Introduction
Our MD&A is provided in addition to the accompanying condensed consolidated financial statements and notes to assist readers in understanding the results of operations, comprehensive income, financial condition and cash flows of Zoetis Inc. (Zoetis). This MD&A is organized as follows:
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Section
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Description
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Page
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Overview of our business
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A general description of our business and the industry in which we operate. For more information regarding our business and the animal health industry, see
Item 1. Business
of our 2013 Annual Report on Form 10-K.
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Our operating environment
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Information regarding the animal health industry and factors that affect our company.
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Comparability of historical results and our relationship with Pfizer
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Information about the limitations of the predictive value of the condensed consolidated financial statements.
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Analysis of the condensed consolidated statements of income
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Consists of the following for all periods presented:
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Revenue:
An analysis of our revenue in total.
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Costs and expenses
: A discussion about the drivers of our costs and expenses.
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Operating segment results
: A discussion of our revenue by operating segment and species and items impacting our earnings before income tax.
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Adjusted net income
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A discussion of adjusted net income, an alternative view of performance used by management. Adjusted net income is a non-GAAP financial measure.
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Our financial guidance for 2014
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A discussion of our 2014 financial guidance.
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Analysis of the condensed consolidated statements of comprehensive income
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An analysis of the components of comprehensive income for all periods presented.
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Analysis of the condensed consolidated balance sheets
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A discussion of changes in certain balance sheet accounts for all balance sheets presented.
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Analysis of the condensed consolidated statements of cash flows
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An analysis of the drivers of our operating, investing and financing cash flows for all periods presented.
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Analysis of financial condition, liquidity and capital resources
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An analysis of our ability to meet our short-term and long-term financing needs.
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New accounting standards
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Accounting standards that we have recently adopted, as well as those that recently have been issued, but not yet adopted.
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Forward-looking statements and factors that may affect future results
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A description of the risks and uncertainties that could cause actual results to differ materially from those discussed in forward-looking statements set forth in this MD&A relating to our financial and operating performance, business plans and prospects, strategic review, capital allocation and business-development plans. Such forward-looking statements are based on management's current expectations about future events, which are inherently susceptible to uncertainty and changes in circumstances.
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Overview of our business
We are a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. For more than 60 years, as a business unit of Pfizer Inc. (Pfizer) and now as an independent public company, we have been committed to enhancing the health of animals and bringing solutions to our customers who raise and care for them.
The animal health medicines and vaccines industry is characterized by meaningful differences in customer needs across different regions. As a result of these differences, among other things, we manage our operations through four geographic operating segments. Within each of these operating segments, we offer a diversified product portfolio for both livestock and companion animal customers in order to capitalize on local and regional trends and customer needs. Our four operating segments are the United States (U.S.), Europe/Africa/Middle East (EuAfME), Canada/Latin America (CLAR) and Asia/Pacific (APAC). See Notes to Condensed Consolidated Financial Statements—
Note 16. Segment and Other Revenue Information
.
We directly market our products to livestock producers and veterinarians located in approximately 70 countries across North America, Europe, Africa, Asia, Australia and Latin America, and are a market leader in nearly all of the major regions in which we operate. Through our efforts to establish an early and direct presence in many emerging markets, such as Brazil, China and India, we believe we are the largest animal health medicines and vaccines business as measured by revenue across emerging markets as a whole. In markets where we do not have a direct commercial presence, we generally contract with distributors that provide logistics and sales and marketing support for our products.
We believe our investments in the industry’s largest sales organization, including our extensive network of technical and veterinary operations specialists, our high-quality manufacturing and reliability of supply, and our long track record of developing products that meet customer needs, has led to enduring and valued relationships with our customers. Our research and development (R&D) efforts enable us to deliver innovative products to address unmet needs and evolve our product lines so they remain relevant for our customers.
A summary of our 2014 performance compared to the comparable 2013 period follows:
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Three Months Ended
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March 30,
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March 31,
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%
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(MILLIONS OF DOLLARS)
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2014
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2013
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Change
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Revenue
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$
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1,097
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$
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1,090
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1
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Net income attributable to Zoetis
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155
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140
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11
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Adjusted net income
(a)
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191
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179
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7
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(a)
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Adjusted net income is a non-GAAP financial measure. See the "Adjusted net income" section of this MD&A for more information.
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Our ownership
On February 6, 2013, an initial public offering (IPO) of our Class A common stock was completed, which represented approximately 19.8% of our total outstanding shares. On February 1, 2013, our Class A common stock began trading on the New York Stock Exchange under the symbol “ZTS.” Prior to and in connection with the IPO, we completed a $3.65 billion senior notes offering and Pfizer transferred to us substantially all of the assets and liabilities of their animal health business. On June 24, 2013, an exchange offer was completed whereby Pfizer shareholders exchanged a portion of Pfizer common stock for Zoetis common stock, resulting in the full separation of Zoetis and the disposal of Pfizer's entire ownership and voting interest in Zoetis. We refer to the transactions to separate our business from Pfizer, as described here and elsewhere in this quarterly report, as the "Separation."
Our operating environment
Industry
The animal health industry, which focuses on both livestock and companion animals, is a growing industry that impacts billions of people worldwide. The primary livestock species for the production of animal protein are cattle (both beef and dairy), swine, poultry, sheep and fish. Livestock health and production are essential to meeting the growing demand for animal protein of a global population. Factors influencing growth in demand for livestock medicines and vaccines include:
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human population growth and increasing standards of living, particularly in many emerging markets;
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increasing demand for improved nutrition, particularly animal protein;
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natural resource constraints, such as scarcity of arable land, fresh water and increased competition for cultivated land, resulting in fewer resources that will be available to meet this increased demand for animal protein; and
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increasing focus on food safety.
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The primary companion animal species are dogs, cats and horses. Health professionals indicate that companion animals improve the physical and emotional well-being of pet owners. Factors influencing growth in demand for companion animal medicines and vaccines include:
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economic development and related increases in disposable income, particularly in many emerging markets;
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increasing pet ownership; and
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companion animals living longer, increasing medical treatment of companion animals and advances in companion animal medicines and vaccines.
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Product development initiatives
Our future success depends on both our existing product portfolio and our pipeline of new products, including new products that we may develop through joint ventures and products that we are able to obtain through license or acquisition. We believe we are an industry leader in animal health R&D, with a track record of generating new products and product lifecycle developments. The majority of our R&D programs focus on product lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations.
Perceptions of product quality, safety and reliability
We believe that animal health medicines and vaccines customers value high-quality manufacturing and reliability of supply. The importance of quality and safety concerns to pet owners, veterinarians and livestock producers also contributes to animal health brand loyalty, which we believe often continues after the loss of patent-based and regulatory exclusivity. We depend on positive perceptions of the safety and quality of our products, and animal health products generally, by our customers, veterinarians and end-users.
The issue of the potential transfer of increased antibacterial resistance in bacteria from food-producing animals to human pathogens, and the causality of that transfer, are the subject of global scientific and regulatory discussion. Antibacterials refer to small molecules that can be used to treat or prevent bacterial infections and are a sub-categorization of the products that make up our anti-infectives and medicated feed additives portfolios. In some countries, this issue has led to government restrictions and bans on the use of specific antibacterials in some food-producing animals, regardless of the route of administration (topical, oral, intramuscular/subcutaneous injections, or intravenous). These restrictions are more prevalent in countries where animal protein is plentiful and governments are willing to take restrictive actions even when there is scientific uncertainty. Historically, antibacterials for livestock have represented a significant portion of our revenue.
In December 2013, the FDA announced final guidance establishing procedures for the voluntary phase out in the United States over a three-year period of the use of medically important antibacterials in animal feed for growth promotion in food production animals (medically important antibacterials include classes that are prescribed in animal and human health). The guidance provides for continued use of antibacterials in food producing animals for treatment, control and under certain circumstances for prevention of disease, all under the supervision of a veterinarian. We believe the impact of this FDA guidance on our financial performance will not be significant based on the overall diversity and breadth of our product portfolio of medicines, vaccines, and diagnostics serving eight core species.
We cannot predict whether antibacterial resistance concerns will result in additional restrictions or bans, expanded regulations or public pressure to discontinue or reduce use of antibacterials in food-producing animals.
Competition
The animal health industry is competitive. Although our business is the largest by revenue in the animal health medicines and vaccines industry, we face competition in the regions in which we operate. Principal methods of competition vary depending on the particular region, species, product category or individual product. Some of these methods include new product development, quality, price, service and promotion to veterinary professionals, pet owners and livestock producers. Our competitors include the animal health businesses of large pharmaceutical companies and specialty animal health businesses. In addition to competition from established market participants, there could be new entrants to the animal health medicines and vaccines industry in the future. In certain markets, we also compete with companies that produce generic products, but the level of competition from generic products varies from market to market. For example, the level of generic competition is higher in Europe and certain emerging markets than in the United States.
Quarterly Variability of Financial Results
Our quarterly financial results are subject to variability related to a number of factors including but not limited to: weather patterns, herd management decisions, economic conditions, regulatory actions, competitive dynamics, disease outbreaks, product and geographic mix, timing of price increases and timing of investment decisions.
Weather conditions and the availability of natural resources
The animal health industry and demand for many of our animal health products in a particular region are affected by weather conditions, as usage of our products follows varying weather patterns and weather-related pressures from pests, such as ticks. As a result, we may experience regional and seasonal fluctuations in our results of operations.
In addition, veterinary hospitals and practitioners depend on visits from and access to the animals under their care. Veterinarians’ patient volume and ability to operate could be adversely affected if they experience prolonged snow, ice or other severe weather conditions, particularly in regions not accustomed to sustained inclement weather. Furthermore, livestock producers depend on the availability of natural resources, including large supplies of fresh water. Their animals’ health and their ability to operate could be adversely affected if they experience a shortage of fresh water due to human population growth or floods, droughts or other weather conditions. In the event of adverse weather conditions or a shortage of fresh water, veterinarians and livestock producers may purchase less of our products.
For example, drought conditions could negatively impact, among other things, the supply of corn and the availability of grazing pastures. A decrease in harvested corn results in higher corn prices, which could negatively impact the profitability of livestock producers of cattle, pork and poultry. Higher corn prices and reduced availability of grazing pastures contributes to reductions in herd or flock sizes that in turn results in less spending on animal health products. As such, a prolonged drought could have a material adverse impact on our operating results and financial condition. Factors influencing the magnitude and timing of effects of a drought on our performance include, but may not be limited to, weather patterns and herd management decisions. The widespread drought which impacted parts of the United States during 2011, 2012, and in some regions in 2013, was considered the worst in many years and affected our performance in the United States market in 2012 and in the first half of 2013.
Disease outbreaks
Sales of our livestock products could be adversely affected by the outbreak of disease carried by animals. Outbreaks of disease may reduce regional or global sales of particular animal-derived food products or result in reduced exports of such products, either due to heightened export restrictions or import prohibitions, which may reduce demand for our products. Also, the outbreak of any highly contagious disease near our main production sites could require us to immediately halt production of our products at such sites or force us to incur substantial expenses in procuring raw materials or products elsewhere. Alternatively, sales of products that treat specific disease outbreaks may increase. For example, in 2012, we successfully launched a vaccine for horses against the deadly Hendra virus in Australia.
Beginning in 2013, there have been several reported cases of the H7N9 avian influenza virus in China. In late March 2013, the Chinese government reported the first case of the H7N9 avian influenza virus. Since that time, over 370 cases have been detected. We are closely monitoring the developments as this situation unfolds and currently believe the impact on our 2014 global revenue will not be significant. While
China continues to represent a growth opportunity for us, sales in this country represented less than 2% of our total revenue in 2013 and the majority was generated by our swine business.
In addition, since the
second quarter
of 2013 some producers in the United States have been experiencing an outbreak of the porcine epidemic diarrhea virus (PEDv). PEDv has existed in parts of Asia for many years. It is important to note that the virus, which affects piglets, does not create a food safety issue. We are committed to supporting pork producers in understanding and controlling PEDv, and we are partnering with the key stakeholders, including various academic institutions such as the University of Minnesota and Iowa State University. Since first reported in the United States in the second quarter of 2013, the disease has continued to spread and has now been reported in at least 30 U.S. states, Canada, Mexico, and parts of South America. According to recent reports, the outbreak has impacted up to 50% of the sows in the United States, and up to one-third of the sows in Mexico. Furthermore, during the first quarter of 2014, active cases of PEDv were reported in several new markets in Asia, including Japan, South Korea and Taiwan. We currently believe the impact of PEDv on our
2014
revenue will not be significant. However, we are closely monitoring the evolution of this on-going outbreak and its impact on the swine industry and on our 2014 revenue.
Foreign exchange rates
Significant portions of our revenue and costs are exposed to changes in foreign exchange rates. Our products are sold in more than 120 countries and, as a result, our revenues are influenced by changes in foreign exchange rates. For the
three months ended
March 30, 2014
, approximately
53%
of our revenue was denominated in foreign currencies. 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. As we operate in multiple foreign currencies, including the euro, the Brazilian real, the Australian dollar and other currencies, changes in those currencies relative to the U.S. dollar will impact our revenue, cost of goods and expenses, and consequently, net income. Exchange rate fluctuations may also have an impact beyond our reported financial results and directly impact operations. These fluctuations may affect the ability to buy and sell our goods and services between markets impacted by significant exchange rate variances. For the
three months ended
March 30, 2014
, approximately
47%
of our total revenue was in U.S. dollars. Our year-over-year revenue growth was unfavorably impacted by
3%
from changes in foreign currency values relative to the U.S. dollar.
On February 13, 2013, the Venezuelan government devalued its currency from a rate of 4.3 to 6.3 Venezuelan bolivars per U.S. dollar. We incurred a foreign currency loss of $9 million immediately on the devaluation as a result of remeasuring the local assets and liabilities, which is included in
Other (income)/deductions—net
for
three months ended
March 31, 2013
.
In the first quarter of 2014, the Venezuelan government expanded its exchange mechanisms, resulting in three official rates of exchange for the Venezuelan bolivar. As of March 31, 2014, those rates of exchange were the CENCOEX rate of 6.3; the SICAD I rate of 10.7; and the SICAD II rate of 50.86. We continue to use the CENCOEX rate of 6.3 to report our Venezuela financial position, results of operations and cash flows.
We will experience ongoing adverse impacts to earnings as our revenue, costs and expenses will be translated into U.S. dollars at lower rates. These impacts are not expected to be significant to our financial condition or results of operations. As of
March 30, 2014
, in Venezuela we had net monetary assets denominated in local currency of $32 million. During the first quarter of 2014, our revenue from Venezuela was approximately $13 million. We cannot predict whether there will be further devaluation of the Venezuelan bolivar or whether our use of the 6.3 rate will continue to be supported by evolving facts and circumstances.
Comparability of historical results and our relationship with Pfizer
During the periods prior to our IPO, we operated solely as a business unit of Pfizer. The combined financial statements prior to the IPO were derived from the consolidated financial statements and accounting records of Pfizer and include allocations for direct costs and indirect costs attributable to the operations of the animal health business of Pfizer. The combined financial statements do not purport to reflect what the results of operations, comprehensive income/(loss), financial position, equity or cash flows would have been had we operated as an independent public company during these periods. In addition, the historical combined financial statements may not be reflective of what our results of operations, comprehensive income/(loss), financial position, equity or cash flows might be in the future as an independent public company.
For a detailed description of the basis of presentation and an understanding of the limitations of the predictive value of the historical combined financial statements, see Notes to Condensed Consolidated Financial Statements—
Note 3. Basis of Presentation.
Our historical expenses are not necessarily indicative of the expenses we may incur in the future as an independent public company. With respect to support functions, for example, our historical combined financial statements include expense allocations for certain support functions that were provided on a centralized basis within Pfizer, such as expenses for business technology, facilities, legal, finance, human resources, and, to a lesser extent, business development, public affairs and procurement, among others. As part of the Separation, pursuant to agreements with Pfizer, Pfizer provides us with some of the services related to these functions on a transitional basis in exchange for agreed-upon fees, and we are incurring other costs to replace the services and resources that will not be provided by Pfizer. As an independent public company, our total costs related to such support functions may differ from the costs that were historically allocated to us from Pfizer.
We also expect to incur certain nonrecurring costs related largely to becoming an independent public company, including new branding (which includes changes to the manufacturing process for required new packaging), the creation of a standalone systems and infrastructure, site separation, certain legal registration and patent assignment costs and certain restructuring and other charges. In addition, we will also incur certain costs related to the completion of FDAH integration activities. We expect all of the aforementioned nonrecurring costs to range between approximately $165 million to $185 million in 2014. These estimates exclude the impact of any depreciation or amortization of capitalized separation expenditures.
Following the IPO, the equity awards previously granted to our employees by Pfizer continued to vest, and service with Zoetis counted as service with Pfizer for equity award purposes. On
June 24, 2013
, Pfizer completed the Exchange Offer whereby Pfizer disposed of all of its shares of Zoetis common stock owned by Pfizer. Pfizer accelerated the vesting of, and in some cases the settlement of, on a pro-rata basis, outstanding Pfizer RSUs, Total Shareholder Return Units (TSRUs) and Performance Share Awards (PSAs) previously granted to our employees, subject, in each case, to the requirements of Section 409A of the U.S. Internal Revenue Code, the terms of the 2004 Pfizer Stock Plan and the applicable award agreements and any outstanding deferral elections. In addition, unvested Pfizer stock options previously granted to our employees accelerated in full, and our employees generally have the ability to exercise the stock options until the earlier of (i) June 23, 2016 (
three
years from Pfizer's completion of the Exchange Offer), (ii) termination of their employment from Zoetis, or (iii) the expiration date of the stock option. Zoetis employees who held Pfizer stock options and were retirement eligible as of
June 24, 2013
will have the full term of the stock option to exercise.
Public company expenses
As a result of the IPO, we became subject to the reporting requirements of the Exchange Act and the Sarbanes-Oxley Act. We have established additional procedures and practices as an independent public company. As a result, we are incurring additional costs, including, but not limited to, internal audit, investor relations, stock administration and regulatory compliance costs.
Recent significant acquisitions and government-mandated divestitures
The assets, liabilities, operating results and cash flows of acquired businesses are included in our results commencing from their respective acquisition dates.
Delays in establishing new operating subsidiaries
Due to local regulatory and operational requirements in certain non-U.S. jurisdictions, the transfer to us of certain assets and liabilities of Pfizer's animal health business had not yet legally occurred as of the IPO Date. These assets and liabilities were not material to our consolidated financial statements, individually or in the aggregate. All expected subsidiaries have been established and the related assets and liabilities have transferred as of December 31, 2013.
Agreements with Pfizer
On February 6, 2013, we entered into a transitional services agreement with Pfizer whereby Pfizer agreed to provide us with various corporate support services. This agreement has a service commencement date of January 1, 2013 in the United States and December 1, 2012 for our international locations. In addition, we also entered into a master manufacturing and supply agreement with Pfizer on October 1, 2012, whereby we and Pfizer agreed to manufacture and supply products to each other commencing January 1, 2013. See Notes to Condensed Consolidated Financial Statements—
Note 17. Transactions and Agreements with Pfizer
for more information related to these and other agreements, including the related costs.
Analysis of the condensed consolidated statements of income
The following discussion and analysis of our statements of income should be read along with our condensed consolidated financial statements and the notes thereto included elsewhere in Part I, Item 1 of this Quarterly Report on Form 10-Q.
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Three Months Ended
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March 30,
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March 31,
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%
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(MILLIONS OF DOLLARS)
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2014
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2013
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Change
|
|
Revenue
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$
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1,097
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$
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1,090
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1
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Costs and expenses:
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Cost of sales
(a)
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379
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402
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(6
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)
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% of revenue
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35
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%
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37
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%
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Selling, general and administrative expenses
(a)
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356
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357
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—
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% of revenue
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32
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%
|
|
33
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%
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Research and development expenses
(a)
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87
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90
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(3
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)
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% of revenue
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8
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%
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8
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%
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Amortization of intangible assets
(a)
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15
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15
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—
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Restructuring charges and certain acquisition-related costs
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3
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7
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(57
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)
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Interest expense, net of capitalized interest
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29
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22
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32
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Other (income)/deductions—net
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1
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5
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(80
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)
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Income before provision for taxes on income
|
|
227
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192
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18
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% of revenue
|
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21
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%
|
|
18
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%
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Provision for taxes on income
|
|
72
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|
|
52
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|
38
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Effective tax rate
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31.7
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%
|
|
27.1
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%
|
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|
Net income before allocation to noncontrolling interests
|
|
155
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|
|
140
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|
|
11
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Less: Net income (loss) attributable to noncontrolling interests
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—
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|
|
—
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|
|
—
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|
Net income attributable to Zoetis
|
|
$
|
155
|
|
|
$
|
140
|
|
|
11
|
|
% of revenue
|
|
14
|
%
|
|
13
|
%
|
|
|
Certain amounts and percentages may reflect rounding adjustments.
|
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(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 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.
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Revenue
Three months ended March 30, 2014 vs. three months ended March 31, 2013
Total revenue
increased
by $
7 million
, or
1%
, in the first quarter of 2014 compared to the first quarter of 2013, reflecting higher operational revenue of $
40 million
or
4%
, comprised of 3% volume and 1% price. Operational results are defined as revenue excluding the impact of foreign exchange. Growth was driven by increased revenue in the U.S. segment as well as good performance in emerging markets, particularly Brazil and China. Total livestock sales increased 4% operationally, driven by strong sales of our swine and poultry portfolios. Total companion animal sales increased 3% operationally, driven by the introduction of Apoquel
®
in the U.S., UK and Germany, as well as the strong performance in Latin American countries due to the continued increase in the medicalization rates. Partially offsetting the increase in operating revenue was the
unfavorable
impact of foreign exchange, which decreased revenue by approximately $
33 million
, or
3%
, driven by the depreciation of certain international currencies, particularly the Brazilian Real, the Australian Dollar and the Japanese Yen.
Costs and Expenses
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Cost of sales
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
Cost of sales
(a)
|
|
$
|
379
|
|
|
$
|
402
|
|
|
(6
|
)
|
% of revenue
|
|
34.5
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%
|
|
36.9
|
%
|
|
|
Certain amounts and percentages may reflect rounding adjustments.
|
|
(a)
|
Allocation of corporate enabling functions were $3 million in the first quarter of 2013.
|
Three months ended March 30, 2014 vs. three months ended March 31, 2013
Cost of sales
decreased
by $
23 million
, or
6%
, in the first quarter of 2014 compared to the first quarter of 2013, primarily as a result of:
|
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•
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lower global manufacturing and supply costs as compared with 2013, reflective of incremental spend associated with the build-up of our operations throughout 2013, which will be most evident in the second half of 2014;
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•
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product and geographic mix; and
|
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|
•
|
favorable foreign exchange;
|
partially offset by:
|
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•
|
an increase in inventory obsolescence reserves in the first quarter of 2014.
|
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|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
Selling, general and administrative expenses
(a)
|
|
$
|
356
|
|
|
$
|
357
|
|
|
—
|
|
% of revenue
|
|
32
|
%
|
|
33
|
%
|
|
|
Certain amounts and percentages may reflect rounding adjustments.
|
|
(a)
|
Allocation of corporate enabling functions were $24 million in the first quarter of 2013.
|
Three months ended March 30, 2014 vs. three months ended March 31, 2013
Selling, general & administrative (SG&A) expenses
decreased
by $
1 million
in the first quarter of 2014 compared to the first quarter of 2013, primarily as a result of:
|
|
•
|
a reduction in the amount of one-time costs related to becoming an independent public company;
|
|
|
•
|
reduced marketing expense due primarily to the timing of spend, as compared with the first quarter of 2013; and
|
|
|
•
|
favorable foreign exchange;
|
partially offset by:
|
|
•
|
additional costs due to the build-up of our enabling functions and related costs post-separation from Pfizer; and
|
|
|
•
|
increased field selling and distribution expenses in certain regions due to higher sales and increased temperature-controlled supply chain costs.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development expenses
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
Research and development expenses
|
|
$
|
87
|
|
|
$
|
90
|
|
|
(3
|
)
|
% of revenue
|
|
8
|
%
|
|
8
|
%
|
|
|
Certain amounts and percentages may reflect rounding adjustments.
Three months ended March 30, 2014 vs. three months ended March 31, 2013
R&D expenses
decreased
by $
3 million
, or
3%
, in the first quarter of 2014 compared to the first quarter of 2013, primarily as a result of
|
|
•
|
lower expenses related to our research alliances R&D spend;
|
|
|
•
|
reduced spending on supplies and other indirect R&D expenses; and
|
|
|
•
|
savings associated with the closure of two R&D sites;
|
partially offset by:
|
|
•
|
an increase in direct project spend.
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of intangible assets
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
Amortization of intangible assets
|
|
$
|
15
|
|
|
$
|
15
|
|
|
—
|
Certain amounts and percentages may reflect rounding adjustments.
Three months ended March 30, 2014 vs. three months ended March 31, 2013
Amortization of intangible assets was flat in the first quarter of 2014 compared to the first quarter of 2013.
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring charges and certain acquisition-related costs
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
Restructuring charges and certain acquisition-related costs
|
|
$
|
3
|
|
|
$
|
7
|
|
|
(57
|
)
|
Certain amounts and percentages may reflect rounding adjustments.
In the first quarter of 2014, we recorded a restructuring charge of $2 million related to employee severance costs in EuAfME as a result of an initiative to reduce costs and better align the organizational structure. We may incur additional restructuring costs throughout 2014 as we finalize plans and programs.
Our acquisition-related costs primarily related to restructuring charges for employees, assets and activities that will not continue in the future as well as integration costs. The majority of these net restructuring charges are related to termination costs, but we also exited a number of distributor and other contracts and performed some facility rationalization efforts. Our integration costs are generally comprised of consulting costs related to the integration of systems and processes, as well as product transfer costs.
For additional information regarding restructuring charges and acquisition-related costs, see Notes to Condensed Consolidated Financial Statements—
Note 5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives
.
Three months ended March 30, 2014 vs. three months ended March 31, 2013
Restructuring charges and certain acquisition-related costs
decreased
by $
4 million
, or
57%
in the first quarter of 2014 compared to the first quarter of 2013 primarily as a result of the nonrecurrence of restructuring charges related to the integration of FDAH and KAH.
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net of capitalized interest
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
Interest expense, net of capitalized interest
|
|
$
|
29
|
|
|
$
|
22
|
|
|
32
|
Certain amounts and percentages may reflect rounding adjustments.
Three months ended March 30, 2014 vs. three months ended March 31, 2013
Interest expense, net of capitalized interest,
increased
by $
7 million
in the first quarter of 2014 compared to the first quarter of 2013, primarily due to the issuance of our senior notes on January 28, 2013. Interest expense related to allocated debt was $
2 million
for the three months ended
March 31, 2013
.
|
|
|
|
|
|
|
|
|
|
|
|
|
Other (income)/deductions—net
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
Other (income)/deductions—net
|
|
$
|
1
|
|
|
$
|
5
|
|
|
(80
|
)
|
Certain amounts and percentages may reflect rounding adjustments.
Three months ended March 30, 2014 vs. three months ended March 31, 2013
The change in
Other (income)/deductions—net
reflects
a favorable
impact of $
4 million
on income attributable to Zoetis in the first quarter of 2014 compared to the first quarter of 2013, primarily due to:
|
|
•
|
an insurance recovery of litigation related charges of $2 million income; and
|
|
|
•
|
lower foreign currency losses;
|
partially offset by:
|
|
•
|
a pension plan settlement charge of $4 million related to the divestiture of a manufacturing plant.
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for taxes on income
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
Provision for taxes on income
|
|
$
|
72
|
|
|
$
|
52
|
|
|
38
|
Effective tax rate
|
|
31.7
|
%
|
|
27.1
|
%
|
|
|
Certain amounts and percentages may reflect rounding adjustments.
The effective tax rate was
31.7%
for the first quarter of 2014, compared to
27.1%
for the first quarter of 2013. The higher effective tax rate for the first quarter of 2014 compared to the first quarter of 2013 was primarily attributable to:
|
|
•
|
an $8 million discrete tax expense during the first quarter of 2014 related to an intercompany inventory adjustment;
|
|
|
•
|
changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings as well as repatriation costs; and
|
|
|
•
|
a $2 million discrete income tax benefit during the first quarter of 2013 related to the 2012 U.S. research and development tax credit, which was retroactively extended on January 3, 2013.
|
Operating Segment Results
In the first quarter of 2014, we realigned our segment reporting with respect to our Client Supply Services (CSS) organization, which provides contract manufacturing services to third parties, to reflect how our chief operating decision maker currently evaluates our financial results. The revenue and earnings associated with CSS are now reported within
Other business activities
, separate from our four reportable segments. In 2013, CSS results were reported in the EuAfME segment. Because CSS is operated differently from our commercial operations within the geographic segments, we believe our current presentation of segments is more reflective of our commercial business. CSS revenue for the first, second, third and fourth quarters of 2013, including livestock (LS) and companion animal (CA) revenue, was $
11 million
(LS - $3 million; CA - $8 million), $
12 million
(LS - $3 million; CA - $9 million), $
14 million
(LS - $4 million; CA - $10 million) and $
16 million
(LS - $5 million; CA - $11 million), respectively. CSS earnings (loss) for the first, second, third and fourth quarters of 2013 was $
3 million
,
$(2) million
, $
2 million
and $
5 million
, respectively. We have revised our segment results presented herein to reflect this new segment structure, including for the comparable 2013 period.
We believe that it is important to not only understand overall revenue and earnings growth, but also “operational growth.” Operational growth is defined as revenue or earnings growth excluding the impact of foreign exchange.
On a global basis, the mix of our revenue between livestock and companion animal products is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
Three Months Ended
|
|
|
|
Related to
|
|
|
March 30,
|
|
|
March 31,
|
|
|
|
|
Foreign
|
|
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Total
|
|
|
Exchange
|
|
|
Operational
|
|
U.S.
|
|
|
|
|
|
|
|
|
|
|
Livestock
|
|
$
|
263
|
|
|
$
|
245
|
|
|
7
|
|
|
—
|
|
|
7
|
|
Companion animal
|
|
216
|
|
|
209
|
|
|
3
|
|
|
—
|
|
|
3
|
|
|
|
479
|
|
|
454
|
|
|
6
|
|
|
—
|
|
|
6
|
|
EuAfME
|
|
|
|
|
|
|
|
|
|
|
Livestock
|
|
181
|
|
|
192
|
|
|
(6
|
)
|
|
—
|
|
|
(6
|
)
|
Companion animal
|
|
89
|
|
|
87
|
|
|
2
|
|
|
1
|
|
|
1
|
|
|
|
270
|
|
|
279
|
|
|
(3
|
)
|
|
1
|
|
|
(4
|
)
|
CLAR
|
|
|
|
|
|
|
|
|
|
|
Livestock
|
|
135
|
|
|
139
|
|
|
(3
|
)
|
|
(12
|
)
|
|
9
|
|
Companion animal
|
|
33
|
|
|
32
|
|
|
3
|
|
|
(12
|
)
|
|
15
|
|
|
|
168
|
|
|
171
|
|
|
(2
|
)
|
|
(12
|
)
|
|
10
|
|
APAC
|
|
|
|
|
|
|
|
|
|
|
Livestock
|
|
127
|
|
|
127
|
|
|
—
|
|
|
(7
|
)
|
|
7
|
|
Companion animal
|
|
42
|
|
|
48
|
|
|
(13
|
)
|
|
(11
|
)
|
|
(2
|
)
|
|
|
169
|
|
|
175
|
|
|
(3
|
)
|
|
(7
|
)
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
Livestock
|
|
706
|
|
|
703
|
|
|
—
|
|
|
(4
|
)
|
|
4
|
|
Companion animal
|
|
380
|
|
|
376
|
|
|
1
|
|
|
(2
|
)
|
|
3
|
|
Contract Manufacturing
|
|
11
|
|
|
11
|
|
|
—
|
|
|
(3
|
)
|
|
3
|
|
|
|
$
|
1,097
|
|
|
$
|
1,090
|
|
|
1
|
|
|
(3
|
)
|
|
4
|
|
Certain amounts and percentages may reflect rounding adjustments.
Earnings information by segment and the operational and foreign exchange changes versus the comparable prior year period are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
Three Months Ended
|
|
|
|
Related to
|
|
|
March 30,
|
|
|
March 31,
|
|
|
|
|
Foreign
|
|
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Total
|
|
|
Exchange
|
|
|
Operational
|
|
U.S.
|
|
$
|
278
|
|
|
$
|
234
|
|
|
19
|
|
|
—
|
|
|
19
|
|
EuAfME
|
|
112
|
|
|
114
|
|
|
(2
|
)
|
|
—
|
|
|
(2
|
)
|
CLAR
|
|
64
|
|
|
52
|
|
|
23
|
|
|
12
|
|
|
11
|
|
APAC
|
|
66
|
|
|
75
|
|
|
(12
|
)
|
|
(10
|
)
|
|
(2
|
)
|
Total reportable segments
|
|
520
|
|
|
475
|
|
|
9
|
|
|
(1
|
)
|
|
10
|
|
Other business activities
|
|
(72
|
)
|
|
(71
|
)
|
|
1
|
|
|
|
|
|
Reconciling Items:
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
(125
|
)
|
|
(116
|
)
|
|
8
|
|
|
|
|
|
Purchase accounting adjustments
|
|
(12
|
)
|
|
(12
|
)
|
|
—
|
|
|
|
|
|
Acquisition-related costs
|
|
(2
|
)
|
|
(6
|
)
|
|
(67
|
)
|
|
|
|
|
Certain significant items
|
|
(36
|
)
|
|
(42
|
)
|
|
(14
|
)
|
|
|
|
|
Other unallocated
|
|
(46
|
)
|
|
(36
|
)
|
|
28
|
|
|
|
|
|
Income before income taxes
|
|
$
|
227
|
|
|
$
|
192
|
|
|
18
|
|
|
|
|
|
Certain amounts and percentages may reflect rounding adjustments.
Three months ended March 30, 2014 vs. three months ended March 31, 2013
U.S. operating segment
U.S. segment revenue
increased
by $
25 million
, or
6%
, in the first quarter of 2014 compared to the first quarter of 2013, of which approximately $
18 million
resulted from
growth
in livestock products and approximately $
7 million
resulted from
growth
in companion animal products.
|
|
•
|
Livestock revenue growth was achieved in all species, particularly cattle. Strong growth in sales of cattle products was primarily due to improved market conditions compared with the first quarter of 2013. Sales of poultry products grew across therapeutic areas and benefited from new vaccines and the growth in swine products was due to continued customer acceptance of new products, tempered by the effect of PEDv.
|
|
|
•
|
Companion animal revenue growth was driven by the introduction of Apoquel
®
. Results were partially offset by a reduced number of clinic visits due to extreme weather conditions across the United States and the favorable impact in the year ago quarter due to a competitor supply issue.
|
U.S. segment earnings
increased
by $
44 million
, or
19%
, in the first quarter of 2014 compared to the first quarter of 2013 due to strong revenue growth, improvement in cost of goods sold, and the timing of certain promotional spending. U.S segment earnings were also favorably impacted by a $5 million decrease in certain supply chain and logistics costs that were reported in the U.S. segment in the first quarter of 2013, but are reported in
Other unallocated
(see
Reconciling items
below) beginning in the first quarter of 2014.
EuAfME operating segment
EuAfME segment revenue
decreased
by
3%
in the first quarter of 2014 compared to the first quarter of 2013. Operational revenue decreased by $
9 million
, or
4%
, of which approximately $
10 million
resulted from
declines
in livestock products, partially offset by
growth
of approximately $
1 million
in companion animal products.
|
|
•
|
The decrease in livestock revenue was primarily driven by lower sales in the cattle portfolio in the UK due to timing of purchases and regulatory issues in certain markets affecting the poultry portfolio. Additionally, sales in the swine portfolio were impacted by local competition and reductions in the use of anti-infectives. These declines were partially offset by growth of cattle product sales in emerging markets.
|
|
|
•
|
Companion animal revenue growth was favorably impacted by the successful launch of Apoquel
®
in Germany and the UK and the sale of parasiticides in France, Italy and emerging markets. Results were partially offset by increased local competition.
|
Additionally, segment revenue was
favorably
impacted by foreign exchange, which increased revenue by approximately
1%
.
EuAfME segment earnings
decreased
by $
2 million
, or
2%
, in the first quarter of 2014 compared to the first quarter of 2013 primarily due to the revenue decline partially offset by lower operating expenses.
CLAR operating segment
CLAR segment revenue
decreased
by $
3 million
, or
2%
, in the first quarter of 2014 compared to the first quarter of 2013. Operational revenue growth was $
16 million
, or
10%
, of which approximately $
11 million
resulted from
growth
in livestock products and $
5 million
resulted from
growth
in companion animal product sales.
|
|
•
|
Livestock revenue growth was primarily driven by increased sales in the poultry, cattle and swine portfolios. Growth in sales of poultry products was primarily driven by higher sales of medicated feed additives in Brazil. Growth in cattle and swine product sales was primarily driven by higher sales across Latin America.
|
|
|
•
|
Companion animal growth was favorably impacted by an increasing companion animal market in Brazil, as well as higher sales in Mexico and Argentina.
|
Additionally, segment revenue was
unfavorably
impacted by foreign exchange, which decreased revenue by approximately $
19 million
, or
12%
, primarily due to the depreciation of the Brazilian Real and the Argentine Peso.
CLAR segment earnings
increased
by $
12 million
, or
23%
, in the first quarter of 2014 compared to the first quarter of 2013, driven by the unfavorable impact of the Venezuela currency devaluation in the year-ago quarter. Operational earnings growth was $
6 million
, or
11%
, in the first quarter of 2014 compared to the first quarter of 2013, primarily driven by revenue growth as well as gross margin and operating expenses remaining in line with revenue.
APAC operating segment
APAC segment revenue
decreased
by $
6 million
, or
3%
, in the first quarter of 2014 compared to the first quarter of 2013. Operational revenue growth was $
8 million
, or
4%
, of which approximately $
9 million
resulted from
growth
in livestock products, partially offset by
declines
in companion animal products of approximately $
1 million
.
|
|
•
|
Livestock revenue growth was driven primarily by increased sales of swine products in China and Japan. Additionally, there was growth in sales of poultry products in India and cattle products in China. Results were tempered by declining cattle sales in Japan, New Zealand and Australia.
|
|
|
•
|
The decrease in companion animal revenue was primarily due to declines in Australia driven by increased competition of parasiticides, as well as changes in the timing of promotional spending and price increases.
|
Additionally, segment revenue was
unfavorably
impacted by foreign exchange, which decreased revenue by approximately $
14 million
, or
7%
.
APAC segment earnings
decreased
by $
9 million
, or
12%
, in the first quarter of 2014 compared to the first quarter of 2013, primarily due to unfavorable mix, the timing of promotional spending and the unfavorable foreign exchange impact. The unfavorable foreign exchange impact was driven by the depreciation of the Japanese Yen, Australian Dollar and Indian Rupee.
Other business activities
Other business activities includes our CSS contract manufacturing results, as well as, expenses associated with our dedicated veterinary medicine research and development organization, research alliances, U.S. regulatory affairs and other operations focused on the development of our products. Other R&D-related costs associated with non-U.S. market clinical trials and regulatory activities are generally included in the respective regional segment.
Three months ended March 30, 2014 vs. three months ended March 31, 2013
Other business activities spending
increased
by $
1 million
, or
1%
, in the first quarter of 2014 compared to the first quarter of 2013, primarily due to an increase in direct R&D project spend, partially offset by decreased spending on supplies and other indirect project expenses.
Reconciling items
Reconciling items include certain costs are not allocated to our operating segments results, such as costs associated with the following:
|
|
•
|
Corporate,
which includes certain costs associated with business technology, facilities, legal, finance, human resources, business development, public affairs and procurement, among others. These costs also include compensation costs and other miscellaneous operating expenses not charged to our operating segments, as well as interest income and expense;
|
|
|
•
|
Certain transactions and events such as (i)
Purchase accounting adjustments
, which includes expenses associated with the amortization of fair value adjustments to inventory, intangible assets and property, plant and equipment; (ii)
Acquisition-related activities
, which includes costs for restructuring and integration; and (iii)
Certain significant items
, which includes non-acquisition-related restructuring charges, certain asset impairment charges, stand-up costs and costs associated with cost reduction/productivity initiatives; and
|
|
|
•
|
Other unallocated
, which includes certain overhead expenses associated with our global manufacturing operations not charged to our operating segments. Effective January 1, 2014,
Other unallocated
also includes certain costs associated with business technology and finance that specifically support our global manufacturing operations. These costs were previously reported in
Corporate
. Also, beginning in the first quarter of 2014, certain supply chain and global logistics costs that were previously reported in the four reportable segments are reported in
Other unallocated
. This presentation better reflects how we measure the performance of the global manufacturing organization.
|
Three months ended March 30, 2014 vs. three months ended March 31, 2013
Corporate expenses increased by $9 million, or 8%, in the first quarter of 2014 compared to the first quarter of 2013, primarily due to higher interest expense, net of capitalized interest, of $7 million as a result of the issuance of our senior notes on January 28, 2013, as well as additional costs associated with the build-up of our enabling functions. These increases were partially offset by a reduction in share-based payment expenses as a result of our separation from Pfizer.
Other unallocated expenses increased by $10 million, or 28%, in the first quarter of 2014 compared to the first quarter of 2013, primarily due to an increase in certain supply chain and logistics costs that were reported in the four reportable segments in the first quarter of 2013, but are reported in
Other unallocated
beginning in the first quarter of 2014.
See the
Adjusted Net Income
section of this MD&A and Notes to Condensed Consolidated Financial Statements—
Note 16. Segment and Other Revenue Information
for further information.
Adjusted net income
General description of adjusted net income (a non-GAAP financial measure)
Adjusted net income is an alternative view of performance used by management, and we believe that investors’ understanding of our performance is enhanced by disclosing this performance measure. We report adjusted net income to portray the results of our major operations, the discovery, development, manufacture and commercialization of animal health medicine and vaccine products, prior to considering certain income statement elements. We have defined adjusted net income as net income attributable to Zoetis before the impact of
Purchase accounting adjustments
,
Acquisition-related costs
and
Certain significant items
. The adjusted net income measure is not, and should not be viewed as, a substitute for U.S. GAAP reported net income attributable to Zoetis.
The adjusted net income measure is an important internal measurement for us. We measure our overall performance on this basis in conjunction with other performance metrics. The following are examples of how the adjusted net income measure is utilized:
|
|
•
|
senior management receives a monthly analysis of our operating results that is prepared on an adjusted net income basis;
|
|
|
•
|
our annual budgets are prepared on an adjusted net income basis; and
|
|
|
•
|
other goal setting and performance measurements.
|
Despite the importance of this measure to management in goal setting and performance measurement, adjusted net income is a non-GAAP financial measure that has no standardized meaning prescribed by U.S. GAAP and, therefore, has limits in its usefulness to investors. Because of its non-standardized definition, adjusted net income, unlike U.S. GAAP net income, may not be comparable to the calculation of similar measures of other companies. Adjusted net income is presented to permit investors to more fully understand how management assesses performance.
We also recognize that, as an internal measure of performance, the adjusted net income measure has limitations, and we do not restrict our performance management process solely to this metric. A limitation of the adjusted net income measure is that it provides a view of our operations without including all events during a period, such as the effects of an acquisition or amortization of purchased intangibles, and does not provide a comparable view of our performance to other companies. We also use other specifically tailored tools designed to achieve the highest levels of performance.
Purchase accounting adjustments
Adjusted net income is calculated prior to considering certain significant purchase accounting impacts that result from business combinations and net asset acquisitions. These impacts, primarily associated with the Pharmacia Animal Health business (acquired in 2003), Fort Dodge Animal Health (FDAH) (acquired in 2009) and King Animal Health (KAH) (acquired in 2011), include amortization related to the increase in fair value of the acquired finite-lived intangible assets and depreciation related to the increase/decrease to fair value of the acquired fixed assets. Therefore, the adjusted net income measure includes the revenue earned upon the sale of the acquired products without considering the aforementioned significant charges.
While certain purchase accounting adjustments can occur through 20 or more years, this presentation provides an alternative view of our performance that is used by management to internally assess business performance. We believe the elimination of amortization attributable to acquired intangible assets provides management and investors an alternative view of our business results by providing a degree of parity to internally developed intangible assets for which R&D costs previously have been expensed.
A completely accurate comparison of internally developed intangible assets and acquired intangible assets cannot be achieved through adjusted net income. These components of adjusted net income are derived solely from the impact of the items listed above. We have not factored in the impact of any other differences in experience that might have occurred if we had discovered and developed those intangible assets on our own, and this approach does not intend to be representative of the results that would have occurred in those circumstances. For example, our R&D costs in total, and in the periods presented, may have been different; our speed to commercialization and resulting revenue, if any, may have been different; or our costs to manufacture may have been different. In addition, our marketing efforts may have been received differently by our customers. As such, in total, there can be no assurance that our adjusted net income amounts would have been the same as presented had we discovered and developed the acquired intangible assets.
Acquisition-related costs
Adjusted net income is calculated prior to considering transaction, integration, restructuring and additional depreciation costs associated with significant business combinations or net-asset acquisitions because these costs are unique to each transaction and represent costs that were incurred to restructure and integrate certain businesses as a result of the acquisition decision. We have made no adjustments for the resulting synergies.
We believe that viewing income prior to considering these charges provides investors with a useful additional perspective because the significant costs incurred in a business combination result primarily from the need to eliminate duplicate assets, activities or employees––a natural result of acquiring a fully integrated set of activities. For this reason, we believe that the costs incurred to convert disparate systems, to close duplicative facilities or to eliminate duplicate positions (for example, in the context of a business combination) can be viewed differently from those costs incurred in the ordinary course of business.
The integration and restructuring costs associated with a business combination may occur over several years, with the more significant impacts ending within three years of the transaction. Because of the need for certain external approvals for some actions, the span of time needed to achieve certain restructuring and integration activities can be lengthy. For example, due to the regulated nature of the animal health medicines and vaccines business, the closure of excess facilities can take several years, as all manufacturing changes are subject to extensive validation and testing and must be approved by the Food and Drug Administration and/or other regulatory authorities.
Certain significant items
Adjusted net income is calculated prior to considering
Certain significant items
.
Certain significant items
represents substantive, unusual items that are evaluated on an individual basis. Such evaluation considers both the quantitative and the qualitative aspect of their unusual nature. Unusual, in this context, may represent items that are not part of our ongoing business; items that, either as a result of their nature or size, we would not expect to occur as part of our normal business on a regular basis; items that would be nonrecurring; or items that relate to products that we no longer sell. While not all-inclusive, examples of items that could be included as
Certain significant items
would be costs related to becoming an independent public company, a major non-acquisition-related restructuring charge and associated implementation costs for a program that is specific in nature with a defined term, such as those related to our non-acquisition-related cost-reduction and productivity initiatives; amounts related to disposals of products or facilities that do not qualify as discontinued operations as defined by U.S. GAAP; certain intangible asset impairments; adjustments related to the resolution of certain tax positions; the impact of adopting certain significant, event-driven tax legislation; or charges related to legal matters. See Notes to Condensed Consolidated Financial Statements—
Note 15. Commitments and Contingencies
. Our normal, ongoing defense costs or settlements of and accruals on legal matters made in the normal course of our business would not be considered
Certain significant items
.
Reconciliation
A reconciliation of net income attributable to Zoetis, as reported under U.S. GAAP, to adjusted net income follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
Reported net income attributable to Zoetis
|
|
$
|
155
|
|
|
$
|
140
|
|
|
11
|
|
Purchase accounting adjustments—net of tax
|
|
8
|
|
|
8
|
|
|
—
|
|
Acquisition-related costs—net of tax
|
|
1
|
|
|
4
|
|
|
(75
|
)
|
Certain significant items—net of tax
|
|
27
|
|
|
27
|
|
|
—
|
|
Adjusted net income
(a)
|
|
$
|
191
|
|
|
$
|
179
|
|
|
7
|
|
Certain amounts and percentages may reflect rounding adjustments.
|
|
(a)
|
The effective tax rate on adjusted pretax income is
31.0%
and
29.0%
for the first quarter of 2014 and 2013, respectively. The
higher
effective tax rate in 2014 compared to 2013 is due to an $8 million discrete tax expense during the first quarter of 2014 related to an intercompany inventory adjustment, as well as changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings as well as repatriation costs. In addition, we recognized a $2 million discrete income tax provision benefit during the first quarter of 2013 related to the 2012 U.S research and development tax credit which was retroactively extended on January 3, 2013.
|
The following table provides a reconciliation of reported diluted earnings per share (EPS), as reported under U.S. GAAP, and non-GAAP adjusted diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
|
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
Earnings per share—diluted
(a)(b)
:
|
|
|
|
|
|
|
GAAP Reported net income attributable to Zoetis
|
|
$
|
0.31
|
|
|
$
|
0.28
|
|
|
11
|
|
Purchase accounting adjustments—net of tax
|
|
0.02
|
|
|
0.02
|
|
|
—
|
|
Acquisition-related costs—net of tax
|
|
—
|
|
|
0.01
|
|
|
(100
|
)
|
Certain significant items—net of tax
|
|
0.05
|
|
|
0.05
|
|
|
—
|
|
Non-GAAP adjusted net income
|
|
$
|
0.38
|
|
|
$
|
0.36
|
|
|
6
|
|
Certain amounts and percentages may reflect rounding adjustments.
|
|
(a)
|
For the
three months ended
March 30, 2014
and March 31, 2013, diluted earnings per share was computed using the weighted-average common shares outstanding during the period plus the common stock equivalents related to stock options, RSUs and DSUs.
|
|
|
(b)
|
EPS amounts may not add due to rounding.
|
Adjusted net income includes the following charges for each of the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
March 30,
|
|
|
March 31,
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
Interest
|
|
$
|
29
|
|
|
$
|
22
|
|
Taxes
|
|
86
|
|
|
73
|
|
Depreciation
|
|
33
|
|
|
35
|
|
Amortization
|
|
3
|
|
|
5
|
|
Adjusted net income, as shown above, excludes the following items:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
March 30,
|
|
|
March 31,
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
Purchase accounting adjustments:
|
|
|
|
|
Amortization and depreciation
(a)
|
|
$
|
11
|
|
|
$
|
11
|
|
Cost of sales
(b)
|
|
1
|
|
|
1
|
|
Total purchase accounting adjustments—pre-tax
|
|
12
|
|
|
12
|
|
Income taxes
(c)
|
|
4
|
|
|
4
|
|
Total purchase accounting adjustments—net of tax
|
|
8
|
|
|
8
|
|
Acquisition-related costs
(d)
:
|
|
|
|
|
Integration costs
(e)
|
|
2
|
|
|
4
|
|
Restructuring costs
(f)
|
|
—
|
|
|
2
|
|
Total acquisition-related costs—pre-tax
|
|
2
|
|
|
6
|
|
Income taxes
(c)
|
|
1
|
|
|
2
|
|
Total acquisition-related costs—net of tax
|
|
1
|
|
|
4
|
|
Certain significant items
(g)
:
|
|
|
|
|
Restructuring charges
(h)
|
|
—
|
|
|
1
|
|
Implementation costs and additional depreciation—asset restructuring
(i)
|
|
1
|
|
|
2
|
|
Certain asset impairment charges
(j)
|
|
—
|
|
|
1
|
|
Stand-up costs
(k)
|
|
33
|
|
|
34
|
|
Other
(l)
|
|
2
|
|
|
4
|
|
Total significant items—pre-tax
|
|
36
|
|
|
42
|
|
Income taxes
(c)
|
|
9
|
|
|
15
|
|
Total significant items—net of tax
|
|
27
|
|
|
27
|
|
Total purchase accounting adjustments, acquisition-related costs,
|
|
|
|
|
and certain significant items—net of tax
|
|
$
|
36
|
|
|
$
|
39
|
|
Certain amounts may reflect rounding adjustments.
|
|
(a)
|
Amortization and depreciation expense related to
Purchase accounting adjustments
with respect to identifiable intangible assets and property, plant and equipment were distributed as follows: $1 million income included in
Selling, general and administrative expenses
and $12 million included in
Amortization of intangible assets
for the three months ended March 30, 2014; and $11 million included in
Amortization of intangible assets
for the three months ended and March 31, 2013.
|
|
|
(b)
|
Depreciation expense included in
Cost of sales.
|
|
|
(c)
|
Included in
Provision for taxes on income
.
|
|
|
(d)
|
Acquisition-related costs were included in
Restructuring charges and certain acquisition-related costs
for the three months ended March 30, 2014 and March 31, 2013.
|
|
|
(e)
|
Integration costs were included in
Restructuring charges and certain acquisition-related costs
.
|
|
|
(f)
|
Included in
Restructuring charges and certain acquisition-related costs
. See Notes to Condensed Consolidated Financial Statements—
Note 5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives.
|
|
|
(g)
|
Certain significant items
were distributed as follows: $3 million in each of the three months ended March 30, 2014 and March 31, 2013, included in
Cost of sales
; $30 million and $35 million in the three months ended March 30, 2014 and March 31, 2013, respectively, included in
Selling, general and administrative expenses
; $1 million in each of the three months ended March 30, 2014 and March 31, 2013, respectively, included in
Restructuring charges and certain acquisition-related costs
; and $2 million and $3 million in the three months ended March 30, 2014 and March 31, 2013, respectively, included in
Other (Income)/Deductions—Net.
|
|
|
(h)
|
Represents restructuring charges incurred for our cost-reduction/productivity initiatives. Included in
Restructuring charges and certain acquisition-related costs
. See Notes to Condensed Consolidated Financial Statements—
Note 5.
Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives
.
|
|
|
(i)
|
Amounts primarily relate to our cost-reduction/productivity initiatives. See Notes to Condensed Consolidated Financial Statements—
Note 5.
Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives
.
|
|
|
(j)
|
Included in
Other (income)/deductions—net
.
|
|
|
(k)
|
Certain nonrecurring costs related to becoming an independent public company, such as new branding (including changes to the manufacturing process for required new packaging), the creation of standalone systems and infrastructure, site separation, and certain legal registration and patent assignment costs which were distributed as follows: $3 million and $2 million in the three months ended March 30, 2014 and March 31, 2013, respectively, included in
Cost of sales
and $30 million and $32 million in the three months ended March 30, 2014 and March 31, 2013, respectively, included in
Selling, general and administrative expenses
.
|
(l)
For the three months ended March 30, 2014, primarily relates to a pension plan settlement charge related to the divestiture of a manufacturing plant of
$4 million
, partially offset by an insurance recovery of litigation related charges of
$2 million
income. For the three months ended March 31, 2013, primarily relates to a change in estimate related to transitional manufacturing purchase agreements associated with divestitures.
Our financial guidance for 2014
Our 2014 financial guidance is summarized below:
|
|
|
|
Selected Line Items
|
|
|
Revenue
|
|
$4,650 to $4,750 million
|
Adjusted cost of sales as a percentage of revenue
(a)
|
|
Approximately 35.5%
|
Adjusted SG&A expenses
(a)
|
|
$1,430 to $1,480 million
|
Adjusted R&D expenses
(a)
|
|
$390 to $405 million
|
Adjusted interest expense and other (income)/deductions
(a)
|
|
Approximately $105 million
|
Effective tax rate on adjusted income
(a)
|
|
Approximately 29%
|
Adjusted diluted EPS
(a)
|
|
$1.48 to $1.54
|
Certain significant items
(b)
and acquisition-related costs
|
|
$165 to $185 million
|
Reported diluted EPS
|
|
$1.15 to $1.21
|
|
|
(a)
|
For an understanding of adjusted net income and its components, see the “Adjusted net income” section of this MD&A.
|
|
|
(b)
|
Includes certain nonrecurring costs related to becoming an independent public company, such as new branding (including changes to the manufacturing process for required new packaging), the creation of standalone systems and infrastructure, site separation and certain legal registration and patent assignment costs.
|
A reconciliation of 2014 adjusted net income and adjusted diluted EPS guidance to 2014 reported net income attributable to Zoetis and reported diluted EPS attributable to Zoetis common shareholders guidance follows:
|
|
|
|
|
|
|
|
Full-Year 2014 Guidance
|
(MILLION OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
|
|
Net Income
|
|
Diluted EPS
|
Adjusted net income/diluted EPS
(a)
guidance
|
|
~$740 - $770
|
|
~$1.48 - $1.54
|
Purchase accounting adjustments
|
|
~(30)
|
|
~(0.06)
|
Certain significant items
(b)
and acquisition-related costs
|
|
~(125 - 140)
|
|
~(0.25 - 0.28)
|
Reported net income attributable to Zoetis Inc./diluted EPS guidance
|
|
~$580 - $610
|
|
~$1.15 - $1.21
|
|
|
(a)
|
For an understanding of adjusted net income, see the “Adjusted net income” section of this MD&A.
|
|
|
(b)
|
Includes certain nonrecurring costs related to becoming an independent public company, such as new branding (including changes to the manufacturing process for required new packaging), the creation of standalone systems and infrastructure, site separation and certain legal registration and patent assignment costs.
|
Our 2014 financial guidance is subject to a number of factors and uncertainties—as described in the “Forward-looking information and factors that may affect future results,” “Our operating environment” and “Our strategy” and in Part I, Item 1A. “Risk Factors” of our 2013 Annual Report on Form 10-K.
Analysis of the condensed consolidated statements of comprehensive income
Virtually all changes in other comprehensive income for the periods presented are related to foreign currency translation adjustments. These changes result from the strengthening or weakening of the U.S. dollar as compared to the currencies in the countries in which we do business. The gains and losses associated with these changes are deferred on the balance sheet in
Accumulated other comprehensive loss
until realized.
Analysis of the condensed consolidated balance sheets
March 30, 2014
vs. December 31, 2013
For a discussion about the changes in
Cash and cash equivalents
,
Short-term borrowing, including current portion of allocated long term debt
, and
Long-term debt
, see “Analysis of financial condition, liquidity and capital resources” below.
Accounts receivable, less allowance for doubtful accounts
decreased as a result of timing of customer collections.
Inventories
increased primarily due to the build up of safety stock levels in preparation of certain production transfers and to support increased commercial demand of selected products. See also Notes to Condensed Consolidated Financial Statements—
Note 10. Inventories.
The net changes in
Current deferred tax assets
,
Noncurrent deferred tax assets
,
Noncurrent deferred tax liabilities, Income taxes payable
and
Other taxes payable
primarily reflect adjustments to the accrual for the income tax provision for the first quarter of 2014. See also Notes to Condensed Consolidated Financial Statements—
Note 7. Income Taxes.
Property, plant and equipment, less accumulated depreciation
decreased slightly. Operational activity, including depreciation and capital spending, were the primary drivers.
Accounts payable
decreased as a result of the timing of payments in the ordinary course of business.
Dividends payable
relates to the dividend declared on March 26, 2014.
Accrued compensation and related items
decreased primarily due to payment of 2013 annual bonuses to eligible U.S.-based employees and 2013 employee savings plan contributions.
Other current liabilities
decreased reflecting a reduction in accrued expenses, including accrued interest and accrued contract rebates, among others.
For an analysis of the changes in
Total Equity
, see the Condensed Consolidated Statements of Equity.
Analysis of the condensed consolidated statements of cash flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 30,
|
|
|
March 31,
|
|
|
%
|
|
(MILLIONS OF DOLLARS)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
Net cash provided by (used in):
|
|
|
|
|
|
|
Operating activities
|
|
$
|
(23
|
)
|
|
$
|
281
|
|
|
*
|
|
Investing activities
|
|
(45
|
)
|
|
(22
|
)
|
|
*
|
|
Financing activities
|
|
(35
|
)
|
|
(108
|
)
|
|
(68
|
)%
|
Effect of exchange-rate changes on cash and cash equivalents
|
|
(1
|
)
|
|
—
|
|
|
*
|
|
Net increase in cash and cash equivalents
|
|
$
|
(104
|
)
|
|
$
|
151
|
|
|
*
|
|
* Calculation not meaningful.
Certain amounts and percentages may reflect rounding adjustments.
Operating activities
Three months ended
March 30, 2014
vs.
three months ended
March 31, 2013
Net cash
used in
operating activities was $
23 million
in the
first quarter
of
2014
compared with cash
provided by
operating activities of $
281 million
in the
first quarter
of
2013
. The
decrease
in operating cash flows for the three months ended March 30, 2014 was attributable to the net change in operating assets and liabilities, net of acquisitions and divestitures and transfers with Pfizer, primarily driven by a decrease in other liabilities, reflecting lower accrued interest on long-term debt and lower accrued compensation, a decrease in accounts payable and higher inventory levels. This decrease was partially offset by income before allocation to non-controlling interests, as adjusted for depreciation and amortization. The operating cash flows for the three months ended March 31, 2013 were primarily attributable to timing of receipts and payments in the ordinary course of business and operational reductions in inventory.
Investing activities
Three months ended
March 30, 2014
vs.
three months ended
March 31, 2013
Our net cash
used in
investing activities was $
45 million
in the
first quarter
of
2014
compared to cash
used in
investing activities of $
22 million
in the
first quarter
of
2013
primarily due to increased investment in property, plant and equipment.
Financing activities
Three months ended
March 30, 2014
vs.
three months ended
March 31, 2013
Our net cash
used in
financing activities was $
35 million
in the
first quarter
of
2014
compared to cash
used in
financing activities of
$108 million
in the
first quarter
of
2013
. The net cash used in financing activities for 2014 was due primarily to the payment of dividends. The net cash used in financing activities for 2013 was attributable to the net transfers to Pfizer as a result of the Separation.
Analysis of financial condition, liquidity and capital resources
While we believe our cash and cash equivalents on hand, our operating cash flows and our existing financing arrangements will be sufficient to support our future cash needs, this may be subject to the environment in which we operate. Risks to our meeting future funding requirements include global economic conditions described in the following paragraph.
Over the last five years, the global financial markets have experienced, and may continue to experience, significant volatility and disruption. The timing and sustainability of an economic recovery is uncertain and additional macroeconomic, business and financial disruptions may arise. As markets change, we will continue to monitor our liquidity position, but there can be no assurance that the challenging economic environment or a further economic downturn will not impact our liquidity or our ability to obtain future financing.
Selected measures of liquidity and capital resources
Certain relevant measures of our liquidity and capital resources follow:
|
|
|
|
|
|
|
|
|
|
March 30,
|
|
|
December 31,
|
|
(MILLIONS OF DOLLARS)
|
2014
|
|
|
2013
|
|
Cash and cash equivalents
|
$
|
506
|
|
|
$
|
610
|
|
Accounts receivable, net
(a)
|
1,100
|
|
|
1,138
|
|
Short-term borrowings
|
16
|
|
|
15
|
|
Long-term debt
(b)
|
3,642
|
|
|
3,642
|
|
Working capital
|
2,095
|
|
|
1,942
|
|
Ratio of current assets to current liabilities
|
2.86:1
|
|
|
2.37:1
|
|
|
|
(a)
|
Accounts receivable are usually collected over a period of 60 to 90 days
.
For the nine months ended
March 30, 2014
compared to
December 31, 2013
, the number of days that accounts receivables are outstanding remained approximately the same. We regularly monitor our accounts receivable for collectability, particularly in markets where economic conditions remain uncertain. We believe that our allowance for doubtful accounts is appropriate. Our assessment is based on such factors as past due history, historical and expected collection patterns, the financial condition of our customers, the robust nature of our credit and collection practices and the economic environment.
|
|
|
(b)
|
Primarily consists of
$3.65 billion
aggregate principal amount of our senior notes, with an original issue discount of
$10 million
. The senior notes are comprised of
$400 million
aggregate principal amount of our
1.150%
senior notes due 2016,
$750 million
aggregate principal amount of our
1.875%
senior notes due 2018,
$1.35 billion
aggregate principal amount of our
3.250%
senior notes due 2023 and
$1.15 billion
aggregate principal amount of our
4.700%
senior notes due 2043.
|
For additional information about the sources and uses of our funds, see the "Analysis of the condensed consolidated balance sheets" and "Analysis of the condensed consolidated statements of cash flows" sections of the MD&A.
Credit facility and other lines of credit
In December 2012, we entered into a revolving credit agreement with a syndicate of banks providing for a five-year
$1.0 billion
senior unsecured revolving credit facility, which became effective in February 2013 upon the completion of the IPO and which expires in December 2017. Subject to certain conditions, we have the right to increase the credit facility to up to
$1.5 billion
. The credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio (the ratio of consolidated net debt as of the end of the period to consolidated Earnings Before Interest, Income Taxes, Depreciation and Amortization (EBITDA) for such period) of
3.95:1
for fiscal year 2014,
3.50:1
for fiscal year 2015 and
3.00:1
thereafter. The credit facility also contains a financial covenant requiring that we maintain a minimum interest coverage ratio (the ratio of EBITDA at the end of the period to interest expense for such period) of
3.50:1
. In addition, the credit facility contains other customary covenants. There were no borrowings outstanding as of
March 30, 2014
and
December 31, 2013
.
We have additional lines of credit with a group of banks and other financial intermediaries for general corporate purposes. We maintain cash and cash equivalent balances in excess of our outstanding short-term borrowings. As of
March 30, 2014
, we had access to
$67 million
of lines of credit which expire at various times through 2016. Short-term borrowings outstanding related to these facilities were
$16 million
and
$15 million
as of
March 30, 2014
and
December 31, 2013
, respectively. Long-term borrowings outstanding related to these facilities were
$2 million
as of both
March 30, 2014
and
December 31, 2013
.
Domestic and international short-term funds
Many of our operations are conducted outside the U.S. The amount of funds held in U.S. tax jurisdictions will fluctuate due to the timing of receipts and payments in the ordinary course of business and due to other reasons, such as business development activities. As part of our ongoing liquidity assessments, we regularly monitor the mix of domestic and international cash flows (both inflows and outflows). Repatriation of overseas funds can result in additional U.S. federal, state and local income tax payments. We record U.S. deferred tax liabilities for certain unremitted earnings, but when amounts earned overseas are expected to be indefinitely reinvested outside the U.S., no accrual for U.S. taxes is provided.
Debt
On January 28, 2013, we issued
$3.65 billion
aggregate principal amount of our senior notes (the senior notes offering) in a private placement, with an original issue discount of
$10 million
. The senior notes are comprised of
$400 million
aggregate principal amount of our
1.150%
senior notes due 2016,
$750 million
aggregate principal amount of our
1.875%
senior notes due 2018,
$1.35 billion
aggregate principal amount of our
3.250%
senior notes due 2023 and
$1.15 billion
aggregate principal amount of our
4.700%
senior notes due 2043.
We sold
$2.65 billion
aggregate principal amount of our senior notes through the initial purchasers in the senior notes offering and Pfizer transferred
$1.0 billion
aggregate principal amount of our senior notes to certain of the initial purchasers, who sold such senior notes through the initial purchasers in the senior notes offering. We paid an amount of cash equal to substantially all of the net proceeds that we received in the senior notes offering to Pfizer prior to the completion of the IPO.
The senior notes are governed by an indenture and supplemental indenture (collectively, the indenture) between us and Deutsche Bank Trust Company Americas, as trustee. The indenture contains certain covenants, including limitations on our and certain of our subsidiaries' ability to incur liens or engage in sale leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets. In addition, the indenture contains other customary terms, including certain events of default, upon the occurrence of which the senior notes may be declared immediately due and payable.
Pursuant to the indenture, we are able to redeem the senior notes of any series, in whole or in part, at any time by paying a “make whole” premium, plus accrued and unpaid interest to, but excluding, the date of redemption. Pursuant to our tax matters agreement with Pfizer, we will not be permitted to redeem the 2023 notes pursuant to this optional redemption provision, except under limited circumstances. Upon the occurrence of a change of control of us and a downgrade of the senior notes below an investment grade rating by each of Moody's Investors Service, Inc. and Standard & Poor's Ratings Services, we are, in certain circumstances, required to make an offer to repurchase all of the outstanding senior notes at a price equal to
101%
of the aggregate principal amount of the senior notes together with accrued and unpaid interest to, but excluding, the date of repurchase.
In connection with the senior notes offering, we entered into a registration rights agreement (the Registration Rights Agreement) with the representatives of the initial purchasers of the senior notes. Pursuant to the terms of the Registration Rights Agreement, we were obligated, among other things, to use our commercially reasonable efforts to file a registration statement with the SEC enabling holders of the senior notes to exchange the privately placed notes for publicly registered notes with substantially the same terms. We filed the registration statement with the SEC on September 13, 2013, the SEC declared the registration statement effective on September 24, 2013, and the exchange offer was completed on October 31, 2013.
The components of our long-term debt follow:
|
|
|
|
|
Description
|
Principal Amount
|
Interest Rate
|
Terms
|
Lines of credit
|
$2 million
|
6.400%
|
Due 2016-2017
|
2016 Senior Note
|
$400 million
|
1.150%
|
Interest due semi annually, not subject to amortization, aggregate principal due on February 1, 2016
|
2018 Senior Note
|
$750 million
|
1.875%
|
Interest due semi annually, not subject to amortization, aggregate principal due on February 1, 2018
|
2023 Senior Note
|
$1,350 million
|
3.250%
|
Interest due semi annually, not subject to amortization, aggregate principal due on February 1, 2023
|
2043 Senior Note
|
$1,150 million
|
4.700%
|
Interest due semi annually, not subject to amortization, aggregate principal due on February 1, 2043
|
Credit Ratings
Two major corporate debt-rating organizations, Moody's and S&P, assign ratings to our short-term and long-term debt. A security rating is not a recommendation to buy, sell or hold securities and the rating is subject to revision or withdrawal at any time by the rating organization. Each rating should be evaluated independently of any other rating.
The following table provides the current ratings assigned by these rating agencies to our commercial paper and senior unsecured non-credit-enhanced long-term debt:
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|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
|
|
|
|
|
|
|
Paper
|
|
Long-term Debt
|
|
Date of
|
Name of Rating Agency
|
|
Rating
|
|
Rating
|
|
Outlook
|
|
Last Action
|
Moody’s
|
|
P-2
|
|
Baa2
|
|
Stable
|
|
January 2013
|
S&P
|
|
A-3
|
|
BBB-
|
|
Stable
|
|
January 2013
|
Pension Obligations
We expect to contribute a total of approximately
$8 million
to our dedicated international benefits plans and the international plans accounted for as multi-employer plans in 2014. As part of the Separation from Pfizer, a net liability was recognized in 2013 for the pension obligations less the fair value of plan assets associated with additional defined benefit pension plans in certain international locations that will be transferred to us in 2014 (approximately
$21 million
), in accordance with the applicable local separation agreements or employee matters agreement. During the first quarter of 2014, our pension plan in Japan was transferred to us from Pfizer. The net pension obligation (approximately $2 million) and the related accumulated other comprehensive loss (approximately $2 million, net of tax) associated with this plan were recorded, and the $21 million net liability recognized in 2013 was reduced to $19 million as of March 30, 2014.
Effective December 31, 2012, our employees ceased to participate in the Pfizer U.S. qualified defined benefit and U.S. retiree medical plans, and liabilities associated with our employees under these plans were retained by Pfizer. As part of the Separation, 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. In connection with the employee matters agreement, Zoetis will be responsible for payment of three-fifths of the total cost of the service credit continuation (approximately
$34 million
as of March 30, 2014) for these plans. The amount of the service cost continuation payment to be paid by Zoetis to Pfizer was determined and fixed based on an actuarial assessment of the value of the grow-in benefits and will be paid in equal semi-annual installments through 2022.
For additional information, see Notes to Condensed Consolidated Financial Statements—
Note 12. Benefit Plans.
Off-balance sheet arrangements
In the ordinary course of business and in connection with the sale of assets and businesses, we may indemnify our counterparties against certain liabilities that may arise in connection with a transaction or that are related to activities prior to a transaction. These indemnifications typically pertain to environmental, tax, employee and/or product-related matters, and patent-infringement claims. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we would be required to reimburse the loss. These indemnifications are generally subject to threshold amounts, specified claim periods and other restrictions and limitations. Historically, we have not paid significant amounts under these provisions and, as of
March 30, 2014
or December 31, 2013, recorded amounts for the estimated fair value of these indemnifications are not significant.
New accounting standards
For discussion of our new accounting standards, see Notes to Condensed Consolidated Financial Statements—
Note 4. Significant Accounting Policies: New Accounting Standards
.
Forward-looking statements and factors that may affect future results
This report contains “forward-looking” statements. We generally identify forward-looking statements by using words such as “anticipate,” “estimate,” “expect,” “intend,” “project,” “plan,” “predict,” “believe,” “seek,” “continue,” “outlook,” “may,” “might,” “will,” “should,” “can have,” “likely” or the negative version of these words or comparable words or by using future dates in connection with any discussion of future performance, actions or events.
In particular, forward-looking statements include statements relating to our indebtedness, our ability to make interest and principal payments on our indebtedness, our ability to satisfy the covenants contained in our indebtedness, the redemption of the notes, new systems infrastructure stand-up, our 2014 financial guidance, future actions, business plans or prospects, prospective products, product approvals or products under development, product supply disruptions, R&D costs, timing and likelihood of success, future operating or financial performance, future results of current and anticipated products and services, strategies, sales efforts, expenses, production efficiencies, production margins, interest rates, foreign exchange rates, growth in emerging markets, the outcome of contingencies, such as legal proceedings, dividend plans, our agreements with Pfizer, government regulation and financial results. These statements are not guarantees of future performance, actions or events. Forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, and are potentially inaccurate assumptions. Among the factors that could cause actual results to differ materially from past results and future plans and projected future results are the following:
|
|
•
|
emerging restrictions and bans on the use of antibacterials in food-producing animals;
|
|
|
•
|
perceived adverse effects on human health linked to the consumption of food derived from animals that utilize our products;
|
|
|
•
|
increased regulation or decreased governmental support relating to the raising, processing or consumption of food-producing animals;
|
|
|
•
|
fluctuations in foreign exchange rates and potential currency controls;
|
|
|
•
|
changes in tax laws and regulation;
|
|
|
•
|
an outbreak of infectious disease carried by animals;
|
|
|
•
|
adverse weather conditions and the availability of natural resources;
|
|
|
•
|
adverse global economic conditions;
|
|
|
•
|
failure of our R&D, acquisition and licensing efforts to generate new products;
|
|
|
•
|
quarterly fluctuations in demand and costs; and
|
|
|
•
|
governmental laws and regulations affecting domestic and foreign operations, including without limitation, tax obligations and changes affecting the tax treatment by the U.S. of income earned outside the U.S. that may result from pending and possible future proposals.
|
However, there may also be other risks that we are unable to predict at this time. These risks or uncertainties may cause actual results to differ materially from those contemplated by a forward-looking statement. You should not put undue reliance on forward-looking statements. Forward-looking statements speak only as of the date on which they are made. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Form 10-Q and 8-K reports and our other filings with the SEC. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the above to be a complete discussion of all potential risks or uncertainties.
|
|
Item 3.
|
Quantitative and Qualitative Disclosures About Market Risk
|
A significant portion of our revenue and costs are exposed to changes in foreign exchange rates. In addition, our outstanding borrowings may be subject to risk from changes in interest rates and foreign exchange rates. The overall objective of our financial risk management program is to seek to minimize the impact of foreign exchange rate movements and interest rate movements on our earnings. We manage these financial exposures through operational means and by using certain financial instruments. These practices may change as economic conditions change.
Foreign exchange risk
Our primary net foreign currency translation exposures are the euro, Brazilian real and Australian dollar. Prior to the IPO, as a business unit of Pfizer and under Pfizer's global cash management system, our foreign exchange risk was managed through Pfizer. Following the Separation, we seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenue in relation to same-currency costs and same-currency assets in relation to same-currency liabilities.
Foreign exchange risk is also managed through the use of foreign currency forward-exchange contracts. These contracts are used to offset the potential earnings effects from mostly intercompany short-term foreign currency assets and liabilities that arise from operations.
Our financial instrument holdings at
March 30, 2014
were analyzed to determine their sensitivity to foreign exchange rate changes. The fair values of these instruments were determined using Level 2 inputs. The sensitivity analysis of changes in the fair value of all foreign currency forward-exchange contracts at
March 30, 2014
indicates that if the U.S. dollar were to appreciate against all other currencies by 10%, the fair value of these contracts would increase by $31 million, and if the U.S. dollar were to weaken against all other currencies by 10%, the fair value of these contracts would decrease by $37 million. For additional details, see Notes to Condensed Consolidated Financial Statements—
Note 9B. Financial Instruments: Derivative Financial Instruments
.
Interest rate risk
Our outstanding debt balances are fixed rate debt. While changes in interest rates will have no impact on the interest we pay on our fixed rate debt, interest on our revolving credit facility will be exposed to interest rate fluctuations. At
March 30, 2014
, we had no outstanding principal balance under our revolving credit facility. See Notes to Condensed Consolidated Financial Statements—
Note 9. Financial Instruments
.
|
|
Item 4.
|
Controls and Procedures
|
Disclosure Controls and Procedures
An evaluation was carried out under the supervision and with the participation of the company's management, including our Chief Executive Officer and Acting Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation as of
March 30, 2014
, our Chief Executive Officer and Acting Chief Financial Officer each concluded that, as of the end of such period, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported on a timely basis, and is accumulated and communicated to our management, including our Chief Executive Officer and Acting Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
During our most recent fiscal quarter, there has not been any change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.