghouse and subject to mandatory margin requirements until settled; however, we are exposed to the credit risk of those exchange brokers for receivables arising from daily margin cash calls, as well as for cash deposited to meet initial margin requirements.

Our trade receivables result primarily from the sale of products from, or related to, our refinery operations and reflect a broad national and international customer base, which limits our exposure to concentrations of credit risk. The majority of these receivables have payment terms of 30 days or less. We continually monitor this exposure and the creditworthiness of the counterparties and recognize bad debt expense based on historical write-off experience or specific counterparty collectability. Generally, we do not require collateral to limit the exposure to loss; however, we will sometimes use letters of credit, prepayments and master netting arrangements to mitigate credit risk with counterparties that both buy from and sell to us, as these agreements permit the amounts owed by us or owed to others to be offset against amounts due us.

Certain of our derivative instruments contain provisions that require us to post collateral if the derivative exposure exceeds a threshold amount. We have contracts with fixed threshold amounts and other contracts with variable threshold amounts that are contingent on our credit rating. The variable threshold amounts typically decline for lower credit ratings, while both the variable and fixed threshold amounts typically revert to zero if our credit ratings fall below investment grade. Cash is the primary collateral in all contracts; however, many contracts also permit us to post letters of credit as collateral.

The aggregate fair values of all derivative instruments with such credit-risk-related contingent features that were in a liability position were not material at September 30, 2013, or December 31, 2012.


Note 15—Fair Value Measurements

Fair Values of Financial Instruments
We used the following methods and assumptions to estimate the fair value of financial instruments:

Cash and cash equivalents: The carrying amount reported on the balance sheet approximates fair value.
Accounts and notes receivable: The carrying amount reported on the balance sheet approximates fair value.
Debt: The carrying amount of our floating-rate debt approximates fair value. The fair value of our fixed-rate debt is estimated based on quoted market prices.
Commodity swaps: Fair value is estimated based on forward market prices and approximates the exit price at period end. When forward market prices are not available, fair value is estimated using the forward prices of a similar commodity with adjustments for differences in quality or location.

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Table of Contents

Futures: Fair values are based on quoted market prices obtained from the New York Mercantile Exchange, the InterContinental Exchange Futures or other traded exchanges.
Forward-exchange contracts: Fair values are estimated by comparing the contract rate to the forward rate in effect at the end of the respective reporting periods and approximating the exit price at those dates.

We carry certain assets and liabilities at fair value, which we measure at the reporting date using an exit price (i.e., the price that would be received to sell an asset or paid to transfer a liability), and disclose the quality of these fair values based on the valuation inputs used in these measurements under the following hierarchy:

Level 1: Fair value measured with unadjusted quoted prices from an active market for identical assets or liabilities.

Level 2: Fair value measured with: 1) adjusted quoted prices from an active market for similar assets; or 2) other valuation inputs that are directly or indirectly observable.

Level 3: Fair value measured with unobservable inputs that are significant to the measurement.

We classify the fair value of an asset or liability based on the lowest level of input significant to its measurement; however, the fair value of an asset or liability initially reported as Level 3 will be subsequently reported as Level 2 if the unobservable inputs become inconsequential to its measurement or corroborating market data becomes available. Conversely, an asset or liability initially reported as Level 2 will be subsequently reported as Level 3 if corroborating market data becomes unavailable. We made no material transfers in or out of Level 1 during the nine-month periods ending September 30, 2013 and 2012.

Recurring Fair Value Measurements
Financial assets and liabilities recorded at fair value on a recurring basis consist primarily of investments to support nonqualified deferred compensation plans and derivative instruments. The deferred compensation investments are measured at fair value using unadjusted prices available from national securities exchanges; therefore, these assets are categorized as Level 1 in the fair value hierarchy. We value our exchange-traded commodity derivatives using closing prices provided by the exchange as of the balance sheet date, and these are also classified as Level 1 in the fair value hierarchy. When exchange-cleared contracts lack sufficient liquidity or are valued using either adjusted exchange-provided prices or non-exchange quotes, we classify those contracts as Level 2. OTC financial swaps and physical commodity forward purchase and sales contracts are generally valued using quotations provided by brokers and price index developers such as Platts and Oil Price Information Service. We corroborate these quotes with market data and classify the resulting fair values as Level 2. In certain less liquid markets or for longer-term contracts, forward prices are not as readily available. In these circumstances, OTC swaps and physical commodity purchase and sales contracts are valued using internally developed methodologies that consider historical relationships among various commodities that result in management’s best estimate of fair value. We classify these contracts as Level 3. Financial OTC and physical commodity options are valued using industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and contractual prices for the underlying instruments, as well as other relevant economic measures. The degree to which these inputs are observable in the forward markets determines whether the options are classified as Level 2 or 3. We use a mid-market pricing convention (the mid-point between bid and ask prices). When appropriate, valuations are adjusted to reflect credit considerations, generally based on available market evidence.

The following tables display the fair value hierarchy for our material financial assets and liabilities either accounted for or disclosed at fair value on a recurring basis. These values are determined by treating each contract as the fundamental unit of account; therefore, derivative assets and liabilities with the same counterparty are shown gross (i.e., without the effect of netting where the legal right of setoff exists) in the hierarchy sections of these tables. These tables also show that our Level 3 activity was not material.

We have master netting arrangements for all of our exchange-cleared derivative instruments, the majority of our OTC derivative instruments, and certain physical commodity forward contracts (primarily pipeline crude oil deliveries). The following tables show these contracts on a net basis in the column “Effect of Counterparty Netting.” We have no contracts that are subject to master netting arrangements that are reflected gross on the balance sheet.

The carrying values and fair values by hierarchy of our material financial instruments, either carried or disclosed at fair value, and derivative assets and liabilities, including any effects of master netting agreements or collateral, were:

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Table of Contents


 
Millions of Dollars
 
September 30, 2013
 
Fair Value Hierarchy
 
Total Fair Value of Gross Assets & Liabilities

Effect of Counterparty Netting

Effect of Collateral Netting

Difference in Carrying Value and Fair Value

Net Carrying Value Presented on the Balance Sheet

Cash Collateral Received or Paid, Not Offset on Balance Sheet

 
Level 1

 
Level 2

 
Level 3

Commodity Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
692

 
268

 

 
960

(931
)
(1
)

28


OTC instruments

 
25

 

 
25

(11
)


14


Physical forward contracts*

 
47

 
5

 
52

(1
)


51


Rabbi trust assets
61

 

 

 
61

N/A

N/A


61

N/A

 
$
753

 
340

 
5

 
1,098

(943
)
(1
)

154

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
705

 
249

 

 
954

(931
)
(23
)



OTC instruments

 
39

 

 
39

(11
)


28


Physical forward contracts*

 
52

 
1

 
53

(1
)


52


Floating-rate debt
50

 

 

 
50

N/A

N/A


50

N/A

Fixed-rate debt, excluding capital leases**

 
6,102

 

 
6,102

N/A

N/A

(193
)
5,909

N/A

 
$
755

 
6,442

 
1

 
7,198

(943
)
(23
)
(193
)
6,039


*Physical forward contracts may have a larger value on the balance sheet than disclosed in the fair value hierarchy when the remaining contract term at the reporting date is greater than 12 months and the short-term portion is an asset while the long-term portion is a liability, or vice versa.
**We carry fixed-rate debt on the balance sheet at amortized cost.


 
Millions of Dollars
 
December 31, 2012
 
Fair Value Hierarchy
 
Total Fair Value of Gross Assets & Liabilities

Effect of Counterparty Netting

Effect of Collateral Netting

Difference in Carrying Value and Fair Value

Net Carrying Value Presented on the Balance Sheet

Cash Collateral Received or Paid, Not Offset on Balance Sheet

 
Level 1

 
Level 2

 
Level 3

 
Commodity Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
380

 
309

 

 
689

(672
)
(8
)

9


OTC instruments

 
15

 

 
15

(7
)


8


Physical forward contracts*

 
61

 
2

 
63

4



67


Rabbi trust assets
50

 

 

 
50

N/A

N/A


50

N/A

 
$
430

 
385

 
2

 
817

(675
)
(8
)

134



 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
393

 
328

 

 
721

(672
)
(42
)

7

(7
)
OTC instruments

 
13

 

 
13

(7
)


6


Physical forward contracts*

 
31

 
1

 
32

4



36


Floating-rate debt
1,050

 

 

 
1,050

N/A

N/A


1,050

N/A

Fixed-rate debt, excluding capital leases**

 
6,508

 

 
6,508

N/A

N/A

(590
)
5,918

N/A

 
$
1,443

 
6,880

 
1

 
8,324

(675
)
(42
)
(590
)
7,017


*Physical forward contracts may have a larger value on the balance sheet than disclosed in the fair value hierarchy when the remaining contract term at the reporting date is greater than 12 months and the short-term portion is an asset while the long-term portion is a liability, or vice versa.
**We carry fixed-rate debt on the balance sheet at amortized cost.


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Table of Contents

Nonrecurring Fair Value Remeasurements
The following table shows the values of assets, by major category, measured at fair value on a nonrecurring basis in periods subsequent to their initial recognition during the nine-month periods ended September 30, 2013 and 2012:

 
Millions of Dollars
 
 
 
Fair Value
Measurements Using
 
 
 
Fair Value*

 
Level 1
Inputs

 
Level 2
Inputs

 
Level 3
Inputs

 
Before-
Tax Loss

September 30, 2013
 
 
 
 
 
 
 
 
 
Net properties, plants and equipment (held for use)
$
22

 
22

 

 

 
27

 
 
 
 
 
 
 
 
 
 
September 30, 2012
 
 
 
 
 
 
 
 
 
Net properties, plants and equipment (held for use)
$
33

 
33

 

 

 
43

Net properties, plants and equipment (held for sale)
32

 
32

 

 

 
42

Equity method investment
283

 

 

 
283

 
480

*Represents the fair value at the time of the impairment.


During the nine-month period ended September 30, 2013, net PP&E held for use related to the composite graphite business in our M&S segment, with a carrying amount of $18 million, was written down to its fair value, resulting in a before-tax loss of $18 million. Fair value was based on an internal assessment of expected discounted future cash flows. During this same period, Corporate net PP&E with a carrying amount of $31 million was written down to its fair value of $22 million, resulting in a before-tax loss of $9 million. The fair value was primarily determined by a third-party valuation.
 
During the nine-month period ended September 30, 2012, net PP&E held for use related to a terminal and storage facility, with a carrying amount of $76 million, was written down to its fair value of $33 million, resulting in a before-tax loss of $43 million. In addition, net PP&E held for sale related to equipment formerly associated with a canceled refinery upgrade project, with a carrying amount of $74 million, was written down to its fair value of $32 million, resulting in a before-tax loss of $42 million. The fair values in each case were primarily determined by negotiated selling prices with third parties. During this same period, our investment in a natural gas transmission pipeline was written down to a fair value of $283 million, resulting in a before-tax loss of $480 million. The fair value was determined principally by the application of an internal discounted cash flow model using estimates of future production, prices, costs and a discount rate believed to be consistent with those used by principal market participants. The decline in the fair value was considered to be other than temporary.


Note 16—Leases

In August 2013, we entered into a 20-year capital lease to continue our use of an oil terminal in the United Kingdom. At September 30, 2013, $177 million of PP&E and debt obligations were recorded for this lease. Future minimum lease payments under this lease are: 2014—$5 million; 2015—$6 million; 2016—$6 million; 2017—$7 million; 2018—$7 million; and 2019 and after—$144 million. In 2013, total payments under this lease are estimated to be $2 million.


Note 17—Employee Benefit Plans

Pension and Postretirement Plans
Prior to the Separation, certain of our U.S. and U.K. employees participated in defined benefit pension plans and postretirement benefit plans (Shared Plans) sponsored by ConocoPhillips, which included participants of other ConocoPhillips subsidiaries. We accounted for such Shared Plans as multiemployer benefit plans. Accordingly, we did not record an asset or liability to recognize the funded status of the Shared Plans on our consolidated balance sheet until the Separation, at which time, the assets and liabilities of the Shared Plans which were allocable to our employees were transferred to us and we became the sponsor of the plans.


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Table of Contents

The allocated benefit cost from Shared Plans, as well as the components of net periodic benefit cost associated with plans sponsored by us for the three and nine months ended September 30, 2013 and 2012, are shown in the table below:
 
 
Millions of Dollars
 
Pension Benefits
 
Other Benefits
 
2013
 
2012
 
2013

 
2012

 
U.S.

 
Int’l.

 
U.S.

 
Int’l.

 
 
 
 
Components of Net Periodic Benefit Cost
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
31

 
9

 
30

 
7

 
2

 
1

Interest cost
23

 
7

 
25

 
8

 
2

 
2

Expected return on plan assets
(30
)
 
(7
)
 
(30
)
 
(7
)
 

 

Amortization of prior service cost
1

 

 

 

 

 

Recognized net actuarial loss (gain)
21

 
4

 
19

 
2

 

 
(1
)
Subtotal net periodic benefit cost
46

 
13

 
44

 
10

 
4

 
2

Allocated benefit cost from ConocoPhillips

 

 

 

 

 

Total net periodic benefit cost
$
46

 
13

 
44

 
10

 
4

 
2

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
93

 
27

 
51

 
14

 
6

 
2

Interest cost
69

 
23

 
41

 
17

 
5

 
3

Expected return on plan assets
(90
)
 
(22
)
 
(50
)
 
(14
)
 

 

Amortization of prior service cost (credit)
2

 
(1
)
 
1

 

 
(1
)
 

Recognized net actuarial loss (gain)
63

 
12

 
31

 
5

 

 
(1
)
Subtotal net periodic benefit cost
137

 
39

 
74

 
22

 
10

 
4

Allocated benefit cost from ConocoPhillips

 

 
71

 
13

 

 
7

Total net periodic benefit cost
$
137

 
39

 
145

 
35

 
10

 
11



During the first nine months of 2013, we contributed $136 million to our U.S. plans and $36 million to our international plans. We currently expect to make additional contributions of approximately $20 million in the fourth quarter of 2013, primarily to our international plans.



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Table of Contents

Note 18—Accumulated Other Comprehensive Income (Loss)

The following table depicts changes in accumulated other comprehensive loss by component, as well as detail on reclassifications out of accumulated other comprehensive loss:
 
 
Millions of Dollars
 
Defined Benefit Plans

 
Foreign Currency Translation

 
Hedging

 
Accumulated Other Comprehensive Loss

 
 
 
 
 
 
 
 
December 31, 2012
$
(778
)
 
466

 
(2
)
 
(314
)
Other comprehensive income (loss) before reclassifications
(1
)
 
(99
)
 
1

 
(99
)
Amounts reclassified from accumulated other comprehensive income (loss)*
 
 
 
 
 
 


Amortization of defined benefit plan items**
 
 
 
 
 
 
 
Actuarial losses
46

 

 

 
46

Net current period other comprehensive income (loss)
45

 
(99
)
 
1

 
(53
)
September 30, 2013
$
(733
)
 
367

 
(1
)
 
(367
)
*There were no significant reclassifications related to foreign currency translation or hedging.
**These accumulated other comprehensive income (loss) components are included in the computation of net periodic benefit cost (see Note 17—Employee Benefit Plans, for additional information).


Note 19—Cash Flow Information
 
 
Millions of Dollars
 
Nine Months Ended
 
September 30
 
2013

 
2012

Noncash Investing and Financing Activities
 
 
 
Increase in net PP&E and debt related to capital lease obligation
$
177

 

Transfer of net PP&E in accordance with the Separation and Distribution Agreement with ConocoPhillips

 
374

Transfer of employee benefit obligations in accordance with the Separation and Distribution Agreement with ConocoPhillips

 
1,234

Increase in deferred tax assets associated with the employee benefit liabilities transferred in accordance with the Separation and Distribution Agreement with ConocoPhillips

 
461

 
 
 
 
Cash Payments
 
 
 
Interest
$
146

 
28

Income taxes*
1,001

 
927

*Excludes our share of cash tax payments made directly by ConocoPhillips prior to the Separation.



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Table of Contents

Note 20—Related Party Transactions

Significant transactions with related parties were:

 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2013

 
2012

 
2013

 
2012

 
 
 
 
 
 
 
 
Operating revenues and other income (a)
$
2,064

 
1,883

 
5,866

 
6,119

Purchases (b)
4,998

 
4,176

 
13,762

 
18,984

Operating expenses and selling, general and administrative expenses (c)
28

 
32

 
80

 
175

Interest expense (d)
2

 
2

 
6

 
6


(a)
We sold crude oil to MRC. NGL and other petrochemical feedstocks, along with solvents, were sold to CPChem, and gas oil and hydrogen feedstocks were sold to Excel. Certain feedstocks and intermediate products were sold to WRB. We also acted as agent for WRB in supplying other crude oil and feedstocks, wherein the transactional amounts did not impact operating revenues. In addition, we charged several of our affiliates, including CPChem and MSLP, for the use of common facilities, such as steam generators, waste and water treaters, and warehouse facilities.

(b)
We purchased refined products from WRB. We also acted as agent for WRB in distributing asphalt and solvents, wherein the transactional amounts did not impact purchases. We purchased natural gas and NGL from DCP Midstream and CPChem for use in our refinery processes and other feedstocks from various affiliates. We purchased refined products from MRC. We also paid fees to various pipeline equity companies for transporting finished refined products. In addition, we paid a price upgrade to MSLP for heavy crude processing. We purchased base oils and fuel products from Excel for use in our refining and specialty businesses.

(c)
We paid utility and processing fees to various affiliates.

(d)
We incurred interest expense on a note payable to MSLP. See Note 6—Investments, Loans and Long-Term Receivables, for additional information on loans to affiliated companies.

Also included in the table above are transactions with ConocoPhillips through April 30, 2012, prior to the Separation. These transactions include crude oil purchased from ConocoPhillips as feedstock for our refineries and power sold to ConocoPhillips from our power generation facilities. Sales to and purchases from ConocoPhillips, while it was a related party, were $381 million and $5,328 million, respectively, for the nine months ended September 30, 2012.

For the period prior to the Separation, the consolidated statement of income includes expense allocations for certain corporate functions historically performed by ConocoPhillips and not allocated to its operating segments, including allocations of general corporate expenses related to executive oversight, accounting, treasury, tax, legal, procurement and information technology. Net charges from ConocoPhillips for these services, reflected in selling, general and administrative expenses, were $70 million for the nine months ended September 30, 2012.



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Table of Contents

Note 21—Segment Disclosures and Related Information

Effective January 1, 2013, we changed the organizational structure of the internal financial information reviewed by our chief executive officer, and determined this resulted in a change in the composition of our operating segments. The primary effects of this reporting reorganization were:

We disaggregated the former R&M segment into two separate operating segments titled "Refining" and "Marketing and Specialties."

We moved our Transportation and power businesses from the former R&M segment to the Midstream and Marketing and Specialties segments, respectively.

This realignment resulted in the following operating segments:

1)
Midstream—Gathers, processes, transports and markets natural gas; and transports, fractionates and markets NGL in the United States. In addition, this segment transports crude oil and other feedstocks to our refineries and other locations, and delivers refined and specialty products to market. The Midstream segment includes, among other businesses, our 50 percent equity investment in DCP Midstream.

2)
Chemicals—Manufactures and markets petrochemicals and plastics on a worldwide basis. The Chemicals segment consists of our 50 percent equity investment in CPChem.

3)
Refining—Buys, sells and refines crude oil and other feedstocks at 15 refineries, mainly in the United States, Europe and Asia.

4)
Marketing and Specialties—Purchases for resale and markets refined products, mainly in the United States and Europe. In addition, this segment includes the manufacturing and marketing of specialty products (such as lubricants and flow improvers), as well as power generation operations.

Corporate and Other includes general corporate overhead, interest expense, our investments in new technologies and various other corporate activities. Corporate assets include all cash and cash equivalents.

We evaluate performance and allocate resources based on net income attributable to Phillips 66. Intersegment sales are at prices that approximate market, except for certain 2012 transportation services provided by the Midstream segment to the Refining and M&S segments.

The new segment alignment is presented for the three- and nine-month periods ended September 30, 2013, with the prior periods recast for comparability.

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Table of Contents

Analysis of Results by Operating Segment

 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2013

 
2012

 
2013

 
2012

Sales and Other Operating Revenues
 
 
 
 
 
 
 
Midstream
 
 
 
 
 
 
 
Total sales
$
1,480

 
1,573

 
4,490

 
5,334

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