Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - Zoetis Inc.a2017q210qex322.htm
EX-32.1 - EXHIBIT 32.1 - Zoetis Inc.a2017q210qex321.htm
EX-31.2 - EXHIBIT 31.2 - Zoetis Inc.a2017q210qex312.htm
EX-31.1 - EXHIBIT 31.1 - Zoetis Inc.a2017q210qex311.htm
EX-15 - EXHIBIT 15 - Zoetis Inc.a2017q210qex15.htm
EX-12 - EXHIBIT 12 - Zoetis Inc.a2017q210-qex12.htm



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 July 2, 2017
 
 
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 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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, 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. (Check one):
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
At August 2, 2017, there were 489,111,671 shares of common stock outstanding.





TABLE OF CONTENTS
 
 
 
 
Page
 
Item 1.
 
 
 
 
Condensed Consolidated Statements of Income (Unaudited)
 
 
 
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
 
 
 
Condensed Consolidated Balance Sheets (Unaudited)
 
 
 
Condensed Consolidated Statements of Equity (Unaudited)
 
 
 
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
 
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
 
 
Review Report of Independent Registered Public Accounting Firm
 
Item 2.
 
 
Item 3.
 
 
Item 4.
 
 
 
Item 1.
 
 
Item 1A.
 
 
Item 2.
 
 
Item 3.
 
Defaults Upon Senior Securities
 
Item 4.
 
Mine Safety Disclosures
 
Item 5.
 
Other Information
 
Item 6.
 
 
 





PART I – FINANCIAL INFORMATION
Item 1.
Financial Statements


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)
 
2017

 
2016

 
2017

 
2016

Revenue
 
$
1,269

 
$
1,208

 
$
2,500

 
$
2,370

Costs and expenses:
 
 
 
 
 
 
 
 
Cost of sales(a)
 
440

 
399

 
883

 
788

Selling, general and administrative expenses(a)
 
336

 
343

 
645

 
658

Research and development expenses(a)
 
86

 
88

 
176

 
178

Amortization of intangible assets(a)
 
23

 
22

 
45

 
43

Restructuring charges/(reversals) and certain acquisition-related costs
 

 
(21
)
 
(1
)
 
(19
)
Interest expense, net of capitalized interest
 
41

 
41

 
82

 
84

Other (income)/deductions—net
 
(2
)
 
4

 
(12
)
 
(26
)
Income before provision for taxes on income
 
345

 
332

 
682

 
664

Provision for taxes on income
 
98

 
108

 
196

 
236

Net income before allocation to noncontrolling interests
 
247

 
224

 
486

 
428

Less: Net income attributable to noncontrolling interests
 

 

 
1

 

Net income attributable to Zoetis Inc.
 
$
247

 
$
224

 
$
485

 
$
428

Earnings per share attributable to Zoetis Inc. stockholders:
 
 
 
 
 
 
 
 
 Basic
 
$
0.50

 
$
0.45

 
$
0.99

 
$
0.86

 Diluted
 
$
0.50

 
$
0.45

 
$
0.98

 
$
0.86

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
 Basic
 
490.8

 
496.3

 
491.6

 
496.9

 Diluted
 
494.0

 
498.8

 
494.6

 
499.2

Dividends declared per common share
 
$
0.105

 
$
0.095

 
$
0.210

 
$
0.190

(a) 
Amortization expense related to finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in Amortization of intangible assets as these intangible assets benefit multiple business functions. Amortization expense related to finite-lived acquired intangible assets that are associated with a single function is included in Cost of sales, Selling, general and administrative expenses or Research and development expenses, as appropriate, in the condensed consolidated statements of income.

See notes to condensed consolidated financial statements.
1 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)

 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

 
2017

 
2016

Net income before allocation to noncontrolling interests
 
$
247

 
$
224

 
$
486

 
$
428

Other comprehensive income/(loss), net of taxes and reclassification adjustments:
 
 
 
 
 
 
 
 
Unrealized losses on derivatives, net(a)
 
(1
)
 
(3
)
 
(1
)
 
(3
)
Foreign currency translation adjustments, net
 
12

 
63

 
56

 
65

Benefit plans: Actuarial (losses)/gains, net(a)
 
(1
)
 
2

 
1

 
3

Total other comprehensive income/(loss), net of tax
 
10

 
62

 
56

 
65

Comprehensive income before allocation to noncontrolling interests
 
257

 
286

 
542

 
493

Less: Comprehensive income/(loss) attributable to noncontrolling interests
 

 

 
1

 
(1
)
Comprehensive income attributable to Zoetis Inc.
 
$
257

 
$
286

 
$
541

 
$
494

(a) 
Presented net of reclassification adjustments and tax impacts, which are not significant in any period presented. Reclassification adjustments related to benefit plans are generally reclassified, as part of net periodic pension cost, into Cost of sales, Selling, general and administrative expenses, and/or Research and development expenses, as appropriate, in the condensed consolidated statements of income.



See notes to condensed consolidated financial statements.
2 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

 
 
July 2,

 
December 31,

 
 
2017

 
2016

(MILLIONS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
 
(Unaudited)

 
 
Assets
 
 
 
 
Cash and cash equivalents(a)
 
$
705

 
$
727

Accounts receivable, less allowance for doubtful accounts of $31 in 2017 and $30 in 2016
 
975

 
913

Inventories
 
1,498

 
1,502

Assets held for sale
 
53

 

Other current assets
 
353

 
248

Total current assets
 
3,584

 
3,390

Property, plant and equipment, less accumulated depreciation of $1,397 in 2017 and $1,358 in 2016
 
1,355

 
1,381

Goodwill
 
1,495

 
1,481

Identifiable intangible assets, less accumulated amortization
 
1,210

 
1,228

Deferred tax assets
 
93

 
96

Other noncurrent assets
 
65

 
73

Total assets
 
$
7,802

 
$
7,649

 
 
 
 
 
Liabilities and Equity
 
 
 
 
Short-term borrowings
 
$
100

 
$

Current portion of long-term debt
 
750

 
$

Accounts payable
 
199

 
265

Dividends payable
 
52

 
52

Accrued expenses
 
406

 
464

Accrued compensation and related items
 
163

 
224

Income taxes payable
 
82

 
71

Liabilities associated with assets held for sale
 
4

 

Other current liabilities
 
28

 
41

Total current liabilities
 
1,784

 
1,117

Long-term debt, net of discount and issuance costs
 
3,719

 
4,468

Deferred tax liabilities
 
261

 
244

Other taxes payable
 
83

 
73

Other noncurrent liabilities
 
209

 
248

Total liabilities
 
6,056

 
6,150

Commitments and contingencies
 

 

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; 489,659,511 and 492,855,297 shares outstanding at July 2, 2017, and December 31, 2016, respectively
 
5

 
5

Treasury stock, at cost, 12,231,732 and 9,035,946 shares of common stock at July 2, 2017, and December 31, 2016, respectively
 
(615
)
 
(421
)
Additional paid-in capital
 
1,024

 
1,024

Retained earnings
 
1,843

 
1,477

Accumulated other comprehensive loss
 
(542
)
 
(598
)
Total Zoetis Inc. equity
 
1,715

 
1,487

Equity attributable to noncontrolling interests
 
31

 
12

Total equity
 
1,746

 
1,499

Total liabilities and equity
 
$
7,802

 
$
7,649

(a) 
As of July 2, 2017, includes $7 million of restricted cash.

See notes to condensed consolidated financial statements.
3 |


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, 2015
 
$
5

 
$
(203
)
 
$
1,012

 
$
876

 
$
(622
)
 
$
23

 
$
1,091

Six months ended July 3, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
428

 

 

 
428

Other comprehensive income/(loss)
 

 

 

 

 
66

 
(1
)
 
65

Share-based compensation awards(b)
 

 
60

 
(3
)
 
(20
)
 

 

 
37

Treasury stock acquired(c)
 

 
(151
)
 

 

 

 

 
(151
)
Employee benefit plan contribution from Pfizer Inc.(d)
 

 

 
1

 

 

 

 
1

Divestitures(e)
 

 

 

 

 
2

 
(8
)
 
(6
)
Dividends declared
 

 

 

 
(94
)
 

 

 
(94
)
Balance, July 3, 2016
 
$
5

 
$
(294
)
 
$
1,010

 
$
1,190

 
$
(554
)
 
$
14

 
$
1,371

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2016
 
$
5

 
$
(421
)
 
$
1,024

 
$
1,477

 
$
(598
)
 
$
12

 
$
1,499

Six months ended July 2, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
485

 

 
1

 
486

Other comprehensive income
 

 

 

 

 
56

 

 
56

Consolidation of a noncontrolling interest(f)
 

 

 

 

 

 
18

 
18

Share-based compensation awards (b)
 

 
56

 
(1
)
 
(16
)
 

 

 
39

Treasury stock acquired(c)
 

 
(250
)
 

 

 

 

 
(250
)
Employee benefit plan contribution from Pfizer Inc.(d)
 

 

 
1

 

 

 

 
1

Dividends declared
 

 

 

 
(103
)
 

 

 
(103
)
Balance, July 2, 2017
 
$
5

 
$
(615
)
 
$
1,024

 
$
1,843

 
$
(542
)
 
$
31

 
$
1,746

(a) 
As of July 2, 2017, and July 3, 2016, there were 489,659,511 and 495,389,702 outstanding shares of common stock, respectively, and 12,231,732 and 6,501,541 shares of treasury stock, respectively. Treasury stock is recognized at the cost to reacquire the shares. For additional information, see Note 13. 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. Upon reissuance of treasury stock, differences between the proceeds from reissuance and the cost of the treasury stock that result in gains are recorded in Additional paid-in capital. Losses are recorded in Additional paid-in capital to the extent that they can offset previously recorded gains. If no such credit exists, the differences are recorded in Retained earnings. Also includes the reacquisition of shares of treasury stock associated with the vesting of employee share-based awards to satisfy tax withholding requirements. For additional information, see Note 12. Share-Based Payments and Note. 13. Stockholders' Equity.
(c) 
Reflects the acquisition of treasury shares in connection with the share repurchase program. For additional information, see Note 13. 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 Note 11. Benefit Plans.
(e) 
Reflects the divestiture of our share of our Taiwan joint venture. See Note 4. Acquisitions and Divestitures: Divestitures.
(f) 
Represents the consolidation of a European livestock monitoring company, a variable interest entity of which Zoetis is the primary beneficiary.




See notes to condensed consolidated financial statements.
4 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Six Months Ended
 
 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

Operating Activities
 
 
 
 
Net income before allocation to noncontrolling interests
 
$
486

 
$
428

Adjustments to reconcile net income before noncontrolling interests to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization expense
 
121

 
117

Share-based compensation expense
 
22

 
19

Restructuring
 
(1
)
 
(19
)
Net loss/(gain) on sale of assets
 
2

 
(27
)
Provision for losses on inventory
 
40

 
35

Deferred taxes
 
13

 
17

Employee benefit plan contribution from Pfizer Inc.
 
1

 
1

Other non-cash adjustments
 

 
9

Other changes in assets and liabilities, net of acquisitions and divestitures
 
 
 
 
    Accounts receivable
 
(41
)
 
53

    Inventories
 
(46
)
 
(87
)
    Other assets
 
(106
)
 
(72
)
    Accounts payable
 
(66
)
 
(71
)
    Other liabilities
 
(147
)
 
(254
)
    Other tax accounts, net
 
21

 
39

Net cash provided by operating activities
 
299

 
188

Investing Activities
 
 
 
 
Purchases of property, plant and equipment
 
(93
)
 
(99
)
Acquisitions
 
(3
)
 
(20
)
Net proceeds from sales of assets
 
1

 
88

Other investing activities
 
7

 

Net cash used in investing activities
 
(88
)
 
(31
)
Financing Activities
 
 
 
 
Decrease in short-term borrowings, net
 

 
(1
)
Issuance of commercial paper
 
100

 

Principal payments on long-term debt
 

 
(400
)
Payment of contingent consideration related to previously acquired assets
 
(5
)
 
(22
)
Share-based compensation-related proceeds, net of taxes paid on withholding shares
 
18

 
17

Purchases of treasury stock(a) 
 
(250
)
 
(151
)
Cash dividends paid
 
(103
)
 
(94
)
Net cash used in financing activities
 
(240
)
 
(651
)
Effect of exchange-rate changes on cash and cash equivalents
 
7

 
(2
)
Net decrease in cash and cash equivalents
 
(22
)
 
(496
)
Cash and cash equivalents at beginning of period
 
727

 
1,154

Cash and cash equivalents at end of period
 
$
705

 
$
658

 
 
 
 
 
Supplemental cash flow information
 
 
 
 
Cash paid during the period for:
 
 
 
 
  Income taxes
 
$
256

 
$
215

  Interest, net of capitalized interest
 
82

 
84

Non-cash transactions:
 
 
 
 
     Purchases of property, plant and equipment
 
3

 
6

     Contingent purchase price consideration(b)
 

 
27

  Dividends declared, not paid
 
52

 
47

(a) 
Reflects the acquisition of treasury shares in connection with the share repurchase programs. For additional information, see Note 13. Stockholders' Equity.
(b) 
For 2016, relates primarily to the non-cash portion of the acquisition of a livestock business in South America.

See notes to condensed consolidated financial statements.
5 |


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 and vaccines, 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 five major product categories: anti-infectives, vaccines, parasiticides, medicated feed additives 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 and six-month periods ended May 28, 2017, and May 29, 2016.
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 2016 Annual Report on Form 10-K.
3.
Significant Accounting Policies
Recently Adopted Accounting Standards
In January 2017, the Financial Accounting Standards Board (FASB) issued an accounting standards update which clarifies the definition of a business. Under the new guidance, a set of integrated activities and assets is a business only if it has, at a minimum, an input and substantive process that together significantly contribute to the ability to create outputs. The update also introduces the concept of an initial screening or “Step 1” which requires companies to first determine if substantially all of the fair value of the gross assets acquired is concentrated in a single (or group of similar) identifiable assets. Transactions that pass the Step 1 screening will be considered a business if they contain an input and substantive process and either; (1) an output or (2) an organized workforce with skills critical to the ability to create outputs and inputs that can be utilized to create the outputs. Companies will no longer be required to evaluate whether a market participant could replace any missing inputs or processes, instead focusing on the substance of what was acquired. The provisions of the new standard are effective, on a prospective basis, beginning January 1, 2018, for annual and interim reporting periods and may be adopted early for any transactions not yet reported in issued financial statements. We elected to early adopt the new standard for any new transactions occurring on or after January 1, 2017.
In July 2015, the FASB issued an accounting standards update to simplify the measurement of inventory by requiring that inventory be measured at the lower of cost or net realizable value, rather than at the lower of cost or market, with market being defined as either replacement cost, net realizable value or net realizable value less a normal profit margin. We adopted this guidance as of January 1, 2017. This guidance did not have a significant impact on our condensed consolidated financial statements.
Recently Issued Accounting Standards
In March 2017, the FASB issued an accounting standards update to simplify and improve the reporting of net periodic pension benefit cost by requiring only present service cost to be presented in the same line item as other current employee compensation costs while remaining components of net periodic benefit cost would be presented within Other (income)/deductions—net outside of operations. We plan to adopt this guidance as of January 1, 2018, the required effective date, and do not expect the new standard will have a significant impact on our consolidated financial statements.
In October 2016, the FASB issued an accounting standards update that will require the recognition of the income tax consequences of an intra-entity asset transfer, other than inventory, when the transfer occurs as opposed to when the asset is sold to an outside third party. The provisions of the new standard are effective beginning January 1, 2018, for annual and interim reporting periods. Early adoption is permitted beginning on January 1, 2017. We plan to adopt this guidance as of January 1, 2018, the required effective date, and do not expect the new standard will have a significant impact on our consolidated financial statements.

6 |


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 plan to adopt this guidance as of January 1, 2019, the required effective date, for annual and interim reporting periods. The new standard requires a modified retrospective adoption approach, at the beginning of the earliest comparative period presented in the financial statements. We continue to assess the potential impact that adopting this new guidance will have on our consolidated financial statements.
In May 2014, the FASB issued an accounting standards update that outlines a new, single comprehensive model for companies to use in accounting for revenue arising from contracts with customers. This update supersedes most current revenue recognition guidance under U.S. GAAP. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance includes a five-step model for determining how, when and how much revenue should be recognized. This update also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. We plan to adopt this guidance as of January 1, 2018, the required effective date, using the modified retrospective transition method. Under the modified retrospective method, the cumulative effect of applying the new standard will be recognized as of the date of initial application with disclosure of results under both the new and prior standards. We continue to assess the impact of the new standard on our current policies, procedures, and disclosures related to revenue recognition. Based on the work performed to date, we do not believe that the adoption will have a material impact on our consolidated financial statements. While implementation procedures are still ongoing, we have evaluated the impact on our primary revenue stream, product sales, in both the United States and our key international markets and no matters have currently been identified individually or in the aggregate that would have a material impact on the timing or amount of revenue recognition based on the provisions of the new standard.
4.
Acquisitions and Divestitures
Assets and Liabilities Held for Sale
On March 30, 2017, as part of our supply network strategy, we announced an agreement with the Brazilian-based pharmaceutical company União Química (UQ) to sell our manufacturing site in Guarulhos, Brazil, and we met the criteria for held for sale classification. The agreement also includes entering into a five-year manufacturing and supply agreement with UQ to begin upon closing of the transaction.
As of July 2, 2017, recorded assets and liabilities held for sale are summarized below:
 
 
July 2,

(MILLIONS OF DOLLARS)
 
2017

Assets held for sale
 
 
Inventories
 
$
12

Property, plant and equipment
 
26

Deferred tax assets
 
4

Other current assets
 
8

Goodwill
 
3

   Total
 
$
53

 
 
 
Liabilities associated with assets held for sale
 
 
Accounts payable
 
$
3

Other current liabilities
 
1

   Total
 
$
4

We expect to complete this transaction during the second half of 2017.
Divestitures
On May 11, 2017, we completed the sale of our manufacturing site in Shenzhou, China. We had previously exited operations at this site during the second quarter of 2015 as part of our operational efficiency program. We received total cash proceeds of approximately $3 million and recorded a net pre-tax gain of approximately $2 million within Other (income)/deductions—net. Additionally, in the second quarter of 2017, we recorded a $4 million expense within Other (income)/deductions—net related to the prior year sale of the U.S. manufacturing sites noted below.
On April 28, 2016, we completed the sale of our 55 percent ownership share of a Taiwan joint venture, including a manufacturing site in Hsinchu, Taiwan to Yung Shin Pharmaceutical Industrial Co., Ltd., a pharmaceutical company with an animal health business and headquarters in Taiwan. The sale also included a portfolio of products in conjunction with our comprehensive operational efficiency program. These products include medicated feed additives, anti-infective medicines and nutritional premixes for livestock, sold primarily in Taiwan and in international markets. We received $13 million in cash upon closing.

7 |


On February 17, 2016, we completed the sale of our manufacturing site in Haridwar, India to the India-based pharmaceutical company Zydus Cadila (Cadila Healthcare Ltd.). The agreement also included the sale of a portfolio of our products in conjunction with our comprehensive operational efficiency program.
On February 12, 2016, we completed the sale of two of our manufacturing sites in the United States: Laurinburg, North Carolina, and Longmont, Colorado, to Huvepharma NV (Huvepharma), a European animal health company. Huvepharma also assumed the assets and operations and the lease of our manufacturing and distribution site in Van Buren, Arkansas. The agreement included the sale of a portfolio of products in conjunction with our comprehensive operational efficiency program.
During the first six months of 2016, we received total cash proceeds of approximately $88 million related to the divestitures of the India and U.S. manufacturing sites noted above. During the first quarter of 2016, we recognized a net pre-tax gain of approximately $33 million, partially offset by a net pre-tax loss of approximately $6 million recognized during the second quarter of 2016. Gains and losses related to divestitures are recorded within Other (income)/deductions—net.
5.
Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/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. This may include charges related to employees, assets and activities that will not continue. 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.
The components of costs incurred in connection with restructuring initiatives, acquisitions and cost-reduction/productivity initiatives are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

 
2017

 
2016

Restructuring charges/(reversals) and certain acquisition-related costs:
 
 
 
 
 
 
 
 
Integration costs(a)
 
$
2

 
$
2

 
$
2

 
$
2

Restructuring charges/(reversals)(b):
 
 
 
 
 
 
 
 
Employee termination costs
 
(3
)
 
(24
)
 
(4
)
 
(23
)
Exit costs
 
1

 
1

 
1

 
2

Total Restructuring charges/(reversals) and certain acquisition-related costs
 
$

 
$
(21
)
 
$
(1
)
 
$
(19
)
(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/(reversals) for the three months ended July 2, 2017, are associated with the following: U.S. ($1 million reversal), International ($1 million) and Manufacturing/research/corporate ($2 million reversal).
The restructuring charges/(reversals) for the six months ended July 2, 2017, are associated with the following: International ($1 million reversal) and Manufacturing/research/corporate ($2 million reversal).
The restructuring charges/(reversals) for the three months ended July 3, 2016, are associated with the following: U.S. ($1 million reversal), International ($14 million reversal) and Manufacturing/research/corporate ($8 million reversal).
The restructuring charges/(reversals) for the six months ended July 3, 2016, are associated with the following: U.S. ($2 million reversal), International ($15 million reversal) and Manufacturing/research/corporate ($4 million reversal).
During 2015, we launched a comprehensive operational efficiency program, which was incremental to the previously announced supply network strategy. These initiatives have focused on reducing complexity in our product portfolios through the elimination of approximately 5,000 product stock keeping units (SKUs), changing our selling approach in certain markets, reducing our presence in certain countries, and planning to sell or exit 10 manufacturing sites over a long term period. As of July 2, 2017, we divested or exited three U.S. manufacturing sites, three international manufacturing sites, and our 55 percent ownership share of a Taiwan joint venture, inclusive of its related manufacturing site. We are also continuing to optimize our resource allocation and efficiency by reducing resources associated with non-customer facing activities and operating more efficiently as a result of less internal complexity and more standardization of processes. As part of these initiatives, we planned to reduce certain positions through divestitures, normal attrition and involuntary terminations by approximately 2,000 to 2,500, subject to consultations with works councils and unions in certain countries. In 2016, the operations of the Guarulhos, Brazil manufacturing site, including approximately 300 employees, were transferred to us from Pfizer, which increased our range of planned reduction in certain positions to 2,300 to 2,800. Including divestitures, as of July 2, 2017, approximately 2,200 positions have been eliminated and the comprehensive operational efficiency program is substantially complete. We expect additional reductions through divestitures related to our supply network strategy over the next several years.

8 |


Charges related to the operational efficiency initiative and supply network strategy are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

 
2017

 
2016

Restructuring charges/(reversals) and certain acquisition-related costs:
 
 
 
 
 
 
 
 
Operational efficiency initiative
 
 
 
 
 
 
 
 
Employee termination costs(a)
 
$
2

 
$
(30
)
 
$
1

 
$
(29
)
Exit costs
 
1

 
2

 
1

 
3

 
 
3

 
(28
)
 
2

 
(26
)
Supply network strategy:
 
 
 
 
 
 
 
 
Employee termination costs
 
(5
)
 
6

 
(5
)
 
6

 
 
(5
)
 
6

 
(5
)
 
6

 
 
 
 
 
 
 
 
 
Total restructuring charges/(reversals) related to the operational efficiency initiative and supply network strategy
 
(2
)
 
(22
)
 
(3
)
 
(20
)
 
 
 
 
 
 
 
 
 
Other operational efficiency initiative charges
 
 
 
 
 
 
 
 
    Selling, general and administrative expenses:
 
 
 
 
 
 
 
 
        Accelerated depreciation
 

 
1

 

 
1

        Consulting fees
 
1

 
4

 
1

 
7

    Other (income)/deductions—net:
 
 
 
 
 
 
 
 
        Net loss/(gain) on sale of assets(b)
 
2

 
6

 
2

 
(27
)
Total other operational efficiency initiative charges
 
3

 
11

 
3

 
(19
)
 
 
 
 
 
 
 
 
 
Other supply network strategy charges
 
 
 
 
 
 
 
 
    Cost of sales:
 
 
 
 
 
 
 
 
        Accelerated depreciation
 
1

 
1

 
2

 
2

        Consulting fees
 

 
1

 
2

 
3

Total other supply network strategy charges
 
1

 
2

 
4

 
5

 
 
 
 
 
 
 
 
 
Total charges associated with the operational efficiency initiative and supply network strategy
 
$
2

 
$
(9
)
 
$
4

 
$
(34
)
(a) 
For the three and six months ended July 3, 2016, includes a reduction in employee termination accruals primarily as a result of higher than expected voluntary attrition rates experienced in the first half of 2016.
(b) 
For the three months ended July 3, 2016, primarily represents the net loss on the sale of our share of our Taiwan joint venture as part of our operational efficiency initiative. For the six months ended July 3, 2016, represents the net gain on the sale of certain manufacturing sites and products, partially offset by the loss on the sale of our share of our Taiwan joint venture, as part of our operational efficiency initiative.
The components of, and changes in, our restructuring accruals are as follows:
 
 
Employee

 
 
 
 
 
 
Termination

 
Exit

 
 
(MILLIONS OF DOLLARS)
 
Costs

 
Costs

 
Accrual(a)

Balance, December 31, 2016(a)
 
$
90

 
$

 
$
90

Provision
 
(4
)
 
1

 
(3
)
Utilization and other(b)
 
(36
)
 
(1
)
 
(37
)
Balance, July 2, 2017(a)
 
$
50

 
$

 
$
50

(a) 
At July 2, 2017, and December 31, 2016, included in Accrued expenses ($29 million and $61 million, respectively) and Other noncurrent liabilities ($21 million and $29 million, respectively).
(b) 
Includes adjustments for foreign currency translation.

9 |


6.
Other (Income)/Deductions—Net
The components of Other (income)/deductions—net are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

 
2017

 
2016

Royalty-related income
 
$
(5
)
 
$
(5
)
 
$
(12
)
 
$
(12
)
Net loss/(gain) on sale of assets(a)
 
2

 
6

 
2

 
(27
)
Certain legal and other matters, net(b)
 
(4
)
 

 
(4
)
 

Foreign currency loss(c)
 
8

 
8

 
10

 
17

Other, net(d)
 
(3
)
 
(5
)
 
(8
)
 
(4
)
Other (income)/deductions—net
 
$
(2
)
 
$
4

 
$
(12
)
 
$
(26
)
(a) 
For the three and six months ended July 2, 2017, represents the net loss related to sales of certain manufacturing sites and products as part of our operational efficiency initiative.
For the three months ended July 3, 2016, primarily represents the net loss on the sale of our share of our Taiwan joint venture as part of our operational efficiency initiative. For the six months ended July 3, 2016, represents the net gain on the sale of certain manufacturing sites and products, partially offset by the loss on the sale of our share of our Taiwan joint venture, as part of our operational efficiency initiative.
(b) 
For the three and six months ended July 2, 2017, represents income associated with an insurance recovery related to commercial settlements in Mexico recorded in 2014 and 2016.
(c) 
Primarily driven by costs related to hedging and exposures to certain emerging market currencies.
(d) 
Includes interest income and other miscellaneous income. For the six months ended July 2, 2017, also includes a settlement refund and reimbursement of legal fees related to costs incurred by Pharmaq prior to the acquisition in 2015. For the three and six months ended July 3, 2016, also includes income associated with certain state business employment tax incentive credits.
7.
Income Taxes
A.
Taxes on Income
The effective tax rate was 28.4% for the three months ended July 2, 2017, compared with 32.5% for the three months ended July 3, 2016. The lower effective tax rate for the three months ended July 2, 2017, was primarily attributable to:
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;
a $2 million discrete tax benefit related to the excess tax benefits for share-based payments recognized as a component of Provision for taxes on income; and
a $3 million net discrete tax expense recorded in the second quarter of 2016, related to changes in uncertain tax positions due to the impact of the European Commission’s negative decision on the excess profits rulings in Belgium, partially offset by a revaluation of the company's deferred tax assets and liabilities using the Belgium tax rates expected to be in place going forward as a result of the decision.
The effective tax rate was 28.7% for the six months ended July 2, 2017, compared with 35.5% for the six months ended July 3, 2016. The lower effective tax rate for the six months ended July 2, 2017, was primarily attributable to:
a $38 million net discrete tax expense recorded in the first half of 2016, related to changes in uncertain tax positions due to the impact of the European Commission’s negative decision on the excess profits rulings in Belgium, partially offset by a revaluation of the company's deferred tax assets and liabilities using the Belgium tax rates expected to be in place going forward as a result of the decision;
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;
a $7 million and $5 million discrete tax benefit recorded in the first half of 2017 and 2016, respectively, related to the excess tax benefits for share-based payments recognized as a component of Provision for taxes on income; and
a $3 million and $10 million discrete tax benefit recorded in the first quarter of 2017 and 2016, respectively, related to a revaluation of deferred taxes as a result of a change in statutory tax rates.
B.
Deferred Taxes
As of July 2, 2017, the total net deferred income tax liability of $168 million is included in Deferred tax assets ($93 million) and Deferred tax liabilities ($261 million).

10 |


As of December 31, 2016, the total net deferred income tax liability of $148 million is included in Deferred tax assets ($96 million) and Deferred tax liabilities ($244 million).
C.
Tax Contingencies
As of July 2, 2017, the tax liabilities associated with uncertain tax positions of $75 million (exclusive of interest and penalties related to uncertain tax positions of $11 million) are included in Deferred tax assets ($4 million) and Other taxes payable ($71 million).
As of December 31, 2016, the tax liabilities associated with uncertain tax positions of $68 million (exclusive of interest and penalties related to uncertain tax positions of $10 million) are included in Deferred tax assets ($3 million) and Other taxes payable ($65 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.
8.
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 five-year $1.0 billion senior unsecured revolving credit facility (the credit facility), which expires in December 2021. 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 to 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 July 2, 2017, and December 31, 2016. There were no amounts drawn under the credit facility as of July 2, 2017, or December 31, 2016.
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 July 2, 2017, we had access to $75 million of lines of credit which expire at various times throughout 2017 and 2018 and are generally renewed annually. We did not have any borrowings outstanding related to these facilities as of July 2, 2017, and December 31, 2016.
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 July 2, 2017, there was $100 million of commercial paper borrowings outstanding, with a weighted average interest rate of 1.4%. As of December 31, 2016, there was no commercial paper issued under this program. As of July 2, 2017, and December 31, 2016, we did not have any other short-term borrowings outstanding.
Senior Notes and Other Long-Term Debt
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 current portion of long-term debt was $750 million as of July 2, 2017, with a weighted-average interest rate of 1.875%. There was no current portion of long-term debt as of December 31, 2016.
The 2013 and 2015 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 and 2015 senior notes may be declared immediately due and payable.

11 |


Pursuant to the indenture, we are able to redeem the 2013 and 2015 senior notes, 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. 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 and 2015 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 and 2015 senior notes at a price equal to 101% of the aggregate principal amount of the 2013 and 2015 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:
 
 
July 2,

 
December 31,

(MILLIONS OF DOLLARS)
 
2017

 
2016

1.875% 2013 senior notes due 2018
 
$
750

 
$
750

3.450% 2015 senior notes due 2020
 
500

 
500

3.250% 2013 senior notes due 2023
 
1,350

 
1,350

4.500% 2015 senior notes due 2025
 
750

 
750

4.700% 2013 senior notes due 2043
 
1,150

 
1,150

 
 
4,500

 
4,500

Unamortized debt discount / debt issuance costs
 
(31
)
 
(32
)
Less current portion of long-term debt
 
(750
)
 

Long-term debt, net of discount and issuance costs
 
$
3,719

 
$
4,468

The fair value of our long-term debt, including the current portion of long-term debt, was $4,773 million and $4,565 million as of July 2, 2017, and December 31, 2016, respectively, and has been determined using a third-party matrix-pricing model that uses significant inputs derived from, or corroborated by, observable market data and Zoetis’ credit rating (Level 2 inputs).
The principal amount of long-term debt outstanding, as of July 2, 2017, matures in the following years:
 
 
 
 
 
 
 
 
 
 
After

 
 
(MILLIONS OF DOLLARS)
 
2018

 
2019

 
2020

 
2021

 
2021

 
Total

Maturities
 
$
750

 
$

 
$
500

 
$

 
$
3,250

 
$
4,500

Interest Expense
Interest expense, net of capitalized interest, was $41 million and $82 million for the three and six months ended July 2, 2017, respectively, and $41 million and $84 million for the three and six months ended July 3, 2016, respectively. Capitalized interest was $1 million and $2 million for each of the three and six months ended July 2, 2017, and July 3, 2016, respectively.
B.
Derivative Financial Instruments
Foreign Exchange Risk
A significant portion of our revenue, earnings and net investment in foreign affiliates is exposed to changes in foreign exchange rates. We seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenue in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Depending on market conditions, foreign exchange risk is also managed through the use of derivative financial instruments. These financial instruments serve to protect net income against the impact of the translation into U.S. dollars of certain foreign exchange-denominated transactions. The aggregate notional amount of foreign exchange derivative financial instruments offsetting foreign currency exposures was $1.1 billion and $1.2 billion, as of July 2, 2017, and December 31, 2016, respectively. The derivative financial instruments primarily offset exposures in the Australian dollar, Brazilian real, Canadian dollar, Chinese yuan, euro, and Japanese yen. The vast majority of the foreign exchange derivative financial instruments mature within 60 days and all mature within 180 days.
All derivative contracts used to manage foreign currency risk are measured at fair value and are reported as assets or liabilities on the condensed consolidated balance sheet. The company has not designated the foreign currency forward-exchange contracts as hedging instruments. We recognize the gains and losses on forward-exchange contracts that are used to offset the same foreign currency assets or liabilities immediately into earnings along with the earnings impact of the items they generally offset. These contracts essentially take the opposite currency position of that reflected in the month-end balance sheet to counterbalance the effect of any currency movement.
Interest Rate Risk
The company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rates and to reduce its overall cost of borrowing. In anticipation of issuing fixed-rate debt, we may use forward-starting interest rate swaps that are designated as cash flow hedges to hedge against changes in interest rates that could impact expected future issuances of debt. To the extent these hedges of cash flows related to anticipated debt are effective, any unrealized gains or losses on the forward-starting interest rate swaps are reported in Accumulated other comprehensive loss and are recognized in income over the life of the future fixed-rate notes. When the company discontinues hedge accounting because it is no longer probable that an anticipated transaction will occur within the originally

12 |


expected period of execution, or within an additional two-month period thereafter, changes to fair value accumulated in other comprehensive income are recognized immediately in earnings.
For the six months ended July 2, 2017, we entered into interest rate swaps with an aggregate notional value of $200 million, having a term of 10 years and an effective date and mandatory termination date in December 2017. In 2016, we entered into interest rate swaps with an aggregate notional value of $250 million, having a term of 10 years and an effective date and mandatory termination date in December 2017. We designated these swaps as cash flow hedges against interest rate exposure related principally to the anticipated future issuance of fixed-rate debt to be used primarily to refinance our 1.875% 2013 senior note due in 2018. In addition, in previous years we had entered into various forward-starting interest rate swap contracts that were designated as cash flow hedges and that were terminated upon issuance of fixed-rate notes. The deferred gains or losses related to the settlement of these contracts are reclassified from Accumulated other comprehensive loss into income over the period during which the hedged transactions affects earnings.
Fair Value of Derivative Instruments
The classification and fair values of derivative instruments are as follows:
 
 
Fair Value of Derivatives
 
 
July 2,

 
December 31,

(MILLIONS OF DOLLARS)
Balance Sheet Location
2017

 
2016

Derivatives Not Designated as Hedging Instruments
 
 
 
 
   Foreign currency forward-exchange contracts
Other current assets
$
6

 
$
12

   Foreign currency forward-exchange contracts
Other current liabilities 
(8
)
 
(8
)
Total derivatives not designated as hedging instruments
 
(2
)
 
4

 
 
 
 
 
Derivatives Designated as Hedging Instruments:
 
 
 
 
   Interest rate swap contracts
Other current assets
14

 
17

Total derivatives designated as hedging instruments
 
14

 
17

 
 
 
 
 
Total derivatives
 
$
12

 
$
21

We use a market approach in valuing financial instruments on a recurring basis. Our derivative financial instruments are measured at fair value on a recurring basis using Level 2 inputs in the calculation of fair value.
The amounts of net gains/(losses) on derivative instruments not designated as hedging instruments, recorded in Other (income)/deductions—net, are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

 
2017

 
2016

Foreign currency forward-exchange contracts
 
$
7

 
$
(13
)
 
$
(22
)
 
$
(12
)
These amounts were substantially offset in Other (income)/deductions—net by the effect of changing exchange rates on the underlying foreign currency exposures.
The amounts of unrecognized net losses on derivative instruments designated as cash flow hedges, recorded, net of tax, in Other comprehensive income/(loss), are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

 
2017

 
2016

Interest rate swaps
 
$
(1
)
 
$
(3
)
 
$
(1
)
 
$
(3
)
The net amount of deferred gains/(losses) that is expected to be reclassified from Accumulated other comprehensive loss into earnings over the next 12 months is insignificant.

13 |


9.
Inventories
The components of inventory are as follows:
 
 
July 2,

 
December 31,

(MILLIONS OF DOLLARS)
 
2017

 
2016

Finished goods
 
$
784

 
$
799

Work-in-process
 
534

 
499

Raw materials and supplies
 
180

 
204

Inventories
 
$
1,498

 
$
1,502

10.
Goodwill and Other Intangible Assets
A.
Goodwill
The components of, and changes in, the carrying amount of goodwill are as follows:
(MILLIONS OF DOLLARS)
 
U.S.

 
International

 
Total

Balance, December 31, 2016
 
$
661

 
$
820

 
$
1,481

Additions(a)
 
5

 
5

 
10

Other(b)
 

 
4

 
4

Balance, July 2, 2017
 
$
666

 
$
829

 
$
1,495

(a) 
Represents the consolidation of a European livestock monitoring company, a variable interest entity of which Zoetis is the primary beneficiary.
(b) 
Includes adjustments for foreign currency translation, partially offset by the reclassification of $3 million to Assets Held for Sale relating to our manufacturing site in Guarulhos, Brazil. For additional information, see Note 4. Acquisitions and Divestitures: Assets Held for Sale.
The gross goodwill balance was $2,031 million and $2,017 million as of July 2, 2017, and December 31, 2016, respectively. Accumulated goodwill impairment losses were $536 million as of July 2, 2017, and December 31, 2016.
B.
Other Intangible Assets
The components of identifiable intangible assets are as follows:
 
 
As of July 2, 2017
 
As of December 31, 2016
 
 
 
 
 
 
Identifiable

 
 
 
 
 
Identifiable

 
 
Gross

 
 
 
Intangible Assets

 
Gross

 
 
 
Intangible Assets

 
 
Carrying

 
Accumulated

 
Less Accumulated

 
Carrying

 
Accumulated

 
Less Accumulated

(MILLIONS OF DOLLARS)
 
Amount

 
Amortization

 
Amortization

 
Amount

 
Amortization

 
Amortization

Finite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology rights(a)(b)
 
$
1,167

 
$
(385
)
 
$
782

 
$
1,064

 
$
(342
)
 
$
722

Brands
 
213

 
(138
)
 
75

 
213

 
(132
)
 
81

Trademarks and trade names
 
62

 
(46
)
 
16

 
62

 
(44
)
 
18

Other
 
225

 
(137
)
 
88

 
222

 
(130
)
 
92

Total finite-lived intangible assets
 
1,667

 
(706
)
 
961

 
1,561

 
(648
)
 
913

Indefinite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Brands
 
37

 

 
37

 
37

 

 
37

Trademarks and trade names
 
67

 

 
67

 
66

 

 
66

In-process research and development(b)
 
137

 

 
137

 
204

 

 
204

Product rights
 
8

 

 
8

 
8

 

 
8

Total indefinite-lived intangible assets
 
249

 

 
249

 
315

 

 
315

Identifiable intangible assets
 
$
1,916

 
$
(706
)
 
$
1,210

 
$
1,876

 
$
(648
)
 
$
1,228

(a) 
Includes the consolidation of a European livestock monitoring company, a variable interest entity of which Zoetis is the primary beneficiary, and intangible assets associated with the purchase of a Norwegian fish vaccination company, both during the first quarter of 2017.
(b)
In the first quarter of 2017, certain intangible assets, acquired in 2015 as part of the Pharmaq acquisition, were placed into service.

14 |


C.
Amortization
Amortization expense related to finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in Amortization of intangible assets as it benefits multiple business functions. Amortization expense related to finite-lived acquired intangible assets that are associated with a single function is included in Cost of sales, Selling, general and administrative expenses or Research and development expenses, as appropriate. Total amortization expense for finite-lived intangible assets was $24 million and $49 million for the three and six months ended July 2, 2017, respectively, and $24 million and $48 million for the three and six months ended July 3, 2016, respectively.
11.
Benefit Plans
Our employees ceased to participate in the Pfizer, Inc. U.S. qualified defined benefit plans and the U.S. retiree medical plan effective December 31, 2012, and liabilities associated with our employees under these plans were retained by Pfizer. Pfizer is continuing to credit certain employees' service with Zoetis generally through December 31, 2017 (or termination of employment from Zoetis, if earlier) for certain early retirement benefits with respect to Pfizer's U.S. defined benefit pension and retiree medical plans. Pension and postretirement benefit expense associated with the extended service for certain employees in the U.S. plans totaled approximately $1 million for each of the three month periods ended July 2, 2017, and July 3, 2016, and $3 million for each of the six month periods ended July 2, 2017, and July 3, 2016.
The following table provides the net periodic benefit cost associated with our international defined benefit pension plans:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

 
2017

 
2016

Service cost
 
$
1

 
$
2

 
$
3

 
$
4

Interest cost
 

 
1

 
1

 
2

Expected return on plan assets
 

 

 
(1
)
 
(1
)
Amortization of net actuarial loss
 
1

 

 
1

 

Curtailment and settlement (gain)/loss
 

 
(1
)
 
1

 
(1
)
Net periodic benefit cost
 
$
2

 
$
2

 
$
5

 
$
4

Total company contributions to the international pension plans were $1 million and $4 million for the three and six months ended July 2, 2017, respectively, and $3 million and $6 million for the three and six months ended July 3, 2016, respectively. We expect to contribute a total of approximately $7 million to these plans in 2017.
12.
Share-Based Payments
The company may grant a variety of share-based payments under the Zoetis 2013 Equity and Incentive Plan (the Equity Plan) to our employees and non-employee directors. The principal types of share-based awards available under the Equity Plan may include, but are not limited to, stock options, restricted stock and restricted stock units (RSUs), deferred stock units (DSUs), performance-vesting restricted stock units (PSUs) and other equity-based or cash-based awards.
The components of share-based compensation expense are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,

 
July 3,

 
July 2,

 
July 3,

(MILLIONS OF DOLLARS)
 
2017

 
2016

 
2017

 
2016

Stock options / stock appreciation rights
 
$
2

 
$
3

 
$
5

 
$
5

RSUs / DSUs
 
7

 
6

 
13

 
12

PSUs
 
2

 
1

 
4

 
2

Share-based compensation expense—total(a)(b)
 
$
11

 
$
10

 
$
22

 
$
19

(a) For the three and six months ended July 2, 2017, and July 3, 2016, amounts capitalized to inventory were insignificant.
(b) For the three and six months ended July 2, 2017, and three months ended July 3, 2016, the additional share-based compensation expense as a result of accelerated vesting of the outstanding stock options and the settlement, on a pro-rata basis, of other equity awards of terminated employees in connection with our operational efficiency initiative and supply network strategy, which is included in Restructuring charges/(reversals) and certain acquisition-related costs, were insignificant. For the six months ended July 3, 2016, additional share-based compensation expense was approximately $1 million.

15 |


During the six months ended July 2, 2017, the company granted 712,112 stock options with a weighted-average exercise price of $55.09 per stock option and a weighted-average fair value of $14.30 per stock option. The fair-value based method for valuing each Zoetis stock option grant on the grant date uses the Black-Scholes-Merton option-pricing model, which incorporates a number of valuation assumptions. The weighted-average fair value was estimated based on the following assumptions: risk-free interest rate of 2.3%; expected dividend yield of 0.76%; expected stock price volatility of 23.28%; and expected term of 6.5 years. In general, stock options vest after three years of continuous service and the values determined through this fair-value based method generally are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.
During the six months ended July 2, 2017, the company granted 529,932 RSUs with a weighted-average grant date fair value of $55.04 per RSU. RSUs are accounted for using a fair-value-based method that utilizes the closing price of Zoetis common stock on the date of grant. In general, RSUs vest after three years of continuous service from the grant date and the values generally are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.
During the six months ended July 2, 2017, the company granted 136,964 PSUs with a weighted-average grant date fair value of $74.28 per PSU. PSUs are accounted for using a Monte Carlo simulation model. The units underlying the PSUs will be earned and vested over a three-year performance period, based upon the total shareholder return of the company in comparison to the total shareholder return of the companies comprising the S&P 500 index at the start of the performance period (Relative TSR). The weighted-average fair value was estimated based on volatility assumptions of Zoetis common stock and an average of the S&P 500 companies, which were 23.1% and 25.5%, respectively. Depending on the company’s Relative TSR performance at the end of the performance period, the recipient may earn between 0% and 200% of the target number of units. Vested units are settled in shares of the company’s common stock. PSU values are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.
13.
Stockholders' Equity
Zoetis is authorized to issue 6 billion shares of common stock and 1 billion shares of preferred stock.
In November 2014, the company's Board of Directors authorized a $500 million share repurchase program. This program was substantially completed as of December 31, 2016. In December 2016, the company's Board of Directors authorized an additional $1.5 billion share repurchase program. Purchases of Zoetis shares may be made at the discretion of management, depending on market conditions and business needs. As of July 2, 2017, there was approximately $1.3 billion remaining under these authorizations.
Changes in common shares and treasury stock were as follows:
(MILLIONS)
 
Common Shares Issued(a)

 
Treasury Stock(a)

Balance, December 31, 2015
 
501.81

 
4.41

Share-based compensation(b)
 
0.08

 
(1.29
)
Share repurchase program
 

 
3.38

Balance, July 3, 2016
 
501.89

 
6.50

 
 
 
 
 
Balance, December 31, 2016
 
501.89

 
9.04

Share-based compensation(b)
 

 
(1.25
)
Share repurchase program
 

 
4.45

Balance, July 2, 2017
 
501.89

 
12.23

(a)    Shares may not add due to rounding.
(b) 
Includes the issuance of shares of common stock and the reissuance of shares from treasury stock in connection with the vesting of employee share-based awards. Treasury stock also includes the reacquisition of shares associated with the vesting of employee share-based awards to satisfy tax withholding requirements. For additional information regarding share-based compensation, see Note 12. Share-Based Payments.     
Changes, net of tax, in accumulated other comprehensive loss, excluding noncontrolling interest, are as follows:
 
 
 
 
Currency Translation