10-Q 1 a2018q2form10-q.htm 10-Q Document


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 June 30, 2018
 
 
or
 
 
TRANSITION REPORT PURSUANT TO SECTION 13
 
 
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
¨
For the transition period from __________ to __________
 
Commission File Number: 001-35797
Zoetis Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
46-0696167
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
10 Sylvan Way, Parsippany, New Jersey
 
07054
(Address of principal executive offices)
 
(Zip Code)
(973) 822-7000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). ¨ Yes x No
At July 27, 2018, there were 481,823,803 shares of common stock outstanding.



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




PART I – FINANCIAL INFORMATION
Item 1.
Financial Statements


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

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

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

 
2017

 
2018

 
2017

Revenue
 
$
1,415

 
$
1,269

 
$
2,781

 
$
2,500

Costs and expenses:
 
 
 
 
 
 
 
 
Cost of sales
 
447

 
440

 
894

 
883

Selling, general and administrative expenses
 
359

 
336

 
697

 
645

Research and development expenses
 
102

 
86

 
199

 
176

Amortization of intangible assets
 
23

 
23

 
46

 
45

Restructuring charges/(reversals) and certain acquisition-related costs
 
5

 
—

 
7

 
(1
)
Interest expense, net of capitalized interest
 
46

 
41

 
93

 
82

Other (income)/deductions—net
 
(4
)
 
(2
)
 
(9
)
 
(12
)
Income before provision for taxes on income
 
437

 
345

 
854

 
682

Provision for taxes on income
 
55

 
98

 
122

 
196

Net income before allocation to noncontrolling interests
 
382

 
247

 
732

 
486

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

 
(4
)
 
1

Net income attributable to Zoetis Inc.
 
$
384

 
$
247

 
$
736

 
$
485

Earnings per share attributable to Zoetis Inc. stockholders:
 
 
 
 
 
 
 
 
 Basic
 
$
0.79

 
$
0.50

 
$
1.52

 
$
0.99

 Diluted
 
$
0.79

 
$
0.50

 
$
1.51

 
$
0.98

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
 Basic
 
483.8

 
490.8

 
484.8

 
491.6

 Diluted
 
487.5

 
494.0

 
488.6

 
494.6

Dividends declared per common share
 
$
0.126

 
$
0.105

 
$
0.252

 
$
0.210



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
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Net income before allocation to noncontrolling interests
 
$
382

 
$
247

 
$
732

 
$
486

Other comprehensive (loss)/income, net of taxes and reclassification adjustments:
 
 
 
 
 
 
 
 
Unrealized losses on derivatives, net(a)
 
—

 
(1
)
 
—

 
(1
)
Foreign currency translation adjustments, net
 
(115
)
 
12

 
(38
)
 
56

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

 
(1
)
 
—

 
1

Total other comprehensive (loss)/income, net of tax
 
(115
)
 
10

 
(38
)
 
56

Comprehensive income before allocation to noncontrolling interests
 
267

 
257

 
694

 
542

Less: Comprehensive (loss)/income attributable to noncontrolling interests
 
(3
)
 
—

 
(4
)
 
1

Comprehensive income attributable to Zoetis Inc.
 
$
270

 
$
257

 
$
698

 
$
541

(a) 
Presented net of reclassification adjustments and tax impacts, which are not significant in any period presented. Reclassification adjustments related to benefit plans are generally reclassified, as part of net periodic pension cost, into Other (income)/deductions, beginning in the first quarter of 2018, and into Cost of sales, Selling, general and administrative expenses, and/or Research and development expenses, as appropriate, for periods prior to 2018, in the condensed consolidated statements of income.



See notes to condensed consolidated financial statements.
2 |

ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

 
 
June 30,

 
December 31,

 
 
2018

 
2017

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

 
 
Assets
 
 
 
 
Cash and cash equivalents(a)
 
$
1,558

 
$
1,564

Accounts receivable, less allowance for doubtful accounts of $24 in 2018 and $25 in 2017
 
973

 
998

Inventories
 
1,420

 
1,427

Other current assets
 
288

 
228

Total current assets
 
4,239

 
4,217

Property, plant and equipment, less accumulated depreciation of $1,522 in 2018 and $1,471 in 2017
 
1,470

 
1,435

Goodwill
 
1,514

 
1,510

Identifiable intangible assets, less accumulated amortization
 
1,225

 
1,269

Noncurrent deferred tax assets
 
80

 
80

Other noncurrent assets
 
75

 
75

Total assets
 
$
8,603

 
$
8,586

 
 
 
 
 
Liabilities and Equity
 
 
 
 
Accounts payable
 
230

 
261

Dividends payable
 
61

 
61

Accrued expenses
 
434

 
432

Accrued compensation and related items
 
160

 
236

Income taxes payable
 
53

 
60

Other current liabilities
 
29

 
44

Total current liabilities
 
967

 
1,094

Long-term debt, net of discount and issuance costs
 
4,955

 
4,953

Noncurrent deferred tax liabilities
 
229

 
380

Other taxes payable
 
266

 
172

Other noncurrent liabilities
 
204

 
201

Total liabilities
 
6,621

 
6,800

Commitments and contingencies (Note 16)
 


 


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; 482,290,154 and 486,130,461 shares outstanding at June 30, 2018, and December 31, 2017, respectively
 
5

 
5

Treasury stock, at cost, 19,601,089 and 15,760,782 shares of common stock at June 30, 2018, and December 31, 2017, respectively
 
(1,215
)
 
(852
)
Additional paid-in capital
 
1,001

 
1,013

Retained earnings
 
2,722

 
2,109

Accumulated other comprehensive loss
 
(543
)
 
(505
)
Total Zoetis Inc. equity
 
1,970

 
1,770

Equity attributable to noncontrolling interests
 
12

 
16

Total equity
 
1,982

 
1,786

Total liabilities and equity
 
$
8,603

 
$
8,586

(a) 
As of June 30, 2018, and December 31, 2017, includes $5 million and $6 million, respectively, of restricted cash.

See notes to condensed consolidated financial statements.
3 |

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

 
Zoetis
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated

 
Equity

 
 
 
 
 
 
 
 
Additional

 
 
 
Other

 
Attributable to

 
 
 
 
Common

 
Treasury

 
Paid-in

 
Retained

 
Comprehensive

 
Noncontrolling

 
Total

(MILLIONS OF DOLLARS)
 
Stock(a)

 
Stock(a)

 
Capital

 
Earnings

 
Loss

 
Interests

 
Equity

Balance, December 31, 2016
 
$
5

 
$
(421
)
 
$
1,024

 
$
1,477

 
$
(598
)
 
$
12

 
$
1,499

Six months ended July 2, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
—

 
—

 
—

 
485

 
—

 
1

 
486

Other comprehensive income
 
—

 
—

 
—

 
—

 
56

 
—

 
56

Consolidation of a noncontrolling interest(b)
 
—

 
—

 
—

 
—

 
—

 
18

 
18

Share-based compensation awards(c)
 
—

 
56

 
(1
)
 
(16
)
 
—

 
—

 
39

Treasury stock acquired(d)
 
—

 
(250
)
 
—

 
—

 
—

 
—

 
(250
)
Employee benefit plan contribution from Pfizer Inc.(e)
 
—

 
—

 
1

 
—

 
—

 
—

 
1

Dividends declared
 
—

 
—

 
—

 
(103
)
 
—

 
—

 
(103
)
Balance, July 2, 2017
 
$
5

 
$
(615
)
 
$
1,024

 
$
1,843

 
$
(542
)
 
$
31

 
$
1,746

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
 
$
5

 
$
(852
)
 
$
1,013

 
$
2,109

 
$
(505
)
 
$
16

 
$
1,786

Six months ended June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income/(loss)
 
—

 
—

 
—

 
736

 
—

 
(4
)
 
732

Other comprehensive income
 
—

 
—

 
—

 
—

 
(38
)
 
—

 
(38
)
Share-based compensation awards (c)
 
—

 
42

 
(13
)
 
(1
)
 
—

 
—

 
28

Treasury stock acquired(d)
 
—

 
(405
)
 
—

 
—

 
—

 
—

 
(405
)
Employee benefit plan contribution from Pfizer Inc.(e)
 
—

 
—

 
1

 
—

 
—

 
—

 
1

Dividends declared
 
—

 
—

 
—

 
(122
)
 
—

 
—

 
(122
)
Balance, June 30, 2018
 
$
5

 
$
(1,215
)
 
$
1,001

 
$
2,722

 
$
(543
)
 
$
12

 
$
1,982

(a) 
As of June 30, 2018, and July 2, 2017, there were 482,290,154 and 489,659,511 outstanding shares of common stock, respectively, and 19,601,089 and 12,231,732 shares of treasury stock, respectively. Treasury stock is recognized at the cost to reacquire the shares. For additional information, see Note 14. Stockholders' Equity.
(b) 
Represents the consolidation of a European livestock monitoring company, a variable interest entity of which Zoetis is the primary beneficiary.
(c)
Includes the issuance of shares of Zoetis Inc. common stock and the reissuance of treasury stock in connection with the vesting of employee share-based awards. Upon reissuance of treasury stock, differences between the proceeds from reissuance and the cost of the treasury stock that result in gains are recorded in Additional paid-in capital. Losses are recorded in Additional paid-in capital to the extent that they can offset previously recorded gains. If no such credit exists, the differences are recorded in Retained earnings. Also includes the reacquisition of shares of treasury stock associated with the vesting of employee share-based awards to satisfy tax withholding requirements. For additional information, see Note 13. Share-Based Payments and Note 14. Stockholders' Equity.
(d) 
Reflects the acquisition of treasury shares in connection with the share repurchase program. For additional information, see Note 14. Stockholders' Equity.
(e) 
Represents contributed capital from Pfizer Inc. associated with service credit continuation for certain Zoetis Inc. employees in Pfizer Inc.'s U.S. qualified defined benefit and U.S. retiree medical plans. See Note 12. Benefit Plans.




See notes to condensed consolidated financial statements.
4 |

ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Six Months Ended
 
 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Operating Activities
 
 
 
 
Net income before allocation to noncontrolling interests
 
$
732

 
$
486

Adjustments to reconcile net income before noncontrolling interests to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization expense
 
123

 
121

Share-based compensation expense
 
22

 
22

Restructuring
 
7

 
(1
)
Asset write-offs and asset impairments
 
7

 
—

Net loss on sale of assets
 
—

 
2

Provision for losses on inventory
 
25

 
40

Deferred taxes(a)
 
(155
)
 
13

Employee benefit plan contribution from Pfizer Inc.
 
1

 
1

Other non-cash adjustments
 
4

 
—

Other changes in assets and liabilities, net of acquisitions and divestitures
 
 
 
 
    Accounts receivable
 
(9
)
 
(41
)
    Inventories
 
(23
)
 
(46
)
    Other assets
 
(63
)
 
(106
)
    Accounts payable
 
(28
)
 
(66
)
    Other liabilities
 
(75
)
 
(147
)
    Other tax accounts, net(a)
 
88

 
21

Net cash provided by operating activities
 
656

 
299

Investing Activities
 
 
 
 
Purchases of property, plant and equipment
 
(126
)
 
(93
)
Acquisitions
 
—

 
(3
)
Net proceeds from sales of assets
 
8

 
1

Other investing activities
 
(3
)
 
7

Net cash used in investing activities
 
(121
)
 
(88
)
Financing Activities
 
 
 
 
Issuance of commercial paper
 
—

 
100

Payment of contingent consideration related to previously acquired assets
 
(12
)
 
(5
)
Share-based compensation-related proceeds, net of taxes paid on withholding shares
 
6

 
18

Purchases of treasury stock
 
(405
)
 
(250
)
Cash dividends paid
 
(122
)
 
(103
)
Net cash used in financing activities
 
(533
)
 
(240
)
Effect of exchange-rate changes on cash and cash equivalents
 
(8
)
 
7

Net increase/(decrease) in cash and cash equivalents
 
(6
)
 
(22
)
Cash and cash equivalents at beginning of period
 
1,564

 
727

Cash and cash equivalents at end of period
 
$
1,558

 
$
705

 
 
 
 
 
Supplemental cash flow information
 
 
 
 
Cash paid during the period for:
 
 
 
 
  Income taxes
 
$
221

 
$
256

  Interest, net of capitalized interest
 
96

 
82

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

 
3

  Dividends declared, not paid
 
61

 
52

(a) 
Reflects the reclassification of the one-time mandatory deemed repatriation tax from Noncurrent deferred tax liabilities to Income taxes payable and Other taxes payable to properly reflect the liability, which became a fixed obligation in 2018 payable over eight years.


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: vaccines, anti-infectives, 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 six-month periods ended May 31, 2018, and May 28, 2017.
Prior to fiscal 2018, the company followed a 13-week quarterly accounting cycle for each of the first three fiscal quarters. The company's fiscal year ends on December 31 for our operations in the United States and on November 30 for subsidiaries operating outside the United States. Beginning in fiscal 2018, the company's first three fiscal quarters will end on the last day of March, June and September in the United States and the last day of February, May and August for subsidiaries operating outside the United States. There is no change to the company's fiscal year-end dates. We did not adjust our results of operations for periods prior to 2018 as the impact was not material.
Revenue, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be representative of those for the full year.
We are responsible for the unaudited condensed consolidated financial statements included in this Form 10-Q. The condensed consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. The information included in this interim report should be read in conjunction with the financial statements and accompanying notes included in our 2017 Annual Report on Form 10-K.
3.
Accounting Standards
Recently Adopted Accounting Standards
In March 2018, the Financial Accounting Standards Board (FASB) issued an accounting standards update to align existing guidance on accounting for income taxes, pursuant to guidance provided by a Staff Accounting Bulletin published by the SEC on December 22, 2017. The update addresses the challenges in accounting for the effects of the Tax Cuts and Jobs Act (the Tax Act), enacted on December 22, 2017, in the period of enactment and required companies to report provisional amounts for those specific income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. Provisional amounts will be subject to adjustment during a measurement period of up to one year from the enactment date. For additional information, see Note 8. Income Taxes.
In August 2017, the FASB issued an accounting standards update which amends the hedge accounting recognition and presentation requirements
and is intended to better align hedge accounting with companies' risk management strategies. The standard eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires that the entire change in fair value of a hedging instrument be presented in the same income statement line item as the respective hedged item. The standard also modifies certain disclosure requirements. The provisions of the update are effective beginning January 1, 2019 for interim and annual periods with early adoption permitted for any interim period after issuance of the update. We elected to early adopt this guidance as of April 1, 2018. There were no hedging contracts in effect as of the date of adoption.
In March 2017, the FASB issued an accounting standards update to simplify and improve the reporting of net periodic pension benefit cost by requiring only present service cost to be presented in the same line item as other current employee compensation costs while remaining components of net periodic benefit cost would be presented within Other (income)/deductions—net outside of operations. We adopted this guidance as of January 1, 2018, the required effective date. The new standard did not have a significant impact on our consolidated financial statements.
In October 2016, the FASB issued an accounting standards update that requires the recognition of the income tax consequences of an intra-entity asset transfer, other than inventory, when the transfer occurs as opposed to when the asset is sold to an outside third party. We adopted this

6 |

guidance as of January 1, 2018, the required effective date. The new standard did not have a significant impact on our consolidated financial statements.
In May 2014, the FASB issued an accounting standards update that outlines a new, single comprehensive model for companies to use in accounting for revenue arising from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted this guidance as of January 1, 2018, the required effective date, using the modified retrospective adoption method. Prior period amounts have not been adjusted and continue to be reported in accordance with our historic accounting policies. Application of the standard using the modified retrospective method did not require an adjustment to opening retained earnings. For additional information, see Note 4. Revenue.
Recently Issued Accounting Standards
In February 2018, the FASB issued an accounting standards update which permits companies to reclassify from accumulated other comprehensive income to retained earnings stranded tax effects resulting from the new federal corporate income tax rate. In the period of adoption, a company may choose to either apply the amendments retrospectively to each period in which the effect of the change in federal income tax rate is recognized or to apply the amendments in that reporting period. The provisions of the update are effective beginning January 1, 2019 for interim and annual periods, with early adoption permitted for any interim period after issuance of the update. We are currently assessing the timing of our adoption and do not expect that the new standard will have a significant impact on our consolidated financial statements.
In February 2016, the FASB issued an accounting standards update which requires lessees to recognize most leases on the balance sheet with a corresponding right of use asset. Leases will be classified as financing or operating which will drive the expense recognition pattern. For lessees, the income statement presentation and expense recognition pattern for financing and operating leases is similar to the current model for capital and operating leases, respectively. Companies may elect to exclude short-term leases. The update also requires additional disclosures that will better enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We plan to adopt this guidance as of January 1, 2019, the required effective date, for annual and interim reporting periods. The new standard requires a modified retrospective adoption approach, at the beginning of the earliest comparative period presented in the financial statements. We have selected a lease accounting system which we are in the process of implementing, while continuing to evaluate our lease contracts, accounting policy elections, and the impact of adoption on our consolidated financial statements. While we do not expect adoption of the standard to have a significant impact on our consolidated statements of income, the impact on the assets and liabilities within our consolidated balance sheet may be material.
4.
Revenue
A.
Revenue from Product Sales
We offer a diversified portfolio of products which allows us to capitalize on local and regional customer needs. Generally, our products are promoted to veterinarians and livestock producers by our sales organization which includes sales representatives and technical and veterinary operations specialists, and then sold directly by us or through distributors. The depth of our product portfolio enables us to address the varying needs of customers in different species and geographies. Many of our top selling product lines are distributed across both of our operating segments, leveraging our R&D operations and manufacturing and supply chain network.
Over the course of our history, we have focused on developing a diverse portfolio of animal health products, including medicines and vaccines, complemented by biodevices, diagnostics, and genetics. We refer to a single product in all brands, or its dosage forms for all species, as a product line. We have approximately 300 comprehensive product lines, including products for both livestock and companion animals across each of our major product categories.
Our major product categories are:
•
vaccines: biological preparations that help prevent diseases of the respiratory, gastrointestinal and reproductive tracts or induce a specific immune response;
•
anti-infectives: products that prevent, kill or slow the growth of bacteria, fungi or protozoa;
•
other pharmaceutical products: allergy and dermatology, pain and sedation, antiemetic, reproductive, and oncology products;
•
parasiticides: products that prevent or eliminate external and internal parasites such as fleas, ticks and worms; and
•
medicated feed additives: products added to animal feed that provide medicines to livestock.
Our remaining revenue is derived from other non-pharmaceutical product categories, such as nutritionals and agribusiness, as well as products and services in complementary areas, including biodevices, diagnostics and genetics.
Our livestock products primarily help prevent or treat diseases and conditions to enable the cost-effective production of safe, high-quality animal protein. Human population growth and increasing standards of living are important long-term growth drivers for our livestock products in three major ways. First, population growth and increasing standards of living drive increased demand for improved nutrition, particularly animal protein. Second, population growth leads to increased natural resource constraints driving a need for enhanced productivity. Finally, as standards of living improve, there is increased focus on food quality and safety.
Our companion animal products help extend and improve the quality of life for pets; increase convenience and compliance for pet owners; and help veterinarians improve the quality of their care and the efficiency of their businesses. Growth in the companion animal medicines

7 |

and vaccines sector is driven by economic development, related increases in disposable income and increases in pet ownership and spending on pet care. Companion animals are also living longer, receiving increased medical treatment and benefiting from advances in animal health medicines and vaccines.
The following tables present our revenue disaggregated by geographic area, species, and major product category.
Revenue by geographic area
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

United States
 
$
677

 
$
623

 
$
1,311

 
$
1,228

Australia
 
51

 
43

 
99

 
83

Brazil
 
68

 
73

 
138

 
139

Canada
 
56

 
49

 
96

 
83

China
 
60

 
45

 
124

 
97

France
 
30

 
26

 
63

 
55

Germany
 
38

 
33

 
76

 
61

Italy
 
26

 
21

 
53

 
43

Japan
 
39

 
36

 
80

 
70

Mexico
 
26

 
21

 
50

 
39

Spain
 
30

 
23

 
55

 
43

United Kingdom
 
36

 
26

 
88

 
69

Other developed markets
 
89

 
76

 
168

 
144

Other emerging markets
 
179

 
162

 
364

 
323

 
 
1,405

 
1,257

 
2,765

 
2,477

 
 
 
 
 
 
 
 
 
Contract Manufacturing
 
10

 
12

 
16

 
23

 
 
 
 
 
 
 
 
 
Total Revenue
 
$
1,415

 
$
1,269

 
$
2,781

 
$
2,500

Revenue by major species
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

U.S.
 
 
 
 
 
 
 
 
Livestock
 
$
271

 
$
269

 
$
563

 
$
551

Companion Animal
 
406

 
354

 
748

 
677

 
 
677

 
623

 
1,311

 
1,228

International
 
 
 
 
 
 
 
 
Livestock
 
463

 
420

 
941

 
841

Companion Animal
 
265

 
214

 
513

 
408

 
 
728

 
634

 
1,454

 
1,249

 
 
 
 
 
 
 
 
 
Contract Manufacturing
 
10

 
12

 
16

 
23

 
 
 
 
 
 
 
 
 
Total Revenue
 
$
1,415

 
$
1,269

 
$
2,781

 
$
2,500


8 |

Revenue by species
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Livestock:
 
 
 
 
 
 
 
 
Cattle
 
$
396

 
$
382

 
$
812

 
$
768

Swine
 
165

 
148

 
340

 
308

Poultry
 
129

 
122

 
265

 
238

Fish
 
24

 
19

 
46

 
40

Other
 
20

 
18

 
41

 
38

 
 
734

 
689

 
1,504

 
1,392

Companion Animal:
 
 
 
 
 
 
 
 
Dogs and Cats
 
630

 
533

 
1,179

 
1,015

Horses
 
41

 
35

 
82

 
70

 
 
671

 
568

 
1,261

 
1,085

 
 
 
 
 
 
 
 
 
Contract Manufacturing
 
10

 
12

 
16

 
23

 
 
 
 
 
 
 
 
 
Total Revenue
 
$
1,415

 
$
1,269

 
$
2,781

 
$
2,500

Revenue by major product category
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Vaccines
 
$
371

 
$
324

 
$
727

 
$
643

Anti-infectives
 
286

 
278

 
583

 
546

Other pharmaceuticals
 
337

 
282

 
656

 
554

Parasiticides
 
245

 
206

 
436

 
390

Medicated feed additives
 
114

 
121

 
251

 
244

Other non-pharmaceuticals
 
52

 
46

 
112

 
100

 
 
1,405

 
1,257

 
2,765

 
2,477

 
 
 
 
 
 
 
 
 
Contract Manufacturing
 
10

 
12

 
16

 
23

 
 
 
 
 
 
 
 
 
Total Revenue
 
$
1,415

 
$
1,269

 
$
2,781

 
$
2,500

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

9 |

Although the amounts recorded for these revenue deductions are dependent on estimates and assumptions, historically our adjustments to actual results have not been material. The sensitivity of our estimates can vary by program, type of customer and geographic location.
A deferral of revenue may be required in the event that we have not satisfied all customer obligations for which we have been compensated. The transaction price is allocated to the individual performance obligations on the basis of relative stand-alone selling price, which is typically based on actual sales prices. Revenue associated with unsatisfied performance obligations are contract liabilities, is recorded within Other current liabilities, and is recognized once control of the underlying products has transferred to the customer. Contract liabilities reflected within Other current liabilities as of the adoption date and subsequently recognized as revenue during the first six months of 2018 were approximately $2 million. Contract liabilities as of June 30, 2018 were approximately $3 million.
We do not disclose the transaction price allocated to unsatisfied performance obligations related to contracts with an original expected duration of one year or less, or for contracts for which we recognize revenue in line with our right to invoice the customer. Estimated future revenue expected to be generated from long-term contracts with unsatisfied performance obligations as of June 30, 2018 are not material.
Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from Revenue. Shipping and handling costs incurred after control of the purchased product has transferred to the customer are accounted for as a fulfillment cost, within Selling, general and administrative expenses.
5.
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 February 12, 2016 sale of two of our manufacturing sites in the United Sates: Laurinburg, North Carolina, and Longmonth, Colorado to Huvepharma NV (Huvepharma), a European animal health company.
6.
Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives
In connection with our cost-reduction/productivity initiatives, we typically incur costs and charges associated with site closings and other facility rationalization actions, workforce reductions and the expansion of shared services, including the development of global systems. In connection with our acquisition activity, we typically incur costs and charges associated with executing the transactions, integrating the acquired operations, which may include expenditures for consulting and the integration of systems and processes, product transfers and restructuring the consolidated company, which may include charges related to employees, assets and activities that will not continue in the consolidated company. All operating functions can be impacted by these actions, including sales and marketing, manufacturing and research and development (R&D), as well as functions such as business technology, shared services and corporate operations.
During 2015, we launched a comprehensive operational efficiency program, which was incremental to the previously announced supply network strategy. These initiatives focused on reducing complexity in our product portfolios, changing our selling approach in certain markets, reducing our presence in certain countries, and exiting manufacturing sites over a long term period. We have also continued to optimize our resource allocation and efficiency by reducing resources associated with non-customer facing activities and operating more efficiently as a result of less internal complexity and more standardization of processes. The comprehensive operational efficiency program was substantially completed as of December 31, 2017. We expect to complete the supply network strategy over the next several years.
The components of costs incurred in connection with restructuring initiatives, acquisitions and cost-reduction/productivity initiatives are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

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

 
$
2

 
$
1

 
$
2

Restructuring charges/(reversals)(b)(c):
 
 
 
 
 
 
 
 
Employee termination costs/(reversals)
 
4

 
(3
)
 
5

 
(4
)
Exit costs
 
1

 
1

 
1

 
1

Total Restructuring charges/(reversals) and certain acquisition-related costs
 
$
5

 
$
—

 
$
7

 
$
(1
)
(a) 
Integration costs represent external, incremental costs directly related to integrating acquired businesses and primarily include expenditures for consulting and the integration of systems and processes, as well as product transfer costs.
(b) 
The restructuring charges for the three months ended June 30, 2018, are primarily related to:
•
employee termination costs of $3 million in Europe as a result of initiatives to better align our organizational structure, and
•
employee termination costs of $1 million and exit costs of $1 million as a result of our operational efficiency initiative and supply network strategy.
The restructuring charges for the six months ended June 30, 2018, are primarily related to:

10 |

•
employee termination costs of $3 million in Europe as a result of initiatives to better align our organizational structure, and
•
employee termination costs of $2 million and exit costs of $1 million as a result of our operational efficiency initiative and supply network strategy.
The restructuring charges/(reversals) for the three and six months ended July 2, 2017, primarily relate to our operational efficiency initiative and supply network strategy.
(c) 
The restructuring charges/(reversals) are associated with the following:
•
For the three months ended June 30, 2018, International of $4 million and Manufacturing/research/corporate of $1 million.
•
For the six months ended June 30, 2018, International of $4 million and Manufacturing/research/corporate of $2 million.
•
For the three months ended July 2, 2017, U.S. of ($1 million), International of $1 million and Manufacturing/research/corporate of ($2 million).
•
For the six months ended July 2, 2017, International of ($1 million) and Manufacturing/research/corporate of ($2 million).
Charges related to the operational efficiency initiative and supply network strategy are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Restructuring charges/(reversals) and certain acquisition-related costs:
 
 
 
 
 
 
 
 
Operational efficiency initiative
 
 
 
 
 
 
 
 
Employee termination costs
 
$
1

 
$
2

 
$
1

 
$
1

Exit costs
 
—

 
1

 
—

 
1

 
 
1

 
3

 
1

 
2

Supply network strategy:
 
 
 
 
 
 
 
 
Employee termination costs
 
—

 
(5
)
 
1

 
(5
)
Exit costs
 
1

 
—

 
1

 
—

 
 
1

 
(5
)
 
2

 
(5
)
 
 
 
 
 
 
 
 
 
Total restructuring charges/(reversals) related to the operational efficiency initiative and supply network strategy
 
2

 
(2
)
 
3

 
(3
)
 
 
 
 
 
 
 
 
 
Other operational efficiency initiative charges
 
 
 
 
 
 
 
 
    Selling, general and administrative expenses:
 
 
 
 
 
 
 
 
        Consulting fees
 
—

 
1

 
—

 
1

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

 
2

 
—

 
2

Total other operational efficiency initiative charges
 
—

 
3

 
—

 
3

 
 
 
 
 
 
 
 
 
Other supply network strategy charges
 
 
 
 
 
 
 
 
    Cost of sales:
 
 
 
 
 
 
 
 
        Accelerated depreciation
 
—

 
1

 
—

 
2

        Consulting fees
 
2

 
—

 
3

 
2

Total other supply network strategy charges
 
2

 
1

 
3

 
4

 
 
 
 
 
 
 
 
 
Total charges associated with the operational efficiency initiative and supply network strategy
 
$
4

 
$
2

 
$
6

 
$
4

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

 
 
 
 
 
 
Termination

 
Exit

 
 
(MILLIONS OF DOLLARS)
 
Costs

 
Costs

 
Accrual

Balance, December 31, 2017(a)
 
$
41

 
$
—

 
$
41

Provision
 
5

 
1

 
6

Utilization and other(b)
 
(12
)
 
(1
)
 
(13
)
Balance, June 30, 2018(a)
 
$
34

 
$
—

 
$
34

(a)  
At June 30, 2018, and December 31, 2017, included in Accrued expenses ($12 million and $19 million, respectively) and Other noncurrent liabilities ($22 million and $22 million, respectively).
(b)  
Includes adjustments for foreign currency translation.

11 |

7.
Other (Income)/Deductions—Net
The components of Other (income)/deductions—net are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Royalty-related income
 
$
(6
)
 
$
(5
)
 
$
(13
)
 
$
(12
)
Net loss/(gain) on sale of assets(a)
 
—

 
2

 
—

 
2

Certain legal and other matters, net(b)
 
—

 
(4
)
 
—

 
(4
)
Foreign currency loss(c)
 
9

 
8

 
17

 
10

Other, net(d)
 
(7
)
 
(3
)
 
(13
)
 
(8
)
Other (income)/deductions—net
 
$
(4
)
 
$
(2
)
 
$
(9
)
 
$
(12
)
(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.
(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 three and six months ended June 30, 2018, primarily includes interest 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.
8.
Income Taxes
A.
Taxes on Income
On December 22, 2017, the Tax Act was enacted which, among other changes, reduced the U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018. The Tax Act made broad and complex changes to the U.S. tax code and it will take time to fully analyze the impact of the changes. Based on the information available at that time, and the current interpretation of the Tax Act, for the year ended December 31, 2017 the company was able to make a reasonable estimate and recorded an initial provisional net tax expense of $212 million related to the one-time mandatory deemed repatriation tax, payable over eight years, partially offset by the remeasurement of the deferred tax assets and liabilities, as of the date of enactment, due to the reduction in the U.S. federal corporate tax rate. Pursuant to the Staff Accounting Bulletin published by the SEC on December 22, 2017, addressing the challenges in accounting for the effects of the Tax Act in the period of enactment, companies must report provisional amounts for those specific income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. Those provisional amounts will be subject to adjustment during a measurement period of up to one year from the enactment date (measurement-period adjustment). Pursuant to this guidance, the estimated impact of the Tax Act was based on a preliminary review of the new tax law and projected future financial results and is subject to revision based upon further analysis and interpretation of the Tax Act and to the extent that future results differ from currently available projections.
Our accounting for the following elements of the Tax Act is incomplete. However, in 2018 we were able to further refine our initial reasonable estimate and adjusted the initial provisional net tax expense of $212 million. We recorded the following measurement-period adjustments of $33 million and $35 million net tax benefit during the three and six months ended June 30, 2018, respectively:
•
One-Time Mandatory Deemed Repatriation Tax: The one-time mandatory deemed repatriation tax is imposed on certain previously untaxed accumulated and current earnings and profits (E&P) of our foreign subsidiaries. We were able to reasonably estimate the one-time mandatory deemed repatriation tax and recorded an initial provisional tax obligation, with a corresponding adjustment to income tax expense for the year ended December 31, 2017. We are continuing to gather additional information to more precisely compute the amount of the one-time mandatory deemed repatriation tax, and our accounting for this item is not yet complete due to the fact that the non-U.S. subsidiaries are on a fiscal year ending November 30, and this tax liability will not become a fixed obligation until November 30, 2018. The estimated impact of the Tax Act is based on a preliminary review of the new law and projected future financial results and is subject to revision based upon further analysis and interpretation of the Tax Act and to the extent that future results differ from currently available projections. However, on the basis of revised computations that were calculated during the reporting period, we recognized a measurement-period adjustment of $33 million and $35 million for the three and six months ended June 30, 2018, respectively, as a decrease to the one-time mandatory deemed repatriation tax obligation, with a corresponding adjustment to income tax benefit during the period. The effect of the measurement-period adjustment to the three and six months ended June 30, 2018 effective tax rate was a reduction to the rate of approximately 7.5% and 4.1%, respectively. In addition, we reclassified the one-time mandatory deemed repatriation tax from Noncurrent deferred tax liabilities to Income taxes payable and Other taxes payable. We expect to complete our accounting within the prescribed measurement period.
•
Reduction of U.S. Federal Corporate Tax Rate: The Tax Act reduced the corporate tax rate to 21%, effective January 1, 2018. Consequently, we recorded a decrease related to deferred tax assets and liabilities with a corresponding net adjustment to deferred income tax benefit for the year ended December 31, 2017. We have not made any measurement-period adjustments related to this item during the first half of 2018. Since the company has recorded provisional amounts related to certain portions of the Tax Act, any corresponding deferred tax remeasurement is also provisional. However, we are continuing to gather additional information to complete our accounting for this item and expect to be completed within the prescribed measurement period.

12 |

•
Valuation Allowances: The company must assess whether its valuation allowance analyses are affected by the various aspects of the Tax Act (e.g., one-time mandatory deemed repatriation of deferred foreign income, global intangible low-taxed income inclusions, and new categories of foreign tax credits). We have not made any measurement-period adjustments related to this item during the first half of 2018. Since the company has recorded provisional amounts related to certain portions of the Tax Act, any corresponding determination of the need for or change in a valuation allowance is also provisional. However, we are continuing to gather additional information to complete our accounting for this item and expect to be completed within the prescribed measurement period.
•
Global Intangible Low-Taxed Income (GILTI) Policy Election: The GILTI provisions of the Tax Act do not apply to the company until 2019, due to the fact that the non-U.S. subsidiaries are on a fiscal year ending November 30, and we are still evaluating its impact. The FASB allows companies to adopt an accounting policy to either recognize deferred taxes for GILTI or treat such tax cost as a current-period expense when incurred. We have not yet determined our accounting policy because determining the impact of the GILTI provisions requires analysis of our existing legal entity structure, the reversal of our U.S. GAAP and U.S. tax basis differences in the assets and liabilities of our foreign subsidiaries, and our ability to offset any tax with foreign tax credits. As such, we have not made a policy decision whether to record deferred taxes on GILTI or treat such tax cost as a current-period expense.
The effective tax rate was 12.6% for the three months ended June 30, 2018, compared with 28.4% for the three months ended July 2, 2017. The lower effective tax rate for the three months ended June 30, 2018, was primarily attributable to:
•
the reduction of the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018, pursuant to the Tax Act;
•
a $33 million net discrete tax benefit recorded in the second quarter of 2018, associated with a measurement-period adjustment related to the provisional one-time mandatory deemed repatriation tax on the company's undistributed non-U.S. earnings pursuant to the Tax Act enacted on December 22, 2017;
•
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; and
•
a $1 million and $2 million discrete tax benefit recorded in the second quarter of 2018 and 2017, respectively, related to the excess tax benefits for share-based payments.
The effective tax rate was 14.3% for the six months ended June 30, 2018, compared with 28.7% for the six months ended July 2, 2017. The lower effective tax rate for the six months ended June 30, 2018, was primarily attributable to:
•
the reduction of the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018, pursuant to the Tax Act;
•
a $35 million net discrete tax benefit recorded in the first half of 2018, associated with a measurement-period adjustment related to the provisional one-time mandatory deemed repatriation tax on the company's undistributed non-U.S. earnings pursuant to the Tax Act enacted on December 22, 2017;
•
changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings from operations and repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and operating fluctuations in the normal course of business and the impact of non-deductible items;
•
an $8 million and $7 million discrete tax benefit recorded in the first half of 2018 and 2017, respectively, related to the excess tax benefits for share-based payments; and
•
an $8 million and $3 million discrete tax benefit recorded in the first half of 2018 and 2017, respectively, related to a remeasurement of deferred taxes as a result of a change in non-U.S. statutory tax rates.
B.
Deferred Taxes
As of June 30, 2018, the total net deferred income tax liability of $149 million is included in Noncurrent deferred tax assets ($80 million) and Noncurrent deferred tax liabilities ($229 million).
As of December 31, 2017, the total net deferred income tax liability of $300 million is included in Noncurrent deferred tax assets ($80 million) and Noncurrent deferred tax liabilities ($380 million).
The change in Noncurrent deferred tax liabilities was primarily due to the reclassification of the one-time mandatory deemed repatriation tax from Noncurrent deferred tax liabilities to Income taxes payable and Other taxes payable to properly reflect the liability, which became a fixed obligation in 2018, payable over eight years.
C.
Tax Contingencies
As of June 30, 2018, the tax liabilities associated with uncertain tax positions of $182 million (exclusive of interest and penalties related to uncertain tax positions of $11 million) are included in Noncurrent deferred tax assets ($4 million) and Other taxes payable ($178 million).
As of December 31, 2017, the tax liabilities associated with uncertain tax positions of $164 million (exclusive of interest and penalties related to uncertain tax positions of $11 million) are included in Noncurrent deferred tax assets ($3 million) and Other taxes payable ($161 million).
Our tax liabilities for uncertain tax positions relate primarily to issues common among multinational corporations. Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Substantially all of these unrecognized tax benefits, if recognized, would impact our effective income tax rate. We do not expect that within the next twelve months any of our uncertain tax positions could significantly decrease as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are

13 |

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.
9.
Financial Instruments
A.
Debt
Credit Facilities
In December 2016, we entered into an amended and restated revolving credit agreement with a syndicate of banks providing for a five-year $1.0 billion senior unsecured revolving credit facility (the credit facility). In December 2017, the maturity for the amended and restated revolving credit agreement was extended through December 2022. Subject to certain conditions, we have the right to increase the credit facility to up to $1.5 billion. The credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio (the ratio of consolidated net debt as of the end of the period to consolidated Earnings Before Interest, Income Taxes, Depreciation and Amortization (EBITDA) for such period) of 3.50:1. Upon entering into a material acquisition, the maximum total leverage ratio increases to 4.00:1, and extends until the fourth full consecutive fiscal quarter ended immediately following the consummation of a material acquisition. The credit facility also contains a clause which adds back to Adjusted Consolidated EBITDA, any operational efficiency restructuring charge (defined as charges recorded by the company during the period commencing on October 1, 2016 and ending December 31, 2019, related to operational efficiency initiatives), provided that for any twelve-month period such charges added back to Adjusted Consolidated EBITDA shall not to exceed $100 million in the aggregate.
The credit facility also contains a financial covenant requiring that we maintain a minimum interest coverage ratio (the ratio of EBITDA at the end of the period to interest expense for such period) of 3.50:1. In addition, the credit facility contains other customary covenants.
We were in compliance with all financial covenants as of June 30, 2018, and December 31, 2017. There were no amounts drawn under the credit facility as of June 30, 2018, or December 31, 2017.
We have additional lines of credit and other credit arrangements with a group of banks and other financial intermediaries for general corporate purposes. We maintain cash and cash equivalent balances in excess of our outstanding short-term borrowings. As of June 30, 2018, we had access to $61 million of lines of credit which expire at various times throughout 2018 and 2019 and are generally renewed annually. We did not have any borrowings outstanding related to these facilities as of June 30, 2018, and December 31, 2017.
Commercial Paper Program and Other Short-Term Borrowings
In February 2013, we entered into a commercial paper program with a capacity of up to $1.0 billion. As of June 30, 2018, and December 31, 2017, there was no commercial paper outstanding under this program. As of June 30, 2018, and December 31, 2017, we did not have any other short-term borrowings outstanding.
Senior Notes and Other Long-Term Debt
On September 12, 2017, we issued $1.25 billion aggregate principal amount of our senior notes (2017 senior notes), with an original issue discount of $7 million. These notes are comprised of $750 million aggregate principal amount of 3.000% senior notes due 2027 and $500 million aggregate principal amount of 3.950% senior notes due 2047. Net proceeds from this offering were partially used in October 2017 to repay, prior to maturity, the aggregate principal amount of $750 million, and a make-whole amount and accrued interest of $4 million, of our 1.875% senior notes due 2018. The remainder of the net proceeds will be used for general corporate purposes.
On November 13, 2015, we issued $1.25 billion aggregate principal amount of our senior notes (2015 senior notes), with an original issue discount of $2 million. On January 28, 2013, we issued $3.65 billion aggregate principal amount of our senior notes (the 2013 senior notes offering) in a private placement, with an original issue discount of $10 million.
The 2013, 2015 and 2017 senior notes are governed by an indenture and supplemental indenture (collectively, the indenture) between us and Deutsche Bank Trust Company Americas, as trustee. The indenture contains certain covenants, including limitations on our and certain of our subsidiaries' ability to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets. In addition, the indenture contains other customary terms, including certain events of default, upon the occurrence of which the 2013, 2015 and 2017 senior notes may be declared immediately due and payable.
Pursuant to the indenture, we are able to redeem the 2013, 2015 and 2017 senior notes, in whole or in part, at any time by paying a “make whole” premium, plus accrued and unpaid interest to, but excluding, the date of redemption. Pursuant to our tax matters agreement with Pfizer, we will not be permitted to redeem the 2013 senior notes due 2023 pursuant to this optional redemption provision, except under limited circumstances. Upon the occurrence of a change of control of us and a downgrade of the 2013, 2015 and 2017 senior notes below an investment grade rating by each of Moody's Investors Service, Inc. and Standard & Poor's Ratings Services, we are, in certain circumstances, required to make an offer to repurchase all of the outstanding 2013, 2015 and 2017 senior notes at a price equal to 101% of the aggregate principal amount of the 2013, 2015 and 2017 senior notes together with accrued and unpaid interest to, but excluding, the date of repurchase.

14 |

The components of our long-term debt are as follows:
 
 
June 30,

 
December 31,

(MILLIONS OF DOLLARS)
 
2018

 
2017

3.450% 2015 senior notes due 2020
 
$
500

 
$
500

3.250% 2013 senior notes due 2023
 
1,350

 
1,350

4.500% 2015 senior notes due 2025
 
750

 
750

3.000% 2017 senior notes due 2027
 
750

 
750

4.700% 2013 senior notes due 2043
 
1,150

 
1,150

3.950% 2017 senior notes due 2047
 
500

 
500

 
 
5,000

 
5,000

Unamortized debt discount / debt issuance costs
 
(45
)
 
(47
)
Long-term debt, net of discount and issuance costs
 
$
4,955

 
$
4,953

The fair value of our long-term debt was $4,994 million and $5,291 million as of June 30, 2018, and December 31, 2017, respectively, and has been determined using a third-party matrix-pricing model that uses significant inputs derived from, or corroborated by, observable market data and Zoetis’ credit rating (Level 2 inputs).
The principal amount of long-term debt outstanding, as of June 30, 2018, matures in the following years:
 
 
 
 
 
 
 
 
 
 
After

 
 
(MILLIONS OF DOLLARS)
 
2019

 
2020

 
2021

 
2022

 
2022

 
Total

Maturities
 
$
—

 
$
500

 
$
—

 
$
—

 
$
4,500

 
$
5,000

Interest Expense
Interest expense, net of capitalized interest, was $46 million and $93 million, for the three and six months ended June 30, 2018, respectively, and $41 million and $82 million, for the three and six months ended July 2, 2017, respectively. Capitalized interest expense was $2 million and $4 million for the three and six months ended June 30, 2018, respectively, and $1 million and $2 million for the three and six months ended July 2, 2017, respectively.
B.
Derivative Financial Instruments
Foreign Exchange Risk
A significant portion of our revenue, earnings and net investment in foreign affiliates is exposed to changes in foreign exchange rates. We seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenue in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Depending on market conditions, foreign exchange risk is also managed through the use of various derivative financial instruments. These derivative financial instruments serve to manage the exposure of our net investment in certain foreign operations to changes in foreign exchange rates and protect net income against the impact of translation into U.S. dollars of certain foreign exchange-denominated transactions.
All derivative financial instruments 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 derivative financial instruments primarily offset exposures in the Australian dollar, Brazilian real, British pound, Canadian dollar, Chinese renminbi, euro, and Norwegian krone. Changes in fair value are reported in earnings or in Accumulated other comprehensive income/(loss), depending on the nature and purpose of the financial instrument, as follows:
•
For foreign exchange contracts not designated 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.
•
For cross-currency interest rate swaps, which are designated as a hedge against our net investment in foreign operations, changes in the fair value are deferred as a component of cumulative translation adjustment within Accumulated other comprehensive loss and reclassified into earnings when the foreign investment is sold or substantially liquidated. Gains and losses excluded from the assessment of hedge effectiveness are recognized in earnings (Interest expense—net of capitalized interest). The impact of the periodic exchange of interest payments is reflected within the operating section of our condensed consolidated statement of cash flows.
The aggregate notional amount of foreign exchange derivative financial instruments offsetting foreign currency exposures was $1.3 billion and $1.4 billion, as of June 30, 2018, and December 31, 2017, respectively. The vast majority of the foreign exchange derivative financial instruments mature within 60 days and all mature within 270 days. The aggregate notional amount of cross-currency interest rate swap contracts was 225 million euro as of June 30, 2018, with a term of up to seven years. We did not have any cross-currency interest rate swap contracts as of December 31, 2017.

15 |

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. Unrealized gains or losses on the forward-starting interest rate swaps are reported in Accumulated other comprehensive loss and are recognized in earnings over the life of the future fixed-rate notes. When the company discontinues hedge accounting because it is no longer probable that an anticipated transaction will occur within the originally expected period of execution, or within an additional two-month period thereafter, changes to fair value accumulated in other comprehensive income are recognized immediately in earnings. There were no outstanding interest rate swap contracts as of both June 30, 2018, and December 31, 2017.
Fair Value of Derivative Instruments
The classification and fair values of derivative instruments are as follows:
 
 
Fair Value of Derivatives
 
 
June 30,

 
December 31,

(MILLIONS OF DOLLARS)
Balance Sheet Location
2018

 
2017

Derivatives Not Designated as Hedging Instruments
 
 
 
 
   Foreign currency forward-exchange contracts
Other current assets
$
20

 
$
10

   Foreign currency forward-exchange contracts
Other current liabilities 
(8
)
 
(9
)
Total derivatives not designated as hedging instruments
 
$
12

 
$
1

 
 
 
 
 
Derivatives Designated as Hedging Instruments:
 
 
 
 
   Cross-currency interest rate swap contracts
Other non-current assets
$
1

 
$
—

Total derivatives designated as hedging instruments
 
1

 
—

 
 
 
 
 
Total derivatives
 
$
13

 
$
1

The company’s cross-currency interest rate swaps are subject to master netting arrangements to mitigate credit risk by permitting net settlement of transactions with the same counterparty. We may also enter into collateral security arrangements with certain of our counterparties to exchange cash collateral when the net fair value of certain derivative instruments fluctuates from contractually established thresholds. At June 30, 2018, there was no collateral posted related to our derivatives.
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
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Foreign currency forward-exchange contracts
 
$
10

 
$
7

 
$
—

 
$
(22
)
These amounts were substantially offset in Other (income)/deductions—net by the effect of changing exchange rates on the underlying foreign currency exposures.
The amounts of unrecognized net gains/(losses) on cross-currency interest rate swap contracts, recorded, net of tax, in Accumulated other comprehensive income/(loss), are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Cross-currency interest rate swap contracts
 
$
1

 
$
—

 
$
1

 
$
—

Gains/(losses) on cross-currency interest rate swap contracts, recognized within Interest expense, net of capitalized interest, are as follows;
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,

 
July 2,

 
June 30,

 
July 2,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Cross-currency interest rate swap contracts
 
$
1

 
$
—

 
$
1

 
$
—


16 |

The net amount of deferred gains/(losses) related to derivative instruments designated as cash flow hedges that is expected to be reclassified from Accumulated other comprehensive loss into earnings over the next 12 months is insignificant.
10.
Inventories
The components of inventory are as follows:
 
 
June 30,

 
December 31,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Finished goods
 
$
768

 
$
788

Work-in-process
 
492

 
484

Raw materials and supplies
 
160

 
155

Inventories
 
$
1,420

 
$
1,427

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

 
International

 
Total

Balance, December 31, 2017