Edgar Filing: Zoetis Inc.

Document

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 March 31, 2019
	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: 001-35797

Zoetis Inc.

(Exact name of registrant as specified in its charter)



Delaware		46-0696167
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)
10 Sylvan Way, Parsippany, New Jersey		07054
(Address of principal executive offices)		(Zip Code)

(973) 822-7000

(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 and 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. x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer x	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company ¨	Emerging growth company ¨



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	ZTS	New York Stock Exchange

At April 26, 2019, there were 478,656,189 shares of common stock outstanding.

Table of Contents

TABLE OF CONTENTS



		Page
PART I — FINANCIAL INFORMATION		1
Item 1.	Financial Statements	1
	Condensed Consolidated Statements of Income (Unaudited)	1
	Condensed Consolidated Statements of Comprehensive Income (Unaudited)	2
	Condensed Consolidated Balance Sheets (Unaudited)	3
	Condensed Consolidated Statements of Equity (Unaudited)	4
	Condensed Consolidated Statements of Cash Flows (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6
	Review Report of Independent Registered Public Accounting Firm	25
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43
Item 4.	Controls and Procedures	43
PART II — OTHER INFORMATION		44
Item 1.	Legal Proceedings	44
Item 1A.	Risk Factors	44
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	44
Item 3.	Defaults Upon Senior Securities	44
Item 4.	Mine Safety Disclosures	44
Item 5.	Other Information	44
Item 6.	Exhibits	44
SIGNATURES		45

Table of Contents

PART I – FINANCIAL INFORMATION


Item 1.	Financial Statements

ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)	2019			2018
Revenue	$	1,455		$	1,366
Costs and expenses:
Cost of sales	518			447
Selling, general and administrative expenses	369			338
Research and development expenses	102			97
Amortization of intangible assets	38			23
Restructuring charges and certain acquisition-related costs	5			2
Interest expense, net of capitalized interest	56			47
Other (income)/deductions—net	(14		)	(5		)
Income before provision for taxes on income	381			417
Provision for taxes on income	69			67
Net income before allocation to noncontrolling interests	312			350
Less: Net loss attributable to noncontrolling interests	—			(2		)
Net income attributable to Zoetis Inc.	$	312		$	352
Earnings per share attributable to Zoetis Inc. stockholders:
Basic	$	0.65		$	0.72
Diluted	$	0.65		$	0.72
Weighted-average common shares outstanding:
Basic	479.6			485.9
Diluted	483.1			489.8
Dividends declared per common share	$	0.164		$	0.126

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS)	2019		2018
Net income before allocation to noncontrolling interests	$	312	$	350
Other comprehensive income, net of taxes and reclassification adjustments:
Foreign currency translation adjustments, net	31		77
Total other comprehensive income, net of tax	31		77
Comprehensive income before allocation to noncontrolling interests	343		427
Less: Comprehensive loss attributable to noncontrolling interests	—		(1		)
Comprehensive income attributable to Zoetis Inc.	$	343	$	428

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS



	March 31,			December 31,
	2019			2018
(MILLIONS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)	(Unaudited)
Assets
Cash and cash equivalents^(a)	$	1,728		$	1,602
Short term investments	65			99
Accounts receivable, less allowance for doubtful accounts of $24 in 2019 and $24 in 2018	970			1,036
Inventories	1,361			1,391
Other current assets	255			271
Total current assets	4,379			4,399
Property, plant and equipment, less accumulated depreciation of $1,642 in 2019 and $1,599 in 2018	1,683			1,658
Operating lease right of use assets	158			—
Goodwill	2,522			2,519
Identifiable intangible assets, less accumulated amortization	1,989			2,046
Noncurrent deferred tax assets	65			61
Other noncurrent assets	87			94
Total assets	$	10,883		$	10,777

Liabilities and Equity
Short-term borrowings	$	—		$	9
Accounts payable	235			313
Dividends payable	79			79
Accrued expenses	448			487
Accrued compensation and related items	200			266
Income taxes payable	65			35
Other current liabilities	55			34
Total current liabilities	1,082			1,223
Long-term debt, net of discount and issuance costs	6,444			6,443
Noncurrent deferred tax liabilities	464			474
Operating lease liabilities	134			—
Other taxes payable	261			265
Other noncurrent liabilities	181			187
Total liabilities	8,566			8,592
Commitments and contingencies (Note 16)
Stockholders' equity:
Preferred stock, $0.01 par value: 1,000,000,000 authorized, none issued	—			—
Common stock, $0.01 par value: 6,000,000,000 authorized; 501,891,243 and 501,891,243 shares issued; 479,026,001 and 479,562,326 shares outstanding at March 31, 2019, and December 31, 2018, respectively	5			5
Treasury stock, at cost, 22,865,242 and 22,328,917 shares of common stock at March 31, 2019, and December 31, 2018, respectively	(1,593		)	(1,487		)
Additional paid-in capital	1,008			1,026
Retained earnings	3,495			3,270
Accumulated other comprehensive loss	(598		)	(629		)
Total equity	2,317			2,185
Total liabilities and equity	$	10,883		$	10,777


^(a)	As of March 31, 2019, and December 31, 2018, includes $3 million and $5 million, respectively, of restricted cash.

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(UNAUDITED)



	Zoetis
													Accumulated			Equity
							Additional						Other			Attributable to
		Common		Treasury			Paid-in			Retained			Comprehensive			Noncontrolling			Total
(MILLIONS OF DOLLARS)		Stock^(a)		Stock^(a)			Capital			Earnings			Loss			Interests			Equity
Balance, December 31, 2017		$	5	$	(852	)	$	1,013		$	2,109		$	(505	)	$	16		$	1,786
Three months ended March 31, 2018
Net income		—		—			—			352			—			(2		)	350
Other comprehensive income		—		—						—			76			1			77
Share-based compensation awards^(b)		—		37			(24		)	(1		)	—			—			12
Treasury stock acquired^(c)		—		(190		)	—			—			—			—			(190		)
Employee benefit plan contribution from Pfizer Inc.^(d)		—		—			1			—			—			—			1
Dividends declared		—		—						(61		)	—			—			(61		)
Balance, March 31, 2018		$	5	$	(1,005	)	$	990		$	2,399		$	(429	)	$	15		$	1,975

Balance, December 31, 2018		$	5	$	(1,487	)	$	1,026		$	3,270		$	(629	)	$	—		$	2,185
Three months ended March 31, 2019
Net income/(loss)		—		—			—			312			—			—			312
Other comprehensive loss		—		—			—			—			31			—			31
Share-based compensation awards^(b)		—		44			(19		)	(8		)	—			—			17
Treasury stock acquired^(c)		—		(150		)	—			—			—			—			(150		)
Employee benefit plan contribution from Pfizer Inc.^(d)		—		—			1			—			—			—			1
Dividends declared		—		—			—			(79		)	—			—			(79		)
Balance, March 31, 2019		$	5	$	(1,593	)	$	1,008		$	3,495		$	(598	)	$	—		$	2,317


^(a)	As of March 31, 2019, and March 31, 2018, there were 479,026,001 and 484,724,245 outstanding shares of common stock, respectively, and 22,865,242 and 17,166,998 shares of treasury stock, respectively. Treasury stock is recognized at the cost to reacquire the shares. For additional information, see Note 14. Stockholders' Equity.


^(b)	Includes the issuance of shares of Zoetis Inc. common stock and the reissuance of treasury stock in connection with the vesting of employee share-based awards. Treasury stock also includes the reacquisition of shares of treasury stock associated with the vesting of employee share-based awards to satisfy tax withholding requirements.


^(c)	Reflects the acquisition of treasury shares in connection with the share repurchase program. For additional information, see Note 14. Stockholders' Equity.


^(d)	Represents contributed capital from Pfizer Inc. associated with service credit continuation for certain Zoetis Inc. employees in Pfizer Inc.'s U.S. qualified defined benefit and U.S. retiree medical plans.

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS)	2019			2018
Operating Activities
Net income before allocation to noncontrolling interests	$	312		$	350
Adjustments to reconcile net income before noncontrolling interests to net cash provided by operating activities:
Depreciation and amortization expense	98			60
Share-based compensation expense	18			11
Asset write-offs and asset impairments	1			2
Provision for losses on inventory	14			16
Deferred taxes^(a)	(16		)	(141		)
Employee benefit plan contribution from Pfizer Inc.	1			1
Other non-cash adjustments	—			3
Other changes in assets and liabilities, net of acquisitions and divestitures
Accounts receivable	75			60
Inventories	17			(33		)
Other assets	24			(2		)
Accounts payable	(79		)	(46		)
Other liabilities	(103		)	(55		)
Other tax accounts, net^(a)	27			163
Net cash provided by operating activities	389			389
Investing Activities
Purchases of property, plant and equipment	(63		)	(53		)
Proceeds from maturities and redemptions of investments	36			—
Net proceeds from sales of assets	—			8
Other investing activities	4			—
Net cash used in investing activities	(23		)	(45		)
Financing Activities
Decrease in short-term borrowings, net	(9		)	—
Payment of contingent consideration related to previously acquired assets	(8		)	(12		)
Share-based compensation-related proceeds, net of taxes paid on withholding shares	3			2
Purchases of treasury stock	(150		)	(190		)
Cash dividends paid	(79		)	(62		)
Net cash used in financing activities	(243		)	(262		)
Effect of exchange-rate changes on cash and cash equivalents	3			8
Net increase in cash and cash equivalents	126			90
Cash and cash equivalents at beginning of period	1,602			1,564
Cash and cash equivalents at end of period	$	1,728		$	1,654

Supplemental cash flow information
Cash paid during the period for:
Income taxes	$	29		$	42
Interest, net of capitalized interest	96			70
Non-cash transactions:
Capital expenditures	5			1
Dividends declared, not paid	79			61


^(a)	For 2018, reflects the reclassification of the one-time mandatory deemed repatriation tax from Noncurrent deferred tax liabilities to Income taxes payable and Other taxes payable to properly reflect the liability, which became a fixed obligation in 2018 payable over eight years.

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Organization

Zoetis Inc. (including its subsidiaries, collectively, Zoetis, the company, we, us or our) is a global leader in the discovery, development, manufacture and commercialization of animal health medicines, vaccines and diagnostic products with a focus on both livestock and companion animals. We organize and operate our business in two geographic regions: the United States (U.S.) and International.

We directly market our products in approximately 45 countries across North America, Europe, Africa, Asia, Australia and South America. Our products are sold in more than 100 countries, including developed markets and emerging markets. We have a diversified business, marketing products across eight core species: cattle, swine, poultry, sheep and fish (collectively, livestock) and dogs, cats and horses (collectively, companion animals); and within six major product categories: anti-infectives, vaccines, parasiticides, medicated feed additives, animal health diagnostics and other pharmaceuticals.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements were prepared following the requirements of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (U.S. GAAP) can be condensed or omitted. Balance sheet amounts and operating results for subsidiaries operating outside the United States are as of and for the three-month periods ended February 28, 2019, and February 28, 2018.

Revenue, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be representative of those for the full year.

We are responsible for the unaudited condensed consolidated financial statements included in this Form 10-Q. The condensed consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. The information included in this interim report should be read in conjunction with the financial statements and accompanying notes included in our 2018 Annual Report on Form 10-K.

3. Accounting Standards

Recently Adopted Accounting Standards

In February 2018, the FASB issued an accounting standards update which permits companies to reclassify from accumulated other comprehensive income to retained earnings stranded tax effects resulting from the new federal corporate income tax rate. In the period of adoption, a company may choose to either apply the amendments retrospectively to each period in which the effect of the change in federal income tax rate is recognized or to apply the amendments in that reporting period. We adopted this guidance as of January 1, 2019, the required effective date. The company has elected to not reclassify the stranded income tax effects from accumulated other comprehensive income to retained earnings as the amount is insignificant.

In February 2016, the FASB issued an accounting standards update which requires lessees to recognize most leases on the balance sheet with a corresponding right of use asset. Leases will be classified as financing or operating which will drive the expense recognition pattern. For lessees, the income statement presentation and expense recognition pattern for financing and operating leases is similar to the current model for capital and operating leases, respectively. Companies may elect to exclude short-term leases. The update also requires additional disclosures that will better enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We adopted this guidance as of January 1, 2019, the required effective date, using the effective date transition method. As permitted under the effective date transition method, financial information and disclosure for periods prior to the date of initial application will not be updated. An adjustment to opening retained earnings was not required in conjunction with our adoption. For additional information, see Note 10. Leases.

We have elected not to reassess whether expired or existing contracts contain leases, nor did we reassess the classification of existing leases as of the adoption date. We did not use hindsight in our assessment of lease terms as of the effective date.

Recently Issued Accounting Standards

In August 2018, the FASB issued an accounting standards update which expands the scope of costs associated with cloud computing arrangements that must be capitalized. Under the new guidance, costs associated with implementing a cloud computing arrangement that is a service contract must be capitalized and expensed over the term of the hosting arrangement. The provisions of the update are effective beginning January 1, 2020 for interim and annual periods with early adoption permitted for any interim period after issuance of the update. We are currently assessing the timing of our adoption as well as the potential impact that the standard will have on our consolidated financial statements.

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4. Revenue

A. Revenue from Product Sales

We offer a diversified portfolio of products which allows us to capitalize on local and regional customer needs. Generally, our products are promoted to veterinarians and livestock producers by our sales organization which includes sales representatives and technical and veterinary operations specialists, and then sold directly by us or through distributors. The depth of our product portfolio enables us to address the varying needs of customers in different species and geographies. Many of our top selling product lines are distributed across both of our operating segments, leveraging our R&D operations and manufacturing and supply chain network.

Over the course of our history, we have focused on developing a diverse portfolio of animal health products, including medicines, vaccines and diagnostics, complemented by biodevices, genetic tests and a range of services. We refer to a single product in all brands, or its dosage forms for all species, as a product line. We have approximately 300 comprehensive product lines, including products for both livestock and companion animals across each of our major product categories.

In the third quarter of 2018, the company modified the list of major product categories to include a category for animal health diagnostics, which was previously included within other non-pharmaceutical products. The prior period presentation has been revised to reflect the new product categories.

Our major product categories are:


•	vaccines: biological preparations that help prevent diseases of the respiratory, gastrointestinal and reproductive tracts or induce a specific immune response;


•	other pharmaceutical products: allergy and dermatology, pain and sedation, antiemetic, reproductive, and oncology products;


•	anti-infectives: products that prevent, kill or slow the growth of bacteria, fungi or protozoa;


•	parasiticides: products that prevent or eliminate external and internal parasites such as fleas, ticks and worms;


•	medicated feed additives: products added to animal feed that provide medicines to livestock; and


•	animal health diagnostics: portable blood and urine analysis systems and point-of-care diagnostic products, including instruments and reagents, rapid immunoassay tests, reference laboratory kits and blood glucose monitors.

Our remaining revenue is derived from other non-pharmaceutical product categories, such as nutritionals and agribusiness, as well as products and services in complementary areas, including biodevices and genetic tests.

Our livestock products primarily help prevent or treat diseases and conditions to enable the cost-effective production of safe, high-quality animal protein. Human population growth and increasing standards of living are important long-term growth drivers for our livestock products in three major ways. First, population growth and increasing standards of living drive increased demand for improved nutrition, particularly animal protein. Second, population growth leads to increased natural resource constraints driving a need for enhanced productivity. Finally, as standards of living improve, there is increased focus on food quality and safety.

Our companion animal products help extend and improve the quality of life for pets; increase convenience and compliance for pet owners; and help veterinarians improve the quality of their care and the efficiency of their businesses. Growth in the companion animal medicines, vaccines and diagnostics sector is driven by economic development, related increases in disposable income and increases in pet ownership and spending on pet care. Companion animals are also living longer, receiving increased medical treatment and benefiting from advances in animal health medicines and vaccines.

The following tables present our revenue disaggregated by geographic area, species, and major product category.

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Revenue by geographic area



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS)	2019		2018
United States	$	718	$	634
Australia	48		48
Brazil	60		70
Canada	41		40
China	60		64
France	32		33
Germany	37		38
Italy	28		27
Japan	37		41
Mexico	28		24
Spain	27		25
United Kingdom	57		52
Other developed markets	84		79
Other emerging markets	179		185
	1,436		1,360

Contract manufacturing & human health diagnostics	19		6

Total Revenue	$	1,455	$	1,366

Revenue by major species



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS)	2019		2018
U.S.
Livestock	$	273	$	292
Companion animal	445		342
	718		634
International
Livestock	434		478
Companion animal	284		248
	718		726

Contract manufacturing & human health diagnostics	19		6

Total Revenue	$	1,455	$	1,366

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Revenue by species



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS)	2019		2018
Livestock:
Cattle	$	380	$	416
Swine	149		175
Poultry	139		136
Fish	23		22
Other	16		21
	707		770
Companion Animal:
Dogs and Cats	688		549
Horses	41		41
	729		590

Contract manufacturing & human health diagnostics	19		6

Total Revenue	$	1,455	$	1,366

Revenue by major product category



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS)	2019		2018
Vaccines	$	358	$	356
Anti-infectives	286		297
Other pharmaceuticals	349		319
Parasiticides	231		191
Medicated feed additives	112		137
Animal health diagnostics	60		11
Other non-pharmaceuticals	40		49
	1,436		1,360

Contract manufacturing & human health diagnostics	19		6

Total Revenue	$	1,455	$	1,366

B. Revenue from Contracts with Customers

Contract liabilities reflected within Other current liabilities as of December 31, 2018 and December 31, 2017, and subsequently recognized as revenue during the first three months of 2019 and 2018 were approximately $1 million and $2 million, respectively. Contract liabilities as of March 31, 2019 and March 31, 2018 were approximately $10 million and $4 million, respectively.

Estimated future revenue expected to be generated from long-term contracts with unsatisfied performance obligations as of March 31, 2019 is not material.

5. Acquisitions and Divestitures

Acquisition of Abaxis, Inc.

On July 31, 2018, we completed the acquisition of Abaxis, Inc. (Abaxis), a California corporation and a leader in the development, manufacture and marketing of diagnostic instruments for veterinary point-of-care services. We acquired all of the outstanding common shares of Abaxis for $83.00 per share in cash resulting in Abaxis becoming our wholly owned subsidiary. The acquisition enhances our presence in animal health diagnostics.

The acquisition date fair value of the consideration transferred was approximately $1,962 million, which consisted of the following:

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(MILLIONS OF DOLLARS)	Amounts
Cash paid to Abaxis' shareholders^(a)	$	1,898
Cash paid for equity awards attributable to pre-merger services^(b)	54
Fair value of Zoetis equity awards issued in exchange for outstanding Abaxis equity awards pertaining to pre-merger service^(c)	10
Total consideration	$	1,962


^(a)	Represents cash paid for cancellation and conversion of each outstanding share of Abaxis' common stock at the acquisition date.


^(b)	Represents cash paid for cancellation and settlement of restricted stock awards that fully vested in July 2018 as a result of service or pre-existing change-in-control provisions and termination provisions. Includes certain awards that were settled in cash during the first quarter of 2019.

^(c)

Represents the fair value of replacement awards issued for Abaxis equity awards outstanding immediately before the acquisition and attributable to the service period prior to the acquisition. The previous Abaxis equity awards were converted into the Zoetis equity awards at an exchange ratio based on the closing prices of shares of Zoetis Common Stock and Abaxis Common Stock for ten full trading days before the closing of the acquisition.

The acquisition has been accounted for as a business combination with the assets acquired and liabilities assumed measured at estimated fair values as of the acquisition date, primarily using Level 3 inputs, except for investments in debt securities which were valued using Level 2 inputs.

During the three months ended March 31, 2019, the company recorded additional measurement period adjustments which were made to reflect the facts and circumstances in existence as of the acquisition date. These adjustments include a reduction to Identifiable intangible assets of $1 million, offset by the corresponding increase to goodwill. These measurement period adjustments primarily related to changes in preliminary valuation assumptions, including market participant estimates of cash flows, as well as other initial estimates. The fair values in the table below, which presents the preliminary fair values allocated to Abaxis' assets and liabilities as of the acquisition date, have been updated to reflect these measurement period adjustments.



(MILLIONS OF DOLLARS)	Amounts
Cash and cash equivalents	$	64
Short term investments^(a)	107
Accounts receivable^(b)	30
Inventories^(c)	79
Other current assets	6
Property, plant and equipment^(d)	54
Identifiable intangible assets^(e)	894
Other noncurrent assets	29
Accounts payable	(21)
Accrued compensation and related items	(10)
Other current liabilities	(22)
Other noncurrent liabilities	(11)
Noncurrent deferred tax liabilities^(f)	(215)
Total net assets acquired	984
Goodwill^(g)	978
Total consideration	$	1,962


^(a)	Short term investments include investments in debt securities that are classified as available-for-sale and measured at fair value.


^(b)	The fair value approximates the gross contractual amount of accounts receivable. The contractual amount not expected to be collected is immaterial.

^(c)

Acquired inventory is comprised of finished goods, work in process and raw materials. The preliminary estimate of fair value of finished goods was determined based on net realizable value adjusted for the costs of the selling effort, a reasonable profit allowance for the selling effort, and estimated holding costs. The preliminary estimate of fair value of work in process was determined based on net realizable value adjusted for costs to complete the manufacturing process, costs of the selling effort, a reasonable profit allowance for the remaining manufacturing and selling effort, and an estimate of holding costs. The fair value of raw materials was determined to approximate book value.

^(d)

Property, plant and equipment is comprised of machinery and equipment, furniture and fixtures, computer equipment, leasehold improvements and construction in progress. The preliminary estimated fair value was primarily determined using a reproduction/replacement cost approach which measures the value of an asset by estimating the cost to acquire or construct comparable assets adjusted for age and condition of the asset.

^(e)

Identifiable intangible assets primarily consist of developed technology rights, customer relationships, and trademarks and tradenames. The preliminary estimate of fair value of identifiable intangible assets is determined using the income approach, which includes a forecast of expected future cash flows. For additional information regarding identifiable intangible assets, see Note 12. Goodwill and Other Intangible Assets.

^(f)

The acquisition was structured as a stock purchase and therefore we assumed the historical tax basis of Abaxis' assets and liabilities. The preliminary estimate of deferred tax effects resulting from the acquisition include the expected federal, state, and foreign tax consequences associated with temporary differences between the preliminary fair values of the assets acquired and liabilities assumed and the respective tax basis. The components of the Abaxis net deferred tax liability are included within amounts reported in Note 8. Income Taxes.


^(g)	Goodwill represents the excess of consideration transferred over the preliminary estimate of fair values of the assets acquired and liabilities assumed. It is

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allocated to our existing reportable segments and is primarily attributable to the future potential of the technology platforms, as well as cost and revenue synergies including market share capture, elimination of cost redundancies and gain of cost efficiencies, and intangible assets such as assembled workforce which are not separately recognizable. The primary strategic purpose of the acquisition was to enhance the company’s existing product portfolio by strengthening Zoetis’ presence in veterinary diagnostics. The goodwill recorded is not deductible for tax purposes. The allocation of goodwill to the reporting units is preliminary and will be completed as the company obtains the information necessary to complete the analysis, but no later than one year from the date of the acquisition.

The preliminary fair values are substantially complete subject to finalization of legal entity fair values (which may impact the fair values of identifiable intangible assets, deferred taxes and goodwill) and tax returns for the pre-acquisition period (which may impact the fair values of deferred taxes, income taxes payable and goodwill). Adjustments to the preliminary purchase price allocation identified during the measurement period, which will not exceed one year from the acquisition date, will be accounted for prospectively.

The company incurred acquisition related costs of approximately $5 million for the three months ended March 31, 2019, which are included within Restructuring charges and certain acquisition-related costs on our condensed consolidated statements of income.

Supplemental Pro Forma Information (Unaudited):

The following table provides unaudited supplemental pro forma financial information as if the acquisition of Abaxis had occurred on January 1, 2017.



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)	2018
Revenue	$	1,433
Net income attributable to Zoetis Inc.	322

The supplemental pro forma financial information has been prepared using the acquisition method of accounting and is based on the historical financial information of Zoetis and Abaxis. The supplemental pro forma financial information does not necessarily represent what the combined company’s revenue or results of operations would have been had the acquisition been completed on January 1, 2017, nor do they intend to be a projection of future operating results of the combined company. It also does not reflect any operating efficiencies or potential cost savings that might be achieved from synergies of combining Zoetis and Abaxis.

The unaudited supplemental pro forma financial information reflects primarily the following pro forma adjustments:


•	Additional amortization expense of $33 million for three months ended March 31, 2018, related to the preliminary fair value estimate of identified intangible assets acquired.


•	Additional depreciation expense of $1 million for the three months ended March 31, 2018, related to the preliminary estimate of fair value adjustments to property, plant and equipment acquired.


•	Additional interest expense and amortization of debt issuance costs for the debt issuance to finance the acquisition, resulting in $15 million added for the three months ended March 31, 2018.


•	Adjustment related to the post merger share-based compensation expense of the replacement awards is $3 million for the three months ended March 31, 2018.


•	Applicable tax impact of the above adjustments based on the statutory tax rates in the various jurisdictions where the adjustments are expected to be incurred.

6. Restructuring Charges and Other Costs Associated with Acquisitions, Cost-Reduction and Productivity Initiatives

In connection with our cost-reduction/productivity initiatives, we typically incur costs and charges associated with site closings and other facility rationalization actions, workforce reductions and the expansion of shared services, including the development of global systems. In connection with our acquisition activity, we typically incur costs and charges associated with executing the transactions, integrating the acquired operations, which may include expenditures for consulting and the integration of systems and processes, product transfers and restructuring the consolidated company, which may include charges related to employees, assets and activities that will not continue in the consolidated company. All operating functions can be impacted by these actions, including sales and marketing, manufacturing and research and development (R&D), as well as functions such as business technology, shared services and corporate operations.

During 2015, we launched a comprehensive operational efficiency program and a supply network strategy initiative. These initiatives focused on reducing complexity in our product portfolios, changing our selling approach in certain markets, reducing our presence in certain countries, and selling certain manufacturing sites over a long term period. As part of these initiatives, we reduced certain positions through divestitures, normal attrition and involuntary terminations.

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The components of costs incurred in connection with restructuring initiatives, acquisitions and cost-reduction/productivity initiatives are as follows:



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS)	2019		2018
Restructuring charges and certain acquisition-related costs:
Integration costs^(a)	$	1	$	1
Restructuring charges^(b)(c):
Employee termination costs	4		1
Total Restructuring charges and certain acquisition-related costs	$	5	$	2


^(a)	Integration costs represent external, incremental costs directly related to integrating acquired businesses and primarily include expenditures for consulting and the integration of systems and processes, as well as product transfer costs.


^(b)	The restructuring charges for the three months ended March 31, 2019 primarily relate to the acquisition of Abaxis.

The restructuring charges for the three months ended March 31, 2018 primarily relate to the supply network strategy initiative.


^(c)	The restructuring charges are associated with the following:


•	For the three months ended March 31, 2019 and March 31, 2018, Manufacturing/research/corporate of $4 million and $1 million, respectively.

The components of, and changes in, our restructuring accruals are as follows:





(MILLIONS OF DOLLARS)	Accrual^(a)
Balance, December 31, 2018^(b)	$	45
Provision	4
Utilization and other^(c)	(19		)
Balance, March 31, 2019^(b)	$	30


^(a)	Changes in our restructuring accrual represents employee termination costs.


^(b)	At March 31, 2019, and December 31, 2018, included in Accrued expenses ($13 million and $27 million, respectively) and Other noncurrent liabilities ($17 million and $18 million, respectively).


^(c)	Includes adjustments for foreign currency translation.

7. Other (Income)/Deductions—Net

The components of Other (income)/deductions—net are as follows:



	Three Months Ended
	March 31,
(MILLIONS OF DOLLARS)	2019			2018
Royalty-related income	$	(5	)	$	(7	)
Interest income	(10		)	(6		)
Foreign currency loss^(a)	—			8
Other, net	1			—
Other (income)/deductions—net	$	(14	)	$	(5	)


^(a)	Primarily driven by costs related to hedging and exposures to certain emerging market currencies.

8. Income Taxes

A. Taxes on Income

Our effective tax rate was 18.1% for the three months ended March 31, 2019, compared with 16.1% for the three months ended March 31, 2018. The higher effective tax rate for the three months ended March 31, 2019, was primarily attributable to:


•	the impact of the global intangible low taxed income (GILTI) tax, a new provision of the Tax Cuts and Jobs Act (the Tax Act), which became effective for the company in the first quarter of 2019;


•	changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings from operations and repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and operating fluctuations in the normal course of business and the impact of non-deductible items; and

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•	a $4 million and $8 million discrete tax benefit recorded in the first quarter of 2019 and 2018, respectively, related to a remeasurement of deferred taxes as a result of a change in non-U.S. statutory tax rates,

partially offset by:


•	a $13 million and $8 million discrete tax benefit recorded in the first quarter of 2019 and 2018, respectively, related to the excess tax benefits for share-based payments.

B. Deferred Taxes

As of March 31, 2019, the total net deferred income tax liability of $399 million is included in Noncurrent deferred tax assets ($65 million) and Noncurrent deferred tax liabilities ($464 million).

As of December 31, 2018, the total net deferred income tax liability of $413 million is included in Noncurrent deferred tax assets ($61 million) and Noncurrent deferred tax liabilities ($474 million).

C. Tax Contingencies

As of March 31, 2019, the tax liabilities associated with uncertain tax positions of $187 million (exclusive of interest and penalties related to uncertain tax positions of $12 million) are included in Noncurrent deferred tax assets ($3 million) and Other taxes payable ($184 million).

As of December 31, 2018, the tax liabilities associated with uncertain tax positions of $185 million (exclusive of interest and penalties related to uncertain tax positions of $11 million) are included in Noncurrent deferred tax assets ($3 million) and Other taxes payable ($182 million).

Our tax liabilities for uncertain tax positions relate primarily to issues common among multinational corporations. Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Substantially all of these unrecognized tax benefits, if recognized, would impact our effective income tax rate. We do not expect that within the next twelve months any of our uncertain tax positions could significantly decrease as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of uncertain tax positions and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant.

9. Financial Instruments

A. Debt

Credit Facilities

In December 2016, we entered into an amended and restated revolving credit agreement with a syndicate of banks providing for a multi-year $1.0 billion senior unsecured revolving credit facility (the credit facility). In December 2018, the maturity for the amended and restated revolving credit agreement was extended through December 2023. Subject to certain conditions, we have the right to increase the credit facility to up to $1.5 billion. The credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio (the ratio of consolidated net debt as of the end of the period to consolidated Earnings Before Interest, Income Taxes, Depreciation and Amortization (EBITDA) for such period) of 3.50:1. Upon entering into a material acquisition, the maximum total leverage ratio increases to 4.00:1, and extends until the fourth full consecutive fiscal quarter ended immediately following the consummation of a material acquisition. The credit facility also contains a clause which adds back to Adjusted Consolidated EBITDA, any operational efficiency restructuring charge (defined as charges recorded by the company during the period commencing on October 1, 2016 and ending December 31, 2019, related to operational efficiency initiatives), provided that for any twelve-month period such charges added back to Adjusted Consolidated EBITDA shall not exceed $100 million in the aggregate.

The credit facility also contains a financial covenant requiring that we maintain a minimum interest coverage ratio (the ratio of EBITDA at the end of the period to interest expense for such period) of 3.50:1. In addition, the credit facility contains other customary covenants.

We were in compliance with all financial covenants as of March 31, 2019, and December 31, 2018. There were no amounts drawn under the credit facility as of March 31, 2019, or December 31, 2018.

We have additional lines of credit and other credit arrangements with a group of banks and other financial intermediaries for general corporate purposes. We maintain cash and cash equivalent balances in excess of our outstanding short-term borrowings. As of March 31, 2019, we had access to $73 million of lines of credit which expire at various times through 2019 and are generally renewed annually. There were no borrowings outstanding related to these facilities as of March 31, 2019 and $9 million of borrowings outstanding related to these facilities as of December 31, 2018.

Commercial Paper Program and Other Short-Term Borrowings

In February 2013, we entered into a commercial paper program with a capacity of up to $1.0 billion. As of March 31, 2019, and December 31, 2018, there was no commercial paper outstanding under this program. As of March 31, 2019, there were no short-term borrowings outstanding. As of December 31, 2018, we had $9 million of short-term borrowings outstanding.

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Senior Notes and Other Long-Term Debt

On August 20, 2018, we issued $1.5 billion aggregate principal amount of our senior notes (2018 senior notes), with an original issue discount of $4 million. These notes are comprised of $300 million aggregate principal amount of floating rate senior notes due 2021 (the "2018 floating rate senior notes"), and $300 million aggregate principal amount of 3.250% senior notes due 2021, $500 million aggregate principal amount of 3.900% senior notes due 2028 and $400 million aggregate principal amount of 4.450% senior notes due 2048 (collectively, the "2018 fixed rate senior notes"). Net proceeds from this offering were partially used to pay down and terminate a revolving credit agreement and repay outstanding commercial paper, which were borrowed to finance a portion of the cash consideration for the acquisition of Abaxis (see Note 5. Acquisitions and Divestitures). The remainder of the net proceeds will be used for general corporate purposes.

On September 12, 2017, we issued $1.25 billion aggregate principal amount of our senior notes (2017 senior notes), with an original issue discount of $7 million. These notes are comprised of $750 million aggregate principal amount of 3.000% senior notes due 2027 and $500 million aggregate principal amount of 3.950% senior notes due 2047. Net proceeds from this offering were partially used in October 2017 to repay, prior to maturity, the aggregate principal amount of $750 million, and a make-whole amount and accrued interest of $4 million, of our 1.875% senior notes due 2018. The remainder of the net proceeds were used for general corporate purposes.

On November 13, 2015, we issued $1.25 billion aggregate principal amount of our senior notes (2015 senior notes), with an original issue discount of $2 million. On January 28, 2013, we issued $3.65 billion aggregate principal amount of our senior notes (the 2013 senior notes offering) in a private placement, with an original issue discount of $10 million.

The 2013, 2015, 2017 and 2018 senior notes are governed by an indenture and supplemental indenture (collectively, the indenture) between us and Deutsche Bank Trust Company Americas, as trustee. The indenture contains certain covenants, including limitations on our and certain of our subsidiaries' ability to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets. In addition, the indenture contains other customary terms, including certain events of default, upon the occurrence of which the 2013, 2015, 2017 and 2018 senior notes may be declared immediately due and payable.

Pursuant to the indenture, we are able to redeem the 2013, 2015 and 2017 senior notes and the 2018 fixed rate senior notes or any series, in whole or in part, at any time by paying a “make whole” premium, plus accrued and unpaid interest to, but excluding, the date of redemption. The 2018 floating rate senior notes are not redeemable at our option prior to their maturity date. Pursuant to our tax matters agreement with Pfizer, we will not be permitted to redeem the 2013 senior notes due 2023 pursuant to this optional redemption provision, except under limited circumstances. Upon the occurrence of a change of control of us and a downgrade of the 2013, 2015, 2017 and 2018 senior notes below an investment grade rating by each of Moody's Investors Service, Inc. and Standard & Poor's Ratings Services, we are, in certain circumstances, required to make an offer to repurchase all of the outstanding 2013, 2015, 2017 and 2018 senior notes at a price equal to 101% of the aggregate principal amount of the 2013, 2015, 2017 and 2018 senior notes together with accrued and unpaid interest to, but excluding, the date of repurchase.

The components of our long-term debt are as follows:



	March 31,		December 31,
(MILLIONS OF DOLLARS)	2019		2018
3.450% 2015 senior notes due 2020	$	500	$	500
2018 floating rate (three-month USD LIBOR plus 0.44%) senior notes due 2021	300		300
3.250% 2018 senior notes due 2021	300		300
3.250% 2013 senior notes due 2023	1,350		1,350
4.500% 2015 senior notes due 2025	750		750
3.000% 2017 senior notes due 2027	750		750
3.900% 2018 senior notes due 2028	500		500
4.700% 2013 senior notes due 2043	1,150		1,150
3.950% 2017 senior notes due 2047	500		500
4.450% 2018 senior notes due 2048