UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
	EXCHANGE ACT OF 1934
	For the quarterly period ended July 2, 2017
	or
	TRANSITION REPORT PURSUANT TO SECTION 13
	OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
¨	For the transition period from __________ to __________

Commission File Number: 001-35797

Zoetis Inc.

(Exact name of registrant as specified in its charter)

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

(973) 822-7000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No

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

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

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

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

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

At August 2, 2017, there were 489,111,671 shares of common stock outstanding.

TABLE OF CONTENTS

		Page
PART I — FINANCIAL INFORMATION		1
Item 1.	Financial Statements	1
	Condensed Consolidated Statements of Income (Unaudited)	1
	Condensed Consolidated Statements of Comprehensive Income (Unaudited)	2
	Condensed Consolidated Balance Sheets (Unaudited)	3
	Condensed Consolidated Statements of Equity (Unaudited)	4
	Condensed Consolidated Statements of Cash Flows (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6
	Review Report of Independent Registered Public Accounting Firm	22
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44
Item 4.	Controls and Procedures	44
PART II — OTHER INFORMATION		45
Item 1.	Legal Proceedings	45
Item 1A.	Risk Factors	45
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Mine Safety Disclosures	47
Item 5.	Other Information	47
Item 6.	Exhibits	48
SIGNATURES		49

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)	2017			2016			2017			2016
Revenue	$	1,269		$	1,208		$	2,500		$	2,370
Costs and expenses:
Cost of sales(a)	440			399			883			788
Selling, general and administrative expenses(a)	336			343			645			658
Research and development expenses(a)	86			88			176			178
Amortization of intangible assets(a)	23			22			45			43
Restructuring charges/(reversals) and certain acquisition-related costs	—			(21		)	(1		)	(19		)
Interest expense, net of capitalized interest	41			41			82			84
Other (income)/deductions—net	(2		)	4			(12		)	(26		)
Income before provision for taxes on income	345			332			682			664
Provision for taxes on income	98			108			196			236
Net income before allocation to noncontrolling interests	247			224			486			428
Less: Net income attributable to noncontrolling interests	—			—			1			—
Net income attributable to Zoetis Inc.	$	247		$	224		$	485		$	428
Earnings per share attributable to Zoetis Inc. stockholders:
Basic	$	0.50		$	0.45		$	0.99		$	0.86
Diluted	$	0.50		$	0.45		$	0.98		$	0.86
Weighted-average common shares outstanding:
Basic	490.8			496.3			491.6			496.9
Diluted	494.0			498.8			494.6			499.2
Dividends declared per common share	$	0.105		$	0.095		$	0.210		$	0.190

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

See notes to condensed consolidated financial statements.

1 |

ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
(MILLIONS OF DOLLARS)	2017			2016			2017			2016
Net income before allocation to noncontrolling interests	$	247		$	224		$	486		$	428
Other comprehensive income/(loss), net of taxes and reclassification adjustments:
Unrealized losses on derivatives, net(a)	(1		)	(3		)	(1		)	(3		)
Foreign currency translation adjustments, net	12			63			56			65
Benefit plans: Actuarial (losses)/gains, net(a)	(1		)	2			1			3
Total other comprehensive income/(loss), net of tax	10			62			56			65
Comprehensive income before allocation to noncontrolling interests	257			286			542			493
Less: Comprehensive income/(loss) attributable to noncontrolling interests	—			—			1			(1		)
Comprehensive income attributable to Zoetis Inc.	$	257		$	286		$	541		$	494

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

See notes to condensed consolidated financial statements.

2 |

ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	July 2,			December 31,
	2017			2016
(MILLIONS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)	(Unaudited)
Assets
Cash and cash equivalents(a)	$	705		$	727
Accounts receivable, less allowance for doubtful accounts of $31 in 2017 and $30 in 2016	975			913
Inventories	1,498			1,502
Assets held for sale	53			—
Other current assets	353			248
Total current assets	3,584			3,390
Property, plant and equipment, less accumulated depreciation of $1,397 in 2017 and $1,358 in 2016	1,355			1,381
Goodwill	1,495			1,481
Identifiable intangible assets, less accumulated amortization	1,210			1,228
Deferred tax assets	93			96
Other noncurrent assets	65			73
Total assets	$	7,802		$	7,649
Liabilities and Equity
Short-term borrowings	$	100		$	—
Current portion of long-term debt	750			$	—
Accounts payable	199			265
Dividends payable	52			52
Accrued expenses	406			464
Accrued compensation and related items	163			224
Income taxes payable	82			71
Liabilities associated with assets held for sale	4			—
Other current liabilities	28			41
Total current liabilities	1,784			1,117
Long-term debt, net of discount and issuance costs	3,719			4,468
Deferred tax liabilities	261			244
Other taxes payable	83			73
Other noncurrent liabilities	209			248
Total liabilities	6,056			6,150
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value: 1,000,000,000 authorized, none issued	—			—
Common stock, $0.01 par value: 6,000,000,000 authorized; 501,891,243 and 501,891,243 shares issued; 489,659,511 and 492,855,297 shares outstanding at July 2, 2017, and December 31, 2016, respectively	5			5
Treasury stock, at cost, 12,231,732 and 9,035,946 shares of common stock at July 2, 2017, and December 31, 2016, respectively	(615		)	(421		)
Additional paid-in capital	1,024			1,024
Retained earnings	1,843			1,477
Accumulated other comprehensive loss	(542		)	(598		)
Total Zoetis Inc. equity	1,715			1,487
Equity attributable to noncontrolling interests	31			12
Total equity	1,746			1,499
Total liabilities and equity	$	7,802		$	7,649

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

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(UNAUDITED)

	Zoetis
													Accumulated			Equity
							Additional						Other			Attributable to
		Common		Treasury			Paid-in			Retained			Comprehensive			Noncontrolling			Total
(MILLIONS OF DOLLARS)		Stock(a)		Stock(a)			Capital			Earnings			Loss			Interests			Equity
Balance, December 31, 2015		$	5	$	(203	)	$	1,012		$	876		$	(622	)	$	23		$	1,091
Six months ended July 3, 2016
Net income		—		—			—			428			—			—			428
Other comprehensive income/(loss)		—		—			—			—			66			(1		)	65
Share-based compensation awards(b)		—		60			(3		)	(20		)	—			—			37
Treasury stock acquired(c)		—		(151		)	—			—			—			—			(151		)
Employee benefit plan contribution from Pfizer Inc.(d)		—		—			1			—			—			—			1
Divestitures(e)		—		—			—			—			2			(8		)	(6		)
Dividends declared		—		—			—			(94		)	—			—			(94		)
Balance, July 3, 2016		$	5	$	(294	)	$	1,010		$	1,190		$	(554	)	$	14		$	1,371
Balance, December 31, 2016		$	5	$	(421	)	$	1,024		$	1,477		$	(598	)	$	12		$	1,499
Six months ended July 2, 2017
Net income		—		—			—			485			—			1			486
Other comprehensive income		—		—			—			—			56			—			56
Consolidation of a noncontrolling interest(f)		—		—			—			—			—			18			18
Share-based compensation awards (b)		—		56			(1		)	(16		)	—			—			39
Treasury stock acquired(c)		—		(250		)	—			—			—			—			(250		)
Employee benefit plan contribution from Pfizer Inc.(d)		—		—			1			—			—			—			1
Dividends declared		—		—			—			(103		)	—			—			(103		)
Balance, July 2, 2017		$	5	$	(615	)	$	1,024		$	1,843		$	(542	)	$	31		$	1,746

^(a)  As of July 2, 2017, and July 3, 2016, there were 489,659,511 and 495,389,702 outstanding shares of common stock, respectively, and 12,231,732 and 6,501,541 shares of treasury stock, respectively. Treasury stock is recognized at the cost to reacquire the shares. For additional information, see Note 13. Stockholders' Equity.

^(b)  Includes the issuance of shares of Zoetis Inc. common stock and the reissuance of treasury stock in connection with the vesting of employee share-based awards. Upon reissuance of treasury stock, differences between the proceeds from reissuance and the cost of the treasury stock that result in gains are recorded in Additional paid-in capital. Losses are recorded in Additional paid-in capital to the extent that they can offset previously recorded gains. If no such credit exists, the differences are recorded in Retained earnings. Also includes the reacquisition of shares of treasury stock associated with the vesting of employee share-based awards to satisfy tax withholding requirements. For additional information, see Note 12. Share-Based Payments and Note. 13. Stockholders' Equity.

^(c)  Reflects the acquisition of treasury shares in connection with the share repurchase program. For additional information, see Note 13. Stockholders' Equity.

^(d)  Represents contributed capital from Pfizer Inc. associated with service credit continuation for certain Zoetis Inc. employees in Pfizer Inc.'s U.S. qualified defined benefit and U.S. retiree medical plans. See Note 11. Benefit Plans.

^(e)  Reflects the divestiture of our share of our Taiwan joint venture. See Note 4. Acquisitions and Divestitures: Divestitures.

^(f)  Represents the consolidation of a European livestock monitoring company, a variable interest entity of which Zoetis is the primary beneficiary.

See notes to condensed consolidated financial statements.

4 |

ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended
	July 2,			July 3,
(MILLIONS OF DOLLARS)	2017			2016
Operating Activities
Net income before allocation to noncontrolling interests	$	486		$	428
Adjustments to reconcile net income before noncontrolling interests to net cash provided by operating activities:
Depreciation and amortization expense	121			117
Share-based compensation expense	22			19
Restructuring	(1		)	(19		)
Net loss/(gain) on sale of assets	2			(27		)
Provision for losses on inventory	40			35
Deferred taxes	13			17
Employee benefit plan contribution from Pfizer Inc.	1			1
Other non-cash adjustments	—			9
Other changes in assets and liabilities, net of acquisitions and divestitures
Accounts receivable	(41		)	53
Inventories	(46		)	(87		)
Other assets	(106		)	(72		)
Accounts payable	(66		)	(71		)
Other liabilities	(147		)	(254		)
Other tax accounts, net	21			39
Net cash provided by operating activities	299			188
Investing Activities
Purchases of property, plant and equipment	(93		)	(99		)
Acquisitions	(3		)	(20		)
Net proceeds from sales of assets	1			88
Other investing activities	7			—
Net cash used in investing activities	(88		)	(31		)
Financing Activities
Decrease in short-term borrowings, net	—			(1		)
Issuance of commercial paper	100			—
Principal payments on long-term debt	—			(400		)
Payment of contingent consideration related to previously acquired assets	(5		)	(22		)
Share-based compensation-related proceeds, net of taxes paid on withholding shares	18			17
Purchases of treasury stock(a)	(250		)	(151		)
Cash dividends paid	(103		)	(94		)
Net cash used in financing activities	(240		)	(651		)
Effect of exchange-rate changes on cash and cash equivalents	7			(2		)
Net decrease in cash and cash equivalents	(22		)	(496		)
Cash and cash equivalents at beginning of period	727			1,154
Cash and cash equivalents at end of period	$	705		$	658
Supplemental cash flow information
Cash paid during the period for:
Income taxes	$	256		$	215
Interest, net of capitalized interest	82			84
Non-cash transactions:
Purchases of property, plant and equipment	3			6
Contingent purchase price consideration(b)	—			27
Dividends declared, not paid	52			47

^(a)  Reflects the acquisition of treasury shares in connection with the share repurchase programs. For additional information, see Note 13. Stockholders' Equity.

^(b)  For 2016, relates primarily to the non-cash portion of the acquisition of a livestock business in South America.

See notes to condensed consolidated financial statements.

5 |

ZOETIS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Organization

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

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

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements were prepared following the requirements of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (U.S. GAAP) can be condensed or omitted. Balance sheet amounts and operating results for subsidiaries operating outside the United States are as of and for the three and six-month periods ended May 28, 2017, and May 29, 2016.

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

We are responsible for the unaudited condensed consolidated financial statements included in this Form 10-Q. The condensed consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. The information included in this interim report should be read in conjunction with the financial statements and accompanying notes included in our 2016 Annual Report on Form 10-K.

3. Significant Accounting Policies

Recently Adopted Accounting Standards

In January 2017, the Financial Accounting Standards Board (FASB) issued an accounting standards update which clarifies the definition of a business. Under the new guidance, a set of integrated activities and assets is a business only if it has, at a minimum, an input and substantive process that together significantly contribute to the ability to create outputs. The update also introduces the concept of an initial screening or “Step 1” which requires companies to first determine if substantially all of the fair value of the gross assets acquired is concentrated in a single (or group of similar) identifiable assets. Transactions that pass the Step 1 screening will be considered a business if they contain an input and substantive process and either; (1) an output or (2) an organized workforce with skills critical to the ability to create outputs and inputs that can be utilized to create the outputs. Companies will no longer be required to evaluate whether a market participant could replace any missing inputs or processes, instead focusing on the substance of what was acquired. The provisions of the new standard are effective, on a prospective basis, beginning January 1, 2018, for annual and interim reporting periods and may be adopted early for any transactions not yet reported in issued financial statements. We elected to early adopt the new standard for any new transactions occurring on or after January 1, 2017.

In July 2015, the FASB issued an accounting standards update to simplify the measurement of inventory by requiring that inventory be measured at the lower of cost or net realizable value, rather than at the lower of cost or market, with market being defined as either replacement cost, net realizable value or net realizable value less a normal profit margin. We adopted this guidance as of January 1, 2017. This guidance did not have a significant impact on our condensed consolidated financial statements.

Recently Issued Accounting Standards

In March 2017, the FASB issued an accounting standards update to simplify and improve the reporting of net periodic pension benefit cost by requiring only present service cost to be presented in the same line item as other current employee compensation costs while remaining components of net periodic benefit cost would be presented within Other (income)/deductions—net outside of operations. We plan to adopt this guidance as of January 1, 2018, the required effective date, and do not expect the new standard will have a significant impact on our consolidated financial statements.

In October 2016, the FASB issued an accounting standards update that will require the recognition of the income tax consequences of an intra-entity asset transfer, other than inventory, when the transfer occurs as opposed to when the asset is sold to an outside third party. The provisions of the new standard are effective beginning January 1, 2018, for annual and interim reporting periods. Early adoption is permitted beginning on January 1, 2017. We plan to adopt this guidance as of January 1, 2018, the required effective date, and do not expect the new standard will have a significant impact on our consolidated financial statements.

6 |

In February 2016, the FASB issued an accounting standards update which requires lessees to recognize most leases on the balance sheet with a corresponding right of use asset. Leases will be classified as financing or operating which will drive the expense recognition pattern. For lessees, the income statement presentation and expense recognition pattern for financing and operating leases is similar to the current model for capital and operating leases, respectively. Companies may elect to exclude short-term leases. The update also requires additional disclosures that will better enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We plan to adopt this guidance as of January 1, 2019, the required effective date, for annual and interim reporting periods. The new standard requires a modified retrospective adoption approach, at the beginning of the earliest comparative period presented in the financial statements. We continue to assess the potential impact that adopting this new guidance will have on our consolidated financial statements.

In May 2014, the FASB issued an accounting standards update that outlines a new, single comprehensive model for companies to use in accounting for revenue arising from contracts with customers. This update supersedes most current revenue recognition guidance under U.S. GAAP. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance includes a five-step model for determining how, when and how much revenue should be recognized. This update also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. We plan to adopt this guidance as of January 1, 2018, the required effective date, using the modified retrospective transition method. Under the modified retrospective method, the cumulative effect of applying the new standard will be recognized as of the date of initial application with disclosure of results under both the new and prior standards. We continue to assess the impact of the new standard on our current policies, procedures, and disclosures related to revenue recognition. Based on the work performed to date, we do not believe that the adoption will have a material impact on our consolidated financial statements. While implementation procedures are still ongoing, we have evaluated the impact on our primary revenue stream, product sales, in both the United States and our key international markets and no matters have currently been identified individually or in the aggregate that would have a material impact on the timing or amount of revenue recognition based on the provisions of the new standard.

4. Acquisitions and Divestitures

Assets and Liabilities Held for Sale

On March 30, 2017, as part of our supply network strategy, we announced an agreement with the Brazilian-based pharmaceutical company União Química (UQ) to sell our manufacturing site in Guarulhos, Brazil, and we met the criteria for held for sale classification. The agreement also includes entering into a five-year manufacturing and supply agreement with UQ to begin upon closing of the transaction.

As of July 2, 2017, recorded assets and liabilities held for sale are summarized below:

	July 2,
(MILLIONS OF DOLLARS)	2017
Assets held for sale
Inventories	$	12
Property, plant and equipment	26
Deferred tax assets	4
Other current assets	8
Goodwill	3
Total	$	53
Liabilities associated with assets held for sale
Accounts payable	$	3
Other current liabilities	1
Total	$	4

We expect to complete this transaction during the second half of 2017.

Divestitures

On May 11, 2017, we completed the sale of our manufacturing site in Shenzhou, China. We had previously exited operations at this site during the second quarter of 2015 as part of our operational efficiency program. We received total cash proceeds of approximately $3 million and recorded a net pre-tax gain of approximately $2 million within Other (income)/deductions—net. Additionally, in the second quarter of 2017, we recorded a $4 million expense within Other (income)/deductions—net related to the prior year sale of the U.S. manufacturing sites noted below.

On April 28, 2016, we completed the sale of our 55 percent ownership share of a Taiwan joint venture, including a manufacturing site in Hsinchu, Taiwan to Yung Shin Pharmaceutical Industrial Co., Ltd., a pharmaceutical company with an animal health business and headquarters in Taiwan. The sale also included a portfolio of products in conjunction with our comprehensive operational efficiency program. These products include medicated feed additives, anti-infective medicines and nutritional premixes for livestock, sold primarily in Taiwan and in international markets. We received $13 million in cash upon closing.

7 |

On February 17, 2016, we completed the sale of our manufacturing site in Haridwar, India to the India-based pharmaceutical company Zydus Cadila (Cadila Healthcare Ltd.). The agreement also included the sale of a portfolio of our products in conjunction with our comprehensive operational efficiency program.

On February 12, 2016, we completed the sale of two of our manufacturing sites in the United States: Laurinburg, North Carolina, and Longmont, Colorado, to Huvepharma NV (Huvepharma), a European animal health company. Huvepharma also assumed the assets and operations and the lease of our manufacturing and distribution site in Van Buren, Arkansas. The agreement included the sale of a portfolio of products in conjunction with our comprehensive operational efficiency program.

During the first six months of 2016, we received total cash proceeds of approximately $88 million related to the divestitures of the India and U.S. manufacturing sites noted above. During the first quarter of 2016, we recognized a net pre-tax gain of approximately $33 million, partially offset by a net pre-tax loss of approximately $6 million recognized during the second quarter of 2016. Gains and losses related to divestitures are recorded within Other (income)/deductions—net.

5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives

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

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

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
(MILLIONS OF DOLLARS)	2017			2016			2017			2016
Restructuring charges/(reversals) and certain acquisition-related costs:
Integration costs(a)	$	2		$	2		$	2		$	2
Restructuring charges/(reversals)(b):
Employee termination costs	(3		)	(24		)	(4		)	(23		)
Exit costs	1			1			1			2
Total Restructuring charges/(reversals) and certain acquisition-related costs	$	—		$	(21	)	$	(1	)	$	(19	)

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

^(b)  The restructuring charges/(reversals) for the three months endedJuly 2, 2017, are associated with the following: U.S. ($1 million reversal), International ($1 million) and Manufacturing/research/corporate ($2 million reversal).

The restructuring charges/(reversals) for the six months endedJuly 2, 2017, are associated with the following: International ($1 million reversal) and Manufacturing/research/corporate ($2 million reversal).

The restructuring charges/(reversals) for the three months endedJuly 3, 2016, are associated with the following: U.S. ($1 million reversal), International ($14 million reversal) and Manufacturing/research/corporate ($8 million reversal).

The restructuring charges/(reversals) for the six months endedJuly 3, 2016, are associated with the following: U.S. ($2 million reversal), International ($15 million reversal) and Manufacturing/research/corporate ($4 million reversal).

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

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Charges related to the operational efficiency initiative and supply network strategy are as follows:

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
(MILLIONS OF DOLLARS)	2017			2016			2017			2016
Restructuring charges/(reversals) and certain acquisition-related costs:
Operational efficiency initiative
Employee termination costs(a)	$	2		$	(30	)	$	1		$	(29	)
Exit costs	1			2			1			3
	3			(28		)	2			(26		)
Supply network strategy:
Employee termination costs	(5		)	6			(5		)	6
	(5		)	6			(5		)	6
Total restructuring charges/(reversals) related to the operational efficiency initiative and supply network strategy	(2		)	(22		)	(3		)	(20		)
Other operational efficiency initiative charges
Selling, general and administrative expenses:
Accelerated depreciation	—			1			—			1
Consulting fees	1			4			1			7
Other (income)/deductions—net:
Net loss/(gain) on sale of assets(b)	2			6			2			(27		)
Total other operational efficiency initiative charges	3			11			3			(19		)
Other supply network strategy charges
Cost of sales:
Accelerated depreciation	1			1			2			2
Consulting fees	—			1			2			3
Total other supply network strategy charges	1			2			4			5
Total charges associated with the operational efficiency initiative and supply network strategy	$	2		$	(9	)	$	4		$	(34	)

^(a)  For the three and six months ended July 3, 2016, includes a reduction in employee termination accruals primarily as a result of higher than expected voluntary attrition rates experienced in the first half of 2016.

^(b)  For the three months ended July 3, 2016, primarily represents the net loss on the sale of our share of our Taiwan joint venture as part of our operational efficiency initiative. For the six months endedJuly 3, 2016, represents the net gain on the sale of certain manufacturing sites and products, partially offset by the loss on the sale of our share of our Taiwan joint venture, as part of our operational efficiency initiative.

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

	Employee
	Termination			Exit
(MILLIONS OF DOLLARS)	Costs			Costs			Accrual(a)
Balance, December 31, 2016(a)	$	90		$	—		$	90
Provision	(4		)	1			(3		)
Utilization and other(b)	(36		)	(1		)	(37		)
Balance, July 2, 2017(a)	$	50		$	—		$	50

^(a)  At July 2, 2017, and December 31, 2016, included in Accrued expenses ($29 million and $61 million, respectively) and Other noncurrent liabilities ($21 million and $29 million, respectively).

^(b)  Includes adjustments for foreign currency translation.

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6. Other (Income)/Deductions—Net

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

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
(MILLIONS OF DOLLARS)	2017			2016			2017			2016
Royalty-related income	$	(5	)	$	(5	)	$	(12	)	$	(12	)
Net loss/(gain) on sale of assets(a)	2			6			2			(27		)
Certain legal and other matters, net(b)	(4		)	—			(4		)	—
Foreign currency loss(c)	8			8			10			17
Other, net(d)	(3		)	(5		)	(8		)	(4		)
Other (income)/deductions—net	$	(2	)	$	4		$	(12	)	$	(26	)

^(a)  For the three and six months ended July 2, 2017, represents the net loss related to sales of certain manufacturing sites and products as part of our operational efficiency initiative.

For the three months ended July 3, 2016, primarily represents the net loss on the sale of our share of our Taiwan joint venture as part of our operational efficiency initiative. For the six months ended July 3, 2016, represents the net gain on the sale of certain manufacturing sites and products, partially offset by the loss on the sale of our share of our Taiwan joint venture, as part of our operational efficiency initiative.

^(b)  For the three and six months ended July 2, 2017, represents income associated with an insurance recovery related to commercial settlements in Mexico recorded in 2014 and 2016.

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

^(d)  Includes interest income and other miscellaneous income. For the six months ended July 2, 2017, also includes a settlement refund and reimbursement of legal fees related to costs incurred by Pharmaq prior to the acquisition in 2015. For the three and six months ended July 3, 2016, also includes income associated with certain state business employment tax incentive credits.

7. Income Taxes

A. Taxes on Income

The effective tax rate was 28.4% for the three months ended July 2, 2017, compared with 32.5% for the three months ended July 3, 2016. The lower effective tax rate for the three months ended July 2, 2017, was primarily attributable to:

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

• a $2 million discrete tax benefit related to the excess tax benefits for share-based payments recognized as a component of Provision for taxes on income; and

• a $3 million net discrete tax expense recorded in the second quarter of 2016, related to changes in uncertain tax positions due to the impact of the European Commission’s negative decision on the excess profits rulings in Belgium, partially offset by a revaluation of the company's deferred tax assets and liabilities using the Belgium tax rates expected to be in place going forward as a result of the decision.

The effective tax rate was 28.7% for the six months ended July 2, 2017, compared with 35.5% for the six months ended July 3, 2016. The lower effective tax rate for the six months ended July 2, 2017, was primarily attributable to:

• a $38 million net discrete tax expense recorded in the first half of 2016, related to changes in uncertain tax positions due to the impact of the European Commission’s negative decision on the excess profits rulings in Belgium, partially offset by a revaluation of the company's deferred tax assets and liabilities using the Belgium tax rates expected to be in place going forward as a result of the decision;

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

• a $7 million and $5 million discrete tax benefit recorded in the first half of 2017 and 2016, respectively, related to the excess tax benefits for share-based payments recognized as a component of Provision for taxes on income; and

• a $3 million and $10 million discrete tax benefit recorded in the first quarter of 2017 and 2016, respectively, related to a revaluation of deferred taxes as a result of a change in statutory tax rates.

B. Deferred Taxes

As of July 2, 2017, the total net deferred income tax liability of $168 million is included in Deferred tax assets ($93 million) and Deferred tax liabilities ($261 million).

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As of December 31, 2016, the total net deferred income tax liability of $148 million is included in Deferred tax assets ($96 million) and Deferred tax liabilities ($244 million).

C. Tax Contingencies

As of July 2, 2017, the tax liabilities associated with uncertain tax positions of $75 million (exclusive of interest and penalties related to uncertain tax positions of $11 million) are included in Deferred tax assets ($4 million) and Other taxes payable ($71 million).

As of December 31, 2016, the tax liabilities associated with uncertain tax positions of $68 million (exclusive of interest and penalties related to uncertain tax positions of $10 million) are included in Deferred tax assets ($3 million) and Other taxes payable ($65 million).

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

8. Financial Instruments

A. Debt

Credit Facilities

In December 2016, we entered into an amended and restated revolving credit agreement with a syndicate of banks providing for a five-year $1.0 billion senior unsecured revolving credit facility (the credit facility), which expires in December 2021. Subject to certain conditions, we have the right to increase the credit facility to up to $1.5 billion. The credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio (the ratio of consolidated net debt as of the end of the period to consolidated Earnings Before Interest, Income Taxes, Depreciation and Amortization (EBITDA) for such period) of 3.50:1. Upon entering into a material acquisition, the maximum total leverage ratio increases to 4.00:1, and extends until the fourth full consecutive fiscal quarter ended immediately following the consummation of a material acquisition. The credit facility also contains a clause which adds back to Adjusted Consolidated EBITDA, any operational efficiency restructuring charge (defined as charges recorded by the company during the period commencing on October 1, 2016 and ending December 31, 2019, related to operational efficiency initiatives), provided that for any twelve-month period such charges added back to Adjusted Consolidated EBITDA shall not to exceed $100 million in the aggregate.

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

We were in compliance with all financial covenants as of July 2, 2017, and December 31, 2016. There were no amounts drawn under the credit facility as of July 2, 2017, or December 31, 2016.

We have additional lines of credit and other credit arrangements with a group of banks and other financial intermediaries for general corporate purposes. We maintain cash and cash equivalent balances in excess of our outstanding short-term borrowings. As of July 2, 2017, we had access to $75 million of lines of credit which expire at various times throughout 2017 and 2018 and are generally renewed annually. We did not have any borrowings outstanding related to these facilities as of July 2, 2017, and December 31, 2016.

Commercial Paper Program and Other Short-Term Borrowings

In February 2013, we entered into a commercial paper program with a capacity of up to $1.0 billion. As of July 2, 2017, there was $100 million of commercial paper borrowings outstanding, with a weighted average interest rate of 1.4%. As of December 31, 2016, there was no commercial paper issued under this program. As of July 2, 2017, and December 31, 2016, we did not have any other short-term borrowings outstanding.

Senior Notes and Other Long-Term Debt

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

The current portion of long-term debt was $750 million as of July 2, 2017, with a weighted-average interest rate of 1.875%. There was no current portion of long-term debt as of December 31, 2016.

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

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

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

	July 2,			December 31,
(MILLIONS OF DOLLARS)	2017			2016
1.875% 2013 senior notes due 2018	$	750		$	750
3.450% 2015 senior notes due 2020	500			500
3.250% 2013 senior notes due 2023	1,350			1,350
4.500% 2015 senior notes due 2025	750			750
4.700% 2013 senior notes due 2043	1,150			1,150
	4,500			4,500
Unamortized debt discount / debt issuance costs	(31		)	(32		)
Less current portion of long-term debt	(750		)	—
Long-term debt, net of discount and issuance costs	$	3,719		$	4,468

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

The principal amount of long-term debt outstanding, as of July 2, 2017, matures in the following years:

									After
(MILLIONS OF DOLLARS)	2018		2019		2020		2021		2021		Total
Maturities	$	750	$	—	$	500	$	—	$	3,250	$	4,500

Interest Expense

Interest expense, net of capitalized interest, was $41 million and $82 million for the three and six months ended July 2, 2017, respectively, and $41 million and $84 million for the three and six months ended July 3, 2016, respectively. Capitalized interest was $1 million and $2 million for each of the three and six months endedJuly 2, 2017, and July 3, 2016, respectively.

B. Derivative Financial Instruments

Foreign Exchange Risk

A significant portion of our revenue, earnings and net investment in foreign affiliates is exposed to changes in foreign exchange rates. We seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenue in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Depending on market conditions, foreign exchange risk is also managed through the use of derivative financial instruments. These financial instruments serve to protect net income against the impact of the translation into U.S. dollars of certain foreign exchange-denominated transactions. The aggregate notional amount of foreign exchange derivative financial instruments offsetting foreign currency exposures was $1.1 billion and $1.2 billion, as of July 2, 2017, and December 31, 2016, respectively. The derivative financial instruments primarily offset exposures in the Australian dollar, Brazilian real, Canadian dollar, Chinese yuan, euro, and Japanese yen. The vast majority of the foreign exchange derivative financial instruments mature within 60 days and all mature within 180 days.

All derivative contracts used to manage foreign currency risk are measured at fair value and are reported as assets or liabilities on the condensed consolidated balance sheet. The company has not designated the foreign currency forward-exchange contracts as hedging instruments. We recognize the gains and losses on forward-exchange contracts that are used to offset the same foreign currency assets or liabilities immediately into earnings along with the earnings impact of the items they generally offset. These contracts essentially take the opposite currency position of that reflected in the month-end balance sheet to counterbalance the effect of any currency movement.

Interest Rate Risk

The company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rates and to reduce its overall cost of borrowing. In anticipation of issuing fixed-rate debt, we may use forward-starting interest rate swaps that are designated as cash flow hedges to hedge against changes in interest rates that could impact expected future issuances of debt. To the extent these hedges of cash flows related to anticipated debt are effective, any unrealized gains or losses on the forward-starting interest rate swaps are reported in Accumulated other comprehensive loss and are recognized in income over the life of the future fixed-rate notes. When the company discontinues hedge accounting because it is no longer probable that an anticipated transaction will occur within the originally

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expected period of execution, or within an additional two-month period thereafter, changes to fair value accumulated in other comprehensive income are recognized immediately in earnings.

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

Fair Value of Derivative Instruments

The classification and fair values of derivative instruments are as follows:

		Fair Value of Derivatives
		July 2,			December 31,
(MILLIONS OF DOLLARS)	Balance Sheet Location	2017			2016
Derivatives Not Designated as Hedging Instruments
Foreign currency forward-exchange contracts	Other current assets	$	6		$	12
Foreign currency forward-exchange contracts	Other current liabilities	(8		)	(8		)
Total derivatives not designated as hedging instruments		(2		)	4
Derivatives Designated as Hedging Instruments:
Interest rate swap contracts	Other current assets	14			17
Total derivatives designated as hedging instruments		14			17
Total derivatives		$	12		$	21

We use a market approach in valuing financial instruments on a recurring basis. Our derivative financial instruments are measured at fair value on a recurring basis using Level 2 inputs in the calculation of fair value.

The amounts of net gains/(losses) on derivative instruments not designated as hedging instruments, recorded in Other (income)/deductions—net, are as follows:

	Three Months Ended					Six Months Ended
	July 2,		July 3,			July 2,			July 3,
(MILLIONS OF DOLLARS)	2017		2016			2017			2016
Foreign currency forward-exchange contracts	$	7	$	(13	)	$	(22	)	$	(12	)

These amounts were substantially offset in Other (income)/deductions—net by the effect of changing exchange rates on the underlying foreign currency exposures.

The amounts of unrecognized net losses on derivative instruments designated as cash flow hedges, recorded, net of tax, in Other comprehensive income/(loss), are as follows:

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
(MILLIONS OF DOLLARS)	2017			2016			2017			2016
Interest rate swaps	$	(1	)	$	(3	)	$	(1	)	$	(3	)

The net amount of deferred gains/(losses) that is expected to be reclassified fromAccumulated other comprehensive loss into earnings over the next 12 months is insignificant.

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9. Inventories

The components of inventory are as follows:

	July 2,		December 31,
(MILLIONS OF DOLLARS)	2017		2016
Finished goods	$	784	$	799
Work-in-process	534		499
Raw materials and supplies	180		204
Inventories	$	1,498	$	1,502

10. Goodwill and Other Intangible Assets

A. Goodwill

The components of, and changes in, the carrying amount of goodwill are as follows:

(MILLIONS OF DOLLARS)	U.S.		International		Total
Balance, December 31, 2016	$	661	$	820	$	1,481
Additions(a)	5		5		10
Other(b)	—		4		4
Balance, July 2, 2017	$	666	$	829	$	1,495

^(a)  Represents the consolidation of a European livestock monitoring company, a variable interest entity of which Zoetis is the primary beneficiary.

^(b)  Includes adjustments for foreign currency translation, partially offset by the reclassification of $3 million to Assets Held for Sale relating to our manufacturing site in Guarulhos, Brazil. For additional information, see Note 4. Acquisitions and Divestitures: Assets Held for Sale.

The gross goodwill balance was $2,031 million and $2,017 million as of July 2, 2017, and December 31, 2016, respectively. Accumulated goodwill impairment losses were $536 million as of July 2, 2017, and December 31, 2016.

B. Other Intangible Assets

The components of identifiable intangible assets are as follows:

	As of July 2, 2017							As of December 31, 2016
						Identifiable							Identifiable
	Gross					Intangible Assets		Gross					Intangible Assets
	Carrying		Accumulated			Less Accumulated		Carrying		Accumulated			Less Accumulated
(MILLIONS OF DOLLARS)	Amount		Amortization			Amortization		Amount		Amortization			Amortization
Finite-lived intangible assets:
Developed technology rights(a)(b)	$	1,167	$	(385	)	$	782	$	1,064	$	(342	)	$	722
Brands	213		(138		)	75		213		(132		)	81
Trademarks and trade names	62		(46		)	16		62		(44		)	18
Other	225		(137		)	88		222		(130		)	92
Total finite-lived intangible assets	1,667		(706		)	961		1,561		(648		)	913
Indefinite-lived intangible assets:
Brands	37		—			37		37		—			37
Trademarks and trade names	67		—			67		66		—			66
In-process research and development(b)	137		—			137		204		—			204
Product rights	8		—			8		8		—			8
Total indefinite-lived intangible assets	249		—			249		315		—			315
Identifiable intangible assets	$	1,916	$	(706	)	$	1,210	$	1,876	$	(648	)	$	1,228

^(a)  Includes the consolidation of a European livestock monitoring company, a variable interest entity of which Zoetis is the primary beneficiary, and intangible assets associated with the purchase of a Norwegian fish vaccination company, both during the first quarter of 2017.

^(b) In the first quarter of 2017, certain intangible assets, acquired in 2015 as part of the Pharmaq acquisition, were placed into service.

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C. Amortization

Amortization expense related to finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in Amortization of intangible assets as it benefits multiple business functions. Amortization expense related to finite-lived acquired intangible assets that are associated with a single function is included in Cost of sales, Selling, general and administrative expenses or Research and development expenses, as appropriate. Total amortization expense for finite-lived intangible assets was $24 million and $49 million for the three and six months endedJuly 2, 2017, respectively, and $24 million and $48 million for the three and six months endedJuly 3, 2016, respectively.

11. Benefit Plans

Our employees ceased to participate in the Pfizer, Inc. U.S. qualified defined benefit plans and the U.S. retiree medical plan effective December 31, 2012, and liabilities associated with our employees under these plans were retained by Pfizer. Pfizer is continuing to credit certain employees' service with Zoetis generally through December 31, 2017 (or termination of employment from Zoetis, if earlier) for certain early retirement benefits with respect to Pfizer's U.S. defined benefit pension and retiree medical plans. Pension and postretirement benefit expense associated with the extended service for certain employees in the U.S. plans totaled approximately $1 million for each of the three month periods ended July 2, 2017, and July 3, 2016, and $3 million for each of the six month periods ended July 2, 2017, and July 3, 2016.

The following table provides the net periodic benefit cost associated with our international defined benefit pension plans:

	Three Months Ended					Six Months Ended
	July 2,		July 3,			July 2,			July 3,
(MILLIONS OF DOLLARS)	2017		2016			2017			2016
Service cost	$	1	$	2		$	3		$	4
Interest cost	—		1			1			2
Expected return on plan assets	—		—			(1		)	(1		)
Amortization of net actuarial loss	1		—			1			—
Curtailment and settlement (gain)/loss	—		(1		)	1			(1		)
Net periodic benefit cost	$	2	$	2		$	5		$	4

Total company contributions to the international pension plans were $1 million and $4 million for the three and six months endedJuly 2, 2017, respectively, and $3 million and $6 million for the three and six months ended July 3, 2016, respectively. We expect to contribute a total of approximately $7 million to these plans in 2017.

12. Share-Based Payments

The company may grant a variety of share-based payments under the Zoetis 2013 Equity and Incentive Plan (the Equity Plan) to our employees and non-employee directors. The principal types of share-based awards available under the Equity Plan may include, but are not limited to, stock options, restricted stock and restricted stock units (RSUs), deferred stock units (DSUs), performance-vesting restricted stock units (PSUs) and other equity-based or cash-based awards.

The components of share-based compensation expense are as follows:

	Three Months Ended				Six Months Ended
	July 2,		July 3,		July 2,		July 3,
(MILLIONS OF DOLLARS)	2017		2016		2017		2016
Stock options / stock appreciation rights	$	2	$	3	$	5	$	5
RSUs / DSUs	7		6		13		12
PSUs	2		1		4		2
Share-based compensation expense—total(a)(b)	$	11	$	10	$	22	$	19

^(a) For the three and six months endedJuly 2, 2017, and July 3, 2016, amounts capitalized to inventory were insignificant.

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

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During the six months endedJuly 2, 2017, the company granted 712,112 stock options with a weighted-average exercise price of $55.09 per stock option and a weighted-average fair value of $14.30 per stock option. The fair-value based method for valuing each Zoetis stock option grant on the grant date uses the Black-Scholes-Merton option-pricing model, which incorporates a number of valuation assumptions. The weighted-average fair value was estimated based on the following assumptions: risk-free interest rate of 2.3%; expected dividend yield of 0.76%; expected stock price volatility of 23.28%; and expected term of 6.5 years. In general, stock options vest after three years of continuous service and the values determined through this fair-value based method generally are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.

During the six months endedJuly 2, 2017, the company granted 529,932 RSUs with a weighted-average grant date fair value of $55.04 per RSU. RSUs are accounted for using a fair-value-based method that utilizes the closing price of Zoetis common stock on the date of grant. In general, RSUs vest after three years of continuous service from the grant date and the values generally are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.

During the six months endedJuly 2, 2017, the company granted 136,964 PSUs with a weighted-average grant date fair value of $74.28 per PSU. PSUs are accounted for using a Monte Carlo simulation model. The units underlying the PSUs will be earned and vested over a three-year performance period, based upon the total shareholder return of the company in comparison to the total shareholder return of the companies comprising the S&P 500 index at the start of the performance period (Relative TSR). The weighted-average fair value was estimated based on volatility assumptions of Zoetis common stock and an average of the S&P 500 companies, which were 23.1% and 25.5%, respectively. Depending on the company’s Relative TSR performance at the end of the performance period, the recipient may earn between 0% and 200% of the target number of units. Vested units are settled in shares of the company’s common stock. PSU values are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.

13. Stockholders' Equity

Zoetis is authorized to issue 6 billion shares of common stock and 1 billion shares of preferred stock.

In November 2014, the company's Board of Directors authorized a $500 million share repurchase program. This program was substantially completed as of December 31, 2016. In December 2016, the company's Board of Directors authorized an additional $1.5 billion share repurchase program. Purchases of Zoetis shares may be made at the discretion of management, depending on market conditions and business needs. As of July 2, 2017, there was approximately $1.3 billion remaining under these authorizations.

Changes in common shares and treasury stock were as follows:

(MILLIONS)	Common Shares Issued(a)	Treasury Stock(a)
Balance, December 31, 2015	501.81	4.41
Share-based compensation(b)	0.08	(1.29	)
Share repurchase program	—	3.38
Balance, July 3, 2016	501.89	6.50
Balance, December 31, 2016	501.89	9.04
Share-based compensation(b)	—	(1.25	)
Share repurchase program	—	4.45
Balance, July 2, 2017	501.89	12.23

^(a)    Shares may not add due to rounding.

^(b)  Includes the issuance of shares of common stock and the reissuance of shares from treasury stock in connection with the vesting of employee share-based awards. Treasury stock also includes the reacquisition of shares associated with the vesting of employee share-based awards to satisfy tax withholding requirements. For additional information regarding share-based compensation, see Note 12. Share-Based Payments.

Changes, net of tax, in accumulated other comprehensive loss, excluding noncontrolling interest, are as follows:

				Currency Translation
	Derivatives			Adjustment			Benefit Plans			Accumulated Other
	Net Unrealized			Net Unrealized			Actuarial			Comprehensive
(MILLIONS OF DOLLARS)	Gains/(Losses)			Gains/(Losses)			Gains/(Losses)			Loss
Balance, December 31, 2015	$	(2	)	$	(604	)	$	(16	)	$	(622	)
Other comprehensive (loss)/income, net of tax	(3		)	66			3			66
Divestiture of noncontrolling interest(a)	—			2			—			2
Balance, July 3, 2016	$	(5	)	$	(536	)	$	(13	)	$	(554	)
Balance, December 31, 2016	$	8		$	(583	)	$	(23	)	$	(598	)
Other comprehensive income, net of tax	(1		)	56			1			56