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EX-32.2 - EXHIBIT 32.2 - Zoetis Inc.a2018q110qex322.htm
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EX-31.2 - EXHIBIT 31.2 - Zoetis Inc.a2018q110qex312.htm
EX-31.1 - EXHIBIT 31.1 - Zoetis Inc.a2018q110qex311.htm
EX-15 - EXHIBIT 15 - Zoetis Inc.a2018q110qex15.htm
EX-12 - EXHIBIT 12 - Zoetis Inc.a2018q110qex12.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 March 31, 2018
 
 
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 April 27, 2018, there were 483,865,442 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
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)
 
2018

 
2017

Revenue
 
$
1,366

 
$
1,231

Costs and expenses:
 
 
 
 
Cost of sales
 
447

 
443

Selling, general and administrative expenses
 
338

 
309

Research and development expenses
 
97

 
90

Amortization of intangible assets
 
23

 
22

Restructuring charges/(reversals) and certain acquisition-related costs
 
2

 
(1
)
Interest expense, net of capitalized interest
 
47

 
41

Other (income)/deductions—net
 
(5
)
 
(10
)
Income before provision for taxes on income
 
417

 
337

Provision for taxes on income
 
67

 
98

Net income before allocation to noncontrolling interests
 
350

 
239

Less: Net (loss)/income attributable to noncontrolling interests
 
(2
)
 
1

Net income attributable to Zoetis Inc.
 
$
352

 
$
238

Earnings per share attributable to Zoetis Inc. stockholders:
 
 
 
 
 Basic
 
$
0.72

 
$
0.48

 Diluted
 
$
0.72

 
$
0.48

Weighted-average common shares outstanding:
 
 
 
 
 Basic
 
485.9

 
492.4

 Diluted
 
489.8

 
495.3

Dividends declared per common share
 
$
0.126

 
$
0.105



See notes to condensed consolidated financial statements.
1 |



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

 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Net income before allocation to noncontrolling interests
 
$
350

 
$
239

Other comprehensive income, net of taxes and reclassification adjustments:
 
 
 
 
Foreign currency translation adjustments, net
 
77

 
44

Benefit plans: Actuarial gains, net(a)
 

 
2

Total other comprehensive income, net of tax
 
77

 
46

Comprehensive income before allocation to noncontrolling interests
 
427

 
285

Less: Comprehensive (loss)/income attributable to noncontrolling interests
 
(1
)
 
1

Comprehensive income attributable to Zoetis Inc.
 
$
428

 
$
284

(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 Other (income)/deductions, beginning in the first quarter of 2018, and into Cost of sales, Selling, general and administrative expenses, and/or Research and development expenses, as appropriate, for periods prior to 2018, in the condensed consolidated statements of income.



See notes to condensed consolidated financial statements.
2 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

 
 
March 31,

 
December 31,

 
 
2018

 
2017

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

 
 
Assets
 
 
 
 
Cash and cash equivalents(a)
 
$
1,654

 
$
1,564

Accounts receivable, less allowance for doubtful accounts of $25 in 2018 and $25 in 2017
 
943

 
998

Inventories
 
1,441

 
1,427

Other current assets
 
229

 
228

Total current assets
 
4,267

 
4,217

Property, plant and equipment, less accumulated depreciation of $1,519 in 2018 and $1,471 in 2017
 
1,453

 
1,435

Goodwill
 
1,532

 
1,510

Identifiable intangible assets, less accumulated amortization
 
1,280

 
1,269

Noncurrent deferred tax assets
 
80

 
80

Other noncurrent assets
 
78

 
75

Total assets
 
$
8,690

 
$
8,586

 
 
 
 
 
Liabilities and Equity
 
 
 
 
Accounts payable
 
$
217

 
$
261

Dividends payable
 
61

 
61

Accrued expenses
 
419

 
432

Accrued compensation and related items
 
182

 
236

Income taxes payable
 
92

 
60

Other current liabilities
 
29

 
44

Total current liabilities
 
1,000

 
1,094

Long-term debt, net of discount and issuance costs
 
4,954

 
4,953

Noncurrent deferred tax liabilities
 
246

 
380

Other taxes payable
 
304

 
172

Other noncurrent liabilities
 
211

 
201

Total liabilities
 
6,715

 
6,800

Commitments and contingencies (Note 15)
 


 


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; 484,724,245 and 486,130,461 shares outstanding at March 31, 2018, and December 31, 2017, respectively
 
5

 
5

Treasury stock, at cost, 17,166,998 and 15,760,782 shares of common stock at March 31, 2018, and December 31, 2017, respectively
 
(1,005
)
 
(852
)
Additional paid-in capital
 
990

 
1,013

Retained earnings
 
2,399

 
2,109

Accumulated other comprehensive loss
 
(429
)
 
(505
)
Total Zoetis Inc. equity
 
1,960

 
1,770

Equity attributable to noncontrolling interests
 
15

 
16

Total equity
 
1,975

 
1,786

Total liabilities and equity
 
$
8,690

 
$
8,586

(a) 
As of both March 31, 2018, and December 31, 2017, includes $6 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, 2016
 
$
5

 
$
(421
)
 
$
1,024

 
$
1,477

 
$
(598
)
 
$
12

 
$
1,499

Three months ended April 2, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
238

 

 
1

 
239

Other comprehensive income
 

 

 

 

 
46

 

 
46

Consolidation of a noncontrolling interest(b)
 

 

 

 

 

 
13

 
13

Share-based compensation awards(c)
 

 
36

 
(10
)
 
(12
)
 

 

 
14

Treasury stock acquired(d)
 

 
(125
)
 

 

 

 

 
(125
)
Employee benefit plan contribution from Pfizer Inc.(e)
 

 

 
1

 

 

 

 
1

Dividends declared
 

 

 

 
(52
)
 

 

 
(52
)
Balance, April 2, 2017
 
$
5

 
$
(510
)
 
$
1,015

 
$
1,651

 
$
(552
)
 
$
26

 
$
1,635

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
 
$
5

 
$
(852
)
 
$
1,013

 
$
2,109

 
$
(505
)
 
$
16

 
$
1,786

Three months ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income/(loss)
 

 

 

 
352

 

 
(2
)
 
350

Other comprehensive income
 

 

 

 

 
76

 
1

 
77

Share-based compensation awards (c)
 

 
37

 
(24
)
 
(1
)
 

 

 
12

Treasury stock acquired(d)
 

 
(190
)
 

 

 

 

 
(190
)
Employee benefit plan contribution from Pfizer Inc.(e)
 

 

 
1

 

 

 

 
1

Dividends declared
 

 

 

 
(61
)
 

 

 
(61
)
Balance, March 31, 2018
 
$
5

 
$
(1,005
)
 
$
990

 
$
2,399

 
$
(429
)
 
$
15

 
$
1,975

(a) 
As of March 31, 2018, and April 2, 2017, there were 484,724,245 and 491,328,479 outstanding shares of common stock, respectively, and 17,166,998 and 10,562,764 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) 
Represents the consolidation of a European livestock monitoring company, a variable interest entity of which Zoetis is the primary beneficiary.
(c)
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.
(d) 
Reflects the acquisition of treasury shares in connection with the share repurchase program. For additional information, see Note 13. Stockholders' Equity.
(e) 
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.




See notes to condensed consolidated financial statements.
4 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Operating Activities
 
 
 
 
Net income before allocation to noncontrolling interests
 
$
350

 
$
239

Adjustments to reconcile net income before noncontrolling interests to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization expense
 
60

 
62

Share-based compensation expense
 
11

 
11

Restructuring
 
2

 
(1
)
Asset write-offs and asset impairments
 
2

 

Provision for losses on inventory
 
16

 
16

Deferred taxes(a)
 
(141
)
 
24

Employee benefit plan contribution from Pfizer Inc.
 
1

 
1

Other non-cash adjustments
 
3

 
4

Other changes in assets and liabilities, net of acquisitions and divestitures
 
 
 
 
    Accounts receivable
 
60

 
(22
)
    Inventories
 
(33
)
 
(52
)
    Other assets
 
(2
)
 
(13
)
    Accounts payable
 
(46
)
 
(37
)
    Other liabilities
 
(57
)
 
(147
)
    Other tax accounts, net(a)
 
163

 
34

Net cash provided by operating activities
 
389

 
119

Investing Activities
 
 
 
 
Purchases of property, plant and equipment
 
(53
)
 
(42
)
Acquisitions
 

 
(3
)
Net proceeds from sales of assets
 
8

 

Other investing activities
 

 
(3
)
Net cash used in investing activities
 
(45
)
 
(48
)
Financing Activities
 
 
 
 
Payment of contingent consideration related to previously acquired assets
 
(12
)
 
(5
)
Share-based compensation-related proceeds, net of taxes paid on withholding shares
 
2

 
6

Purchases of treasury stock
 
(190
)
 
(125
)
Cash dividends paid
 
(62
)
 
(52
)
Net cash used in financing activities
 
(262
)
 
(176
)
Effect of exchange-rate changes on cash and cash equivalents
 
8

 
7

Net increase/(decrease) in cash and cash equivalents
 
90

 
(98
)
Cash and cash equivalents at beginning of period
 
1,564

 
727

Cash and cash equivalents at end of period
 
$
1,654

 
$
629

 
 
 
 
 
Supplemental cash flow information
 
 
 
 
Cash paid during the period for:
 
 
 
 
  Income taxes
 
$
42

 
$
37

  Interest, net of capitalized interest
 
70

 
56

Non-cash transactions:
 
 
 
 
     Purchases of property, plant and equipment
 
1

 
4

     Contingent purchase price consideration(b)
 

 
2

  Dividends declared, not paid
 
61

 
52

(a) 
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.
(b) 
For 2017, relates primarily to 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.
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-month periods ended February 28, 2018, and February 26, 2017.
Prior to fiscal 2018, the company followed a 13-week quarterly accounting cycle for each of the first three fiscal quarters. The company's fiscal year ends on December 31 for our operations in the United States and on November 30 for subsidiaries operating outside the United States. Beginning in fiscal 2018, the company's first three fiscal quarters will end on the last day of March, June and September in the United States and the last day of February, May and August for subsidiaries operating outside the United States. There is no change to the company's fiscal year-end dates. We did not adjust our results of operations for periods prior to 2018 as the impact was not material.
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 2017 Annual Report on Form 10-K.
3.
Accounting Standards
Recently Adopted Accounting Standards
In March 2018, the Financial Accounting Standards Board (FASB) issued an accounting standards update to align existing guidance on accounting for income taxes, pursuant to guidance provided by a Staff Accounting Bulletin published by the SEC on December 22, 2017. The update addresses the challenges in accounting for the effects of the Tax Cuts and Jobs Act (the Tax Act), enacted on December 22, 2017, in the period of enactment and required companies to report provisional amounts for those specific income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. Provisional amounts will be subject to adjustment during a measurement period of up to one year from the enactment date. For additional information, see Note 7. Tax Matters.
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 adopted this guidance as of January 1, 2018, the required effective date. The new standard did not have a significant impact on our consolidated financial statements.
In October 2016, the FASB issued an accounting standards update that requires 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. We adopted this guidance as of January 1, 2018, the required effective date. The new standard did not have a significant impact 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. 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. We adopted this guidance as of January 1, 2018, the required effective date, using the modified retrospective adoption method. Prior period amounts have not been adjusted and continue to be reported in accordance with our historic

6 |


accounting policies. Application of the standard using the modified retrospective method did not require an adjustment to opening retained earnings. For additional information, see Note 4. Revenue.
Recently Issued 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. The provisions of the update are effective beginning January 1, 2019 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 and do not expect that the new standard will have a significant impact on our consolidated financial statements.
In August 2017, the FASB issued an accounting standards update which amends the hedge accounting recognition and presentation requirements and allows for more hedging strategies to be eligible for hedge accounting. Recognition of periodic hedge effectiveness will no longer be required for cash flow and net investment hedges and companies may elect to perform subsequent hedge effectiveness assessments qualitatively. The update also clarifies that the change in fair value of a derivative must be recorded in the same income statement line item as the earnings effect of the hedged item and introduces additional disclosure requirements including cumulative basis adjustments for fair value hedges and the effect of hedging on individual income statement line items. The provisions of the update are effective beginning January 1, 2019 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.
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 have selected a lease accounting system and are currently evaluating our lease contracts, accounting policy elections, and the impact of adoption on our consolidated financial statements. While we do not expect adoption of the standard to have a significant impact on our consolidated statements of income, the impact on the assets and liabilities within our consolidated balance sheet may be material.
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 and vaccines, complemented by biodevices, diagnostics, and genetics. 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.
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;
anti-infectives: products that prevent, kill or slow the growth of bacteria, fungi or protozoa;
other pharmaceutical products: allergy and dermatology, pain and sedation, antiemetic, reproductive, and oncology products;
parasiticides: products that prevent or eliminate external and internal parasites such as fleas, ticks and worms; and
medicated feed additives: products added to animal feed that provide medicines to livestock.
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 and vaccines 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.

7 |


The following tables present our revenue disaggregated by geographic area, species, and major product category.
Revenue by geographic area
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

United States
 
$
634

 
$
605

Australia
 
48

 
40

Brazil
 
70

 
66

Canada
 
40

 
34

China
 
64

 
52

France
 
33

 
29

Germany
 
38

 
28

Italy
 
27

 
22

Japan
 
41

 
34

Mexico
 
24

 
18

Spain
 
25

 
20

United Kingdom
 
52

 
43

Other developed markets
 
79

 
68

Other emerging markets
 
185

 
161

 
 
1,360

 
1,220

 
 
 
 
 
Contract Manufacturing
 
6

 
11

 
 
 
 
 
Total Revenue
 
$
1,366

 
$
1,231

Revenue by major species
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

U.S.
 
 
 
 
Livestock
 
$
292

 
$
282

Companion Animal
 
342

 
323

 
 
634

 
605

International
 
 
 
 
Livestock
 
478

 
421

Companion Animal
 
248

 
194

 
 
726

 
615

 
 
 
 
 
Contract Manufacturing
 
6

 
11

 
 
 
 
 
Total Revenue
 
$
1,366

 
$
1,231


8 |


Revenue by species
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Livestock:
 
 
 
 
Cattle
 
$
416

 
$
386

Swine
 
175

 
160

Poultry
 
136

 
116

Fish
 
22

 
21

Other
 
21

 
20

 
 
770

 
703

Companion Animal:
 
 
 
 
Dogs and Cats
 
549

 
482

Horses
 
41

 
35

 
 
590

 
517

 
 
 
 
 
Contract Manufacturing
 
6

 
11

 
 
 
 
 
Total Revenue
 
$
1,366

 
$
1,231

Revenue by major product category
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Vaccines
 
$
356

 
$
319

Anti-infectives
 
297

 
268

Other pharmaceuticals
 
319

 
272

Parasiticides
 
191

 
184

Medicated feed additives
 
137

 
123

Other non-pharmaceuticals
 
60

 
54

 
 
1,360

 
1,220

 
 
 
 
 
Contract Manufacturing
 
6

 
11

 
 
 
 
 
Total Revenue
 
$
1,366

 
$
1,231

B.    Revenue Accounting Policy
Below are the significant accounting policies updated as of January 1, 2018 as a result of the adoption of the new revenue recognition guidance. For additional information, see Note 3. Accounting Standards.
We recognize revenue from product sales when control of the goods has transferred to the customer, which is typically once the goods have shipped and the customer has assumed title. Revenue reflects the total consideration to which we expect to be entitled (i.e. the transaction price), in exchange for products sold, after considering various types of variable consideration including rebates, sales allowances, product returns and discounts.
Variable consideration is estimated and recorded at the time that related revenue is recognized. Our estimates reflect the amount by which we expect variable consideration to impact revenue recognized and are generally based on contractual terms or historical experience, adjusted as necessary to reflect our expectations about the future. Our customer payment terms generally range from 60 to 90 days.
Estimates of variable consideration utilize a complex series of judgments and assumptions to determine the amount by which we expect revenue to be reduced, for example;
for sales returns, we perform calculations in each market that incorporate the following, as appropriate: local returns policies and practices; historic returns as a percentage of revenue; estimated shelf life by product; an estimate of the amount of time between shipment and return or lag time; and any other factors that could impact the estimate of future returns, product recalls, discontinuation of products or a changing competitive environment; and
for revenue incentives, we use our historical experience with similar incentives programs to estimate the impact of such programs on revenue for the current period.

9 |


Although the amounts recorded for these revenue deductions are dependent on estimates and assumptions, historically our adjustments to actual results have not been material. The sensitivity of our estimates can vary by program, type of customer and geographic location.
A deferral of revenue may be required in the event that we have not satisfied all customer obligations for which we have been compensated. The transaction price is allocated to the individual performance obligations on the basis of relative stand-alone selling price, which is typically based on actual sales prices. Revenue associated with unsatisfied performance obligations are contract liabilities, is recorded within Other current liabilities, and is recognized once control of the underlying products has transferred to the customer. Contract liabilities reflected within Other current liabilities as of the adoption date and subsequently recognized as revenue during the first quarter of 2018 were approximately $2 million. Contract liabilities as of March 31, 2018 were approximately $4 million.
We do not disclose the transaction price allocated to unsatisfied performance obligations related to contracts with an original expected duration of one year or less, or for contracts for which we recognize revenue in line with our right to invoice the customer. Estimated future revenue expected to be generated from long-term contracts with unsatisfied performance obligations as of March 31, 2018 are not material.
Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from Revenue. Shipping and handling costs incurred after control of the purchased product has transferred to the customer are accounted for as a fulfillment cost, within Selling, general and administrative expenses.
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 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, which was incremental to the previously announced supply network strategy. These initiatives focused on reducing complexity in our product portfolios, changing our selling approach in certain markets, reducing our presence in certain countries, and exiting manufacturing sites over a long term period. We have also continued 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 2,800, subject to consultations with works councils and unions in certain countries. Including divestitures, as of March 31, 2018, approximately 2,600 positions have been eliminated related to these initiatives. The comprehensive operational efficiency program was substantially completed as of December 31, 2017. We expect to complete the supply network strategy over the next several years.
The components of costs incurred in connection with restructuring initiatives, acquisitions and cost-reduction/productivity initiatives are as follows:
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Restructuring charges/(reversals) and certain acquisition-related costs:
 
 
 
 
Integration costs(a)
 
$
1

 
$

Restructuring charges/(reversals)(b)(c):
 
 
 
 
Employee termination costs/(reversals)
 
1

 
(1
)
Total Restructuring charges/(reversals) and certain acquisition-related costs
 
$
2

 
$
(1
)
(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 March 31, 2018, primarily relate to the supply network strategy.
The restructuring charges/(reversals) for the three months ended April 2, 2017, primarily relate to the operational efficiency initiative.
(c) 
The restructuring charges/(reversals) are associated with the following:
For the three months ended March 31, 2018, Manufacturing/research/corporate ($1 million).
For the three months ended April 2, 2017, U.S. ($1 million) and International ($2 million reversal).

10 |


Charges related to the operational efficiency initiative and supply network strategy are as follows:
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

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

 
$
(1
)
 
 

 
(1
)
Supply network strategy:
 
 
 
 
Employee termination costs
 
1

 

 
 
1

 

 
 
 
 
 
Total restructuring charges/(reversals) related to the operational efficiency initiative and supply network strategy
 
1

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

 
1

        Consulting fees
 
1

 
2

Total other supply network strategy charges
 
1

 
3

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

 
$
2

The components of, and changes in, our restructuring accruals are as follows:
 
 
 
 
 
 
(MILLIONS OF DOLLARS)
 
Accrual(a)

Balance, December 31, 2017(b)
 
$
41

Provision
 
1

Utilization and other(c)
 
(7
)
Balance, March 31, 2018(b)
 
$
35

(a)  
Changes in our restructuring accruals represent employee termination costs.
(b) 
At March 31, 2018, and December 31, 2017, included in Accrued expenses ($14 million and $19 million, respectively) and Other noncurrent liabilities ($21 million and $22 million, respectively).
(c)  
Includes adjustments for foreign currency translation.
6.
Other (Income)/Deductions—Net
The components of Other (income)/deductions—net are as follows:
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Royalty-related income
 
$
(7
)
 
$
(7
)
Foreign currency loss(a)
 
8

 
2

Other, net(b)
 
(6
)
 
(5
)
Other (income)/deductions—net
 
$
(5
)
 
$
(10
)
(a) 
Primarily driven by costs related to hedging and exposures to certain emerging market currencies.
(b) 
For the three months ended March 31, 2018, primarily includes interest income and other miscellaneous income. For the three months ended April 2, 2017, primarily includes a settlement refund and reimbursement of legal fees related to costs incurred by Pharmaq prior to the acquisition in 2015, as well as interest income and other miscellaneous income.

11 |


7.
Income Taxes
A.
Taxes on Income
On December 22, 2017, the Tax Act was enacted which, among other changes, reduced the U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018. The Tax Act made broad and complex changes to the U.S. tax code and it will take time to fully analyze the impact of the changes. Based on the information available at that time, and the current interpretation of the Tax Act, for the year ended December 31, 2017 the company was able to make a reasonable estimate and recorded an initial provisional net tax expense of $212 million related to the one-time mandatory deemed repatriation tax, payable over eight years, partially offset by the remeasurement of the deferred tax assets and liabilities, as of the date of enactment, due to the reduction in the U.S. federal corporate tax rate. Pursuant to the Staff Accounting Bulletin published by the SEC on December 22, 2017, addressing the challenges in accounting for the effects of the Tax Act in the period of enactment, companies must report provisional amounts for those specific income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. Those provisional amounts will be subject to adjustment during a measurement period of up to one year from the enactment date (measurement-period adjustment). Pursuant to this guidance, the estimated impact of the Tax Act was based on a preliminary review of the new tax law and projected future financial results and is subject to revision based upon further analysis and interpretation of the Tax Act and to the extent that future results differ from currently available projections.
Our accounting for the following elements of the Tax Act is incomplete. However, we were able to further refine our initial reasonable estimate and adjusted the initial provisional net tax expense of $212 million and recorded the following measurement-period adjustments during the first quarter of 2018:
One-Time Mandatory Deemed Repatriation Tax: The one-time mandatory deemed repatriation tax is a tax on certain previously untaxed accumulated and current earnings and profits (E&P) of our foreign subsidiaries. We were able to reasonably estimate the one-time mandatory deemed repatriation tax and recorded an initial provisional tax obligation, with a corresponding adjustment to income tax expense for the year ended December 31, 2017. We are continuing to gather additional information to more precisely compute the amount of the one-time mandatory deemed repatriation tax, and our accounting for this item is not yet complete due to the fact that the non-U.S. subsidiaries are on a fiscal year ending November 30, and this tax liability will not become a fixed obligation until November 30, 2018. The estimated impact of the Tax Act is based on a preliminary review of the new law and projected future financial results and is subject to revision based upon further analysis and interpretation of the Tax Act and to the extent that future results differ from currently available projections. However, on the basis of revised E&P computations that were calculated during the reporting period, we recognized a measurement-period adjustment of $2 million as a decrease to the one-time mandatory deemed repatriation tax obligation, with a corresponding adjustment to income tax benefit during the period. The effect of the measurement-period adjustment to the first quarter 2018 effective tax rate was a reduction to the rate of approximately 0.6%. In addition, we reclassified the one-time mandatory deemed repatriation tax from Noncurrent deferred tax liabilities to Income taxes payable and Other taxes payable. We expect to complete our accounting within the prescribed measurement period.
Reduction of U.S. Federal Corporate Tax Rate: The Tax Act reduced the corporate tax rate to 21%, effective January 1, 2018. Consequently, we recorded a decrease related to deferred tax assets and liabilities with a corresponding net adjustment to deferred income tax benefit for the year ended December 31, 2017. We have not made any measurement-period adjustments related to this item during the first quarter of 2018. Since the company has recorded provisional amounts related to certain portions of the Tax Act, any corresponding deferred tax remeasurement is also provisional. However, we are continuing to gather additional information to complete our accounting for this item and expect to be completed within the prescribed measurement period.
Valuation Allowances: The company must assess whether its valuation allowance analyses are affected by the various aspects of the Tax Act (e.g., one-time mandatory deemed repatriation of deferred foreign income, global intangible low-taxed income inclusions, and new categories of foreign tax credits). We have not made any measurement-period adjustments related to this item during the first quarter of 2018. Since the company has recorded provisional amounts related to certain portions of the Tax Act, any corresponding determination of the need for or change in a valuation allowance is also provisional. However, we are continuing to gather additional information to complete our accounting for this item and expect to be completed within the prescribed measurement period.
Global Intangible Low-Taxed Income (GILTI) Policy Election: The GILTI provisions of the Tax Act do not apply to the company until 2019, due to the fact that the non-U.S. subsidiaries are on a fiscal year ending November 30, and we are still evaluating its impact. The FASB allows companies to adopt an accounting policy to either recognize deferred taxes for GILTI or treat such tax cost as a current-period expense when incurred. We have not yet determined our accounting policy because determining the impact of the GILTI provisions requires analysis of our existing legal entity structure, the reversal of our U.S. GAAP and U.S. tax basis differences in the assets and liabilities of our foreign subsidiaries, and our ability to offset any tax with foreign tax credits. As such, we have not made a policy decision whether to record deferred taxes on GILTI or treat such tax cost as a current-period expense.
The effective tax rate was 16.1% for the three months ended March 31, 2018, compared with 29.1% for the three months ended April 2, 2017. The lower effective tax rate for the three months ended March 31, 2018, was primarily attributable to:
the reduction of the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018, pursuant to the Tax Act;
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;
an $8 million and $5 million discrete tax benefit recorded in the first quarter of 2018 and 2017, respectively, related to the excess tax benefits for share-based payments;

12 |


an $8 million and $3 million discrete tax benefit recorded in the first quarter of 2018 and 2017, respectively, related to a remeasurement of deferred taxes as a result of a change in non-U.S. statutory tax rates; and
a $2 million net discrete tax benefit recorded in the first quarter of 2018, associated with a measurement-period adjustment related to the provisional one-time mandatory deemed repatriation tax on the company's undistributed non-U.S. earnings pursuant to the Tax Act enacted on December 22, 2017.
B.
Deferred Taxes
As of March 31, 2018, the total net deferred income tax liability of $166 million is included in Noncurrent deferred tax assets ($80 million) and Noncurrent deferred tax liabilities ($246 million).
As of December 31, 2017, the total net deferred income tax liability of $300 million is included in Noncurrent deferred tax assets ($80 million) and Noncurrent deferred tax liabilities ($380 million).
The change in Noncurrent deferred tax liabilities was primarily due to 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.
C.
Tax Contingencies
As of March 31, 2018, the tax liabilities associated with uncertain tax positions of $191 million (exclusive of interest and penalties related to uncertain tax positions of $12 million) are included in Noncurrent deferred tax assets ($4 million) and Other taxes payable ($187 million).
As of December 31, 2017, the tax liabilities associated with uncertain tax positions of $164 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 ($161 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). In December 2017, the maturity for the amended and restated revolving credit agreement was extended through December 2022. 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 March 31, 2018, and December 31, 2017. There were no amounts drawn under the credit facility as of March 31, 2018, or December 31, 2017.
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, 2018, we had access to $71 million of lines of credit which expire at various times throughout 2018 and 2019 and are generally renewed annually. We did not have any borrowings outstanding related to these facilities as of March 31, 2018, and December 31, 2017.
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, 2018, and December 31, 2017, there was no commercial paper outstanding under this program. As of March 31, 2018, and December 31, 2017, we did not have any other short-term borrowings outstanding.

13 |


Senior Notes and Other Long-Term Debt
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 will be 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 and 2017 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 and 2017 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, 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, 2015 and 2017 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 and 2017 senior notes at a price equal to 101% of the aggregate principal amount of the 2013, 2015 and 2017 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)
 
2018

 
2017

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

3.000% 2017 senior notes due 2027
 
750

 
750

4.700% 2013 senior notes due 2043
 
1,150

 
1,150

3.950% 2017 senior notes due 2047
 
500

 
500

 
 
5,000

 
5,000

Unamortized debt discount / debt issuance costs
 
(46
)
 
(47
)
Long-term debt, net of discount and issuance costs
 
$
4,954

 
$
4,953

The fair value of our long-term debt was $5,083 million and $5,291 million as of March 31, 2018, and December 31, 2017, 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 March 31, 2018, matures in the following years:
 
 
 
 
 
 
 
 
 
 
After

 
 
(MILLIONS OF DOLLARS)
 
2019

 
2020

 
2021

 
2022

 
2022

 
Total

Maturities
 
$

 
$
500

 
$

 
$

 
$
4,500

 
$
5,000

Interest Expense
Interest expense, net of capitalized interest, was $47 million and $41 million for the three months ended March 31, 2018, and April 2, 2017, respectively. Capitalized interest expense was $2 million and $1 million for the three months ended March 31, 2018, and April 2, 2017, 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 $1.5 billion and $1.4 billion, as of March 31, 2018, and

14 |


December 31, 2017, respectively. The derivative financial instruments primarily offset exposures in the Australian dollar, Brazilian real, British pound, Canadian dollar, Chinese renminbi, euro, and Norwegian krone. The vast majority of the foreign exchange derivative financial instruments mature within 60 days and all mature within 270 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 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.
During 2017 and 2016, we entered into forward starting interest rate swaps with an aggregate notional value of $500 million. During the third quarter of 2017, we also entered in treasury lock trades with an aggregate notional value of $500 million. We designated these swaps and treasury locks (contracts) 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.
Upon issuance of our 2017 senior notes (see A. Debt: Senior Notes and Other Long-Term Debt), we terminated these contracts and paid $3 million in cash to the counterparties for settlement. The settlement amount, which represents the fair value of the contracts at the time of termination, was recorded in Accumulated other comprehensive loss, and will be amortized into income over the life of the 2017 senior notes. There was $0.1 million of ineffectiveness related to the forward swaps through the date of settlement which was immediately recognized as a loss within Interest expense—net of capitalized interest. 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. There were no outstanding interest rate swap contracts as of both March 31, 2018, and December 31, 2017.
Fair Value of Derivative Instruments
The classification and fair values of derivative instruments are as follows:
 
 
Fair Value of Derivatives
 
 
March 31,

 
December 31,

(MILLIONS OF DOLLARS)
Balance Sheet Location
2018

 
2017

Derivatives Not Designated as Hedging Instruments
 
 
 
 
   Foreign currency forward-exchange contracts
Other current assets
$
11

 
$
10

   Foreign currency forward-exchange contracts
Other current liabilities 
(11
)
 
(9
)
Total derivatives not designated as hedging instruments
 
$

 
$
1

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 losses on derivative instruments not designated as hedging instruments, recorded in Other (income)/deductions—net, are as follows:
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Foreign currency forward-exchange contracts
 
$
10

 
$
29

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 gains/(losses) on derivative instruments designated as cash flow hedges, recorded, net of tax, in Other comprehensive income/(loss) were insignificant for both of the three months ended March 31, 2018 and April 2, 2017.
The net amount of deferred gains/(losses) related to derivative instruments designated as cash flow hedges that is expected to be reclassified from Accumulated other comprehensive loss into earnings over the next 12 months is insignificant.

15 |


9.
Inventories
The components of inventory are as follows:
 
 
March 31,

 
December 31,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Finished goods
 
$
770

 
$
788

Work-in-process
 
541

 
484

Raw materials and supplies
 
130

 
155

Inventories
 
$
1,441

 
$
1,427

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, 2017
 
$
671

 
$
839

 
$
1,510

Other(a)
 

 
22

 
22

Balance, March 31, 2018
 
$
671

 
$
861

 
$
1,532

(a) 
Includes adjustments for foreign currency translation.
The gross goodwill balance was $2,068 million and $2,046 million as of March 31, 2018, and December 31, 2017, respectively. Accumulated goodwill impairment losses were $536 million as of March 31, 2018, and December 31, 2017.
B.
Other Intangible Assets
The components of identifiable intangible assets are as follows:
 
 
As of March 31, 2018
 
As of December 31, 2017
 
 
 
 
 
 
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
 
$
1,216

 
$
(454
)
 
$
762

 
$
1,185

 
$
(428
)
 
$
757

Brands
 
213

 
(146
)
 
67

 
213

 
(143
)
 
70

Trademarks and trade names
 
63

 
(48
)
 
15

 
62

 
(47
)
 
15

Other
 
239

 
(146
)
 
93

 
234

 
(143
)
 
91

Total finite-lived intangible assets
 
1,731

 
(794
)
 
937

 
1,694

 
(761
)
 
933

Indefinite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Brands
 
37

 

 
37

 
37

 

 
37

Trademarks and trade names
 
67

 

 
67

 
67

 

 
67

In-process research and development
 
231

 

 
231

 
224

 

 
224

Product rights
 
8

 

 
8

 
8

 

 
8

Total indefinite-lived intangible assets
 
343

 

 
343

 
336

 

 
336

Identifiable intangible assets
 
$
2,074

 
$
(794
)
 
$
1,280

 
$
2,030

 
$
(761
)
 
$
1,269

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 $25 million for each of the three months ended March 31, 2018, and April 2, 2017.

16 |


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 continued to credit certain employees' service with Zoetis 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 $2 million in each three month period ended March 31, 2018, and April 2, 2017.
The following table provides the net periodic benefit cost associated with our international defined benefit pension plans:
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Service cost
 
$
2

 
$
2

Interest cost
 
1

 
1

Expected return on plan assets
 
(1
)
 
(1
)
Curtailment and settlement loss
 

 
1

Net periodic benefit cost
 
$
2

 
$
3

Total company contributions to the international pension plans were $2 million and $3 million for the three months ended March 31, 2018, and April 2, 2017, respectively. We expect to contribute a total of approximately $6 million to these plans in 2018.
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
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Stock options / stock appreciation rights
 
$
2

 
$
3

RSUs / DSUs
 
7

 
6

PSUs
 
2

 
2

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

 
$
11

(a) 
For the three months ended March 31, 2018, and April 2, 2017, amounts capitalized to inventory were insignificant.
During the three months ended March 31, 2018, the company granted 536,070 stock options with a weighted-average exercise price of $73.26 per stock option and a weighted-average fair value of $20.29 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 2.74%; expected dividend yield of 0.69%; expected stock price volatility of 23.62%; 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 three months ended March 31, 2018, the company granted 428,976 RSUs with a weighted-average grant date fair value of $73.25 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 three months ended March 31, 2018, the company granted 109,574 PSUs with a weighted-average grant date fair value of $100.34 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 21.9% and 25.1%, 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.

17 |


13.
Stockholders' Equity
Zoetis is authorized to issue 6 billion shares of common stock and 1 billion shares of preferred stock.
In December 2016, the company's Board of Directors authorized a $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 March 31, 2018, there was approximately $810 million remaining under this authorization.
Changes in common shares and treasury stock were as follows:
(MILLIONS)
 
Common Shares Issued(a)

 
Treasury Stock(a)

Balance, December 31, 2016
 
501.89

 
9.04

Share-based compensation(b)
 

 
(0.78
)
Share repurchase program
 

 
2.31

Balance, April 2, 2017
 
501.89

 
10.56

 
 
 
 
 
Balance, December 31, 2017
 
501.89

 
15.76

Share-based compensation(b)
 

 
(0.99
)
Share repurchase program
 

 
2.40

Balance, March 31, 2018
 
501.89

 
17.17

(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

 
 
 
 
 
 
Derivatives

 
Adjustment

 
Benefit Plans

 
Accumulated Other

 
 
Net Unrealized

 
Net Unrealized

 
Actuarial

 
Comprehensive

(MILLIONS OF DOLLARS)
 
Gains/(Losses)

 
Gains/(Losses)

 
Gains/(Losses)

 
Loss

Balance, December 31, 2016
 
$
8

 
$
(583
)
 
$
(23
)
 
$
(598
)
Other comprehensive income, net of tax
 

 
44

 
2

 
46

Balance, April 2, 2017
 
$
8

 
$
(539
)
 
$
(21
)
 
$
(552
)
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
 
$
(3
)
 
$
(487
)
 
$
(15
)
 
$
(505
)
Other comprehensive income, net of tax
 

 
76

 


76

Balance, March 31, 2018
 
$
(3
)
 
$
(411
)
 
$
(15
)
 
$
(429
)
14.
Earnings per Share
The following table presents the calculation of basic and diluted earnings per share:
 
 
Three Months Ended
 
 
March 31,

 
April 2,

(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)
 
2018

 
2017

Numerator
 
 
 
 
Net income before allocation to noncontrolling interests
 
$
350

 
$
239

Less: Net (loss)/income attributable to noncontrolling interests
 
(2
)
 
1

Net income attributable to Zoetis Inc.
 
$
352

 
$
238

Denominator
 
 
 
 
Weighted-average common shares outstanding
 
485.9

 
492.4

Common stock equivalents: stock options, RSUs, PSUs and DSUs
 
3.9

 
2.9

Weighted-average common and potential dilutive shares outstanding
 
489.8

 
495.3

 
 
 
 
 
Earnings per share attributable to Zoetis Inc. stockholders—basic
 
$
0.72

 
$
0.48

Earnings per share attributable to Zoetis Inc. stockholders—diluted
 
$
0.72

 
$
0.48

The number of stock options outstanding under the company's Equity Plan that were excluded from the computation of diluted earnings per share, as the effect would have been antidilutive, were de minimis for the three months ended March 31, 2018, and approximately 1 million for the three months ended April 2, 2017.

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15.
Commitments and Contingencies
We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business. For a discussion of our tax contingencies, see Note 7. Income Taxes.
A.
Legal Proceedings
Our non-tax contingencies include, among others, the following:
Product liability and other product-related litigation, which can include injury, consumer, off-label promotion, antitrust and breach of contract claims.
Commercial and other matters, which can include product-pricing claims and environmental claims and proceedings.
Patent litigation, which typically involves challenges to the coverage and/or validity of our patents or those of third parties on various products or processes.
Government investigations, which can involve regulation by national, state and local government agencies in the United States and in other countries.
Certain of these contingencies could result in losses, including damages, fines and/or civil penalties, and/or criminal charges, which could be substantial.
We believe that we have strong defenses in these types of matters, but litigation is inherently unpredictable and excessive verdicts do occur. We do not believe that any of these matters will have a material adverse effect on our financial position. However, we could incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations or cash flows in the period in which the amounts are paid.
We have accrued for losses that are both probable and reasonably estimable. Substantially all of these contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. Consequently, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but the assessment process relies on estimates and assumptions that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions.
Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely on estimates and assumptions.
The principal matters to which we are a party are discussed below. In determining whether a pending matter is significant for financial reporting and disclosure purposes, we consider both quantitative and qualitative factors in order to assess materiality, such as, among other things, the amount of damages and the nature of any other relief sought in the proceeding, if such damages and other relief are specified; our view of the merits of the claims and of the strength of our defenses; whether the action purports to be a class action and our view of the likelihood that a class will be certified by the court; the jurisdiction in which the proceeding is pending; any experience that we or, to our knowledge, other companies have had in similar proceedings; whether disclosure of the action would be important to a reader of our financial statements, including whether disclosure might change a reader’s judgment about our financial statements in light of all of the information about the company that is available to the reader; the potential impact of the proceeding on our reputation; and the extent of public interest in the matter. In addition, with respect to patent matters, we consider, among other things, the financial significance of the product protected by the patent.
Ulianopolis, Brazil
In February 2012, the Municipality of Ulianopolis (State of Para, Brazil) filed a complaint against Fort Dodge Saúde Animal Ltda. (FDSAL), a Zoetis entity, and five other large companies alleging that waste sent to a local waste incineration facility for destruction, but that was not ultimately destroyed as the facility lost its operating permit, caused environmental impacts requiring cleanup.
The Municipality is seeking recovery of cleanup costs purportedly related to FDSAL's share of all waste accumulated at the incineration facility awaiting destruction, and compensatory damages to be allocated among the six defendants. We believe we have strong arguments against the claim, including defense strategies against any claim of joint and several liability.
At the request of the Municipal prosecutor, in April 2012, the lawsuit was suspended for one year. Since that time, the prosecutor has initiated investigations into the Municipality's actions in the matter as well as the efforts undertaken by the six defendants to remove and dispose of their individual waste from the incineration facility. On October 3, 2014, the Municipal prosecutor announced that the investigation remained ongoing and outlined the terms of a proposed Term of Reference (a document that establishes the minimum elements to be addressed in the preparation of an Environmental Impact Assessment), under which the companies would be liable to withdraw the waste and remediate the area. On March 5, 2015, we presented our response to the prosecutor’s proposed Term of Reference, arguing that the proposed terms were overly general in nature and expressing our interest in discussing alternatives to address the matter. The prosecutor agreed to consider our request to engage a technical consultant to conduct an environmental diagnostic of the contaminated area. On May 29, 2015, we, in conjunction with the other defendant companies, submitted a draft cooperation agreement to the prosecutor, which outlined the proposed terms and conditions for the engagement of a technical consultant to conduct the environmental diagnostic. On August 19, 2016, the parties and the prosecutor agreed to engage the services of a third-party consultant to conduct a limited environmental assessment of the site. The site assessment was conducted during June 2017, and a written report summarizing the results of the assessment was provided to the parties and the

19 |


prosecutor in November 2017. The report noted that waste is still present on the site and that further environmental assessments are needed before a plan to manage that remaining waste can be prepared. We have not received any further communication from the prosecutor in response to the report.
Lascadoil Contamination in Animal Feed
An investigation by the U.S. Food and Drug Administration (FDA) and the Michigan Department of Agriculture is ongoing to determine how lascadoil, oil for industrial use, made its way into the feed supply of certain turkey and hog feed mills in Michigan. The contaminated feed is believed to have caused the deaths of approximately 50,000 turkeys and the contamination (but not death) of at least 20,000 hogs in August 2014. While it remains an open question as to how the lascadoil made its way into the animal feed, the allegations are that lascadoil intended to be sold for reuse as biofuel was inadvertently sold to producers of soy oil, who in turn, unknowingly sold the contaminated soy oil to fat recycling vendors, who then sold the contaminated soy oil to feed mills for use in animal feed. Indeed, related to the FDA investigation, Shur-Green Farms LLC, a producer of soy oil, recalled certain batches of soy oil allegedly contaminated with lascadoil on October 13, 2014.
During the course of its investigation, the FDA identified the process used to manufacture Zoetis’ Avatec® (lasalocid sodium) and Bovatec® (lasalocid sodium) products as one possible source of the lascadoil, since lascadoil contains small amounts of lasalocid, the active ingredient found in both products. Zoetis has historically sold any and all industrial lascadoil byproduct to an environmental company specializing in waste disposal. The environmental company is contractually obligated to incinerate the lascadoil or resell it for use in biofuel. Under the terms of the agreement, the environmental company is expressly prohibited from reselling the lascadoil to be used as a component in food. The FDA inspected the Zoetis site where Avatec and Bovatec are manufactured, and found no evidence that Zoetis was involved in the contamination of the animal feed.
On March 10, 2015, plaintiffs Restaurant Recycling, LLC (Restaurant Recycling) and Superior Feed Ingredients, LLC (Superior), both of whom are in the fat recycling business, filed a complaint in the Seventeenth Circuit Court for the State of Michigan against Shur-Green Farms alleging negligence and breach of warranty claims arising from their purchase of soy oil allegedly contaminated with lascadoil. Plaintiffs resold the allegedly contaminated soy oil to turkey feed mills for use in feed ingredient. Plaintiffs also named Zoetis as a defendant in the complaint alleging that Zoetis failed to properly manufacture its products and breached an implied warranty that the soy oil was fit for use at turkey and hog mills. Zoetis was served with the complaint on June 3, 2015, and we filed our answer, denying all allegations, on July 15, 2015. On August 10, 2015, several of the turkey feed mills filed a joint complaint against Restaurant Recycling, Superior, Shur-Green Farms and others, alleging claims for negligence, misrepresentation, and breach of warranty, arising out of their alleged purchase and use of the contaminated soy oil. The complaint raises only one count against Zoetis for negligence. We filed an answer to the complaint on November 2, 2015, denying the allegation. On May 16, 2016, two additional turkey producers filed a complaint in the Seventeenth Circuit Court for the State of Michigan against the company, Restaurant Recycling, Superior, Shur-Green Farms and others, alleging claims for negligence and breach of warranties. We filed an answer to the complaint on June 20, 2016, denying the allegations. The Court has consolidated all three cases in Michigan for purposes of discovery and disposition. On July 28, 2017, we filed a motion for summary disposition on the grounds that no genuine issues of material fact exist and that Zoetis is entitled to judgment as a matter of law. On October 19, 2017, the Court granted our motion and dismissed all claims against Zoetis. On October 31, 2017, the plaintiffs filed motions for reconsideration of the Court's decision granting summary disposition. The Court, denied all such motions on December 6, 2017, for the same reasons cited in the Court’s original decision. On December 27, 2017, the plaintiffs filed a request with the Michigan Court of Appeals seeking an interlocutory appeal of the lower Court’s decision, which we opposed on January 17, 2018. The matter is stayed pending a decision by the Court of Appeals.
Other Matters
The European Commission published a decision on alleged competition law infringements by several human health pharmaceutical companies on June 19, 2013. One of the involved legal entities is Alpharma LLC (previously having the name Zoetis Products LLC). Alpharma LLC's involvement is solely related to its human health activities prior to Pfizer's acquisition of King/Alpharma. Zoetis paid a fine in the amount of Euro 11 million (approximately $14 million) and was reimbursed in full by Pfizer in accordance with the Global Separation Agreement between Pfizer and Zoetis, which provides that Pfizer is obligated to indemnify Zoetis for any liabilities arising out of claims not related to its animal health assets. We filed an appeal of the decision on September 6, 2013, to the General Court of the European Union. On September 8, 2016, the General Court upheld the decision of the European Commission. On November 25, 2016, we filed an appeal to the Court of Justice of the European Union and are awaiting a ruling.
B.
Guarantees and Indemnifications
In the ordinary course of business and in connection with the sale of assets and businesses, we indemnify our counterparties against certain liabilities that may arise in connection with the transaction or related to activities prior to the transaction. These indemnifications typically pertain to environmental, tax, employee and/or product-related matters and patent-infringement claims. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we would be required to reimburse the loss. These indemnifications are generally subject to threshold amounts, specified claim periods and other restrictions and limitations. Historically, we have not paid significant amounts under these provisions and, as of March 31, 2018, recorded amounts for the estimated fair value of these indemnifications were not significant.

20 |


16.
Segment Information
Operating Segments
We manage our operations through two geographic operating segments: the United States and International. Each operating segment has responsibility for its commercial activities. Within each of these operating segments, we offer a diversified product portfolio, including vaccines, parasiticides, anti-infectives, medicated feed additives and other pharmaceuticals, for both livestock and companion animal customers. Our chief operating decision maker uses the revenue and earnings of the two operating segments, among other factors, for performance evaluation and resource allocation.
In the first quarter of 2018, the company realigned certain management responsibilities. These changes did not impact the determination of our operating segments, however they resulted in the reallocation of certain costs between segments. These changes primarily include the following: i) R&D costs related to our aquaculture business which were previously reported in Other business activities are now reported in the international commercial segment results, and ii) certain other miscellaneous costs which were previously reported in Corporate are now reported in the international commercial segment results.
Other Costs and Business Activities
Certain costs are not allocated to our operating segment results, such as costs associated with the following:
Other business activities includes our Client Supply Services (CSS) contract manufacturing results, as well as expenses associated with our dedicated veterinary medicine research and development organization, research alliances, U.S. regulatory affairs, and other operations focused on the development of our products. Other R&D-related costs associated with our aquaculture business and non-U.S. market and regulatory activities are generally included in the international commercial segment.
Corporate, which is responsible for platform functions such as business technology, facilities, legal, finance, human resources, business development, and communications, among others. These costs also include compensation costs, certain procurement costs, and other miscellaneous operating expenses not charged to our operating segments, as well as interest income and expense.
Certain transactions and events such as (i) Purchase accounting adjustments, where we incur expenses associated with the amortization of fair value adjustments to inventory, intangible assets and property, plant and equipment; (ii) Acquisition-related activities, where we incur costs associated with acquiring and integrating newly acquired businesses, such as transaction costs and integration costs; and (iii) Certain significant items, which comprise substantive, unusual items that, either as a result of their nature or size, would not be expected to occur as part of our normal business on a regular basis, such as certain costs related to becoming an independent public company, restructuring charges and implementation costs associated with our cost-reduction/productivity initiatives that are not associated with an acquisition, certain asset impairment charges, certain legal and commercial settlements and the impact of divestiture-related gains and losses.
Other unallocated includes (i) certain overhead expenses associated with our global manufacturing operations not charged to our operating segments; (ii) certain costs associated with business technology and finance that specifically support our global manufacturing operations; (iii) certain supply chain and global logistics costs; and (iv) certain procurement costs.
Segment Assets
We manage our assets on a total company basis, not by operating segment. Therefore, our chief operating decision maker does not regularly review any asset information by operating segment and, accordingly, we do not report asset information by operating segment.


21 |


Selected Statement of Income Information                                                
 
 
Earnings
 
Depreciation and Amortization(a)
 
 
Three Months Ended
 
Three Months Ended
 
 
March 31,

 
April 2,

 
March 31,

 
April 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

U.S.
 
 
 
 
 
 
 
 
Revenue
 
$
634

 
$
605