Acquisitions and Divestitures

6 Months Ended

Jun. 30, 2019

Business Combinations [Abstract]

Acquisitions and Divestitures

we completed the acquisition of Abaxis, Inc. (Abaxis), a California corporation and a leader in the development, manufacture and marketing of diagnostic instruments for veterinary point-of-care services. We acquired all of the outstanding common shares of Abaxis for $83.00 per share in cash resulting in Abaxis becoming our wholly owned subsidiary. The acquisition enhances our presence in animal health diagnostics.

The acquisition date fair value of the consideration transferred was approximately $1,962 million, which consisted of the following:

(MILLIONS OF DOLLARS)	Amounts
Cash paid to Abaxis' shareholders(a)	$	1,898
Cash paid for equity awards attributable to pre-merger services(b)	54
Fair value of Zoetis equity awards issued in exchange for outstanding Abaxis equity awards pertaining to pre-merger service(c)	10
Total consideration	$	1,962

^(a)  Represents cash paid for cancellation and conversion of each outstanding share of Abaxis' common stock at the acquisition date.

^(b)  Represents cash paid for cancellation and settlement of restricted stock awards that fully vested in July 2018 as a result of service or pre-existing change-in-control provisions and termination provisions. Includes certain awards that were settled in cash during the first quarter of 2019.

^(c)  Represents the fair value of replacement awards issued for Abaxis equity awards outstanding immediately before the acquisition and attributable to the service period prior to the acquisition. The previous Abaxis equity awards were converted into the Zoetis equity awards at an exchange ratio based on the closing prices of shares of Zoetis common stock and Abaxis common stock for ten full trading days before the closing of the acquisition.

The acquisition has been accounted for as a business combination with the assets acquired and liabilities assumed measured at fair value as of the acquisition date, primarily using Level 3 inputs, except for investments in debt securities which were valued using Level 2 inputs.

During the six months ended June 30, 2019, the company recorded additional measurement period adjustments which were made to reflect the facts and circumstances in existence as of the acquisition date. These adjustments include a reduction to Identifiable intangible assets and Noncurrent deferred tax liabilities of $1 million each with a corresponding offset to goodwill. These measurement period adjustments were primarily attributable to changes in preliminary valuation assumptions, including market participant estimates of cash flows as well as other initial estimates and the finalization of legal entity fair values. The valuation was finalized during the second quarter of 2019. The final fair values allocated to Abaxis' assets and liabilities as of the acquisition date, are reflected in the table below.

(MILLIONS OF DOLLARS)	Amounts
Cash and cash equivalents	$	64
Short term investments(a)	107
Accounts receivable(b)	30
Inventories(c)	79
Other current assets	6
Property, plant and equipment(d)	54
Identifiable intangible assets(e)	894
Other noncurrent assets	29
Accounts payable	(21)
Accrued compensation and related items	(10)
Other current liabilities	(22)
Other noncurrent liabilities	(11)
Noncurrent deferred tax liabilities(f)	(214)
Total net assets acquired	985
Goodwill(g)	977
Total consideration	$	1,962

^(a)  Short term investments include investments in debt securities that are classified as available-for-sale and measured at fair value.

^(b)  The fair value approximates the gross contractual amount of accounts receivable. The contractual amount not expected to be collected is immaterial.

^(c)  Acquired inventory is comprised of finished goods, work in process and raw materials. The fair value of finished goods was determined based on net realizable value adjusted for the costs of the selling effort, a reasonable profit allowance for the selling effort, and estimated holding costs. The fair value of work in process was determined based on net realizable value adjusted for costs to complete the manufacturing process, costs of the selling effort, a reasonable profit allowance for the remaining manufacturing and selling effort, and an estimate of holding costs. The fair value of raw materials was determined to approximate book value.

^(d)  Property, plant and equipment is comprised of machinery and equipment, furniture and fixtures, computer equipment, leasehold improvements and construction in progress. The fair value was primarily determined using a reproduction/replacement cost approach which measures the value of an asset by estimating the cost to acquire or construct comparable assets adjusted for age and condition of the asset.

^(e)  Identifiable intangible assets primarily consist of developed technology rights, customer relationships, and trademarks and tradenames. The fair value of identifiable intangible assets is determined using the income approach, which includes a forecast of expected future cash flows. For additional information regarding identifiable intangible assets, see Note 12. Goodwill and Other Intangible Assets.

^(f)  The acquisition was structured as a stock purchase and therefore we assumed the historical tax basis of Abaxis' assets and liabilities. The deferred tax effects resulting from the acquisition include the expected federal, state, and foreign tax consequences associated with temporary differences between the fair values of the assets acquired and liabilities assumed and the respective tax basis. The components of the Abaxis net deferred tax liability are included within amounts reported in Note 8. Income Taxes.

^(g)  Goodwill represents the excess of consideration transferred over the of fair values of the assets acquired and liabilities assumed. It is allocated to our existing reportable segments and is primarily attributable to the future potential of the technology platforms, as well as cost and revenue synergies including

market share capture, elimination of cost redundancies and gain of cost efficiencies, and intangible assets such as assembled workforce which are not separately recognizable. The primary strategic purpose of the acquisition was to enhance the company’s existing product portfolio by strengthening Zoetis’ presence in veterinary diagnostics. The goodwill recorded is not deductible for tax purposes.

The company incurred acquisition related costs of approximately $22 million and $27 million for the three and six months ended June 30, 2019, respectively, which are included within Restructuring charges and certain acquisition-related costs on our condensed consolidated statements of income.

Supplemental Pro Forma Information (Unaudited):

The following table provides unaudited supplemental pro forma financial information as if the acquisition of Abaxis had occurred on January 1, 2017.

	Three Months Ended		Six Months Ended
(MILLIONS OF DOLLARS)	June 30, 2018
Revenue	$	1,483	$	2,916
Net income attributable to Zoetis Inc.	353		676

The supplemental pro forma financial information has been prepared using the acquisition method of accounting and is based on the historical financial information of Zoetis and Abaxis. The supplemental pro forma financial information does not necessarily represent what the combined company’s revenue or results of operations would have been had the acquisition been completed on January 1, 2017, nor do they intend to be a projection of future operating results of the combined company. It also does not reflect any operating efficiencies or potential cost savings that might be achieved from synergies of combining Zoetis and Abaxis.

The unaudited supplemental pro forma financial information reflects primarily the following pro forma adjustments:

• Additional amortization expense of $31 million for the three months ended June 30, 2018 and $64 million for the six months ended June 30, 2018, related to the fair value of identified intangible assets acquired.

• Additional depreciation expense of $1 million for the three months ended June 30, 2018 and $2 million for the six months ended June 30, 2018, related to the fair value adjustments to property, plant and equipment acquired.

• Additional interest expense and amortization of debt issuance costs for the debt issuance to finance the acquisition, resulting in $14 million added for the three months ended June 30, 2018 and $29 million added for the six months ended June 30, 2018.

• Adjustment related to the post merger share-based compensation expense of the replacement awards is $2 million for the three months ended June 30, 2018 and $5 million for the six months ended June 30, 2018.

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Applicable tax impact of the above adjustments based on the statutory tax rates in the various jurisdictions where the adjustments are expected to be incurred.