Financial Instruments

The combined balance sheet for the year ended December 31, 2012 includes the financial assets and liabilities that are directly attributable to the animal health operations of Pfizer, except that the combined balance sheet also includes an allocation of long-term debt from Pfizer, see Note 3. Basis of Presentation.


A.	Debt

Credit Facilities

In December 2012, we entered into a 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 became effective in February 2013 upon the completion of the IPO and expires in December 2017. 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 4.35:1 for fiscal year 2013, 3.95:1 for fiscal year 2014, 3.50:1 for fiscal year 2015 and 3.00:1 thereafter. 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 December 31, 2013. There were no borrowings outstanding as of December 31, 2013.

We have additional lines of credit 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 December 31, 2013, we had access to $69 million of lines of credit which expire at various times through 2016. As of December 31, 2013, we had $15 million of short-term borrowings outstanding and $2 million of long-term borrowings outstanding related to these facilities.

Commercial Paper Program

In February 2013, we entered into a commercial paper program with a capacity of up to $1.0 billion. As of December 31, 2013, no commercial paper has been issued under this program.

Short-Term Borrowings

There were short-term borrowings of $15 million as of December 31, 2013 (see A. Credit Facilities). As of December 31, 2012 the current portion of allocated debt from Pfizer was $73 million. The weighted-average interest rate on short-term borrowings outstanding, including the current portion of allocated debt, was 5.7% and 3.7% as of December 31, 2013 and December 31, 2012, respectively.

Senior Notes Offering and Other Long-Term Debt

On January 28, 2013, we issued $3.65 billion aggregate principal amount of our senior notes (the senior notes offering) in a private placement, with an original issue discount of $10 million. The senior notes are comprised of $400 million aggregate principal amount of our 1.150% senior notes due 2016, $750 million aggregate principal amount of our 1.875% senior notes due 2018, $1.35 billion aggregate principal amount of our 3.250% senior notes due 2023 and $1.15 billion aggregate principal amount of our 4.700% senior notes due 2043.

We sold $2.65 billion aggregate principal amount of our senior notes through the initial purchasers in the senior notes offering and Pfizer transferred $1.0 billion aggregate principal amount of our senior notes to certain of the initial purchasers, who sold such senior notes in the senior notes offering.

The 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 senior notes may be declared immediately due and payable.

Pursuant to the indenture, we are able to redeem the 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 2023 notes 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 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 senior notes at a price equal to 101% of the aggregate principal amount of the senior notes together with accrued and unpaid interest to, but excluding, the date of repurchase.

In connection with the senior notes offering, we entered into a registration rights agreement (Registration Rights Agreement) with the representatives of the initial purchasers of the senior notes. Pursuant to the terms of the Registration Rights Agreement, we were obligated, among other things, to use our commercially reasonable efforts to file a registration statement with the Securities and Exchange Commission (SEC) enabling holders of the senior notes to exchange the privately placed notes for publicly registered notes with substantially the same terms. We filed the registration statement with the SEC on September 13, 2013, the SEC declared the registration statement effective on September 24, 2013, and the exchange offer was completed on October 31, 2013.

The components of our long-term debt follow:



	December 31,			December 31,
(MILLIONS OF DOLLARS)	2013			2012
Allocated long-term debt	$	—		$	509
Lines of credit	2			—
1.150% Senior Notes due 2016	400			—
1.875% Senior Notes due 2018	750			—
3.250% Senior Notes due 2023	1,350			—
4.700% Senior Notes due 2043	1,150			—
	3,652			509
Unamortized debt discount	(10		)	—
Long-term debt / Allocated long-term debt	$	3,642		$	509

As of December 31, 2013, the fair value of our long-term debt was $3,526 million 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). At December 31, 2012, the fair value of our allocated long-term debt was $732 million, and has been determined using a third-party matrix-pricing model that uses significant inputs derived from or corroborated by observable market data and Pfizer’s credit rating (Level 2 inputs). See Note 4. Significant Accounting Policies— Fair Value. The fair value of the allocated long-term debt as of December 31, 2012 does not purport to reflect the fair value that might have been determined if Zoetis had operated as an independent public company for the periods presented or if we had used Zoetis’ credit rating in the calculation.

The principal amount of long-term debt outstanding as of December 31, 2013 matures in the following years:



											After
(MILLIONS OF DOLLARS)	2014		2015		2016		2017		2018		2018		Total
Maturities	$	—	$	—	$	401	$	1	$	750	$	2,500	$	3,652

Interest Expense

Interest expense, net of capitalized interest, was $113 million for 2013, $31 million for 2012 and $36 million for 2011. Capitalized interest expense was $3 million for the year ended December 31, 2013. We did not have capitalized interest expense for the years ended December 31, 2012 and 2011.


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. Prior to the IPO, as a business unit of Pfizer and under Pfizer's global cash management system, our foreign exchange risk was managed through Pfizer. Following the Separation, 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. As of December 31, 2013, the aggregate notional amount of foreign exchange derivative financial instruments offsetting foreign currency exposures was $1.4 billion. The derivative financial instruments primarily offset exposures in the euro, the Brazilian real and the Australian dollar. 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 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.

Fair Value of Derivative Instruments

The location and fair values of derivative instruments not designated as hedging instruments at December 31, 2013 are as follows:



		Fair Value of
(MILLIONS OF DOLLARS)	Balance Sheet Location	Derivatives
Foreign currency forward-exchange contracts	Other current assets	$	10
Foreign currency forward-exchange contracts	Other current liabilities	(5		)
Total foreign currency forward-exchange contracts		$	5

We use a market approach in valuing financial instruments on a recurring basis. Our derivative financial instruments measured at fair value on a recurring basis use Level 2 inputs in the calculation of fair value. See Note 4. Significant Accounting Policies— Fair Value.

The net gains incurred on foreign currency forward-exchange contracts not designated as hedging instruments were $27 million for the year ended December 31, 2013, respectively, and are recorded in Other (income)/deductions—net. This amount was substantially offset in Other (income)/deductions—net by the effect of changing exchange rates on the underlying foreign currency exposures.