Imperial Oil - 10-Q quarterly report FY

 

 

(Exact name of registrant as specified in its charter)

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.
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (see definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Securities Exchange Act of 1934).
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
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IMPERIAL OIL LIMITED

INDEX

In this report all dollar amounts are expressed in Canadian dollars unless otherwise stated. This report should be read in conjunction with the company’s Annual Report on Form 10-K for the year ended December 31, 2005, and Form 10-Q for the quarter ended March 31, 2006.

Statements in this report regarding future events or conditions are forward-looking statements. Actual results could differ materially due to the impact of market conditions, changes in law or governmental policy, changes in operating conditions and costs, changes in project schedules, operating performance, demand for oil and gas, commercial negotiations or other technical and economic factors.

IMPERIAL OIL LIMITED

CONSOLIDATED STATEMENT OF INCOME
(U.S. GAAP, unaudited)

The notes to the financial statements are part of these financial statements. Certain figures for the prior year have been reclassified in the financial statements to conform with the current year’s presentation.

IMPERIAL OIL LIMITED

The notes to the financial statements are part of these financial statements. Certain figures for the prior year have been reclassified in the financial statements to conform with the current year’s presentation.

IMPERIAL OIL LIMITED

IMPERIAL OIL LIMITED

These unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles of the United States of America and follow the same accounting policies and methods of computation as, and should be read in conjunction with, the most recent annual consolidated financial statements. In the opinion of the management, the information furnished herein reflects all known accruals and adjustments necessary for a fair presentation of the financial position of the company as at June 30, 2006, and December 31, 2005, and the results of operations and changes in cash flows for the three and six months ending June 30, 2006 and 2005. All such adjustments are of a normal recurring nature. The company’s exploration and production activities are accounted for under the “successful efforts” method.

The results for the three and six months ending June 30, 2006, are not necessarily indicative of the operations to be expected for the full year.

All amounts are in Canadian dollars unless otherwise indicated.

Effective January 1, 2006, the company adopted the Financial Accounting Standards Board’s revised Statement of Financial Accounting Standards No. 123 (SFAS 123R), Share-based Payment. SFAS 123R requires compensation costs related to share-based payments to be recognized in the income statement over the requisite service period. The amount of the compensation costs is to be measured based on the grant-date fair value of the instrument issued. In addition, liability awards are to be remeasured each reporting period through settlement. SFAS 123R is effective for awards granted or modified after the date of adoption and for awards granted prior to that date that have not vested. In 2003, the company adopted a policy of expensing all share-based payments that is consistent with the provisions of SFAS 123R, and all prior years outstanding stock option awards have vested. SFAS 123R will therefore not materially change the company’s existing accounting practices or the amount of share-based compensation recognized in earnings.

The cumulative compensation expense associated with share-based payments made in 2004 and 2005 has been recognized in the income statement using the “nominal vesting period approach”. The full cost of awards given to employees who have retired before the end of the vesting period has been expensed. The use of a “non-substantive vesting period approach” based on the retirement eligibility age, is not significantly different from the nominal vesting period approach. The non-substantive vesting period approach is applicable to grants made after the adoption of SFAS 123R.

Incentive share units have value if the market price of the company’s common shares when the unit is exercised exceeds the market value when the unit was issued, as adjusted for any share splits. The issue price of incentive share units is the closing price of the company’s shares on the Toronto Stock Exchange on the grant date. Up to 50 percent of the units may be exercised after one year from issuance; an additional 25 percent may be exercised after two years; and the remaining 25 percent may be exercised after three years. Incentive share units are eligible for exercise up to 10 years from issuance. The units may expire earlier if employment is terminated other than by retirement, death or disability.

The deferred share unit plan is made available to selected executives and nonemployee directors. The selected executives can elect to receive all or part of their performance bonus compensation in units and the nonemployee directors can elect to receive all or part of their directors’ fees in units. The number of units granted to executives is determined by dividing the amount of the bonus elected to be received as deferred share units by the average of the closing prices of the company’s shares on the Toronto Stock Exchange for the five consecutive trading days immediately prior to the date that the bonus would have been paid. The number of units granted to a nonemployee director is determined at the end of each calendar quarter by dividing the amount of director’s fees for the calendar quarter that the nonemployee director elected to receive as deferred share units by the average closing price of the company’s shares for the five consecutive trading days immediately prior to the last day of the calendar quarter. Additional units are granted based on the cash dividend payable on the company’s shares divided by the average closing price immediately prior to the payment date for that dividend and multiplying the resulting number by the number of deferred share units held by the recipient, as adjusted for any share splits.

IMPERIAL OIL LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Deferred share units cannot be exercised until after termination of employment with the company or resignation as a director and must be exercised no later than December 31 of the year following termination or resignation. On the exercise date, the cash value to be received for the units is determined based on the average closing price of the company’s shares for the five consecutive trading days immediately prior to the date of exercise, as adjusted for any share splits.

Under the restricted stock unit plan, each unit entitles the recipient to the conditional right to receive from the company, upon exercise, an amount equal to the closing price of the company’s common shares on the Toronto Stock Exchange on the exercise dates, as adjusted for any share splits. Fifty percent of the units are exercised three years following the grant date, and the remainder are exercised seven years following the grant date.

All units require settlement by cash payments with one exception. The restricted stock unit program was amended for units granted in 2003 and future years by providing that the recipient may receive one common share of the company per unit, as adjusted for any share splits, or elect to receive the cash payment for the units to be exercised on the seventh anniversary of the grant date.

In accordance with SFAS 123R, the company accounts for these units by using the fair-value-based method, which is the same method of accounting as under SFAS 123. The fair value of awards in the form of incentive share, deferred share and restricted stock units is the market price of the stock. Under this method, compensation expense related to the units of these programs is measured each reporting period based on the company’s current share price and is recorded in the consolidated statement of income over the vesting period.

The following table summarizes information about these units for the six months ended June 30, 2006:

The compensation expense that has been charged against income for these programs was $7 million and $54 million for the second quarter of 2006 and 2005 and $55 million and $152 million for the six months ended June 30, 2006 and 2005, respectively. The total income tax benefit recognized in income related to this compensation expense was $3 million and $28 million for the second quarter of 2006 and 2005 and $29 million and $77 million for the six months ended June 30, 2006 and 2005, respectively.

As of June 30, 2006, there was $223 million of total before-tax unrecognized compensation expenses related to nonvested restricted stock units based on the company’s share price at the end of the current reporting period. The weighted-average vesting period of nonvested restricted stock units is 3.3 years. All units under the incentive share and deferred share programs have vested as of June 30, 2006.

In April 2002, incentive stock options were granted for the purchase of the company’s common shares at an exercise price of $15.50 per share (adjusted to reflect the three-for-one share split). Up to 50 percent of the options may be exercised on or after January 1, 2003, a further 25 percent may be exercised on or after January 1, 2004, and the remaining 25 percent may be exercised on or after January 1, 2005. Any unexercised options expire after April 29, 2012. The company has not issued incentive stock options since 2002 and has no plans to issue incentive stock options in the future.

The company has purchased shares on the market to fully offset the dilutive effects from the exercise of stock options. The practice is expected to continue.

As permitted by SFAS 123, the company continues to apply the intrinsic-value-based method of accounting for the incentive stock options granted in April 2002. Under this method, compensation expense is not recognized on the issuance of stock options as the exercise price is equal to the market value at the date of grant. All incentive stock options have vested as of January 1, 2005.

IMPERIAL OIL LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The following table summarizes information about stock options for the six months ended June 30, 2006:

No compensation expense and no income tax benefit related to stock options were recognized for stock options in the six months ended June 30, 2006, and 2005. Cash received from stock option exercises for the six months ended June 30, 2006, was $4 million. The aggregate intrinsic value of stock options exercised in the six months ended June 30, 2006, was $7 million, and for the balance of outstanding stock options is $148 million.

Effective January 1, 2006, the company adopted the Emerging Issues Task Force (EITF) consensus on Issue No. 04-13, Accounting for Purchases and Sales of Inventory with the Same Counterparty. The EITF concluded that purchases and sales of inventory with the same counterparty that are entered into in contemplation of one another should be combined and recorded as exchanges measured at the book value of the item sold. In prior periods, the company recorded certain crude oil, natural gas, petroleum product and chemical sales and purchases contemporaneously negotiated with the same counterparty as revenues and purchases. As a result of the EITF consensus, the company’s accounts “operating revenue” and “purchases of crude oil and products” on the consolidated statement of income will be reduced by associated amounts with no impact on net income. All operating segments are affected by this change, with the largest impact in the petroleum products segment.

IMPERIAL OIL LIMITED

IMPERIAL OIL LIMITED

IMPERIAL OIL LIMITED

Investment and other income includes gains and losses on asset sales as follows:

The components of net benefit cost included in production and manufacturing and selling and general expenses in the consolidated statement of income are as follows:

IMPERIAL OIL LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Effective May 23, 2006, the issued common shares of the company were split on a three-for-one basis and the number of authorized shares was increased from 450 million to 1,100 million. The prior period number of shares outstanding and shares purchased, as well as net income and dividends per share, have been adjusted to reflect the three-for one split.

In 1995 through 2005, the company purchased shares under eleven 12-month normal course share purchase programs, as well as an auction tender. On June 23, 2006, another 12-month normal course program was implemented with an allowable purchase of up to 48.8 million shares (five percent of the total on June 21, 2006), less any shares purchased by the employee savings plan and company pension fund. The results of these activities are as shown below:

Exxon Mobil Corporation’s participation in the above maintained its ownership interest in Imperial at 69.6 percent.

The excess of the purchase cost over the stated value of shares purchased has been recorded as a distribution of earnings reinvested.

IMPERIAL OIL LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The following table provides the calculation of net income per common share:

The company’s net income for the second quarter was $837 million or $0.85 a share on a diluted basis, compared with $539 million or $0.52 a share for the same quarter of 2005. Net income for the first six months of 2006 was $1,428 million or $1.44 a share on a diluted basis, versus $932 million or $0.89 a share for the first half of 2005.

Earnings in the second quarter were higher than the same period of 2005 due mainly to higher natural resources realizations and stronger refining margins, which combined for a positive impact of about $465 million. Earnings were also positively impacted by lower tax expenses of about $110 million primarily from the impact of a one-time future income tax adjustment based on lower federal and Alberta tax rates and lower stock-related compensation expenses of about $45 million. These factors were partially offset by lower net, after-royalties natural resources volumes of about $100 million, higher planned refinery maintenance and capital project activities impacting both refinery throughput and expenses of about $100 million and the negative impact of a stronger Canadian dollar of about $100 million.

For the first six months, higher natural resources realizations and stronger refining and marketing margins contributed about $750 million to earnings when compared to the same period in 2005. Also positive to earnings were lower tax expenses of about $115 million and lower stock-related compensation expenses of about $95 million. Partially offsetting these positive factors were the impact of a stronger Canadian dollar of about $150 million, higher energy, Syncrude and other operating costs of about $120 million, higher planned refinery maintenance and capital project impacts of about $100 million and lower conventional crude oil and natural gas liquids (NGL) volumes of about $90 million.

Total operating revenues were $6,604 million in the second quarter and $12,390 million in the first half of 2006, versus $6,710 million and $12,650 million in the same periods last year.

Net income from natural resources in the second quarter was a record $754 million, up $285 million from the second quarter in 2005. Earnings increased primarily due to higher realizations for Cold Lake bitumen and crude oil of about $330 million. Natural resources volumes, on a net after-royalties basis, were unfavourable to earnings by about $100 million. Higher production volumes at Cold Lake in the quarter were more than offset by higher royalties and lower conventional crude oil and NGL volumes due to natural decline and divestments. Positive earnings were also offset partially by the negative impact of a stronger Canadian dollar of about $70 million and higher energy and Syncrude maintenance costs of about $35 million. Tax expenses in second quarter 2006 were lower by about $160 million primarily from reductions in federal and Alberta tax rates.

Net income for the first six months was $1,151 million versus $745 million during the same period last year. Cold Lake bitumen, crude oil and natural gas realizations were stronger by about $540 million compared to the first six months of 2005. Their positive impact on earnings was partially offset by the negative impact of a higher Canadian dollar of about $105 million, higher operating costs of about $100 million, primarily driven by higher energy and Syncrude costs, and lower net, after-royalties volumes of about $90 million. Tax expenses in the first six months were lower by about $165 million primarily from reductions in federal and Alberta tax rates.

While Brent crude oil prices in U.S. dollars averaged 35 percent higher in the second quarter and 32 percent higher for the first six months compared with the same periods last year, increased realizations for conventional crude oil averaged less at 23 and 16 percent respectively mainly because of a stronger Canadian dollar. Average realizations for Cold Lake bitumen were higher in 2006, by over 90 percent in the second quarter and almost 70 percent in the first six months, reflecting a price spread between light crude oil and Cold Lake bitumen more consistent with historical trend levels.

Realizations for natural gas averaged $6.52 a thousand cubic feet in the second quarter, down from $7.71 a thousand cubic feet in the same quarter last year, primarily a result of increased industry inventory levels of natural gas. For the first six-month period, realizations for natural gas averaged $7.99 a thousand cubic feet in 2006, up from $7.37 a thousand cubic feet in the same period of 2005.

Total gross production of crude oil and NGLs was 273 thousand barrels a day, up from 267 thousand barrels in the second quarter of 2005. For the first six months of the year, total gross production of crude oil and NGLs averaged 269 thousand barrels a day, compared with 264 thousand barrels in the same period of 2005.

Gross production of Cold Lake bitumen averaged a record 157 thousand barrels a day during the second quarter versus 137 thousand barrels in the same quarter last year. For the first six months, gross production was 154 thousand barrels a day this year, up from 144 thousand barrels in the same period of 2005. Higher production was due to the cyclic nature of production at Cold Lake and increased volumes from the ongoing development drilling program.

The company’s share of Syncrude’s gross production was 60 thousand barrels a day in the second quarter compared with 58 thousand barrels during the same period a year ago. During the first six-month period, the company’s share of gross production from Syncrude averaged 56 thousand barrels a day in 2006, up from 49 thousand barrels in the same period of 2005. Higher production volumes were due to lower maintenance activities in the first half of 2006.

In the second quarter and first six months of this year, gross production of conventional crude oil averaged 31 and 32 thousand barrels a day respectively, compared with 40 thousand barrels during the corresponding periods in 2005. The impact of divested producing properties and the natural reservoir decline in the Western Canadian Basin were the main reasons for the reduced production.

Gross production of NGLs available for sale was 25 thousand barrels a day in the second quarter, down from 32 thousand barrels a day in the same quarter last year. During the first half of 2006, gross production of NGLs available for sale decreased to 27 thousand barrels a day, from 31 thousand barrels in the same period of 2005, mainly due to declining NGL content of Wizard Lake gas production.

Gross production of natural gas during the second quarter of 2006 decreased to 557 million cubic feet a day from 576 million cubic feet in the same period last year. In the first half of the year, gross production was 568 million cubic feet a day, down from 580 million in the first six months of 2005.

In April, the company sold its interests in the Calmette and Westlock natural gas fields, both located in Alberta, for net proceeds of about $57 million, realizing a gain of $38 million. Natural gas production for the company’s share of these two properties averaged about 2.6 million cubic feet a day during 2005.

The new coker unit at the Syncrude Stage 3 expansion project was temporarily shut down on May 18, 2006 in response to an Environmental Protection Order (EPO) issued by Alberta Environment. The EPO was issued regarding odorous emissions associated with the start-up of the new coker unit in early May. On July 6, 2006, Syncrude obtained regulatory approval from Alberta Environment for its plan to resume operation of the shut-down facilities following completion of modifications to rectify the problem. Start-up activities commenced on July 10, 2006 and the start-up and run-in period is expected to last several weeks prior to reintroduction of bitumen feed into the new coker. The company’s share of production capacity affected was approximately 25,000 barrels a day. Production capacity of Syncrude’s base operations, excluding volumes from the new coker unit, were unaffected by these events.

In view of significant cost pressures on the Mackenzie Gas project, the project proponents are currently developing action plans aimed at reducing all aspects of cost. A revised cost and schedule estimate for the project is expected later this fall.

Net income from petroleum products was $62 million in the second quarter of 2006, compared with $94 million in the same period a year ago. Stronger industry refining margins were largely offset by an increase in planned shutdowns of refinery operating units for maintenance activities as well as capital project work required to reduce sulphur content in diesel fuel. These extensive maintenance and project activities impacted both refinery throughput and expenses by a total of about $100 million, as compared to the same period last year. Earnings were also negatively impacted by higher tax expenses of $40 million due to unfavourable effects of tax rate changes and a stronger Canadian dollar of about $25 million. Lower product sales volume had limited impact on earnings.

Six-month net income was $261 million versus $260 million in the same period of 2005. Stronger refining and marketing margins were partially offset by the higher planned refinery maintenance and low-sulphur diesel project activities impacting both refinery throughput and expenses of about $100 million versus the prior year. Earnings were also negatively impacted by a stronger Canadian dollar of about $45 million, higher tax expenses of $40 million and higher energy costs from higher prices of about $20 million. Lower product sales volume had limited impact on earnings.

Net income from chemicals was $31 million in the second quarter, slightly lower than $33 million in the second quarter last year. Six-month net income was $70 million, compared with $77 million for the same period in 2005. Lower industry margins for aromatics and polyethylene were the primary contributors to the reduction in six-month earnings.

Net income from corporate and other at negative $10 million in the second quarter compared with negative $57 million in the same period of 2005. Six-month net income was negative $54 million versus negative $150 million last year due mainly to lower stock-related compensation expenses.

Cash flow from operating activities was $926 million during the second quarter of 2006, up from $827 million in the same period last year. The increase in cash flow was driven primarily by higher net income and lower petroleum product inventory levels. These positive factors on cash flow were partially offset by the combined unfavourable impact of higher accounts receivable balances due mainly to higher crude oil prices and lower accounts and income taxes payable balances due to timing of expenditures and income tax payments, respectively.

Year-to-date cash flow from operating activities was $888 million, versus $770 million during the first half of 2005. Increased net income, lower accounts receivable balances and lower seasonal inventory builds contributed largely to the higher cash inflow. These positive factors were moderated by lower accounts payable balances through lower crude oil and petroleum product purchases and the timing of expenditures.

Capital and exploration expenditures were $283 million in the second quarter, down from $353 million during the same quarter of 2005, and $605 million in the first half of 2006, versus $678 million in the same period a year ago. For the resources segment, capital and exploration expenditures were used mainly at Syncrude and Cold Lake to maintain and expand production capacity. The petroleum products segment spent its capital expenditures mainly on projects to reduce the sulphur content of diesel fuel, improve operating efficiency and upgrade the network of Esso retail outlets. The company was producing ultra-low-sulphur diesel to meet the new government regulations by June 1, 2006.

On June 21, 2006, the company announced that it had received acceptance from the Toronto Stock Exchange for a new normal course issuer bid to continue its existing share-purchase program that expired on June 22, 2006. The new share-purchase program enables the company to repurchase up to 48.8 million shares during the period from June 23, 2006, to June 22, 2007. During the first half of 2006, the company repurchased about 24.1 million shares for $937 million.

Cash dividends of $159 million were paid in the first six months of 2006. This compared with dividends of $154 million in the comparable period of 2005. Per-share dividends paid in the first two quarters of 2006 totaled $0.16, up from $0.15 in the same period last year.

The above factors led to a decrease in the company’s balance of cash and marketable securities to $997 million at June 30, 2006, from $1,661 million at the end of 2005.

On May 2, 2006, shareholders approved a proposal to split the company’s shares on a three-for-one basis. Shares commenced trading on a post-split basis on May 17, 2006.

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes”. FIN 48 is an interpretation of FASB Statement No. 109 “Accounting for Income Taxes” and must be adopted by the company no later than January 1, 2007. FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting, and disclosing in the financial statements uncertain tax positions that the company has taken or expects to take in its tax returns. The company is evaluating the impact of adopting FIN 48.

Information about market risks for the six months ended June 30, 2006 does not differ materially from that discussed on page 31 in the company’s annual report on Form 10-K for the year ended December 31, 2005 and Form 10-Q for the quarter ended March 31, 2006, except for the following sensitivities:

The sensitivity of net income to changes in the Canadian dollar versus the U.S. dollar increased from the first quarter 2006 by about $3 million (after tax) for each one-cent difference. This is primarily due to the increase in crude oil prices.

The sensitivity to changes in crude oil prices decreased from 2005 year-end by about $3 million (after tax) for each one U.S.-dollar difference. An increase in the value of the Canadian dollar has lessened the impact of U.S. dollar denominated crude oil prices on the company’s revenues and earnings.

The company’s principal executive officer and principal financial officer have evaluated the company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, these officers have concluded that, as of the end of the period covered by this quarterly report, the company’s disclosure controls and procedures are effective for the purpose of ensuring that information required to be disclosed by the company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There has not been any change in the company’s internal control over financial reporting during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.

During the period April 1, 2006 to June 30, 2006, the company issued 196,635 common shares (on a post-split basis) to employees or former employees outside the U.S.A. for $15.50 per share (on a post-split basis) upon the exercise of stock options. These issuances were not registered under the Securities Act in reliance on Regulation S thereunder.

(a) Certifications by each of the principal executive officer and principal financial officer of the company pursuant to Rule 13a-14(a) are Exhibits (31.1) and (31.2).

Certifications by each of the chief executive officer and the chief financial officer of the company pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350 are Exhibits (32.1) and (32.2).

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.