10-Q 1 zoetis-2014330x10q1q.htm 10-Q Zoetis-2014.3.30-10Q 1Q



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 30, 2014
 
 
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)
 
 
100 Campus Drive, Florham Park, New Jersey
 
07932
(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 or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨
 
Accelerated filer ¨
 
Non-accelerated filer x
 
Smaller reporting company ¨
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 May 9, 2014, there were 501,018,690 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 (Unaudited) Balance Sheets
 
 
 
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 30,

 
March 31,

(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)
 
2014

 
2013

Revenue
 
$
1,097

 
$
1,090

Costs and expenses:
 
 
 
 
Cost of sales(a)
 
379

 
402

Selling, general and administrative expenses(a)
 
356

 
357

Research and development expenses(a)
 
87

 
90

Amortization of intangible assets(a)
 
15

 
15

Restructuring charges and certain acquisition-related costs
 
3

 
7

Interest expense, net of capitalized interest
 
29

 
22

Other (income)/deductions—net
 
1

 
5

Income before provision for taxes on income
 
227

 
192

Provision for taxes on income
 
72

 
52

Net income before allocation to noncontrolling interests
 
155

 
140

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

 

Net income attributable to Zoetis Inc.
 
$
155

 
$
140

Earnings per share attributable to Zoetis Inc. stockholders:
 
 
 
 
 Basic
 
$
0.31

 
$
0.28

 Diluted
 
$
0.31

 
$
0.28

Weighted-average common shares outstanding:
 
 
 
 
 Basic
 
500.231

 
500.000

 Diluted
 
500.702

 
500.111

Dividends declared per common share
 
$
0.072

 
$
0.065

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

See notes to condensed consolidated financial statements.
1 |


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

 
 
Three Months Ended
 
 
March 30,

 
March 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

Net income attributable to Zoetis Inc.
 
$
155

 
$
140

Other comprehensive income/(loss), net of taxes and reclassification adjustments(a):
 
 
 
 
Foreign currency translation adjustments, net
 
(11
)
 
16

Benefit plans: Actuarial gains/(losses), net
 

 
(2
)
                       Plan settlement, net(b)
 
3

 

Total other comprehensive income/(loss), net of tax
 
(8
)
 
14

Comprehensive income before allocation to noncontrolling interests
 
147

 
154

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

 

Comprehensive income attributable to Zoetis Inc.
 
$
147

 
$
154

(a) 
Presented net of reclassification adjustments and tax impacts, which are not significant in any period presented. Reclassification adjustments related to benefit plans are generally reclassified, as part of net periodic pension cost, into Cost of sales, Selling, general and administrative expenses, and/or Research and development expenses, as appropriate, in the condensed consolidated statements of income.
(b) Reflects the first quarter 2014 settlement charge associated with the 2012 sale of our Netherlands manufacturing facility. See Note 12. Benefit Plans.
 

See notes to condensed consolidated financial statements.
2 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

 
 
March 30,

 
December 31,

 
 
2014

 
2013

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

 
 
Assets
 
 
 
 
Cash and cash equivalents
 
$
506

 
$
610

Accounts receivable, less allowance for doubtful accounts of $31 in each of 2014 and 2013
 
1,100

 
1,138

Inventories
 
1,316

 
1,293

Current deferred tax assets
 
95

 
97

Other current assets
 
205

 
219

Total current assets
 
3,222

 
3,357

Property, plant and equipment, less accumulated depreciation of $1,066 in 2014 and $1,028 in 2013
 
1,292

 
1,295

Goodwill
 
982

 
982

Identifiable intangible assets, less accumulated amortization
 
787

 
803

Noncurrent deferred tax assets
 
57

 
63

Other noncurrent assets
 
63

 
58

Total assets
 
$
6,403

 
$
6,558

 
 
 
 
 
Liabilities and Equity
 
 
 
 
Short-term borrowings
 
$
16

 
$
15

Accounts payable
 
363

 
506

Accrued compensation and related items
 
177

 
229

Income taxes payable
 
84

 
40

Dividends payable
 
36

 
36

Other current liabilities
 
451

 
589

Total current liabilities
 
1,127

 
1,415

Long-term debt
 
3,642

 
3,642

Noncurrent deferred tax liabilities
 
319

 
322

Other taxes payable
 
51

 
49

Other noncurrent liabilities
 
165

 
168

Total liabilities
 
5,304

 
5,596

Commitments and contingencies
 

 

Stockholders' equity:
 
 
 
 
Preferred stock, $0.01 par value: 1,000 authorized, none issued
 

 

Common stock, $0.01 par value: 6,000 authorized, issued and outstanding 501 shares at March 30, 2014 and 500 shares at December 31, 2013
 
5

 
5

Additional paid-in capital
 
906

 
878

Retained earnings
 
395

 
276

Accumulated other comprehensive loss
 
(229
)
 
(219
)
Total Zoetis Inc. equity
 
1,077

 
940

Equity attributable to noncontrolling interests
 
22

 
22

Total equity
 
1,099

 
962

Total liabilities and equity
 
$
6,403

 
$
6,558

 

See notes to condensed consolidated financial statements.
3 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(UNAUDITED)
 
 
Zoetis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated

 
Equity

 
 
 
 
Business

 
 
 
Additional

 
 
 
Other

 
Attributable to

 
 
 
 
Unit

 
Common

 
Paid-in

 
Retained

 
Comprehensive

 
Noncontrolling

 
Total

(MILLIONS OF DOLLARS)
 
Equity(a)

 
Stock(b)

 
Capital

 
Earnings

 
Loss

 
Interests

 
Equity

Balance, December 31, 2012
 
$
4,183

 
$

 
$

 
$

 
$
(157
)
 
$
15

 
$
4,041

Three months ended March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive income
 
94

 

 

 
46

 
14

 

 
154

Share-based compensation expense
 
3

 

 
8

 

 

 

 
11

Net transfers—Pfizer Inc.
 
(376
)
 

 

 

 

 

 
(376
)
Separation adjustments(c)
 
414

 

 

 

 
22

 

 
436

Reclassification of net liability due to Pfizer, Inc.(d)
 
(60
)
 

 

 

 

 

 
(60
)
Consideration paid to Pfizer Inc. in connection with
 
 
 
 
 
 
 
 
 
 
 
 
 
 
the Separation(e)
 

 

 
(3,449
)
 

 

 

 
(3,449
)
Issuance of common stock to Pfizer Inc. in connection
 
 
 
 
 
 
 
 
 
 
 
 
 
 
with the Separation and reclassification of Business
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unit Equity(e)
 
(4,258
)
 
5

 
4,253

 

 

 

 

Dividends declared
 

 

 

 
(33
)
 

 

 
(33
)
Balance, March 31, 2013
 
$

 
$
5

 
$
812

 
$
13

 
$
(121
)
 
$
15

 
$
724

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2013
 
$

 
$
5

 
$
878

 
$
276

 
$
(219
)
 
$
22

 
$
962

Three months ended March 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive income
 

 

 

 
155

 
(8
)
 

 
147

Share-based compensation plans
 

 

 
5

 

 

 

 
5

Defined contribution plan transactions(f)
 

 

 
21

 

 

 

 
21

Pension plan transfer from Pfizer Inc.(g)
 

 

 
2

 

 
(2
)
 

 

Employee benefit plan contribution from Pfizer Inc.(h)
 

 

 

 

 

 

 

Dividends declared
 

 

 

 
(36
)
 

 

 
(36
)
Balance, March 30, 2014
 
$

 
$
5

 
$
906

 
$
395

 
$
(229
)
 
$
22

 
$
1,099

(a) 
All amounts associated with Business Unit Equity relate to periods prior to the Separation. See Note 2A. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: The Separation.
(b) 
As of March 30, 2014, there were 500,738,620 outstanding shares of common stock.
(c) 
For additional information, see Note 2B. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: Adjustments Associated with the Separation.
(d) 
Represents the reclassification of the Receivable from Pfizer Inc. and the Payable to Pfizer Inc. from Business Unit Equity as of the Separation date. See Note 2A. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: The Separation.
(e) 
Reflects the Separation transaction. See Note 2A. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: The Separation.
(f) 
Reflects company matching and profit-sharing contributions funded through the issuance of 704,671 shares of Zoetis Inc. common stock.
(g) 
Reflects the first quarter 2014 transfer of a defined benefit pension plan from Pfizer Inc. and the associated reclassification from Additional Paid in Capital to Accumulated Other Comprehensive Loss. See Note 12. Benefit Plans.
(h) 
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 12. 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 30,

 
March 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

Operating Activities
 
 
 
 
Net income before allocation to noncontrolling interests
 
$
155

 
$
140

Adjustments to reconcile net income before noncontrolling interests to net cash
 
 
 
 
provided by operating activities:
 
 
 
 
Depreciation and amortization expense
 
50

 
51

Share-based compensation expense
 
5

 
11

Asset write-offs and asset impairments
 

 
3

Deferred taxes
 
2

 
7

Other non-cash adjustments
 
3

 
1

Other changes in assets and liabilities, net of acquisitions and divestitures and transfers with Pfizer Inc.
 
(238
)
 
68

Net cash (used in) provided by operating activities
 
(23
)
 
281

Investing Activities
 
 
 
 
Purchases of property, plant and equipment
 
(45
)
 
(22
)
Net cash used in investing activities
 
(45
)
 
(22
)
Financing Activities
 
 
 
 
Increase in short-term borrowings, net
 
1

 
6

Proceeds from issuance of long-term debt—senior notes, net of discount and fees
 

 
2,624

Consideration paid to Pfizer Inc. in connection with the Separation(a)
 

 
(2,457
)
Cash dividends paid
 
(36
)
 

Other net financing activities with Pfizer Inc.
 

 
(281
)
Net cash used in financing activities
 
(35
)
 
(108
)
Effect of exchange-rate changes on cash and cash equivalents
 
(1
)
 

Net (decrease) increase in cash and cash equivalents
 
(104
)
 
151

Cash and cash equivalents at beginning of period
 
610

 
317

Cash and cash equivalents at end of period
 
$
506

 
$
468

 
 
 
 
 
Supplemental cash flow information
 
 
 
 
Cash paid during the period for:
 
 
 
 
  Income taxes
 
$
13

 
$
9

  Interest, net of capitalized interest
 
59

 

Non-cash transactions:
 
 
 
 
  Dividends declared, not paid
 
$
36

 
$
33

  Zoetis Inc. senior notes transferred to Pfizer Inc. in connection with the Separation(b)
 

 
992

(a) 
Reflects the Separation transaction. Amount is net of the non-cash portion. See Note 2A. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: The Separation.
(b) 
Reflects the non-cash portion of the Separation transaction. See Note 2A. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: The Separation.


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 four geographic regions: the United States (U.S.); Europe/Africa/Middle East (EuAfME); Canada/Latin America (CLAR); and Asia/Pacific (APAC).
We market our products in more than 120 countries, including developed markets and emerging markets. Our revenue is mostly generated in the U.S. and EuAfME. 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.
The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer
Pfizer Inc. (Pfizer) formed Zoetis to acquire, own and operate the animal health business of Pfizer. On June 24, 2013, Pfizer completed an exchange offer resulting in the full separation of Zoetis from Pfizer. For additional information, see E. Exchange Offer.
A.
The Separation
In the first quarter of 2013, through a series of steps (collectively, the Separation), Pfizer transferred to us its subsidiaries holding substantially all of the assets and liabilities of its animal health business. In exchange, we transferred to Pfizer: (i) all of the issued and outstanding shares of our Class A common stock; (ii) all of the issued and outstanding shares of our Class B common stock; (iii) $1.0 billion in senior notes (see C. Senior Notes Offering below); and (iv) an amount of cash equal to substantially all of the net proceeds received in the senior notes offering (approximately $2.5 billion).
B.
Adjustments Associated with the Separation
In connection with the Separation, certain animal health assets and liabilities included in the pre-Separation balance sheet were retained by Pfizer and certain non-animal health assets and liabilities (not included in the pre-Separation balance sheet) were transferred to Zoetis. The 2013 adjustments to the historical balance sheet of Zoetis (collectively, the Separation Adjustments) represented approximately $445 million of net liabilities retained by Pfizer.
The Separation Adjustment associated with Accumulated Other Comprehensive Loss reflects the accumulated currency translation adjustment based on the actual legal entity structure of Zoetis.
C.
Senior Notes Offering
In connection with the Separation, 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. For additional information, see Note 9A. Financial Instruments: Debt.
D.
Initial Public Offering (IPO)
After the Separation, on February 6, 2013, an IPO of 99,015,000 shares of our Class A common stock (including the exercise of the underwriters' over-allotment option) at a price of $26.00 per share was completed. Pfizer retained the net proceeds from the IPO.
Immediately following the IPO, there were 99,015,000 outstanding shares of Class A common stock and 400,985,000 outstanding shares of Class B common stock. The rights of the holders of Class A common stock and Class B common stock were identical, except with respect to voting and conversion rights. Following the IPO, Pfizer owned all of the outstanding shares of our Class B common stock, all of which was converted to Class A common stock in connection with the Exchange Offer. See E. Exchange Offer. There are no longer any shares of our Class B common stock outstanding.
As of February 6, 2013, the total number of shares authorized to issue are 6,000,000,000 shares of common stock and 1,000,000,000 shares of preferred stock.
In connection with the IPO, we entered into certain agreements that provide a framework for an ongoing relationship with Pfizer. For additional information, see Note 17. Transactions and Agreements with Pfizer.
E.
Exchange Offer
On May 22, 2013, Pfizer announced an exchange offer (the Exchange Offer) whereby Pfizer shareholders could exchange a portion of Pfizer common stock for Zoetis common stock. The Exchange Offer was completed on June 24, 2013, resulting in the full separation of Zoetis and the disposal of Pfizer's entire ownership and voting interest in Zoetis.

6 |


3.
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 23, 2014 and February 24, 2013.
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 the Company’s 2013 Annual Report on Form 10-K.
Certain reclassifications of prior year information have been made to conform to the current year's presentation. In the first quarter of 2014, we realigned our segment reporting with respect to our Client Supply Services organization (CSS), which provides contract manufacturing services to third parties, to reflect how our chief operating decision maker currently evaluates our financial results. The revenue and earnings associated with CSS are now reported within Other business activities, separate from the four reportable segments. In 2013, CSS results were reported in the EuAfME segment. Such revisions have no impact on our consolidated financial condition, results of operations or cash flows for the periods presented. We have revised our segment results presented herein to reflect this new segment structure, including for the comparable 2013 period. For additional information, see Note 16. Segment and Other Revenue Information.
A.
Basis of Presentation Prior to the Separation
Prior to the Separation, the combined financial statements were derived from the consolidated financial statements and accounting records of Pfizer and included allocations for direct costs and indirect costs attributable to the operations of the animal health business of Pfizer. The pre-Separation financial statements and activities do not purport to reflect what the results of operations, comprehensive income/(loss), financial position, equity or cash flows would have been had we operated as an independent public company during the period presented.
The pre-Separation period included in the condensed consolidated statement of income for the three months ended March 31, 2013 includes allocations from certain support functions (Enabling Functions) that are provided on a centralized basis within Pfizer, such as expenses for business technology, facilities, legal, finance, human resources, and, to a lesser extent, business development, public affairs and procurement, among others, as Pfizer does not routinely allocate these costs to any of its business units. These allocations are based on either a specific identification basis or, when specific identification is not practicable, proportional allocation methods (e.g., using third-party sales, headcount, etc.), depending on the nature of the services.
Costs associated with business technology, facilities and human resources were allocated primarily using proportional allocation methods and, for legal and finance, primarily using specific identification. In all cases, for support function costs where proportional allocation methods were used, we determined whether the costs are primarily influenced by headcount (such as a significant majority of facilities and human resources costs) or by the size of the business (such as most business technology costs), and we also determined whether the associated scope of those services provided are global, regional or local. Based on those analyses, the costs were allocated based on our share of worldwide revenue, domestic revenue, international revenue, regional revenue, country revenue, worldwide headcount, country headcount or site headcount, as appropriate.
As a result, costs associated with business technology and legal that were not specifically identified were mostly allocated based on revenue drivers and, to a lesser extent, based on headcount drivers; costs associated with finance that were not specifically identified were all allocated based on revenue drivers; and costs associated with facilities and human resources that were not specifically identified were predominantly allocated based on headcount drivers.
The pre-Separation period included in the condensed consolidated statement of income for the three months ended March 31, 2013 includes allocations of certain manufacturing and supply costs incurred by manufacturing plants that are shared with other Pfizer business units, Pfizer’s global external supply group and Pfizer’s global logistics and support group (collectively, Pfizer Global Supply, or PGS). These costs may include manufacturing variances and changes in the standard costs of inventory, among others, as Pfizer does not routinely allocate these costs to any of its business units. These allocations are based on either a specific identification basis or, when specific identification is not practicable, proportional allocation methods, such as animal health identified manufacturing costs, depending on the nature of the costs.
The pre-Separation period included in the condensed consolidated statement of income for the three months ended March 31, 2013 also includes allocations from the Enabling Functions and PGS for restructuring charges, integration costs, additional depreciation associated with asset restructuring and implementation costs, as Pfizer does not routinely allocate these costs to any of its business units. For additional information about allocations of restructuring charges and other costs associated with acquisitions and cost-reduction/productivity initiatives, see Note 5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives.
The pre-Separation period included in the condensed consolidated statement of income for the three months ended March 31, 2013 includes an allocation of share-based compensation expense and certain other compensation expense items, such as certain fringe benefit expenses, maintained on a centralized basis within Pfizer, as Pfizer does not routinely allocate these costs to any of its business units. For additional information about allocations of share-based payments, see Note 13. Share-Based Payments.

7 |


The allocated expenses from Pfizer include the items noted below for the pre-Separation period for the three months ended March 31, 2013.
Enabling Functions operating expenses––approximately $11 million (in Selling, general and administrative expenses).
PGS manufacturing costs—approximately $2 million (in Cost of sales).
Other costs associated with cost reduction/productivity initiatives—additional depreciation associated with asset restructuring—approximately $2 million (in Selling, general and administrative expenses).
Other costs associated with cost reduction/productivity initiatives—implementation costs—approximately $1 million (in Selling, general and administrative expenses).
Share-based compensation expense—approximately $3 million ($1 million in Cost of sales and $2 million in Selling, general and administrative expenses).
Compensation-related expenses—approximately $1 million (in Selling, general and administrative expenses).
Interest expense—approximately $2 million.
Management believes that the allocations are a reasonable reflection of the services received or the costs incurred on behalf of Zoetis and its operations and that the pre-Separation period included in the condensed consolidated statement of income for the three months ended March 31, 2013 reflects all of the costs of the animal health business of Pfizer.
B.
Basis of Presentation After the Separation
The unaudited condensed consolidated financial statements as of and for the three months ended March 31, 2013 comprise the following: (i) the results of operations, comprehensive income, and cash flow amounts for the period prior to the Separation (see above), which includes allocations for direct costs and indirect costs attributable to the operations of the animal health business; and (ii) the amounts for the period after the Separation, which reflect the results of operations, comprehensive income, financial position, equity and cash flows resulting from our operation as an independent public company.
The income tax provision prepared after the Separation is based on the actual legal entity structure of Zoetis, with certain accommodations pursuant to a tax matters agreement. For additional information, see Note 17. Transactions and Agreements with Pfizer.
4.
Significant Accounting Policies
New Accounting Standards
In July 2013, the Financial Accounting Standards Board (FASB) issued an accounting standards update regarding the presentation of an unrecognized tax benefit related to a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. Under this new standard, this unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset if available under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position. Otherwise, the unrecognized tax benefit should be presented in the financial statements as a separate liability. The assessment is based on the unrecognized tax benefits and deferred tax assets that exist at the reporting date. The provisions of the new standard were effective January 1, 2014 for annual and interim reporting periods and did not have a significant impact on our consolidated financial statements.
In March 2013, the Financial Accounting Standards Board (FASB) issued an accounting standards update regarding the accounting for cumulative translation adjustment (CTA) upon derecognition of assets or investment within a foreign entity. This new standard provides additional CTA accounting guidance on sales or transfers of foreign entity investments and assets as well as step acquisitions involving a foreign entity. The provisions of the new standard were effective as of January 1, 2014 and did not have a significant impact on our consolidated financial statements.
In February 2013, the FASB issued an accounting standards update regarding the measurement of obligations resulting from joint and several liability arrangements that may include debt agreements, other contractual obligations and settled litigation or judicial rulings. The provisions of this standard require that these obligations are measured at the amount representing the agreed upon obligation of the company as well as additional liability amounts it expects to assume on behalf of other parties in the arrangement. The provisions of the new standard were effective January 1, 2014 and did not have a significant impact on our consolidated financial statements.

8 |


5.
Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives
In the first quarter of 2014, we recorded a restructuring charge of $2 million related to employee severance costs in EuAfME as a result of an initiative to reduce costs and better align our organizational structure.
We incurred significant costs in connection with Pfizer’s cost-reduction initiatives (several programs initiated since 2005), and the acquisitions of Fort Dodge Animal Health (FDAH) on October 15, 2009 and King Animal Health (KAH) on January 31, 2011.
For example:
in connection with the 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; and
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, as well as functions such as business technology, shared services and corporate operations.
The components of costs incurred in connection with restructuring initiatives, acquisitions and cost-reduction/productivity initiatives follow:
 
 
Three Months Ended
 
 
March 30,

 
March 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

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

 
$
4

Restructuring charges(b):
 
 
 
 
Employee termination costs
 

 

Accelerated depreciation
 
1

 

Exit costs
 

 
3

Total Restructuring charges and certain acquisition-related costs
 
3

 
7

 
 
 
 
 
Other costs associated with cost-reduction/productivity initiatives:
 
 
 
 
Additional depreciation associated with asset restructuring––allocated(c)
 

 
2

Implementation costs––allocated(d)
 

 
1

Total costs associated with acquisitions and cost-reduction/productivity initiatives
 
$
3

 
$
10

(a) 
Integration costs represent external, incremental costs directly related to integrating acquired businesses and primarily include expenditures for consulting and the integration of systems and processes, as well as product transfer costs.
(b) 
The restructuring charges for the three months ended March 30, 2014 are primarily related to employee severance costs in EuAfME ($2 million), a reversal of a previously established reserve as a result of a change in estimate of severance costs ($2 million income), and accelerated depreciation related to the exiting of a research facility ($1 million). The restructuring charges for the three months ended March 31, 2013 are primarily related to the integration of FDAH and KAH.
The direct restructuring charges (benefits) are associated with the following:
For the three months ended March 30, 2014––EuAfME ($2 million) and Manufacturing/research/corporate ($1 million income).
For the three months ended March 31, 2013––Manufacturing/research/corporate ($3 million).
(c) 
Additional depreciation associated with asset restructuring represents the impact of changes in the estimated lives of assets involved in restructuring actions. For the three months ended March 31, 2013, included in Selling, general and administrative expenses.
(d) 
Implementation costs—allocated represent external, incremental costs directly related to implementing cost reduction/productivity initiatives, and primarily include expenditures related to system and process standardization and the expansion of shared services. Included in Selling, general and administrative expenses.

9 |


The components of and changes in our direct restructuring accruals follow:
 
 
Employee

 
 
 
 
 
 
 
 
Termination

 
Accelerated

 
Exit

 
 
(MILLIONS OF DOLLARS)
 
Costs

 
Depreciation

 
Costs

 
Accrual

Balance, December 31, 2013(a)
 
$
15

 

 
$
6

 
$
21

Provision
 

 
1

 

 
1

Utilization and other(b)
 
(4
)
 
(1
)
 
(1
)
 
(6
)
Balance, March 30, 2014(a)
 
$
11

 

 
$
5

 
$
16

(a) 
At March 30, 2014 and December 31, 2013, included in Other current liabilities ($8 million and $13 million, respectively) and Other noncurrent liabilities ($8 million and $8 million, respectively).
(b) 
Includes adjustments for foreign currency translation.
6.
Other (Income)/Deductions—Net
The components of Other (income)/deductions—net follow:
 
 
Three Months Ended
 
 
March 30,

 
March 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

Royalty-related income
 
$
(8
)
 
$
(8
)
Identifiable intangible asset impairment charges
 

 
1

Certain legal matters, net(a)
 
(2
)
 

Foreign currency loss(b)
 
9

 
10

Other, net(c)
 
2

 
2

Other (income)/deductions—net
 
$
1

 
$
5

(a) 
For the three months ended March 30, 2014, represents an insurance recovery of litigation related charges.
(b) 
For the three months ended March 30, 2014, primarily driven by losses related to the depreciation of the Argentine peso in the first quarter of 2014. For the three months ended March 31, 2013, primarily related to the Venezuela currency devaluation in February 2013.
(c) 
For the three months ended March 30, 2014, represents a pension plan settlement charge related to the divestiture of a manufacturing plant, partially offset by interest income and other miscellaneous income.
7.
Income Taxes
A.
Taxes on Income
The effective tax rate was 31.7% for the first quarter of 2014, compared to 27.1% for the first quarter of 2013. The higher effective tax rate in the first quarter of 2014 compared to the first quarter of 2013 was primarily attributable to:
an $8 million discrete tax expense during the first quarter of 2014 related to a prior period intercompany inventory adjustment;
changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings as well as repatriation costs; and
a $2 million discrete income tax benefit during the first quarter of 2013 related to the 2012 U.S. research and development tax credit, which was retroactively extended on January 3, 2013.
As of the Separation date, we operate under a new standalone legal entity structure. In connection with the Separation, adjustments have been made to the income tax accounts. See Note 2B. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: Adjustments Associated with the Separation.
B.
Tax Matters Agreement
In connection with the Separation, we entered into a tax matters agreement with Pfizer that governs the parties' respective rights, responsibilities and obligations with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings and other matters regarding taxes. For additional information, see below and Note 17. Transactions and Agreements with Pfizer.
In connection with this agreement and the Separation, our income tax accounts reflect Separation Adjustments, including significant adjustments to the deferred income tax asset and liability accounts and the tax liabilities associated with uncertain tax positions. For additional information, see below and Note 2B. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: Adjustments Associated with the Separation.

10 |


In general, under the agreement:
Pfizer will be responsible for any U.S. federal, state, local or foreign income taxes and any U.S. state or local non-income taxes (and any related interest, penalties or audit adjustments and including those taxes attributable to our business) reportable on a consolidated, combined or unitary return that includes Pfizer or any of its subsidiaries (and us and/or any of our subsidiaries) for any periods or portions thereof ending on or prior to December 31, 2012. We will be responsible for the portion of any such taxes for periods or portions thereof beginning on or after January 1, 2013, as would be applicable to us if we filed the relevant tax returns on a standalone basis.
We will be responsible for any U.S. federal, state, local or foreign income taxes and any U.S. state or local non-income taxes (and any related interest, penalties or audit adjustments) that are reportable on returns that include only us and/or any of our subsidiaries, for all tax periods whether before or after the completion of the Separation.
Pfizer will be responsible for certain specified foreign taxes directly resulting from certain aspects of the Separation.
We will not generally be entitled to receive payment from Pfizer in respect of any of our tax attributes or tax benefits or any reduction of taxes of Pfizer. Neither party's obligations under the agreement will be limited in amount or subject to any cap. The agreement also assigns responsibilities for administrative matters, such as the filing of returns, payment of taxes due, retention of records and conduct of audits, examinations or similar proceedings. In addition, the agreement provides for cooperation and information sharing with respect to tax matters.
Pfizer will be primarily responsible for preparing and filing any tax return with respect to the Pfizer affiliated group for U.S. federal income tax purposes and with respect to any consolidated, combined, unitary or similar group for U.S. state or local or foreign income tax purposes or U.S. state or local non-income tax purposes that includes Pfizer or any of its subsidiaries, including those that also include us and/or any of our subsidiaries. We will generally be responsible for preparing and filing any tax returns that include only us and/or any of our subsidiaries.
The party responsible for preparing and filing a given tax return will generally have exclusive authority to control tax contests related to any such tax return.
C.
Deferred Taxes
As of March 30, 2014, the total net deferred income tax liability of $180 million is included in Current deferred tax assets ($95 million), Noncurrent deferred tax assets ($57 million), Other current liabilities ($13 million) and Noncurrent deferred tax liabilities ($319 million).
As of December 31, 2013, the total net deferred income tax liability of $177 million is included in Current deferred tax assets ($97 million), Noncurrent deferred tax assets ($63 million), Other current liabilities ($15 million) and Noncurrent deferred tax liabilities ($322 million).
D.
Tax Contingencies
As of March 30, 2014, the tax liabilities associated with uncertain tax positions of $48 million (exclusive of interest and penalties related to uncertain tax positions of $9 million) are included in Noncurrent deferred tax assets ($6 million) and Other taxes payable ($42 million).
As of December 31, 2013, the tax liabilities associated with uncertain tax positions of $45 million (exclusive of interest related to uncertain tax positions of $11 million) are included in Noncurrent deferred tax assets ($6 million) and Other taxes payable ($39 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.

11 |


8.
Accumulated Other Comprehensive Loss
Changes, net of tax, in accumulated other comprehensive loss follow:
 
 
Currency Translation

 
 
 
Accumulated

 
 
Adjustment

 
Benefit Plans

 
Other

 
 
Net Unrealized

 
Actuarial

 
Comprehensive

(MILLIONS OF DOLLARS)
 
Losses

 
Gains/(Losses)

 
Loss

Balance, December 31, 2013
 
$
(212
)
 
$
(7
)
 
$
(219
)
Other comprehensive income (loss), net of tax
 
(11
)
 
3

(a) 
(8
)
Pension plan transfer from Pfizer Inc.(b)
 

 
(2
)
 
(2
)
Balance, March 30, 2014
 
$
(223
)
 
$
(6
)
 
$
(229
)
(a)
Includes the first quarter 2014 settlement charge associated with the 2012 sale of our Netherlands manufacturing facility. See Note 12. Benefit Plans.
(b) Reflects the first quarter 2014 transfer of a defined benefit pension plan from Pfizer Inc. and the associated reclassification from Additional Paid in Capital to Accumulated other Comprehensive Loss. See Note 12 Benefit Plans.
9.
Financial Instruments
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 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 March 30, 2014 and December 31, 2013. There were no borrowings outstanding as of March 30, 2014 and 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 March 30, 2014, we had access to $67 million of lines of credit which expire at various times through 2016. Short-term borrowings outstanding related to these facilities were $16 million and $15 million as of March 30, 2014 and December 31, 2013, respectively. Long-term borrowings outstanding related to these facilities were $2 million as of both March 30, 2014 and December 31, 2013.
Commercial Paper Program
In February 2013, we entered into a commercial paper program with a capacity of up to $1.0 billion. As of March 30, 2014 and December 31, 2013, there was no commercial paper issued under this program.
Short-Term Borrowings
There were short-term borrowings of $16 million and $15 million as of March 30, 2014 and December 31, 2013, respectively (see Credit Facilities). The weighted-average interest rate on short-term borrowings outstanding was 7.2% and 5.7% for the periods ended March 30, 2014 and December 31, 2013, 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

12 |


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 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:
 
 
March 30,

 
December 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

Lines of credit, due 2016-2017
 
2

 
2

1.150% Senior Notes due 2016
 
400

 
400

1.875% Senior Notes due 2018
 
750

 
750

3.250% Senior Notes due 2023
 
1,350

 
1,350

4.700% Senior Notes due 2043
 
1,150

 
1,150

 
 
3,652

 
3,652

Unamortized debt discount
 
(10
)
 
(10
)
Long-term debt
 
$
3,642

 
$
3,642

The fair value of our long-term debt was $3,612 million and $3,526 million as of March 30, 2014 and December 31, 2013, 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’s credit rating (Level 2 inputs).
The principal amount of long-term debt outstanding as of March 30, 2014 matures in the following years:
 
 
 
 
 
 
 
 
 
 
 
 
After

 
 
(MILLIONS OF DOLLARS)
 
2015

 
2016

 
2017

 
2018

 
2019

 
2019

 
Total

Maturities
 
$

 
$
401

 
$
1

 
$
750

 
$

 
$
2,500

 
$
3,652

Interest Expense
Interest expense, net of capitalized interest, was $29 million and $22 million for the three months ended March 30, 2014 and March 31, 2013, respectively. Capitalized interest was $1 million for each three-month period ended March 30, 2014 and March 31, 2013.
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 $1.6 billion and $1.4 billion, as of March 30, 2014 and December 31, 2013, respectively. 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 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.

13 |


Fair Value of Derivative Instruments
The location and fair values of derivative instruments not designated as hedging instruments are as follows:
 
 
Fair Value of Derivatives
 
 
March 30,

 
December 31,

(MILLIONS OF DOLLARS)
Balance Sheet Location
2014

 
2013

Foreign currency forward-exchange contracts
Other current assets
$
7

 
$
10

Foreign currency forward-exchange contracts
Other current liabilities 
(7
)
 
(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 are measured at fair value on a recurring basis using Level 2 inputs in the calculation of fair value.
The net gains incurred on foreign currency forward-exchange contracts not designated as hedging instruments were $12 million and $6 million for the three months ended March 30, 2014 and March 31, 2013, respectively, and are recorded in Other (income)/deductions—net. These amounts were substantially offset in Other (income)/deductions—net by the effect of changing exchange rates on the underlying foreign currency exposures.
10.
Inventories
The components of inventory follow:
 
 
March 30,

 
December 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

Finished goods
 
$
790

 
$
862

Work-in-process
 
284

 
218

Raw materials and supplies
 
242

 
213

Inventories
 
$
1,316

 
$
1,293

11.
Goodwill and Other Intangible Assets
A.
Goodwill
The components of, and changes in, the carrying amount of goodwill follow:
(MILLIONS OF DOLLARS)
 
U.S.

 
EuAfME

 
CLAR

 
APAC

 
Total

Balance, December 31, 2013
 
$
501

 
$
157

 
$
162

 
$
162

 
$
982

Other(a)
 

 

 

 

 

Balance, March 30, 2014
 
$
501

 
$
157

 
$
162

 
$
162

 
$
982

(a) 
Primarily reflects adjustments for foreign currency translation.
The gross goodwill balance was $1,518 million as of March 30, 2014 and December 31, 2013. Accumulated goodwill impairment losses (generated entirely in fiscal 2002) were $536 million as of March 30, 2014 and December 31, 2013.

14 |


B.
Other Intangible Assets
The components of identifiable intangible assets follow:
 
 
As of March 30, 2014
 
As of December 31, 2013
 
 
 
 
 
 
Identifiable

 
 
 
 
 
Identifiable

 
 
 
 
 
 
Intangible

 
 
 
 
 
Intangible

 
 
Gross

 
 
 
Assets, Less

 
Gross

 
 
 
Assets, Less

 
 
Carrying

 
Accumulated

 
Accumulated

 
Carrying

 
Accumulated

 
Accumulated

(MILLIONS OF DOLLARS)
 
Amount

 
Amortization

 
Amortization

 
Amount

 
Amortization

 
Amortization

Finite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology rights
 
$
766

 
$
(230
)
 
$
536

 
$
762

 
$
(219
)
 
$
543

Brands
 
216

 
(102
)
 
114

 
216

 
(100
)
 
116

Trademarks and trade names
 
59

 
(39
)
 
20

 
59

 
(38
)
 
21

Other
 
120

 
(117
)
 
3

 
121

 
(116
)
 
5

Total finite-lived intangible assets
 
1,161

 
(488
)
 
673

 
1,158

 
(473
)
 
685

Indefinite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Brands
 
39

 

 
39

 
39

 

 
39

Trademarks and trade names
 
67

 

 
67

 
67

 

 
67

In-process research and development
 
8

 

 
8

 
12

 

 
12

Total indefinite-lived intangible assets
 
114

 

 
114

 
118

 

 
118

Identifiable intangible assets
 
$
1,275

 
$
(488
)
 
$
787

 
$
1,276

 
$
(473
)
 
$
803

C.
Amortization
Amortization expense related to 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 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 $15 million and $16 million for the three months ended March 30, 2014 and March 31, 2013, respectively.
12.
Benefit Plans
Prior to the Separation from Pfizer, employees who met certain eligibility requirements participated in various defined benefit pension plans and postretirement plans administered and sponsored by Pfizer. Effective December 31, 2012, our employees ceased to participate in the Pfizer U.S. qualified defined benefit and U.S. retiree medical plans, and liabilities associated with our employees under these plans were retained by Pfizer. Pfizer is continuing to credit certain employees' service with Zoetis generally through December 31, 2017 (or termination of employment from Zoetis, if earlier) for certain early retirement benefits with respect to Pfizer's U.S. defined benefit pension and retiree medical plans. Pension and postretirement benefit expense associated with the extended service for certain employees in the U.S. plans totaled approximately $2 million in each three-month period ended March 30, 2014 and March 31, 2013.
As part of the Separation, certain Separation Adjustments (see Note 2B. The Separation, Adjustments Associated with the Separation, Senior Notes Offering, Initial Public Offering and Exchange Offer: Adjustments Associated with the Separation) were made to transfer the assets and liabilities of certain international defined benefit pension plans to Zoetis in the first quarter of 2013, and we assumed the liabilities allocable to employees transferring to us. Prior to the Separation, these benefit plans were accounted for as multi-employer plans. Also as part of the Separation, a net liability was recognized in 2013 for the pension obligations less the fair value of plan assets associated with additional defined benefit pension plans in certain international locations that will be transferred to us in 2014 (approximately $21 million), in accordance with the applicable local separation agreements or employee matters agreement. During the first quarter of 2014, our pension plan in Japan was transferred to us from Pfizer. The net pension obligation (approximately $2 million) and the related accumulated other comprehensive loss (approximately $2 million, net of tax) associated with this plan were recorded, and the $21 million net liability recognized in 2013 was reduced to $19 million as of March 30, 2014.
Pension expense associated with our dedicated international pension plans was approximately $6 million and $0.5 million for the three months ended March 30, 2014 and March 31, 2013, respectively. The three months ended March 30, 2014 includes a settlement charge of approximately $4 million (approximately $3 million, net of tax) associated with the 2012 sale of our Netherlands manufacturing plant. The active participants in the plan were transferred to the buyer at the time of sale and the plan liability associated with inactive participants remained with the insurance contract that was used to finance the plan. The insurance contract was also transferred to the buyer although we remained liable for the proportion of administrative costs that related to inactive members under the terms of this contract through December 31, 2013. Under the terms of the sale agreement, the contract was terminated on December 31, 2013 (fiscal year 2014 for our international operations) and the liability for benefits associated with this plan reverted in full to the insurance company.
Pension expense associated with international benefit plans accounted for as multi-employer plans was approximately $1 million and $3 million for the three months ended March 30, 2014 and March 31, 2013, respectively.

15 |


Contributions to the dedicated international benefits plans and the international plans accounted for as multi-employer plans were approximately $3 million and $2 million for the three months ended March 30, 2014 and March 31, 2013, respectively. We expect to contribute a total of approximately $8 million to these plans in 2014.
13.
Share-Based Payments
The company may grant a variety of share-based payments under the Zoetis 2013 Equity and Incentive Plan (Equity Plan) to 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 unit awards (DSUs), performance-based awards and other equity-based or cash-based awards.
The components of share-based compensation expense follow:
 
 
Three Months Ended
 
 
March 30,

 
March 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

Stock option expense
 
$
3

 
$
2

RSU / DSU expense
 
2

 
1

Pfizer stock benefit plans—direct
 

 
8

Share-based compensation expense—total
 
$
5

 
$
11

During the three months ended March 30, 2014, the company granted 2,900,817 stock options with a weighted-average exercise price of $30.89 per stock option and a weighted-average fair value of $8.01 per 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 fair value was estimated based on the following assumptions: risk-free interest rate of 2.01%; expected dividend yield of 0.93%; expected stock price volatility of 24.8%; and expected term of 6.5 years. 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 30, 2014, the company granted 803,652 RSUs with a weighted-average grant date fair value of $30.89 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 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 30, 2014, the company granted 36,256 DSUs with a weighted-average grant date fair value of $30.89 per DSU. DSUs are accounted for using a fair-value-based method that utilizes the closing price of Zoetis common stock on the date of grant. DSUs vest immediately as of the grant date and the values are expensed at the time of grant into Selling, general and administrative expenses.
14.
Earnings per Share
The following table presents the calculation of basic and diluted earnings per share:
 
 
Three Months Ended
 
 
March 30,

 
March 31,

(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)
 
2014

 
2013

Numerator
 
 
 
 
Net income before allocation to noncontrolling interests
 
$
155

 
$
140

Less: net income attributable to noncontrolling interests
 

 

Net income attributable to Zoetis Inc.
 
$
155

 
$
140

Denominator
 
 
 
 
Weighted-average common shares outstanding
 
500.231

 
500.000

Common stock equivalents: stock options, RSUs and DSUs
 
0.471

 
0.111

Weighted-average common and potential dilutive shares outstanding
 
500.702

 
500.111

Earnings per share attributable to Zoetis Inc. stockholders—basic
 
$
0.31

 
$
0.28

Earnings per share attributable to Zoetis Inc. stockholders—diluted
 
$
0.31

 
$
0.28


16 |


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 heavily 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 heavily 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.
Roxarsone®(3-Nitro)  
We are defendants in nine actions involving approximately 140 plaintiffs that allege that the distribution of the medicated feed additive Roxarsone allegedly caused various diseases in the plaintiffs, including cancers and neurological diseases. Other defendants, including various poultry companies, are also named in these lawsuits. Compensatory and punitive damages are sought in unspecified amounts.
In September 2006, the Circuit Court of Washington County returned a defense verdict in one of the lawsuits, Mary Green, et al. v. Alpharma, Inc. et al. In 2008, this verdict was appealed and affirmed by the Arkansas Supreme Court. Certain summary judgments favoring the poultry company co-defendants in Mary Green, et al. v. Alpharma, Inc. et al. were reversed by the Arkansas Supreme Court in 2008. These claims were retried in 2009 and that trial also resulted in a defense verdict, which was affirmed by the Arkansas Supreme Court in April 2011. In October 2012, we entered into an agreement to resolve these cases, subject to the execution of full releases or dismissals with prejudice by all of the claimants. We received full releases from all claimants, and as a result, on January 23, 2014, the Court dismissed all nine actions with prejudice.
In June 2011, we announced that we would suspend sales in the United States of Roxarsone (3-Nitro) in response to a request by the U.S. FDA and subsequently stopped sales in several international markets.
Following our decision to suspend sales of Roxarsone (3-Nitro) in June 2011, Zhejiang Rongyao Chemical Co., Ltd., the supplier of certain materials used in the production of Roxarsone (3-Nitro), filed a lawsuit in the U.S. District Court for the District of New Jersey alleging that we are liable for damages it suffered as a result of the decision to suspend sales. In October 2013, the parties reached a preliminary agreement to resolve the matter, and the Court dismissed the action with prejudice. In December 2013, the parties finalized and executed the settlement agreement.

17 |


PregSure®
We have received in total approximately 240 claims in Europe and New Zealand seeking damages related to calves claimed to have died of Bovine Neonatal Pancytopenia (BNP) on farms where PregSure BVD, a vaccine against Bovine Virus Diarrhea (BVD) was used. BNP is a rare syndrome that first emerged in cattle in Europe in 2006. Studies of BNP suggest a potential association between the administration of PregSure and the development of BNP, although no causal connection has been established. The cause of BNP is not known.
In 2010, we voluntarily stopped sales of PregSure BVD in Europe, and recalled the product at wholesalers while investigations into possible causes of BNP continue. In 2011, after incidences of BNP were reported in New Zealand, we voluntarily withdrew the marketing authorization for PregSure throughout the world.
We have settled approximately 20 of these claims for amounts that are not material individually or in the aggregate. Investigations into possible causes of BNP continue and these settlements may not be representative of any future claims resolutions.
Advocin
On January 30, 2012, Bayer filed a complaint against Pfizer alleging infringement and inducement of infringement of Bayer patent US 5,756,506 covering, among other things, a process for treating bovine respiratory disease (BRD) by administering a single high dose of fluoroquinolone. The complaint was filed after Pfizer's product Advocin® was approved as a single dose treatment of BRD, in addition to its previous approval as a multi-dose treatment of BRD. Bayer seeks a permanent injunction, damages and a recovery of attorney's fees, and has demanded a jury trial. Discovery has now concluded. We have filed motions for summary judgment of non-infringement and invalidity of the Bayer patent, which are currently pending before the Court.
Ulianopolis, Brazil
In February 2012, the Municipality of Ulianopolis (State of Para, Brazil) filed a complaint against Fort Dodge Saúde Animal Ltda. (FDSAL) 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.
In early August 2013, new labor claims were filed against FDSAL as well as 57 other companies. These claims were filed by 30 employees of the local waste incineration facility that was used by FDSAL and the 57 other companies. The employees of the incineration facility allege that FDSAL and the other users of the facility are severally liable for health injuries suffered in connection with plaintiffs’ employment at the waste site. Based on legal precedent, it is possible that FDSAL may be considered a liable party. The plaintiffs' lawyers presented a motion for discontinuance of these 30 labor claims during the hearing held on December 9, 2013, because (i) not all defendants had been summoned which would generate delays in the proceedings and preliminaries of lawsuits' dismissal, and (ii) the pieces of evidence for each claim shall be more concentrated. The court dismissed the cases on the same date.
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 Zoetis Products LLC, formerly having the name Alpharma Inc. Zoetis Products 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 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.
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 30, 2014, recorded amounts for the estimated fair value of these indemnifications are not significant.

18 |


16.
Segment and Other Revenue Information
A.
Segment Information
In the first quarter of 2014, we realigned our segment reporting with respect to our Client Supply Services (CSS) organization, which provides contract manufacturing services to third parties, to reflect how our chief operating decision maker currently evaluates our financial results. The revenue and earnings associated with CSS are now reported within Other business activities, separate from our four reportable segments. In 2013, CSS results were reported in the EuAfME segment. The current presentation of segments is more reflective of our commercial business since CSS operates differently from our commercial operations within the geographic segments. CSS revenue for the first, second, third and fourth quarters of 2013, including livestock (LS) and companion animal (CA) revenue, was $11 million (LS - $3 million; CA - $8 million), $12 million (LS - $3 million; CA - $9 million), $14 million (LS - $4 million; CA - $10 million) and $16 million (LS - $5 million; CA - $11 million), respectively. CSS earnings (loss) for the first, second, third and fourth quarters of 2013 was $3 million, $(2) million, $2 million and $5 million, respectively. We have revised our segment results presented herein to reflect this new segment structure, including for the comparable 2013 period.
The animal health medicines and vaccines industry is characterized by meaningful differences in customer needs across different regions. As a result of these differences, among other things, we manage our operations through four geographic regions. Each operating segment has responsibility for its commercial activities. Within each of these regional 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.
Operating Segments
The United States (U.S.).
Europe/Africa/Middle East (EuAfME)—Includes, among others, the United Kingdom, Germany, France, Italy, Spain, Northern Europe and Central Europe as well as Russia, Turkey and South Africa.
Canada/Latin America (CLAR)––Includes Canada, Brazil, Mexico, Central America and Other South America.
Asia/Pacific (APAC)––Includes Australia, Japan, New Zealand, South Korea, India, China/Hong Kong, Northeast Asia, Southeast Asia and South Asia.
Our chief operating decision maker uses the revenue and earnings of the four operating segments, among other factors, for performance evaluation and resource allocation.
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 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 non-U.S. market clinical trials and regulatory activities are generally included in the respective regional segment.
Corporate, which is responsible for platform functions such as business technology, facilities, legal, finance, human resources, business development, public affairs and procurement, among others. These costs also include compensation 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 for restructuring and integration; and (iii) Certain significant items, which includes non-acquisition-related restructuring charges, certain asset impairment charges, stand-up costs and costs associated with cost reduction/productivity initiatives.
Other unallocated, which includes certain overhead expenses associated with our global manufacturing operations not charged to our operating segments. Effective January 1, 2014, Other unallocated also includes certain costs associated with business technology and finance that specifically support our global manufacturing operations. These costs were previously reported in Corporate. Also, beginning in the first quarter of 2014, certain supply chain and global logistics costs that were previously reported in the four reportable segments are reported in Other unallocated. This presentation better reflects how we measure the performance of the global manufacturing organization.
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. Total assets were approximately $6.4 billion and $6.6 billion at March 30, 2014 and December 31, 2013, respectively.

19 |


Selected Statement of Income Information                                 
 
 
 
 
 
 
 
 
 
 
Depreciation and
 
 
Revenue(a)
 
Earnings(b)
 
Amortization(c)
 
 
March 30,

 
March 31,

 
March 30,

 
March 31,

 
March 30,

 
March 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

 
2014

 
2013

 
2014

 
2013

Three months ended
 
 
 
 
 
 
 
 
 
 
 
 
U.S.
 
$
479

 
$
454

 
$
278

 
$
234

 
$
8

 
$
14

EuAfME
 
270

 
279

 
112

 
114

 
5

 
6

CLAR
 
168

 
171

 
64

 
52

 
3

 
5

APAC
 
169

 
175

 
66

 
75

 
5

 
4

Total reportable segments
 
1,086

 
1,079

 
520

 
475

 
21

 
29

Other business activities(d)
 
11

 
11

 
(72
)
 
(71
)
 
7

 
7

Reconciling Items:
 
 
 
 
 
 
 
 
 
 
 
 
Corporate(e)
 

 

 
(125
)
 
(116
)
 
6

 
2

Purchase accounting adjustments(f)
 

 

 
(12
)
 
(12
)
 
12

 
12

Acquisition-related costs(g)
 

 

 
(2
)
 
(6
)
 

 

Certain significant items(h)
 

 

 
(36
)
 
(42
)
 
2

 

Other unallocated(i)
 

 

 
(46
)
 
(36
)
 
2

 
1

 
 
$
1,097

 
$
1,090

 
$
227

 
$
192

 
$
50

 
$
51

(a) 
Revenue denominated in euros was $168 million for both the three months ended March 30, 2014 and March 31, 2013.
(b) 
Defined as income before provision for taxes on income.
(c) 
Certain production facilities are shared. Depreciation and amortization is allocated to the reportable operating segments based on estimates of where the benefits of the related assets are realized.
(d) 
Other business activities reflect the research and development costs managed by our Research and Development organization, as well as our contract manufacturing business.
(e) 
Corporate includes, among other things, administration expenses, interest expense, certain compensation and other costs not charged to our operating segments.
(f) 
Purchase accounting adjustments include certain charges related to intangible assets and property, plant and equipment not charged to our operating segments.
(g) 
Acquisition-related costs can include costs associated with acquiring, integrating and restructuring acquired businesses, such as allocated transaction costs, integration costs, restructuring charges and additional depreciation associated with asset restructuring. For additional information, see Note 5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives.
(h) 
Certain significant items are 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 items primarily include restructuring charges and implementation costs associated with our cost-reduction/productivity initiatives that are not associated with an acquisition, the impact of divestiture-related gains and losses and certain costs related to becoming an independent public company. For additional information, see Note 5. Restructuring Charges and Other Costs Associated with Acquisition and Cost-Reduction/Productivity Initiatives.
In the first quarter of 2014, Certain significant items primarily includes: (i) Zoetis stand-up costs of $33 million; (ii) restructuring charges of $2 million related to employee severance costs in EuAfME, offset by $2 million income related to a reversal of a previously established reserve as a result of a change in estimate of severance costs; (iii) additional depreciation associated with asset restructuring of $1 million; (iv) a pension plan settlement charge related to the divestiture of a manufacturing plant of $4 million; and (v) an insurance recovery of litigation related charges of $2 million income. Stand-up costs include certain nonrecurring costs related to becoming an independent public company, such as new branding (including changes to the manufacturing process for required new packaging), the creation of standalone systems and infrastructure, site separation, and certain legal registration and patent assignment costs.
In the first quarter of 2013, Certain significant items includes: (i) Zoetis stand-up costs of $34 million; (ii) charges related to transitional manufacturing purchase agreements associated with divestitures of $4 million; (iii) restructuring charges and implementation costs associated with our cost-reduction/productivity initiatives that are not associated with an acquisition of $3 million; and (iv) certain asset impairment charges of $1 million.
(i) 
Includes overhead expenses associated with our manufacturing operations.

20 |


B.
Other Revenue Information
Revenue by Species
Significant species revenue are as follows:
 
 
Three Months Ended
 
 
March 30,

 
March 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

Livestock:
 
 
 
 
Cattle
 
$
391

 
$
390

Swine
 
160

 
155

Poultry
 
135

 
133

Other
 
20

 
25

 
 
706

 
703

Companion Animal:
 
 
 
 
Horses
 
43

 
42

Dogs and Cats
 
337

 
334

 
 
380

 
376

 
 
 
 
 
Contract Manufacturing
 
$
11

 
$
11

 
 
 
 
 
Total revenue
 
$
1,097

 
$
1,090

Revenue by Major Product Category
Significant revenue by major product category are as follows:
 
 
Three Months Ended
 
 
March 30,

 
March 31,

(MILLIONS OF DOLLARS)
 
2014

 
2013

Anti-infectives
 
$
322

 
$
307

Vaccines
 
274

 
274

Parasiticides
 
151

 
163

Medicated feed additives
 
104

 
104

Other pharmaceuticals
 
191

 
187

Other non-pharmaceuticals
 
44

 
44

Contract manufacturing
 
11

 
11

Total revenue
 
$
1,097

 
$
1,090

17.
Transactions and Agreements with Pfizer
Zoetis had related party transactions with Pfizer through the completion of the Exchange Offer on June 24, 2013. As of the completion of the Exchange Offer, Pfizer is no longer a related party. Activities while Pfizer was a related party, as well as ongoing agreements with Pfizer, are detailed below.
In connection with the Separation and IPO, we and Pfizer entered into agreements that provide a framework for our ongoing relationship with Pfizer, certain of which are described below.
Global separation agreement. This agreement governs the relationship between Pfizer and us following the IPO and includes provisions related to the allocation of assets and liabilities, indemnification, delayed transfers and further assurances, mutual releases, insurance and certain covenants.
Transitional services agreement. This agreement grants us the right to continue to use certain of Pfizer's services and resources related to our corporate functions, such as business technology, facilities, finance, human resources, public affairs and procurement, in exchange for mutually agreed-upon fees based on Pfizer's costs of providing these services.
Tax matters agreement. This agreement governs ours and Pfizer's respective rights, responsibilities and obligations with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings and other matters regarding taxes. Pursuant to this agreement, we have also agreed to certain covenants that contain restrictions intended to preserve the tax-free status of certain transactions, and we have agreed to indemnify Pfizer and its affiliates against any and all tax-

21 |


related liabilities incurred by them relating to these transactions to the extent caused by an acquisition of our stock or assets or by any other action undertaken by us.
Research and development collaboration and license agreement. This agreement permits certain of our employees to be able to review a Pfizer database to identify compounds that may be of interest to the animal health field. Pfizer has granted to us an option to enter into a license agreement subject to certain restrictions and requirements and we will make payments to Pfizer.
Employee matters agreement. This agreement governs ours and Pfizer's respective rights, responsibilities and obligations with respect to the following matters: employees and former employees (and their respective dependents and beneficiaries) who are or were associated with Pfizer, us or the parties' respective subsidiaries or affiliates; the allocation of assets and liabilities generally relating to employees, employment or service-related matters and employee benefit plans; and other human resources, employment and employee benefits matters.
Master manufacturing and supply agreements. These two agreements govern our manufacturing and supply arrangements with Pfizer. Under one of these agreements, Pfizer will manufacture and supply us with animal health products. Under this agreement, our manufacturing and supply chain leadership will have oversight responsibility over product quality and other key aspects of the manufacturing process with respect to the Pfizer-supplied products. Under the other agreement, we will manufacture and supply certain human health products to Pfizer.
Environmental matters agreement. This agreement governs the performance of remedial actions for liabilities allocated to each party under the global separation agreement; addresses our substitution for Pfizer with respect to animal health assets and remedial actions allocated to us (including substitution related to, for example, permits, financial assurances and consent orders); allows our conditional use of Pfizer's consultants and contractors to assist in the conduct of remedial actions; and addresses the exchange of related information between the parties. The agreement also sets forth standards of conduct for remedial activities at the co-located facilities: Guarulhos, Brazil; Catania, Italy; Hsinchu, Taiwan; and Kalamazoo, Michigan in the U.S. In addition, the agreement sets forth site-specific terms to govern conduct at several of these co-located facilities.
Screening services agreement. This agreement requires us to provide certain high throughput screening services to Pfizer's R&D organization for which Pfizer pays to us agreed-upon fees.
Intellectual property license agreements. Under these agreements (i) Pfizer and certain of its affiliates licensed to us and certain of our affiliates the right to use certain intellectual property rights in the animal health field; (ii) we licensed to Pfizer and certain of its affiliates certain rights to intellectual property in all fields outside of the animal health field; and (iii) Pfizer granted us rights with respect to certain trademarks and copyrighted works.
Following the Separation, we own, have access to or have the right to use, substantially all of the resources that were used, or held for use, exclusively in Pfizer's animal health business, including the following:
Intellectual Property. As part of the Separation, Pfizer assigned to us ownership of certain animal health related patents, pending patent applications, and trademark applications and registrations. In addition, Pfizer licensed to us the right to use certain intellectual property rights in the animal health field. We licensed to Pfizer the right to use certain of our trademarks and substantially all of our other intellectual property rights in the human health field and all other fields outside of animal health. In addition, Pfizer granted us a transitional license to use certain of Pfizer's trademarks and we granted Pfizer a transitional license to use certain of our trademarks for a period of time following the completion of the IPO.
Manufacturing Facilities. Our global manufacturing network consists of 13 “anchor” manufacturing sites and 15 “satellite” manufacturing sites. Ownership of, or the existing leasehold interest in, these facilities were conveyed to us by Pfizer as part of the Separation. Among these 28 manufacturing sites is our facility in Guarulhos, Brazil, which we leased back to Pfizer. Certain of our products are currently manufactured at 13 manufacturing sites that were retained by Pfizer. The products manufactured by Pfizer at these sites and at our Guarulhos, Brazil facility continue to be supplied to us under the terms of a manufacturing and supply agreement we entered into with Pfizer.
R&D Facilities. We have R&D operations co-located with certain of our manufacturing sites in Australia, Belgium, Brazil, Canada, China, Spain and the United States to facilitate the efficient transfer of production processes from our laboratories to manufacturing sites. In addition, we maintain R&D operations at non-manufacturing locations in Belgium, Brazil, India and the United States. As part of the Separation, Pfizer conveyed to us its interest in each of these R&D facilities, with the exception of our Mumbai, India facility, which we expect Pfizer to transfer to us after the completion of the Separation for cash consideration to be agreed upon, and, in the interim, we are leasing this facility from Pfizer.
Employees. In general, as part of the Separation, employees of Pfizer who were substantially dedicated to the animal health business became our employees. However, labor and employment laws or other business considerations in some jurisdictions delayed Pfizer from transferring to us employees who are substantially dedicated to the animal health business. In those instances, to the extent permissible under applicable law, we and Pfizer entered into mutually-acceptable arrangements to provide for continued operation of the business until such time as the employees in those jurisdictions can be transferred to us.

22 |


The amounts charged under each of the agreements with Pfizer, while Pfizer was still a related party, for the three months ended March 31, 2013 were as follows:
(MILLIONS OF DOLLARS)
 
 
 
Transitional services agreement
 
 
$
27

Master manufacturing and supply agreements
 
 
57

Employee matters agreement
 
 
31

In certain jurisdictions, while the Zoetis entities obtain appropriate registration and licensing, Pfizer entities purchase product from Zoetis entities and resell such product to the local Zoetis entity at cost. This activity is reflected in Accounts receivable for the product Pfizer purchases from Zoetis entities and in Accounts payable for the product purchased from such Pfizer entities by our local Zoetis entity.
At March 30, 2014 and December 31, 2013, $88 million and $121 million, respectively, was included in Accounts receivable as receivable from Pfizer, and $126 million and $181 million, respectively, was included in Accounts payable as payable to Pfizer.


23 |



Review Report of Independent Registered Public Accounting Firm
The Shareholders and Board of Directors
Zoetis Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of Zoetis Inc. and subsidiaries (the Company) as of March 30, 2014, and the related condensed consolidated statements of income, comprehensive income, equity, and cash flows for the three-month periods ended March 30, 2014 and March 31, 2013. These condensed consolidated financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements as of March 30, 2014 and for the three-month periods ended March 30, 2014 and March 31, 2013 referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Zoetis Inc. and subsidiaries as of December 31, 2013, and the related consolidated statements of income, comprehensive income, equity, and cash flows for the year then ended (not presented herein); and in our report dated March 26, 2014, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2013, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ KPMG LLP
New York, New York
May 13, 2014


24 |


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
Introduction
Our MD&A is provided in addition to the accompanying condensed consolidated financial statements and notes to assist readers in understanding the results of operations, comprehensive income, financial condition and cash flows of Zoetis Inc. (Zoetis). This MD&A is organized as follows:
Section
Description
Page
Overview of our business
A general description of our business and the industry in which we operate. For more information regarding our business and the animal health industry, see Item 1. Business of our 2013 Annual Report on Form 10-K.
Our operating environment
Information regarding the animal health industry and factors that affect our company.
Comparability of historical results and our relationship with Pfizer
Information about the limitations of the predictive value of the condensed consolidated financial statements.
Analysis of the condensed consolidated statements of income
Consists of the following for all periods presented:
 
Revenue: An analysis of our revenue in total.
 Costs and expenses: A discussion about the drivers of our costs and expenses.
Operating segment results: A discussion of our revenue by operating segment and species and items impacting our earnings before income tax.
Adjusted net income
A discussion of adjusted net income, an alternative view of performance used by management. Adjusted net income is a non-GAAP financial measure.
Our financial guidance for 2014
A discussion of our 2014 financial guidance.
Analysis of the condensed consolidated statements of comprehensive income
An analysis of the components of comprehensive income for all periods presented.
Analysis of the condensed consolidated balance sheets
A discussion of changes in certain balance sheet accounts for all balance sheets presented.
Analysis of the condensed consolidated statements of cash flows
An analysis of the drivers of our operating, investing and financing cash flows for all periods presented.
Analysis of financial condition, liquidity and capital resources
An analysis of our ability to meet our short-term and long-term financing needs.
New accounting standards
Accounting standards that we have recently adopted, as well as those that recently have been issued, but not yet adopted.
Forward-looking statements and factors that may affect future results
A description of the risks and uncertainties that could cause actual results to differ materially from those discussed in forward-looking statements set forth in this MD&A relating to our financial and operating performance, business plans and prospects, strategic review, capital allocation and business-development plans. Such forward-looking statements are based on management's current expectations about future events, which are inherently susceptible to uncertainty and changes in circumstances.
Overview of our business
We are 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. For more than 60 years, as a business unit of Pfizer Inc. (Pfizer) and now as an independent public company, we have been committed to enhancing the health of animals and bringing solutions to our customers who raise and care for them.
The animal health medicines and vaccines industry is characterized by meaningful differences in customer needs across different regions. As a result of these differences, among other things, we manage our operations through four geographic operating segments. Within each of these operating segments, we offer a diversified product portfolio for both livestock and companion animal customers in order to capitalize on local and regional trends and customer needs. Our four operating segments are the United States (U.S.), Europe/Africa/Middle East (EuAfME), Canada/Latin America (CLAR) and Asia/Pacific (APAC). See Notes to Condensed Consolidated Financial Statements—Note 16. Segment and Other Revenue Information.
We directly market our products to livestock producers and veterinarians located in approximately 70 countries across North America, Europe, Africa, Asia, Australia and Latin America, and are a market leader in nearly all of the major regions in which we operate. Through our efforts to establish an early and direct presence in many emerging markets, such as Brazil, China and India, we believe we are the largest animal health medicines and vaccines business as measured by revenue across emerging markets as a whole. In markets where we do not have a direct commercial presence, we generally contract with distributors that provide logistics and sales and marketing support for our products.

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We believe our investments in the industry’s largest sales organization, including our extensive network of technical and veterinary operations specialists, our high-quality manufacturing and reliability of supply, and our long track record of developing products that meet customer needs, has led to enduring and valued relationships with our customers. Our research and development (R&D) efforts enable us to deliver innovative products to address unmet needs and evolve our product lines so they remain relevant for our customers.
A summary of our 2014 performance compared to the comparable 2013 period follows:
 
 
Three Months Ended
 
 
 
 
March 30,

 
March 31,

 
%
(MILLIONS OF DOLLARS)
 
2014

 
2013