NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Zoetis Inc. (including its subsidiaries, collectively, Zoetis, the company, we, us or our) is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. We organize and operate our business in
two
geographic regions: the United States (U.S.) and International.
We directly market our products in approximately
45
countries across North America, Europe, Africa, Asia, Australia and South America. Our products are sold in more than
100
countries, including developed markets and emerging markets. We have a diversified business, marketing products across
eight
core species: cattle, swine, poultry, sheep and fish (collectively, livestock) and dogs, cats and horses (collectively, companion animals); and within
six
major product categories: vaccines, anti-infectives, parasiticides, medicated feed additives, animal health diagnostics and other pharmaceuticals.
The accompanying unaudited condensed consolidated financial statements were prepared following the requirements of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (U.S. GAAP) can be condensed or omitted. Balance sheet amounts and operating results for subsidiaries operating outside the United States are as of and for the three and
nine
-month periods ended
August 31, 2018
, and
August 27, 2017
.
Prior to fiscal
2018
, the company followed a 13-week quarterly accounting cycle for each of the first three fiscal quarters. The company's fiscal year ends on December 31 for our operations in the United States and on November 30 for subsidiaries operating outside the United States. Beginning in fiscal
2018
, the company's first three fiscal quarters will end on the last day of March, June and September in the United States and the last day of February, May and August for subsidiaries operating outside the United States. There is no change to the company's fiscal year-end dates. We did not adjust our results of operations for periods prior to
2018
as the impact was not material.
Revenue, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be representative of those for the full year.
We are responsible for the unaudited condensed consolidated financial statements included in this Form 10-Q. The condensed consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. The information included in this interim report should be read in conjunction with the financial statements and accompanying notes included in our
2017
Annual Report on Form 10-K.
Recently Adopted Accounting Standards
In March 2018, the Financial Accounting Standards Board (FASB) issued an accounting standards update to align existing guidance on accounting for income taxes, pursuant to guidance provided by a Staff Accounting Bulletin published by the SEC on December 22, 2017. The update addresses the challenges in accounting for the effects of the Tax Cuts and Jobs Act (the Tax Act), enacted on December 22, 2017, in the period of enactment and required companies to report provisional amounts for those specific income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. Provisional amounts will be subject to adjustment during a measurement period of up to one year from the enactment date. For additional information, see
Note 8. Income Taxes
.
In August 2017, the FASB issued an accounting standards update which amends the hedge accounting recognition and presentation requirements
and is intended to better align hedge accounting with companies' risk management strategies. The standard eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires that the entire change in fair value of a hedging instrument be presented in the same income statement line item as the respective hedged item. The standard also modifies certain disclosure requirements. The provisions of the update are effective beginning January 1, 2019 for interim and annual periods with early adoption permitted for any interim period after issuance of the update. We elected to early adopt this guidance as of April 1, 2018. There were no hedging contracts in effect as of the date of adoption.
In March 2017, the FASB issued an accounting standards update to simplify and improve the reporting of net periodic pension benefit cost by requiring only present service cost to be presented in the same line item as other current employee compensation costs while remaining components of net periodic benefit cost would be presented within
Other (income)/deductions—net
outside of operations. We adopted this guidance as of January 1, 2018, the required effective date. The new standard did not have a significant impact on our consolidated financial statements.
In October 2016, the FASB issued an accounting standards update that requires the recognition of the income tax consequences of an intra-entity asset transfer, other than inventory, when the transfer occurs as opposed to when the asset is sold to an outside third party. We adopted this
guidance as of January 1, 2018, the required effective date. The new standard did not have a significant impact on our consolidated financial statements.
In May 2014, the FASB issued an accounting standards update that outlines a new, single comprehensive model for companies to use in accounting for revenue arising from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted this guidance as of January 1, 2018, the required effective date, using the modified retrospective adoption method. Prior period amounts have not been adjusted and continue to be reported in accordance with our historic accounting policies. Application of the standard using the modified retrospective method did not require an adjustment to opening retained earnings. For additional information, see
Note 4. Revenue
.
Recently Issued Accounting Standards
In August 2018, the FASB issued an accounting standards update which expands the scope of costs associated with cloud computing arrangements that must be capitalized. Under the new guidance, costs associated with implementing a cloud computing arrangement that is a service contract must be capitalized and expensed over the term of the hosting arrangement. The provisions of the update are effective beginning January 1, 2020 for interim and annual periods with early adoption permitted for any interim period after issuance of the update. We are currently assessing the timing of our adoption as well as the potential impact that the standard will have on our consolidated financial statements.
In February 2018, the FASB issued an accounting standards update which permits companies to reclassify from accumulated other comprehensive income to retained earnings stranded tax effects resulting from the new federal corporate income tax rate. In the period of adoption, a company may choose to either apply the amendments retrospectively to each period in which the effect of the change in federal income tax rate is recognized or to apply the amendments in that reporting period. The provisions of the update are effective beginning January 1, 2019 for interim and annual periods, with early adoption permitted for any interim period after issuance of the update. We are currently assessing the timing of our adoption and do not expect that the new standard will have a significant impact on our consolidated financial statements.
In February 2016, the FASB issued an accounting standards update which requires lessees to recognize most leases on the balance sheet with a corresponding right of use asset. Leases will be classified as financing or operating which will drive the expense recognition pattern. For lessees, the income statement presentation and expense recognition pattern for financing and operating leases is similar to the current model for capital and operating leases, respectively. Companies may elect to exclude short-term leases. The update also requires additional disclosures that will better enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We plan to adopt this guidance as of January 1, 2019, using the effective date as the date of initial application. As permitted, utilizing an optional transition method, a cumulative-effect adjustment to the opening balance of retained earnings will be recognized in the period of adoption, and financial information and disclosure for periods prior to the date of initial application will not be updated. We have selected a lease accounting system which we are in the process of implementing, while continuing to evaluate our lease contracts, accounting policy elections, and the impact of adoption on our consolidated financial statements. While we do not expect adoption of the standard to have a significant impact on our consolidated statements of income, the impact on the assets and liabilities within our consolidated balance sheet will be material.
|
|
A.
|
Revenue from Product Sales
|
We offer a diversified portfolio of products which allows us to capitalize on local and regional customer needs. Generally, our products are promoted to veterinarians and livestock producers by our sales organization which includes sales representatives and technical and veterinary operations specialists, and then sold directly by us or through distributors. The depth of our product portfolio enables us to address the varying needs of customers in different species and geographies. Many of our top selling product lines are distributed across both of our operating segments, leveraging our R&D operations and manufacturing and supply chain network.
Over the course of our history, we have focused on developing a diverse portfolio of animal health products, including medicines and vaccines, complemented by biodevices, diagnostics, and genetics. We refer to a single product in all brands, or its dosage forms for all species, as a product line. We have approximately
300
comprehensive product lines, including products for both livestock and companion animals across each of our major product categories.
In the third quarter of 2018, the company modified the list of major product categories to include a category for animal health diagnostics, which was previously included within other non-pharmaceutical products. The prior period presentation has been revised to reflect the new product categories.
Our major product categories are:
|
|
•
|
vaccines
: biological preparations that help prevent diseases of the respiratory, gastrointestinal and reproductive tracts or induce a specific immune response;
|
|
|
•
|
anti-infectives
: products that prevent, kill or slow the growth of bacteria, fungi or protozoa;
|
|
|
•
|
other pharmaceutical products
: allergy and dermatology, pain and sedation, antiemetic, reproductive, and oncology products;
|
|
|
•
|
parasiticides
: products that prevent or eliminate external and internal parasites such as fleas, ticks and worms;
|
|
|
•
|
medicated feed additives
: products added to animal feed that provide medicines to livestock; and
|
|
|
•
|
animal health diagnostics
: portable blood and urine analysis systems and point-of-care diagnostic products, including instruments
|
and reagents, rapid immunoassay tests, reference laboratory kits and blood glucose monitors.
Our remaining revenue is derived from other non-pharmaceutical product categories, such as nutritionals and agribusiness, as well as products and services in complementary areas, including biodevices and genetics.
Our livestock products primarily help prevent or treat diseases and conditions to enable the cost-effective production of safe, high-quality animal protein. Human population growth and increasing standards of living are important long-term growth drivers for our livestock products in three major ways. First, population growth and increasing standards of living drive increased demand for improved nutrition, particularly animal protein. Second, population growth leads to increased natural resource constraints driving a need for enhanced productivity. Finally, as standards of living improve, there is increased focus on food quality and safety.
Our companion animal products help extend and improve the quality of life for pets; increase convenience and compliance for pet owners; and help veterinarians improve the quality of their care and the efficiency of their businesses. Growth in the companion animal medicines and vaccines sector is driven by economic development, related increases in disposable income and increases in pet ownership and spending on pet care. Companion animals are also living longer, receiving increased medical treatment and benefiting from advances in animal health medicines and vaccines.
The following tables present our revenue disaggregated by geographic area, species, and major product category.
Revenue by geographic area
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
United States
|
|
$
|
757
|
|
|
$
|
680
|
|
|
$
|
2,068
|
|
|
$
|
1,908
|
|
Australia
|
|
53
|
|
|
51
|
|
|
152
|
|
|
134
|
|
Brazil
|
|
72
|
|
|
66
|
|
|
210
|
|
|
205
|
|
Canada
|
|
42
|
|
|
40
|
|
|
138
|
|
|
123
|
|
China
|
|
46
|
|
|
40
|
|
|
170
|
|
|
137
|
|
France
|
|
29
|
|
|
30
|
|
|
92
|
|
|
85
|
|
Germany
|
|
36
|
|
|
35
|
|
|
112
|
|
|
96
|
|
Italy
|
|
27
|
|
|
22
|
|
|
80
|
|
|
65
|
|
Japan
|
|
34
|
|
|
31
|
|
|
114
|
|
|
101
|
|
Mexico
|
|
24
|
|
|
21
|
|
|
74
|
|
|
60
|
|
Spain
|
|
28
|
|
|
24
|
|
|
83
|
|
|
67
|
|
United Kingdom
|
|
47
|
|
|
36
|
|
|
135
|
|
|
105
|
|
Other developed markets
|
|
98
|
|
|
96
|
|
|
266
|
|
|
240
|
|
Other emerging markets
|
|
173
|
|
|
162
|
|
|
537
|
|
|
485
|
|
|
|
1,466
|
|
|
1,334
|
|
|
4,231
|
|
|
3,811
|
|
|
|
|
|
|
|
|
|
|
Contract manufacturing & human health diagnostics
|
|
14
|
|
|
13
|
|
|
30
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
1,480
|
|
|
$
|
1,347
|
|
|
$
|
4,261
|
|
|
$
|
3,847
|
|
Revenue by major species
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
U.S.
|
|
|
|
|
|
|
|
|
Livestock
|
|
$
|
322
|
|
|
$
|
319
|
|
|
$
|
885
|
|
|
$
|
870
|
|
Companion animal
|
|
435
|
|
|
361
|
|
|
1,183
|
|
|
1,038
|
|
|
|
757
|
|
|
680
|
|
|
2,068
|
|
|
1,908
|
|
International
|
|
|
|
|
|
|
|
|
Livestock
|
|
456
|
|
|
435
|
|
|
1,397
|
|
|
1,276
|
|
Companion animal
|
|
253
|
|
|
219
|
|
|
766
|
|
|
627
|
|
|
|
709
|
|
|
654
|
|
|
2,163
|
|
|
1,903
|
|
|
|
|
|
|
|
|
|
|
Contract manufacturing & human health diagnostics
|
|
14
|
|
|
13
|
|
|
30
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
1,480
|
|
|
$
|
1,347
|
|
|
$
|
4,261
|
|
|
$
|
3,847
|
|
Revenue by species
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Livestock:
|
|
|
|
|
|
|
|
|
Cattle
|
|
$
|
417
|
|
|
$
|
424
|
|
|
$
|
1,229
|
|
|
$
|
1,192
|
|
Swine
|
|
160
|
|
|
147
|
|
|
500
|
|
|
455
|
|
Poultry
|
|
130
|
|
|
119
|
|
|
395
|
|
|
357
|
|
Fish
|
|
46
|
|
|
39
|
|
|
92
|
|
|
79
|
|
Other
|
|
25
|
|
|
25
|
|
|
66
|
|
|
63
|
|
|
|
778
|
|
|
754
|
|
|
2,282
|
|
|
2,146
|
|
Companion Animal:
|
|
|
|
|
|
|
|
|
Dogs and Cats
|
|
653
|
|
|
546
|
|
|
1,832
|
|
|
1,561
|
|
Horses
|
|
35
|
|
|
34
|
|
|
117
|
|
|
104
|
|
|
|
688
|
|
|
580
|
|
|
1,949
|
|
|
1,665
|
|
|
|
|
|
|
|
|
|
|
Contract manufacturing & human health diagnostics
|
|
14
|
|
|
13
|
|
|
30
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
1,480
|
|
|
$
|
1,347
|
|
|
$
|
4,261
|
|
|
$
|
3,847
|
|
Revenue by major product category
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Vaccines
|
|
$
|
382
|
|
|
$
|
363
|
|
|
$
|
1,109
|
|
|
$
|
1,006
|
|
Anti-infectives
|
|
323
|
|
|
324
|
|
|
906
|
|
|
870
|
|
Other pharmaceuticals
|
|
361
|
|
|
304
|
|
|
1,017
|
|
|
858
|
|
Parasiticides
|
|
203
|
|
|
191
|
|
|
639
|
|
|
581
|
|
Medicated feed additives
|
|
111
|
|
|
107
|
|
|
362
|
|
|
351
|
|
Animal health diagnostics
|
|
46
|
|
|
11
|
|
|
69
|
|
|
32
|
|
Other non-pharmaceuticals
|
|
40
|
|
|
34
|
|
|
129
|
|
|
113
|
|
|
|
1,466
|
|
|
1,334
|
|
|
4,231
|
|
|
3,811
|
|
|
|
|
|
|
|
|
|
|
Contract manufacturing & human health diagnostics
|
|
14
|
|
|
13
|
|
|
30
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
1,480
|
|
|
$
|
1,347
|
|
|
$
|
4,261
|
|
|
$
|
3,847
|
|
B. Revenue Accounting Policy
Below are the significant accounting policies updated as of January 1, 2018 as a result of the adoption of the new revenue recognition guidance. For additional information, see
Note 3. Accounting Standards
.
We recognize revenue from product sales when control of the goods has transferred to the customer, which is typically once the goods have shipped and the customer has assumed title.
Revenue reflects the total consideration to which we expect to be entitled (i.e. the transaction price), in exchange for products sold, after considering various types of variable consideration including rebates, sales allowances, product returns and discounts.
Variable consideration is estimated and recorded at the time that related revenue is recognized. Our estimates reflect the amount by which we expect variable consideration to impact revenue recognized and are generally based on contractual terms or historical experience, adjusted as necessary to reflect our expectations about the future. Our customer payment terms generally range from 45 to 75 days.
Estimates of variable consideration utilize a complex series of judgments and assumptions to determine the amount by which we expect revenue to be reduced, for example;
|
|
•
|
for sales returns, we perform calculations in each market that incorporate the following, as appropriate: local returns policies and practices; historic returns as a percentage of revenue; estimated shelf life by product; an estimate of the amount of time between shipment and return or lag time; and any other factors that could impact the estimate of future returns, product recalls, discontinuation of products or a changing competitive environment; and
|
|
|
•
|
for revenue incentives, we use our historical experience with similar incentives programs to estimate the impact of such programs on revenue for the current period.
|
Although the amounts recorded for these revenue deductions are dependent on estimates and assumptions, historically our adjustments to actual results have not been material. The sensitivity of our estimates can vary by program, type of customer and geographic location.
A deferral of revenue may be required in the event that we have not satisfied all customer obligations for which we have been compensated. The transaction price is allocated to the individual performance obligations on the basis of relative stand-alone selling price, which is typically based on actual sales prices. Revenue associated with unsatisfied performance obligations are contract liabilities, is recorded within
Other current liabilities
, and is recognized once control of the underlying products has transferred to the customer. Contract liabilities reflected within
Other current liabilities
as of the adoption date and subsequently recognized as revenue during the first nine months of 2018 were approximately
$2 million
. Contract liabilities as of
September 30, 2018
were approximately
$7 million
.
We do not disclose the transaction price allocated to unsatisfied performance obligations related to contracts with an original expected duration of one year or less, or for contracts for which we recognize revenue in line with our right to invoice the customer. Estimated future revenue expected to be generated from long-term contracts with unsatisfied performance obligations as of
September 30, 2018
is insignificant.
Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from
Revenue.
Shipping and handling costs incurred after control of the purchased product has transferred to the customer are accounted for as a fulfillment cost, within
Selling, general and administrative expenses.
|
|
5.
|
Acquisitions and Divestitures
|
Acquisition of Abaxis, Inc.
On
July 31, 2018
, we completed the acquisition of
Abaxis, Inc. (Abaxis), a California corporation and a leader in the development, manufacture and marketing of diagnostic instruments for veterinary point-of-care services.
We acquired all of the outstanding common shares of Abaxis for
$83.00
per share in cash resulting in Abaxis becoming our wholly owned subsidiary. The acquisition enhances our presence in veterinary diagnostics.
The acquisition date fair value of the consideration transferred was approximately
$1,962 million
, which consisted of the following:
|
|
|
|
|
(MILLIONS OF DOLLARS)
|
Amounts
|
|
Cash paid to Abaxis' shareholders
(a)
|
$
|
1,898
|
|
Cash paid for equity awards attributable for pre-merger services
(b)
|
54
|
|
Fair value of Zoetis equity awards issued in exchange for outstanding Abaxis equity awards pertaining to pre-merger service
(c)
|
10
|
|
Total consideration
|
$
|
1,962
|
|
|
|
(a)
|
Represents cash paid for cancellation and conversion of each outstanding share of Abaxis' common stock at the acquisition date.
|
|
|
(b)
|
Represents cash paid for cancellation and settlement of restricted stock awards that fully vested in July 2018 as a result of service or pre-existing change-in-control provisions and termination provisions. Includes certain awards that will be settled in cash during 2019, reflected in
Other current liabilities
within the condensed consolidated balance sheet.
|
|
|
(c)
|
Represents the fair value of replacement awards issued for Abaxis equity awards outstanding immediately before the acquisition and attributable to the service period prior to the acquisition. The previous Abaxis equity awards were converted into the Zoetis equity awards at an exchange ratio based on the closing prices of shares of Zoetis Common Stock and Abaxis Common Stock for ten full trading days before the closing of the acquisition.
|
The acquisition has been accounted for as a business combination with the assets acquired and liabilities assumed measured at estimated fair values as of the acquisition date, primarily using Level 3 inputs, except for investments in debt securities which were valued using Level 2 inputs.
The table below presents the preliminary fair values allocated to Abaxis' assets and liabilities as of the acquisition date.
|
|
|
|
|
(MILLIONS OF DOLLARS)
|
Amounts
|
|
Cash and cash equivalents
|
$
|
64
|
|
Short term investments
(a)
|
107
|
|
Accounts receivable
(b)
|
30
|
|
Inventories
(c)
|
79
|
Other current assets
|
6
|
Property, plant and equipment
(d)
|
49
|
Identifiable intangible assets
(e)
|
898
|
Other noncurrent assets
|
29
|
Accounts payable
|
(21)
|
Accrued compensation and related items
|
(10)
|
Other current liabilities
|
(26)
|
Other noncurrent liabilities
|
(11)
|
Noncurrent deferred tax liabilities
(f)
|
(215)
|
Total net assets acquired
|
979
|
Goodwill
(g)
|
983
|
Total consideration
|
$
|
1,962
|
|
|
|
(a)
|
Short term investments include investments in debt securities that are classified as available-for-sale and measured at fair value.
|
|
|
(b)
|
The fair value approximates the gross contractual amount of accounts receivable. The contractual amount not expected to be collected is immaterial.
|
|
|
(c)
|
Acquired inventory is comprised of finished goods, work in process and raw materials. The preliminary estimate of fair value of finished goods was determined based on net realizable value adjusted for the costs of the selling effort, a reasonable profit allowance for the selling effort, and estimated holding costs. The preliminary estimate of fair value of work in process was determined based on net realizable value adjusted for costs to complete the manufacturing process, costs of the selling effort, a reasonable profit allowance for the remaining manufacturing and selling effort, and an estimate of holding costs. The fair value of raw materials was determined to approximate book value.
|
|
|
(d)
|
Property, plant and equipment is comprised of machinery and equipment, furniture and fixtures, computer equipment, leasehold improvements and construction in progress. The preliminary estimated fair value was primarily determined using a reproduction/replacement cost approach which measures the value of an asset by estimating the cost to acquire or construct comparable assets adjusted for age and condition of the asset.
|
|
|
(e)
|
Identifiable intangible assets primarily consist of developed technology rights, customer relationships, and trademarks and tradenames. The preliminary estimate of fair value of identifiable intangible assets is determined using the income approach, which includes a forecast of expected future cash flows. For additional information regarding identifiable intangible assets, see
Note 11. Goodwill and Other Intangible Assets
.
|
|
|
(f)
|
The acquisition was structured as a stock purchase and therefore we assumed the historical tax basis of Abaxis' assets and liabilities. The preliminary estimate of deferred tax effects resulting from the acquisition include the expected federal, state, and foreign tax consequences associated with temporary differences between the preliminary fair values of the assets acquired and liabilities assumed and the respective tax basis. The components of the Abaxis net deferred tax liability are included within amounts reported in
Note 8. Income Taxes
.
|
|
|
(g)
|
Goodwill represents the excess of consideration transferred over the preliminary estimate of fair values of the assets acquired and liabilities assumed. It is allocated to our existing reportable segments and is primarily attributable to the future potential of the technology platforms, as well as cost and revenue synergies including market share capture, elimination of cost redundancies and gain of cost efficiencies, and intangible assets such as assembled workforce which are not separately recognizable. The primary strategic purpose of the acquisition was to enhance the company’s existing product portfolio by strengthening Zoetis’ presence in veterinary diagnostics. The goodwill recorded is not deductible for tax purposes. The allocation of goodwill to the reporting units is preliminary and will be completed as the company obtains the information necessary to complete the analysis, but no later than one year from the date of the acquisition.
|
All amounts recorded are subject to final valuation. Any adjustments to our preliminary purchase price allocation identified during the measurement period, which will not exceed one year from the acquisition date, will be accounted for prospectively.
The company incurred acquisition related costs of approximately
$39 million
and
$40 million
for the
three and nine months ended
September 30, 2018
, respectively, which are included within
Restructuring charges/(reversals) and certain acquisition-related costs
and
Selling, general and administrative expenses
on our condensed consolidated statements of income.
The following table presents information for Abaxis' operations from the acquisition date through
September 30, 2018
which are included in our condensed consolidated statements of income for the
three months ended
September 30, 2018
:
|
|
|
|
|
(MILLIONS OF DOLLARS)
|
July 31 - September 30,
2018
|
|
Revenue
|
$
|
42
|
|
Net loss attributable to Zoetis Inc.
(a)
|
32
|
|
|
|
(a)
|
Included in the net loss are (i)
$7 million
of cost of goods sold related to the preliminary fair value adjustment for acquisition date inventory estimated to have been sold during the period ended
September 30, 2018
, (ii)
$20 million
of amortization expense related to the preliminary fair value of identifiable intangible assets recognized at the acquisition date, (iii)
$10 million
of severance costs directly related to the acquisition, and (iv) the applicable tax impact of above adjustments based on the statutory tax rates in the various jurisdictions where the adjustments are expected to be incurred.
|
Supplemental Pro Forma Information:
The following table provides unaudited supplemental pro forma financial information as if the acquisition of Abaxis had occurred on January 1, 2017.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
(MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)
|
September 30,
|
|
October 1,
|
|
|
September 30,
|
|
October 1,
|
|
2018
|
|
2017
|
|
|
2018
|
|
2017
|
|
Revenue
|
$
|
1,500
|
|
$
|
1,406
|
|
|
$
|
4,416
|
|
$
|
4,022
|
|
Net income attributable to Zoetis Inc.
|
348
|
|
267
|
|
|
1,024
|
|
665
|
|
Net income per common share - basic
|
0.72
|
|
0.55
|
|
|
2.12
|
|
1.35
|
|
Net income per common share - diluted
|
0.72
|
|
0.54
|
|
|
2.10
|
|
1.35
|
|
The supplemental pro forma financial information has been prepared using the acquisition method of accounting and is based on the historical financial information of Zoetis and Abaxis. The supplemental pro forma financial information does not necessarily represent what the combined company’s revenue or results of operations would have been had the acquisition been completed on
January 1, 2017
, nor do they intend to be a projection of future operating results of the combined company. It also does not reflect any operating efficiencies or potential cost savings that might be achieved from synergies of combining Zoetis and Abaxis.
The unaudited supplemental pro forma financial information reflect primarily the following pro forma adjustments:
|
|
•
|
Acquisition related costs incurred by Zoetis and Abaxis of
$57 million
and
$60 million
have been removed for each of the
three and nine months ended
September 30, 2018
, respectively. Acquisition related costs of
$0 million
and
$38 million
are assumed to be have been incurred during the
three and nine months ended
October 1, 2017
, respectively.
|
|
|
•
|
Additional amortization expense of
$13 million
and
$78 million
for each of the
three and nine months ended
September 30, 2018
, respectively, and
$33 million
and
$98 million
for each of the
three and nine months ended
October 1, 2017
, respectively, related to the preliminary fair value estimate of identified intangible assets acquired.
|
|
|
•
|
Additional depreciation expense of
$1 million
for the
nine months ended
September 30, 2018
, and
$1 million
for the
nine months ended
October 1, 2017
, related to the preliminary estimate of fair value adjustments to property, plant and equipment acquired.
|
|
|
•
|
Adjustments related to the preliminary estimate of the non-recurring fair value adjustment to acquisition date inventory estimated to have been sold, resulting in
$7 million
removed for each of the
three and nine months ended
September 30, 2018
, respectively, and
$11 million
and
$33 million
added to the
three and nine months ended
October 1, 2017
, respectively.
|
|
|
•
|
Additional interest expense and amortization of debt issuance costs for the debt issuance to finance the acquisition, resulting in
$8 million
and
$36 million
added for the
three and nine months ended
September 30, 2018
, respectively, and
$14 million
and
$43 million
added to the
three and nine months ended
October 1, 2017
, respectively.
|
|
|
•
|
Adjustments related to the post merger share-based compensation expense of the replacement awards are
$0 million
and
$7 million
for the
three and nine months ended
September 30, 2018
, respectively, and
$3 million
and
$10 million
for the
three and nine months ended
October 1, 2017
, respectively.
|
|
|
•
|
Applicable tax impact of the above adjustments based on the statutory tax rates in the various jurisdictions where the adjustments are expected to be incurred.
|
Other Acquisitions
In the third quarter of 2018, we completed the acquisition of a manufacturing business in Ireland and the noncontrolling interest of a European livestock monitoring company. These transactions did not have a significant impact on our consolidated financial statements.
Divestitures
On
May 11, 2017
, we completed the sale of our manufacturing site in Shenzhou, China. We had previously exited operations at this site during the second quarter of 2015 as part of our operational efficiency program. We received total cash proceeds of approximately
$3 million
and recorded a net pre-tax gain of approximately
$2 million
within
Other (income)/deductions—net
.
Additionally, in the second quarter of 2017, we recorded a
$4 million
expense within
Other (income)/deductions—net
related to the February 12, 2016 sale of two of our manufacturing sites in the United Sates: Laurinburg, North Carolina, and Longmonth, Colorado to Huvepharma NV (Huvepharma), a European animal health company.
|
|
6.
|
Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives
|
In connection with our cost-reduction/productivity initiatives, we typically incur costs and charges associated with site closings and other facility rationalization actions, workforce reductions and the expansion of shared services, including the development of global systems. In connection with our acquisition activity, we typically incur costs and charges associated with executing the transactions, integrating the acquired operations, which may include expenditures for consulting and the integration of systems and processes, product transfers and restructuring the consolidated company, which may include charges related to employees, assets and activities that will not continue in the consolidated company. All operating functions can be impacted by these actions, including sales and marketing, manufacturing and research and development (R&D), as well as functions such as business technology, shared services and corporate operations.
During 2015, we launched a comprehensive operational efficiency program, which was incremental to the previously announced supply network strategy. These initiatives focused on reducing complexity in our product portfolios, changing our selling approach in certain markets, reducing our presence in certain countries, and exiting manufacturing sites over a long term period. We have also continued to optimize our resource allocation and efficiency by reducing resources associated with non-customer facing activities and operating more efficiently as a result of less internal complexity and more standardization of processes. The comprehensive operational efficiency program was substantially completed as of December 31, 2017. We expect to complete the supply network strategy over the next several years.
The components of costs incurred in connection with restructuring initiatives, acquisitions and cost-reduction/productivity initiatives are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Restructuring charges/(reversals) and certain acquisition-related costs:
|
|
|
|
|
|
|
|
|
Transaction costs
(a)
|
|
$
|
21
|
|
|
$
|
—
|
|
|
$
|
21
|
|
|
$
|
—
|
|
Integration costs
(b)
|
|
9
|
|
|
2
|
|
|
10
|
|
|
4
|
|
Restructuring charges/(reversals)
(c)(d)
:
|
|
|
|
|
|
|
|
|
Employee termination costs
|
|
17
|
|
|
7
|
|
|
22
|
|
|
3
|
|
Exit costs
|
|
—
|
|
|
(1
|
)
|
|
1
|
|
|
—
|
|
Total Restructuring charges/(reversals) and certain acquisition-related costs
|
|
$
|
47
|
|
|
$
|
8
|
|
|
$
|
54
|
|
|
$
|
7
|
|
|
|
(a)
|
Transaction costs represent external costs directly related to acquiring businesses and primarily include expenditures for banking, legal, accounting and other similar services.
|
|
|
(b)
|
Integration costs represent external, incremental costs directly related to integrating acquired businesses and primarily include expenditures for consulting and the integration of systems and processes, as well as product transfer costs.
|
|
|
(c)
|
The restructuring charges for the
three months ended
September 30, 2018
, are primarily related to:
|
|
|
•
|
employee termination costs of
$8 million
in Europe as a result of initiatives to better align our organizational structure, and
|
|
|
•
|
employee termination costs of
$10 million
related to the acquisition of Abaxis.
|
The restructuring charges for the
nine months ended
September 30, 2018
, are primarily related to:
|
|
•
|
employee termination costs of
$11 million
in Europe as a result of initiatives to better align our organizational structure, and
|
|
|
•
|
employee termination costs of
$10 million
related to the acquisition of Abaxis.
|
|
|
|
The restructuring charges/(reversals) for the
three months ended
October 1, 2017
, are primarily related to:
|
|
|
•
|
employee termination costs of
$3 million
related to the operational efficiency initiative and supply network strategy, and
|
|
|
•
|
employee termination costs of
$4 million
related to the acquisition of an Irish biologic therapeutics company in the third quarter of 2017.
|
The restructuring charges/(reversals) for the
nine months ended
October 1, 2017
, are primarily related to:
|
|
•
|
employee termination costs of
$4 million
related to the acquisition of an Irish biologic therapeutics company in the third quarter of 2017.
|
|
|
(d)
|
The restructuring charges/(reversals) are associated with the following:
|
|
|
•
|
For the
three months ended
September 30, 2018
, International of
$8 million
and Manufacturing/research/corporate of
$9 million
.
|
|
|
•
|
For the
nine months ended
September 30, 2018
, International of
$12 million
and Manufacturing/research/corporate of
$11 million
.
|
|
|
•
|
For the
three months ended
October 1, 2017
, International of (
$1 million
reversal) and Manufacturing/research/corporate of
$7 million
.
|
|
|
•
|
For the
nine months ended
October 1, 2017
, International of (
$2 million
reversal) and Manufacturing/research/corporate of
$5 million
.
|
Charges related to the operational efficiency initiative and supply network strategy are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Restructuring charges/(reversals) and certain acquisition-related costs:
|
|
|
|
|
|
|
|
|
Operational efficiency initiative
|
|
|
|
|
|
|
|
|
Employee termination costs
|
|
$
|
(1
|
)
|
|
$
|
1
|
|
|
$
|
—
|
|
|
$
|
2
|
|
Exit costs
|
|
—
|
|
|
(1
|
)
|
|
—
|
|
|
—
|
|
|
|
(1
|
)
|
|
—
|
|
|
—
|
|
|
2
|
|
Supply network strategy:
|
|
|
|
|
|
|
|
|
Employee termination costs
|
|
—
|
|
|
2
|
|
|
1
|
|
|
(3
|
)
|
Exit costs
|
|
—
|
|
|
—
|
|
|
1
|
|
|
—
|
|
|
|
—
|
|
|
2
|
|
|
2
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
Total restructuring charges/(reversals) related to the operational efficiency initiative and supply network strategy
|
|
(1
|
)
|
|
2
|
|
|
2
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
Other operational efficiency initiative charges
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses:
|
|
|
|
|
|
|
|
|
Consulting fees
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1
|
|
Other (income)/deductions—net:
|
|
|
|
|
|
|
|
|
Net (gain)/loss on sale of assets
|
|
—
|
|
|
(1
|
)
|
|
—
|
|
|
1
|
|
Total other operational efficiency initiative charges
|
|
—
|
|
|
(1
|
)
|
|
—
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
Other supply network strategy charges
|
|
|
|
|
|
|
|
|
Cost of sales:
|
|
|
|
|
|
|
|
|
Accelerated depreciation
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2
|
|
Consulting fees and other costs
|
|
1
|
|
|
1
|
|
|
4
|
|
|
3
|
|
Other (income)/deductions—net:
|
|
|
|
|
|
|
|
|
Net loss on sale of assets
(a)
|
|
2
|
|
|
5
|
|
|
2
|
|
|
5
|
|
Total other supply network strategy charges
|
|
3
|
|
|
6
|
|
|
6
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
Total charges associated with the operational efficiency initiative and supply network strategy
|
|
$
|
2
|
|
|
$
|
7
|
|
|
$
|
8
|
|
|
$
|
11
|
|
|
|
(a)
|
For the
three and nine months ended
October 1, 2017
, represents charges related to the agreement to sell a manufacturing site in Guarulhos, Brazil, which includes a
$3 million
charge to reduce the carrying value of the disposal group to an amount equal to fair value, less costs to sell, as well as
$2 million
of costs related to the anticipated disposal.
|
The components of, and changes in, our restructuring accruals are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee
|
|
|
|
|
|
|
|
Termination
|
|
|
Exit
|
|
|
|
(MILLIONS OF DOLLARS)
|
|
Costs
|
|
|
Costs
|
|
|
Accrual
|
|
Balance, December 31, 2017
(a)
|
|
$
|
41
|
|
|
$
|
—
|
|
|
$
|
41
|
|
Provision
|
|
22
|
|
|
1
|
|
|
23
|
|
Utilization and other
(b)
|
|
(26
|
)
|
|
(1
|
)
|
|
(27
|
)
|
Balance, September 30
, 2018
(a)
|
|
$
|
37
|
|
|
$
|
—
|
|
|
$
|
37
|
|
|
|
(a)
|
At
September 30, 2018
, and
December 31, 2017
, included in Accrued expenses (
$15 million
and
$19 million
, respectively) and Other noncurrent liabilities (
$22 million
and
$22 million
, respectively).
|
|
|
(b)
|
Includes adjustments for foreign currency translation.
|
|
|
7.
|
Other (Income)/Deductions—Net
|
The components of
Other (income)/deductions—net
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Royalty-related income
|
|
$
|
(5
|
)
|
|
$
|
(7
|
)
|
|
$
|
(18
|
)
|
|
$
|
(19
|
)
|
Interest income
|
|
(6
|
)
|
|
(3
|
)
|
|
(20
|
)
|
|
(8
|
)
|
Net (gain)/loss on sale of assets
(a)
|
|
2
|
|
|
4
|
|
|
2
|
|
|
6
|
|
Certain legal and other matters, net
(b)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(4
|
)
|
Foreign currency loss
(c)
|
|
9
|
|
|
7
|
|
|
26
|
|
|
17
|
|
Other, net
(d)
|
|
(19
|
)
|
|
—
|
|
|
(18
|
)
|
|
(3
|
)
|
Other (income)/deductions—net
|
|
$
|
(19
|
)
|
|
$
|
1
|
|
|
$
|
(28
|
)
|
|
$
|
(11
|
)
|
|
|
(a)
|
Represents net losses related to sales of certain manufacturing sites and products as part of our operational efficiency initiative and supply network strategy.
|
|
|
(b)
|
For the
nine months ended
October 1, 2017
, represents income associated with an insurance recovery related to commercial settlements in Mexico recorded in 2014 and 2016.
|
|
|
(c)
|
Primarily driven by costs related to hedging and exposures to certain emerging market currencies.
|
|
|
(d)
|
For the
three and nine months ended
September 30, 2018
, primarily includes a net gain related to the relocation of a manufacturing site in China. For the
nine months ended
October 1, 2017
, primarily includes a settlement refund and reimbursement of legal fees related to costs incurred by Pharmaq prior to the acquisition in 2015 and income associated with certain state business employment tax incentive credits.
|
On December 22, 2017, the Tax Act was enacted which, among other changes, reduced the U.S. federal corporate tax rate from
35%
to
21%
effective January 1, 2018. The Tax Act made broad and complex changes to the U.S. tax code and it will take time to fully analyze the impact of the changes. Based on the information available at that time, and the current interpretation of the Tax Act, for the year ended December 31, 2017 the company was able to make a reasonable estimate and recorded an initial provisional net tax expense of
$212 million
related to the one-time mandatory deemed repatriation tax, payable over eight years, partially offset by the remeasurement of the deferred tax assets and liabilities, as of the date of enactment, due to the reduction in the U.S. federal corporate tax rate. Pursuant to the Staff Accounting Bulletin published by the SEC on December 22, 2017, addressing the challenges in accounting for the effects of the Tax Act in the period of enactment, companies must report provisional amounts for those specific income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. Those provisional amounts will be subject to adjustment during a measurement period of up to one year from the enactment date (measurement-period adjustment). Pursuant to this guidance, the estimated impact of the Tax Act was based on a preliminary review of the new tax law and projected future financial results and is subject to revision based upon further analysis and interpretation of the Tax Act and to the extent that future results differ from currently available projections.
Our accounting for the following elements of the Tax Act is incomplete. However, in 2018 we were able to further refine our initial reasonable estimate and adjusted the initial provisional net tax expense of
$212 million
. We recorded the following measurement-period adjustments of
$23 million
and
$58 million
net tax benefit during the
three and nine months ended
September 30, 2018
, respectively:
|
|
•
|
One-Time Mandatory Deemed Repatriation Tax: The one-time mandatory deemed repatriation tax is imposed on previously untaxed accumulated and current earnings and profits (E&P) of our foreign subsidiaries. We were able to reasonably estimate the one-time mandatory deemed repatriation tax and recorded an initial provisional tax obligation, with a corresponding adjustment to income tax expense for the year ended December 31, 2017. We are continuing to gather additional information to more precisely compute the amount of the one-time mandatory deemed repatriation tax. Our accounting for this item is not yet complete due to the fact that the non-U.S. subsidiaries are on a fiscal year ending November 30, and this tax liability will not become a fixed obligation until November 30, 2018. The estimated impact of the Tax Act is based on a preliminary review of the new law and projected future financial results and is subject to revision based upon further analysis and interpretation of the Tax Act and to the extent that future results differ from currently available projections. However, on the basis of revised computations that were calculated during the reporting period, we recognized a measurement-period adjustment of
$23 million
and
$58 million
for the
three and nine months ended
September 30, 2018
, respectively, as a decrease to the one-time mandatory deemed repatriation tax obligation, with a corresponding adjustment to income tax benefit during the period. The effect of the measurement-period adjustment to the
three and nine months ended
September 30, 2018
effective tax rate was a reduction to the rate of approximately
5.4%
and
4.6%
, respectively. In addition, we reclassified the one-time mandatory deemed repatriation tax from
Noncurrent deferred tax liabilities
to
Income taxes payable
and
Other taxes payable
. We expect to complete our accounting within the prescribed measurement period.
|
|
|
•
|
Reduction of U.S. Federal Corporate Tax Rate: The Tax Act reduced the corporate tax rate to
21%
, effective January 1, 2018. Consequently, we recorded a decrease related to deferred tax assets and liabilities with a corresponding net adjustment to deferred income tax benefit for the year ended December 31, 2017. We have not made any measurement-period adjustments related to this item during the nine months of 2018. Since the company has recorded provisional amounts related to certain portions of the Tax Act, any
|
corresponding deferred tax remeasurement is also provisional. However, we are continuing to gather additional information to complete our accounting for this item and expect to be completed within the prescribed measurement period.
|
|
•
|
Valuation Allowances: The company must assess whether its valuation allowance analyses are affected by the various aspects of the Tax Act (e.g., one-time mandatory deemed repatriation of deferred foreign income, global intangible low-taxed income inclusions, and new categories of foreign tax credits). We have not made any measurement-period adjustments related to this item during the nine months of 2018. Since the company has recorded provisional amounts related to certain portions of the Tax Act, any corresponding determination of the need for or change in a valuation allowance is also provisional. However, we are continuing to gather additional information to complete our accounting for this item and expect to be completed within the prescribed measurement period.
|
|
|
•
|
Global Intangible Low-Taxed Income (GILTI) Policy Election: The GILTI provisions of the Tax Act do not apply to the company until 2019, due to the fact that the non-U.S. subsidiaries are on a fiscal year ending November 30, and we are still evaluating its impact. The FASB allows companies to adopt an accounting policy to either recognize deferred taxes for GILTI or treat such tax cost as a current-period expense when incurred. We have not yet determined our accounting policy because determining the impact of the GILTI provisions requires analysis of our existing legal entity structure, the reversal of our U.S. GAAP and U.S. tax basis differences in the assets and liabilities of our foreign subsidiaries, and our ability to offset any tax with foreign tax credits. As such, we have not made a policy decision whether to record deferred taxes on GILTI or treat such tax cost as a current-period expense.
|
The effective tax rate was
17.0%
for the
three months ended September 30, 2018
, compared with
28.3%
for the
three months ended October 1, 2017
. The lower effective tax rate for the
three months ended September 30, 2018
, was primarily attributable to:
|
|
•
|
the reduction of the U.S. federal corporate income tax rate from
35%
to
21%
, effective January 1, 2018, pursuant to the Tax Act;
|
|
|
•
|
a
$23 million
net tax benefit recorded in the
third quarter
of 2018, associated with a measurement-period adjustment related to the provisional one-time mandatory deemed repatriation tax on the company's undistributed non-U.S. earnings pursuant to the Tax Act enacted on December 22, 2017;
|
|
|
•
|
changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings from operations and repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and operating fluctuations in the normal course of business and the impact of non-deductible items; and
|
|
|
•
|
a
$3 million
and
$1 million
discrete tax benefit recorded in the
third quarter
of 2018 and 2017, respectively, related to the excess tax benefits for share-based payments.
|
The effective tax rate was
15.2%
for the
nine months ended September 30, 2018
, compared with
28.6%
for the
nine months ended October 1, 2017
. The lower effective tax rate for the
nine months ended September 30, 2018
, was primarily attributable to:
|
|
•
|
the reduction of the U.S. federal corporate income tax rate from
35%
to
21%
, effective January 1, 2018, pursuant to the Tax Act;
|
|
|
•
|
a
$58 million
net tax benefit recorded in the
nine months ended
2018, associated with a measurement-period adjustment related to the provisional one-time mandatory deemed repatriation tax on the company's undistributed non-U.S. earnings pursuant to the Tax Act enacted on December 22, 2017;
|
|
|
•
|
changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings from operations and repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and operating fluctuations in the normal course of business and the impact of non-deductible items;
|
|
|
•
|
a
$12 million
and
$8 million
discrete tax benefit recorded in the
nine months ended
2018 and 2017, respectively, related to the excess tax benefits for share-based payments; and
|
|
|
•
|
an
$8 million
and
$3 million
discrete tax benefit recorded in the
nine months ended
2018 and 2017, respectively, related to a remeasurement of deferred taxes as a result of a change in non-U.S. statutory tax rates.
|
As of
September 30, 2018
, the total net deferred income tax liability of
$373 million
is included in
Noncurrent deferred tax assets
(
$73 million
) and
Noncurrent deferred tax liabilities
(
$446 million
).
As of
December 31, 2017
, the total net deferred income tax liability of
$300 million
is included in
Noncurrent deferred tax assets
(
$80 million
) and
Noncurrent deferred tax liabilities
(
$380 million
).
The change in
Noncurrent deferred tax liabilities
was primarily due to the acquisition of Abaxis, partially offset by the reclassification of the one-time mandatory deemed repatriation tax from
Noncurrent deferred tax liabilities
to
Income taxes payable
and
Other taxes payable
to properly reflect the liability, which became a fixed obligation in 2018, payable over eight years.
As of
September 30, 2018
, the tax liabilities associated with uncertain tax positions of
$184 million
(exclusive of interest and penalties related to uncertain tax positions of
$11 million
) are included in
Noncurrent deferred tax assets
(
$4 million
) and
Other taxes payable
(
$180 million
).
As of
December 31, 2017
, the tax liabilities associated with uncertain tax positions of
$164 million
(exclusive of interest and penalties related to uncertain tax positions of
$11 million
) are included in
Noncurrent deferred tax assets
(
$3 million
) and
Other taxes payable
(
$161 million
).
Our tax liabilities for uncertain tax positions relate primarily to issues common among multinational corporations. Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Substantially all of these unrecognized tax benefits, if
recognized, would impact our effective income tax rate. We do not expect that within the next twelve months any of our uncertain tax positions could significantly decrease as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of uncertain tax positions and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant.
Credit Facilities
In
December 2016
, we entered into an amended and restated revolving credit agreement with a syndicate of banks providing for a
five
-year
$1.0 billion
senior unsecured revolving credit facility (the credit facility). In December 2017, the maturity for the amended and restated revolving credit agreement was extended through December 2022. Subject to certain conditions, we have the right to increase the credit facility to up to
$1.5 billion
. The credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio (the ratio of consolidated net debt as of the end of the period to consolidated Earnings Before Interest, Income Taxes, Depreciation and Amortization (EBITDA) for such period) of
3.50:1
. Upon entering into a material acquisition, the maximum total leverage ratio increases to
4.00:1
, and extends until the fourth full consecutive fiscal quarter ended immediately following the consummation of a material acquisition. The credit facility also contains a clause which adds back to Adjusted Consolidated EBITDA, any operational efficiency restructuring charge (defined as charges recorded by the company during the period commencing on October 1, 2016 and ending December 31, 2019, related to operational efficiency initiatives), provided that for any twelve-month period such charges added back to Adjusted Consolidated EBITDA shall not to exceed
$100 million
in the aggregate.
The credit facility also contains a financial covenant requiring that we maintain a minimum interest coverage ratio (the ratio of EBITDA at the end of the period to interest expense for such period) of
3.50:1
. In addition, the credit facility contains other customary covenants.
We were in compliance with all financial covenants as of
September 30, 2018
, and
December 31, 2017
. There were
no
amounts drawn under the credit facility as of
September 30, 2018
, or
December 31, 2017
.
We have additional lines of credit and other credit arrangements with a group of banks and other financial intermediaries for general corporate purposes. We maintain cash and cash equivalent balances in excess of our outstanding short-term borrowings. As of
September 30, 2018
, we had access to
$75 million
of lines of credit which expire at various times throughout 2018 and 2019 and are generally renewed annually. We did not have any borrowings outstanding related to these facilities as of
September 30, 2018
, and
December 31, 2017
.
Commercial Paper Program and Other Short-Term Borrowings
In
February 2013
, we entered into a commercial paper program with a capacity of up to
$1.0 billion
. As of
September 30, 2018
, and
December 31, 2017
, there was
no
commercial paper outstanding under this program. As of
September 30, 2018
, and
December 31, 2017
, we did not have any other short-term borrowings outstanding.
Senior Notes and Other Long-Term Debt
On August 20, 2018, we issued
$1.5 billion
aggregate principal amount of our senior notes (2018 senior notes), with an original issue discount of
$4 million
. These notes are comprised of
$300 million
aggregate principal amount of floating rate senior notes due 2021 (the "2018 floating rate senior notes"), and
$300 million
aggregate principal amount of
3.250%
senior notes due 2021,
$500 million
aggregate principal amount of
3.900%
senior notes due 2028 and
$400 million
aggregate principal amount of
4.450%
senior notes due 2048 (collectively, the "2018 fixed rate senior notes"). Net proceeds from this offering were partially used to pay down and terminate a revolving credit agreement and repay outstanding commercial paper, which were borrowed to finance a portion of the cash consideration for the acquisition of Abaxis (see
Note 5. Acquisitions and Divestitures
). The remainder of the net proceeds will be used for general corporate purposes.
On September 12, 2017, we issued
$1.25 billion
aggregate principal amount of our senior notes (2017 senior notes), with an original issue discount of
$7 million
. These notes are comprised of
$750 million
aggregate principal amount of
3.000%
senior notes due 2027 and
$500 million
aggregate principal amount of
3.950%
senior notes due 2047. Net proceeds from this offering were partially used in October 2017 to repay, prior to maturity, the aggregate principal amount of
$750 million
, and a make-whole amount and accrued interest of
$4 million
, of our
1.875%
senior notes due 2018. The remainder of the net proceeds will be used for general corporate purposes.
On November 13, 2015, we issued
$1.25 billion
aggregate principal amount of our senior notes (2015 senior notes), with an original issue discount of
$2 million
. On January 28, 2013, we issued
$3.65 billion
aggregate principal amount of our senior notes (the 2013 senior notes offering) in a private placement, with an original issue discount of
$10 million
.
The 2013, 2015, 2017 and 2018 senior notes are governed by an indenture and supplemental indenture (collectively, the indenture) between us and Deutsche Bank Trust Company Americas, as trustee. The indenture contains certain covenants, including limitations on our and certain of our subsidiaries' ability to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets. In addition, the indenture contains other customary terms, including certain events of default, upon the occurrence of which the 2013, 2015, 2017 and 2018 senior notes may be declared immediately due and payable.
Pursuant to the indenture, we are able to redeem the 2013, 2015 and 2017 senior notes and the 2018 fixed rate senior notes or 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. The 2018 floating rate senior notes are not redeemable at our option prior to their maturity date. Pursuant to our tax matters agreement with Pfizer, we will not be permitted to redeem the 2013 senior notes due 2023 pursuant to this optional redemption provision, except under limited circumstances. Upon the occurrence of a change of control of us and a downgrade of the 2013, 2015, 2017 and 2018 senior notes below an investment grade rating by each of Moody's Investors Service, Inc. and Standard & Poor's Ratings Services, we are, in certain circumstances, required to make an offer to repurchase all of the outstanding 2013, 2015, 2017 and 2018 senior notes at a price equal to
101%
of the aggregate principal amount of the 2013, 2015, 2017 and 2018 senior notes together with accrued and unpaid interest to, but excluding, the date of repurchase.
The components of our long-term debt are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
3.450% 2015 senior notes due 2020
|
|
$
|
500
|
|
|
$
|
500
|
|
2018 floating rate senior notes due 2021
|
|
300
|
|
|
—
|
|
3.250% 2018 senior notes due 2021
|
|
300
|
|
|
—
|
|
3.250% 2013 senior notes due 2023
|
|
1,350
|
|
|
1,350
|
|
4.500% 2015 senior notes due 2025
|
|
750
|
|
|
750
|
|
3.000% 2017 senior notes due 2027
|
|
750
|
|
|
750
|
|
3.900% 2018 senior notes due 2028
|
|
500
|
|
|
—
|
|
4.700% 2013 senior notes due 2043
|
|
1,150
|
|
|
1,150
|
|
3.950% 2017 senior notes due 2047
|
|
500
|
|
|
500
|
|
4.450% 2018 senior notes due 2048
|
|
400
|
|
|
—
|
|
|
|
6,500
|
|
|
5,000
|
|
Unamortized debt discount / debt issuance costs
|
|
(59
|
)
|
|
(47
|
)
|
Long-term debt, net of discount and issuance costs
|
|
$
|
6,441
|
|
|
$
|
4,953
|
|
The fair value of our long-term debt was
$6,460 million
and
$5,291 million
as of
September 30, 2018
, and
December 31, 2017
, respectively, and has been determined using a third-party matrix-pricing model that uses significant inputs derived from, or corroborated by, observable market data and Zoetis’ credit rating (Level 2 inputs).
The principal amount of long-term debt outstanding, as of
September 30, 2018
, matures in the following years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
After
|
|
|
|
(MILLIONS OF DOLLARS)
|
|
2019
|
|
|
2020
|
|
|
2021
|
|
|
2022
|
|
|
2022
|
|
|
Total
|
|
Maturities
|
|
$
|
—
|
|
|
$
|
500
|
|
|
$
|
600
|
|
|
$
|
—
|
|
|
$
|
5,400
|
|
|
$
|
6,500
|
|
Interest Expense
Interest expense, net of capitalized interest, was
$54 million
and
$147 million
, for the
three and nine months ended
September 30, 2018
, respectively, and
$43 million
and
$125 million
, for the
three and nine months ended
October 1, 2017
, respectively. Capitalized interest expense was
$2 million
and
$6 million
for the
three and nine months ended
September 30, 2018
, respectively, and
$1 million
and
$3 million
for the
three and nine months ended
October 1, 2017
, respectively.
B. Investments
As part of the acquisition of Abaxis, we acquired short and long-term investments in debt securities (see
Note 5. Acquisitions and Divestitures
). These investments are classified as available-for-sale securities and, therefore, are measured at fair value at each reporting date. The changes in fair value are recognized in
Accumulated other comprehensive income/(loss)
. We utilized Level 2 inputs such as observable quoted prices for similar assets and liabilities in active markets and observable quoted prices for identical or similar assets in markets that are not very active.
At
September 30, 2018
, the investment securities portfolio consisted of debt securities that were virtually all investment grade. Information on investments in the debt securities at
September 30, 2018
, including the contractual maturities, or as necessary, the estimated maturities, of the available-for-sale securities is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Unrealized
|
|
Maturities by Period
(a)
|
(MILLIONS OF DOLLARS)
|
|
Amortized Cost
|
|
Gains
|
|
Losses
|
|
Fair Value
|
|
Within 1 year
|
|
Over 1 to 5 years
|
|
Over 5 years
|
|
Total
|
Available-for-sale debt securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal Bonds
|
|
$
|
1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1
|
|
|
$
|
1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1
|
|
Corporate Bonds
|
|
117
|
|
|
—
|
|
|
—
|
|
|
117
|
|
|
104
|
|
|
13
|
|
|
—
|
|
|
117
|
|
Total debt securities
|
|
$
|
118
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
118
|
|
|
$
|
105
|
|
|
$
|
13
|
|
|
$
|
—
|
|
|
$
|
118
|
|
(a)
Long term investments are included in
Other noncurrent assets
.
|
|
C.
|
Derivative Financial Instruments
|
Foreign Exchange Risk
A significant portion of our revenue, earnings and net investment in foreign affiliates is exposed to changes in foreign exchange rates. We seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenue in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Depending on market conditions, foreign exchange risk is also managed through the use of various derivative financial instruments. These derivative financial instruments serve to manage the exposure of our net investment in certain foreign operations to changes in foreign exchange rates and protect net income against the impact of translation into U.S. dollars of certain foreign exchange-denominated transactions.
All derivative financial instruments used to manage foreign currency risk are measured at fair value and are reported as assets or liabilities on the condensed consolidated balance sheet. The derivative financial instruments primarily offset exposures in the Australian dollar, Brazilian real, British pound, Canadian dollar, Chinese renminbi, euro, and Norwegian krone. Changes in fair value are reported in earnings or in
Accumulated other comprehensive income/(loss),
depending on the nature and purpose of the financial instrument, as follows:
|
|
•
|
For foreign exchange contracts not designated as hedging instruments, we recognize the gains and losses on forward-exchange contracts that are used to offset the same foreign currency assets or liabilities immediately into earnings along with the earnings impact of the items they generally offset. These contracts essentially take the opposite currency position of that reflected in the month-end balance sheet to counterbalance the effect of any currency movement.
|
|
|
•
|
For cross-currency interest rate swaps, which are designated as a hedge against our net investment in foreign operations, changes in the fair value are deferred as a component of cumulative translation adjustment within
Accumulated other comprehensive loss
and reclassified into earnings when the foreign investment is sold or substantially liquidated. Gains and losses excluded from the assessment of hedge effectiveness are recognized in earnings (
Interest expense—net of capitalized interest)
. The impact of the periodic exchange of interest payments is reflected within the operating section of our
condensed consolidated statement of cash flows.
|
The aggregate notional amount of foreign exchange derivative financial instruments offsetting foreign currency exposures was
$1.2 billion
and
$1.4 billion
, as of
September 30, 2018
, and
December 31, 2017
, respectively. The vast majority of the foreign exchange derivative financial instruments mature within
60
days and all mature within
one
year. The aggregate notional amount of cross-currency interest rate swap contracts was
425 million
euro as of
September 30, 2018
, with a term of up to seven years. We did not have any cross-currency interest rate swap contracts as of December 31, 2017.
Interest Rate Risk
The company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rates and to reduce its overall cost of borrowing. In anticipation of issuing fixed-rate debt, we may use forward-starting interest rate swaps that are designated as cash flow hedges to hedge against changes in interest rates that could impact expected future issuances of debt. Unrealized gains or losses on the forward-starting interest rate swaps are reported in
Accumulated other comprehensive loss
and are recognized in earnings over the life of the future fixed-rate notes. When the company discontinues hedge accounting because it is no longer probable that an anticipated transaction will occur within the originally expected period of execution, or within an additional two-month period thereafter, changes to fair value accumulated in other comprehensive income are recognized immediately in earnings.
During the third quarter of 2018, we entered into forward starting interest rate swaps with an aggregate notional value of
$350 million
. We also entered into treasury lock trades with an aggregate notional value of
$350 million
. We designated these swaps and treasury locks (contracts) as cash flow hedges against interest rate exposure related principally to the issuance of fixed-rate debt to be used primarily to fund the acquisition of Abaxis. Upon issuance of our 2018 senior notes (see
A. Debt: Senior Notes and Other Long-Term Debt
), we terminated these contracts and paid $1.7 million in cash to the counterparties for settlement. The settlement amount, which represents the fair value of the contracts at the time of termination, was recorded in
Accumulated other comprehensive loss
, and will be amortized into income over the life of the 2018 senior notes.
There were
no
outstanding interest rate swap contracts as of
September 30, 2018
and
December 31, 2017
.
Fair Value of Derivative Instruments
The classification and fair values of derivative instruments are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value of Derivatives
|
|
|
September 30,
|
|
|
December 31,
|
|
(MILLIONS OF DOLLARS)
|
Balance Sheet Location
|
2018
|
|
|
2017
|
|
Derivatives Not Designated as Hedging Instruments
|
|
|
|
|
Foreign currency forward-exchange contracts
|
Other current assets
|
$
|
19
|
|
|
$
|
10
|
|
Foreign currency forward-exchange contracts
|
Other current liabilities
|
(6
|
)
|
|
(9
|
)
|
Total derivatives not designated as hedging instruments
|
|
$
|
13
|
|
|
$
|
1
|
|
|
|
|
|
|
Derivatives Designated as Hedging Instruments:
|
|
|
|
|
Cross-currency interest rate swap contracts
|
Other current assets
|
$
|
3
|
|
|
$
|
—
|
|
Cross-currency interest rate swap contracts
|
Other non-current assets
|
1
|
|
|
—
|
|
Total derivatives designated as hedging instruments
|
|
4
|
|
|
—
|
|
|
|
|
|
|
Total derivatives
|
|
$
|
17
|
|
|
$
|
1
|
|
The company’s cross-currency interest rate swaps are subject to master netting arrangements to mitigate credit risk by permitting net settlement of transactions with the same counterparty. We may also enter into collateral security arrangements with certain of our counterparties to exchange cash collateral when the net fair value of certain derivative instruments fluctuates from contractually established thresholds. At
September 30, 2018
, there was no collateral posted related to our derivatives.
We use a market approach in valuing financial instruments on a recurring basis. Our derivative financial instruments are measured at fair value on a recurring basis using Level 2 inputs in the calculation of fair value.
The amounts of net gains/(losses) on derivative instruments not designated as hedging instruments, recorded in
Other (income)/deductions—net
, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Foreign currency forward-exchange contracts
|
|
$
|
22
|
|
|
$
|
(17
|
)
|
|
$
|
22
|
|
|
$
|
(39
|
)
|
These amounts were substantially offset in
Other (income)/deductions—net
by the effect of changing exchange rates on the underlying foreign currency exposures.
The amounts of unrecognized net gains/(losses) on derivative instruments designated as cash flow hedges, recorded, net of tax, in
Other comprehensive income/(loss)
, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Interest rate swaps
|
|
$
|
—
|
|
|
$
|
(10
|
)
|
|
$
|
—
|
|
|
$
|
(11
|
)
|
The amounts of unrecognized net gains/(losses) on cross-currency interest rate swap contracts, recorded, net of tax, in
Accumulated other comprehensive income/(loss)
, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Cross-currency interest rate swap contracts
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1
|
|
|
$
|
—
|
|
Gains/(losses) on cross-currency interest rate swap contracts, recognized within
Interest expense, net of capitalized interest,
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Cross-currency interest rate swap contracts
|
|
$
|
2
|
|
|
$
|
—
|
|
|
$
|
3
|
|
|
$
|
—
|
|
The net amount of deferred gains/(losses) related to derivative instruments designated as cash flow hedges that is expected to be reclassified from
Accumulated other comprehensive loss
into earnings over the next 12 months is insignificant.
The components of inventory are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
Finished goods
|
|
$
|
785
|
|
|
$
|
788
|
|
Work-in-process
|
|
492
|
|
|
484
|
|
Raw materials and supplies
|
|
164
|
|
|
155
|
|
Inventories
|
|
$
|
1,441
|
|
|
$
|
1,427
|
|
|
|
11.
|
Goodwill and Other Intangible Assets
|
The components of, and changes in, the carrying amount of goodwill are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(MILLIONS OF DOLLARS)
|
|
U.S.
|
|
|
International
|
|
|
Total
|
|
Balance, December 31, 2017
|
|
$
|
671
|
|
|
$
|
839
|
|
|
$
|
1,510
|
|
Additions
(a)
|
|
598
|
|
|
433
|
|
|
1,031
|
|
Other
(b)
|
|
—
|
|
|
(4
|
)
|
|
(4
|
)
|
Balance, September 30, 2018
|
|
$
|
1,269
|
|
|
$
|
1,268
|
|
|
$
|
2,537
|
|
(a)
Primarily includes a
$983 million
purchase price allocation associated with the acquisition of Abaxis and
$48 million
related to the acquisition of a manufacturing business in Ireland. See
Note 5. Acquisitions and Divestitures
.
(b)
Includes adjustments for foreign currency translation.
The gross goodwill balance was
$3,073 million
and
$2,046 million
as of
September 30, 2018
, and
December 31, 2017
, respectively. Accumulated goodwill impairment losses were
$536 million
as of
September 30, 2018
, and
December 31, 2017
.
|
|
B.
|
Other Intangible Assets
|
The components of identifiable intangible assets are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2018
|
|
As of December 31, 2017
|
|
|
|
|
|
|
Identifiable
|
|
|
|
|
|
|
Identifiable
|
|
|
|
Gross
|
|
|
|
|
Intangible Assets
|
|
|
Gross
|
|
|
|
|
Intangible Assets
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Less Accumulated
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Less Accumulated
|
|
(MILLIONS OF DOLLARS)
|
|
Amount
|
|
|
Amortization
|
|
|
Amortization
|
|
|
Amount
|
|
|
Amortization
|
|
|
Amortization
|
|
Finite-lived intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Developed technology rights
(a)(b)
|
|
$
|
1,849
|
|
|
$
|
(491
|
)
|
|
$
|
1,358
|
|
|
$
|
1,185
|
|
|
$
|
(428
|
)
|
|
$
|
757
|
|
Brands
|
|
213
|
|
|
(152
|
)
|
|
61
|
|
|
213
|
|
|
(143
|
)
|
|
70
|
|
Trademarks and trade names
(b)
|
|
166
|
|
|
(50
|
)
|
|
116
|
|
|
62
|
|
|
(47
|
)
|
|
15
|
|
Other
(b)
|
|
413
|
|
|
(158
|
)
|
|
255
|
|
|
234
|
|
|
(143
|
)
|
|
91
|
|
Total finite-lived intangible assets
|
|
2,641
|
|
|
(851
|
)
|
|
1,790
|
|
|
1,694
|
|
|
(761
|
)
|
|
933
|
|
Indefinite-lived intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
In-process research and development
|
|
219
|
|
|
—
|
|
|
219
|
|
|
224
|
|
|
—
|
|
|
224
|
|
Brands
|
|
37
|
|
|
—
|
|
|
37
|
|
|
37
|
|
|
—
|
|
|
37
|
|
Trademarks and trade names
|
|
67
|
|
|
—
|
|
|
67
|
|
|
67
|
|
|
—
|
|
|
67
|
|
Product rights
|
|
7
|
|
|
—
|
|
|
7
|
|
|
8
|
|
|
—
|
|
|
8
|
|
Total indefinite-lived intangible assets
|
|
330
|
|
|
—
|
|
|
330
|
|
|
336
|
|
|
—
|
|
|
336
|
|
Identifiable intangible assets
|
|
$
|
2,971
|
|
|
$
|
(851
|
)
|
|
$
|
2,120
|
|
|
$
|
2,030
|
|
|
$
|
(761
|
)
|
|
$
|
1,269
|
|
(a)
Includes the intangible assets related to the acquisition of a manufacturing business in Ireland.
(b)
In connection with the acquisition of Abaxis, the company recorded
$898 million
of intangible assets, as shown in the table below, representing the preliminary fair value at the acquisition date. See
Note 5. Acquisitions and Divestitures
for additional information.
|
|
|
|
|
|
|
|
|
|
Gross Carrying
|
|
|
Weighted-average
|
(MILLIONS OF DOLLARS)
|
|
Amount
|
|
|
Life (years)
|
Finite-lived intangible assets:
|
|
|
|
|
Developed technology rights
|
|
$
|
614
|
|
|
10
|
Trademarks and tradenames
|
|
104
|
|
|
20
|
Other
|
|
180
|
|
|
4
|
Total
|
|
$
|
898
|
|
|
|
Amortization expense related to finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in
Amortization of intangible assets
as it benefits multiple business functions. Amortization expense related to finite-lived acquired intangible assets that are associated with a single function is included in
Cost of sales, Selling, general and administrative expenses
or
Research and development expenses
, as appropriate. Total amortization expense for finite-lived intangible assets was
$45 million
and
$96 million
for each of the
three and nine months ended
September 30, 2018
, respectively, and
$26 million
and
$75 million
for each of the
three and nine months ended
October 1, 2017
, respectively.
Our employees ceased to participate in the Pfizer, Inc. U.S. qualified defined benefit plans and the U.S. retiree medical plan effective December 31, 2012, and liabilities associated with our employees under these plans were retained by Pfizer. Pfizer continued to credit certain employees' service with Zoetis through December 31, 2017 (or termination of employment from Zoetis, if earlier) for certain early retirement benefits with respect to Pfizer's U.S. defined benefit pension and retiree medical plans. Pension and postretirement benefit expense associated with the extended service for certain employees in the U.S. plans totaled approximately
$2 million
for each of the three month periods ended
September 30, 2018
, and
October 1, 2017
, and
$5 million
for each of the nine month periods ended
September 30, 2018
, and
October 1, 2017
.
The following table provides the net periodic benefit cost associated with our international defined benefit pension plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Service cost
|
|
$
|
1
|
|
|
$
|
2
|
|
|
$
|
5
|
|
|
$
|
5
|
|
Interest cost
|
|
1
|
|
|
1
|
|
|
2
|
|
|
2
|
|
Expected return on plan assets
|
|
(1
|
)
|
|
(1
|
)
|
|
(2
|
)
|
|
(2
|
)
|
Amortization of net actuarial loss
|
|
1
|
|
|
—
|
|
|
1
|
|
|
1
|
|
Curtailment and settlement loss
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1
|
|
Net periodic benefit cost
|
|
$
|
2
|
|
|
$
|
2
|
|
|
$
|
6
|
|
|
$
|
7
|
|
Total company contributions to the international pension plans were
$1 million
and
$4 million
for the
three and nine months ended
September 30, 2018
, respectively, and
$1 million
and
$5 million
for the
three and nine months ended
October 1, 2017
, respectively. We expect to contribute a total of approximately
$6 million
to these plans in 2018.
The company may grant a variety of share-based payments under the Zoetis 2013 Equity and Incentive Plan (the Equity Plan) to our employees and non-employee directors. The principal types of share-based awards available under the Equity Plan may include, but are not limited to, stock options, restricted stock and restricted stock units (RSUs), deferred stock units (DSUs), performance-vesting restricted stock units (PSUs) and other equity-based or cash-based awards.
In connection with the acquisition of Abaxis, in August 2018, the company issued
502,766
restricted stock units (replacement awards) with a weighted average grant date fair value of
$85.26
per RSU, per the terms of the merger agreement between Zoetis and Abaxis, in connection with unvested Abaxis employee equity awards. The Abaxis unvested equity awards were canceled and exchanged for the replacement awards using a conversion ratio stated in the merger agreement. The grant date fair value of the replacement awards that is attributable to pre merger service is
$10 million
and is part of the consideration transferred in exchange for the acquisition of Abaxis. The fair value of the replacement awards attributable to post merger service is
$33 million
and will be recorded over future vesting periods. The replacements awards vest over varying terms of continuous service up to four years from the grant date and the values are amortized on a straight-line basis over the vesting term into
Cost of sales, Selling, general and administrative expenses,
or
Research and development expenses,
as appropriate. For additional information see
Note 5. Acquisitions and Divestitures.
The components of share-based compensation expense are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Stock options / stock appreciation rights
|
|
$
|
2
|
|
|
$
|
2
|
|
|
$
|
7
|
|
|
$
|
7
|
|
RSUs / DSUs
(a)
|
|
10
|
|
|
7
|
|
|
23
|
|
|
20
|
|
PSUs
|
|
2
|
|
|
2
|
|
|
6
|
|
|
6
|
|
Share-based compensation expense—total
(b)
|
|
$
|
14
|
|
|
$
|
11
|
|
|
$
|
36
|
|
|
$
|
33
|
|
|
|
(a)
|
For the
three and nine months ended
September 30, 2018
, includes share-based compensation expense of
$3 million
related to the acquisition of Abaxis, for the post-merger service period. For additional details see
Note 5. Acquisitions and Divestitures
.
|
|
|
(b)
|
For the
three and nine months ended
September 30, 2018
, and the three months ended
October 1, 2017
, amounts capitalized to inventory were insignificant. For the nine months ended October 1, 2017, we capitalized
$1 million
of share-based compensation expense to inventory.
|
During the
nine months ended
September 30, 2018
, the company granted
538,820
stock options with a weighted-average exercise price of
$73.32
per stock option and a weighted-average fair value of
$20.30
per stock option. The fair-value based method for valuing each Zoetis stock option grant on the grant date uses the Black-Scholes-Merton option-pricing model, which incorporates a number of valuation assumptions. The weighted-average fair value was estimated based on the following assumptions: risk-free interest rate of
2.74%
; expected dividend yield of
0.69%
; expected stock price volatility of
23.61%
; and expected term of
6.5
years. In general, stock options vest after
three years
of continuous service and the values determined through this fair-value based method generally are amortized on a straight-line basis over the vesting term into
Cost of sales, Selling, general and administrative expenses,
or
Research and development expenses,
as appropriate.
During the
nine months ended
September 30, 2018
, the company granted
433,628
RSUs, with a weighted-average grant date fair value of $
73.37
per RSU. RSUs are accounted for using a fair-value-based method that utilizes the closing price of Zoetis common stock on the date of grant. In general, RSUs vest after
three
years of continuous service from the grant date and the values generally are amortized on a straight-line basis over the vesting term into
Cost of sales, Selling, general and administrative expenses,
or
Research and development expenses,
as appropriate.
During the
nine months ended
September 30, 2018
, the company granted
109,574
PSUs with a weighted-average grant date fair value of
$100.34
per PSU. PSUs are accounted for using a Monte Carlo simulation model. The units underlying the PSUs will be earned and vested over a
three
-year performance period, based upon the total shareholder return of the company in comparison to the total shareholder return of the companies comprising the S&P 500 index at the start of the performance period (Relative TSR). The weighted-average fair value was estimated based on volatility assumptions of Zoetis common stock and an average of the S&P 500 companies, which were
21.9%
and
25.1%
, respectively. Depending on the company’s Relative TSR performance at the end of the performance period, the recipient may earn between
0%
and
200%
of the target number of units. Vested units are settled in shares of the company’s common stock. PSU values are amortized on a straight-line basis over the vesting term into
Cost of sales, Selling, general and administrative expenses,
or
Research and development expenses,
as appropriate.
Zoetis is authorized to issue
6 billion
shares of common stock and
1 billion
shares of preferred stock.
In December 2016, the company's Board of Directors authorized a
$1.5 billion
share repurchase program. Purchases of Zoetis shares may be made at the discretion of management, depending on market conditions and business needs. As of
September 30, 2018
, there was approximately
$451 million
remaining under this authorization.
Changes in common shares and treasury stock were as follows:
|
|
|
|
|
|
|
|
(MILLIONS)
|
|
Common Shares Issued
(a)
|
|
|
Treasury Stock
(a)
|
|
Balance, December 31, 2016
|
|
501.89
|
|
|
9.04
|
|
Share-based compensation
(b)
|
|
—
|
|
|
(1.42
|
)
|
Share repurchase program
|
|
—
|
|
|
6.45
|
|
Balance, October 1, 2017
|
|
501.89
|
|
|
14.06
|
|
|
|
|
|
|
Balance, December 31, 2017
|
|
501.89
|
|
|
15.76
|
|
Share-based compensation
(b)
|
|
—
|
|
|
(1.42
|
)
|
Share repurchase program
|
|
—
|
|
|
6.57
|
|
Balance, September 30, 2018
|
|
501.89
|
|
|
20.91
|
|
|
|
(a)
|
Shares may not add due to rounding.
|
|
|
(b)
|
Includes the reissuance of shares from treasury stock in connection with the vesting of employee share-based awards, and the reacquisition of shares associated with the vesting of employee share-based awards to satisfy tax withholding requirements. For additional information regarding share-based compensation, see
Note 13. Share-Based Payments
.
|
Changes, net of tax, in accumulated other comprehensive loss, excluding noncontrolling interests, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Currency Translation
|
|
|
|
|
|
|
|
Derivatives
|
|
|
Adjustment
|
|
|
Benefit Plans
|
|
|
Accumulated Other
|
|
|
|
Net Unrealized
|
|
|
Net Unrealized
|
|
|
Actuarial
|
|
|
Comprehensive
|
|
(MILLIONS OF DOLLARS)
|
|
Gains/(Losses)
|
|
|
Gains/(Losses)
|
|
|
Gains/(Losses)
|
|
|
Loss
|
|
Balance, December 31, 2016
|
|
$
|
8
|
|
|
$
|
(583
|
)
|
|
$
|
(23
|
)
|
|
$
|
(598
|
)
|
Other comprehensive (loss)/income, net of tax
|
|
(11
|
)
|
|
153
|
|
|
1
|
|
|
143
|
|
Balance, October 1, 2017
|
|
$
|
(3
|
)
|
|
$
|
(430
|
)
|
|
$
|
(22
|
)
|
|
$
|
(455
|
)
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2017
|
|
$
|
(3
|
)
|
|
$
|
(487
|
)
|
|
$
|
(15
|
)
|
|
$
|
(505
|
)
|
Other comprehensive loss, net of tax
|
|
(1
|
)
|
|
(113
|
)
|
|
—
|
|
|
(114
|
)
|
Balance, September 30, 2018
|
|
$
|
(4
|
)
|
|
$
|
(600
|
)
|
|
$
|
(15
|
)
|
|
$
|
(619
|
)
|
The following table presents the calculation of basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Numerator
|
|
|
|
|
|
|
|
|
Net income before allocation to noncontrolling interests
|
|
$
|
347
|
|
|
$
|
296
|
|
|
$
|
1,079
|
|
|
$
|
782
|
|
Less: Net loss attributable to noncontrolling interests
|
|
—
|
|
|
(2
|
)
|
|
(4
|
)
|
|
(1
|
)
|
Net income attributable to Zoetis Inc.
|
|
$
|
347
|
|
|
$
|
298
|
|
|
$
|
1,083
|
|
|
$
|
783
|
|
Denominator
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding
|
|
482.0
|
|
|
489.1
|
|
|
483.9
|
|
|
490.8
|
|
Common stock equivalents: stock options, RSUs, PSUs and DSUs
|
|
3.8
|
|
|
3.3
|
|
|
3.8
|
|
|
3.1
|
|
Weighted-average common and potential dilutive shares outstanding
|
|
485.8
|
|
|
492.4
|
|
|
487.7
|
|
|
493.9
|
|
|
|
|
|
|
|
|
|
|
Earnings per share attributable to Zoetis Inc. stockholders—basic
|
|
$
|
0.72
|
|
|
$
|
0.61
|
|
|
$
|
2.24
|
|
|
$
|
1.60
|
|
Earnings per share attributable to Zoetis Inc. stockholders—diluted
|
|
$
|
0.71
|
|
|
$
|
0.61
|
|
|
$
|
2.22
|
|
|
$
|
1.59
|
|
The number of stock options outstanding under the company's Equity Plan that were excluded from the computation of diluted earnings per share, as the effect would have been antidilutive, were de minimis for the
three months ended
September 30, 2018
and the
three months ended
October 1, 2017
, and approximately
1 million
for both the
nine months ended
September 30, 2018
and
October 1, 2017
.
|
|
16.
|
Commitments and Contingencies
|
We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business. For a discussion of our tax contingencies, see
Note 8. Income Taxes
.
Our non-tax contingencies include, among others, the following:
|
|
•
|
Product liability and other product-related litigation, which can include injury, consumer, off-label promotion, antitrust and breach of contract claims.
|
|
|
•
|
Commercial and other matters, which can include product-pricing claims and environmental claims and proceedings.
|
|
|
•
|
Patent litigation, which typically involves challenges to the coverage and/or validity of our patents or those of third parties on various products or processes.
|
|
|
•
|
Government investigations, which can involve regulation by national, state and local government agencies in the United States and in other countries.
|
Certain of these contingencies could result in losses, including damages, fines and/or civil penalties, and/or criminal charges, which could be substantial.
We believe that we have strong defenses in these types of matters, but litigation is inherently unpredictable and excessive verdicts do occur. We do not believe that any of these matters will have a material adverse effect on our financial position. However, we could incur judgments, enter
into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations or cash flows in the period in which the amounts are paid.
We have accrued for losses that are both probable and reasonably estimable. Substantially all of these contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. Consequently, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but the assessment process relies on estimates and assumptions that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions.
Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely on estimates and assumptions.
The principal matters to which we are a party are discussed below. In determining whether a pending matter is significant for financial reporting and disclosure purposes, we consider both quantitative and qualitative factors in order to assess materiality, such as, among other things, the amount of damages and the nature of any other relief sought in the proceeding, if such damages and other relief are specified; our view of the merits of the claims and of the strength of our defenses; whether the action purports to be a class action and our view of the likelihood that a class will be certified by the court; the jurisdiction in which the proceeding is pending; any experience that we or, to our knowledge, other companies have had in similar proceedings; whether disclosure of the action would be important to a reader of our financial statements, including whether disclosure might change a reader’s judgment about our financial statements in light of all of the information about the company that is available to the reader; the potential impact of the proceeding on our reputation; and the extent of public interest in the matter. In addition, with respect to patent matters, we consider, among other things, the financial significance of the product protected by the patent.
Ulianopolis, Brazil
In February 2012, the Municipality of Ulianopolis (State of Para, Brazil) filed a complaint against Fort Dodge Saúde Animal Ltda. (FDSAL), a Zoetis entity, and
five
other large companies alleging that waste sent to a local waste incineration facility for destruction, but that was not ultimately destroyed as the facility lost its operating permit, caused environmental impacts requiring cleanup.
The Municipality is seeking recovery of cleanup costs purportedly related to FDSAL's share of all waste accumulated at the incineration facility awaiting destruction, and compensatory damages to be allocated among the
six
defendants. We believe we have strong arguments against the claim, including defense strategies against any claim of joint and several liability.
At the request of the Municipal prosecutor, in April 2012, the lawsuit was suspended for
one
year. Since that time, the prosecutor has initiated investigations into the Municipality's actions in the matter as well as the efforts undertaken by the
six
defendants to remove and dispose of their individual waste from the incineration facility. On October 3, 2014, the Municipal prosecutor announced that the investigation remained ongoing and outlined the terms of a proposed Term of Reference (a document that establishes the minimum elements to be addressed in the preparation of an Environmental Impact Assessment), under which the companies would be liable to withdraw the waste and remediate the area. On March 5, 2015, we presented our response to the prosecutor’s proposed Term of Reference, arguing that the proposed terms were overly general in nature and expressing our interest in discussing alternatives to address the matter. The prosecutor agreed to consider our request to engage a technical consultant to conduct an environmental diagnostic of the contaminated area. On May 29, 2015, we, in conjunction with the other defendant companies, submitted a draft cooperation agreement to the prosecutor, which outlined the proposed terms and conditions for the engagement of a technical consultant to conduct the environmental diagnostic. On August 19, 2016, the parties and the prosecutor agreed to engage the services of a third-party consultant to conduct a limited environmental assessment of the site. The site assessment was conducted during June 2017, and a written report summarizing the results of the assessment was provided to the parties and the prosecutor in November 2017. The report noted that waste is still present on the site and that further environmental assessments are needed before a plan to manage that remaining waste can be prepared. We have not received any further communication from the prosecutor in response to the report.
Lascadoil Contamination in Animal Feed
An investigation by the U.S. Food and Drug Administration (FDA) and the Michigan Department of Agriculture is ongoing to determine how lascadoil, oil for industrial use, made its way into the feed supply of certain turkey and hog feed mills in Michigan. The contaminated feed is believed to have caused the deaths of approximately
50,000
turkeys and the contamination (but not death) of at least
20,000
hogs in August 2014. While it remains an open question as to how the lascadoil made its way into the animal feed, the allegations are that lascadoil intended to be sold for reuse as biofuel was inadvertently sold to producers of soy oil, who in turn, unknowingly sold the contaminated soy oil to fat recycling vendors, who then sold the contaminated soy oil to feed mills for use in animal feed. Indeed, related to the FDA investigation, Shur-Green Farms LLC, a producer of soy oil, recalled certain batches of soy oil allegedly contaminated with lascadoil on October 13, 2014.
During the course of its investigation, the FDA identified the process used to manufacture Zoetis’ Avatec® (lasalocid sodium) and Bovatec® (lasalocid sodium) products as one possible source of the lascadoil, since lascadoil contains small amounts of lasalocid, the active ingredient found in both products. Zoetis has historically sold any and all industrial lascadoil byproduct to an environmental company specializing in waste disposal. The environmental company is contractually obligated to incinerate the lascadoil or resell it for use in biofuel. Under the terms of the agreement, the environmental company is expressly prohibited from reselling the lascadoil to be used as a component in food. The FDA inspected the Zoetis site where Avatec and Bovatec are manufactured, and found no evidence that Zoetis was involved in the contamination of the animal feed.
On March 10, 2015, plaintiffs Restaurant Recycling, LLC (Restaurant Recycling) and Superior Feed Ingredients, LLC (Superior), both of whom are in the fat recycling business, filed a complaint in the Seventeenth Circuit Court for the State of Michigan against Shur-Green Farms alleging negligence and breach of warranty claims arising from their purchase of soy oil allegedly contaminated with lascadoil. Plaintiffs resold the allegedly contaminated soy oil to turkey feed mills for use in feed ingredient. Plaintiffs also named Zoetis as a defendant in the complaint alleging that Zoetis failed to properly manufacture its products and breached an implied warranty that the soy oil was fit for use at turkey and hog mills. Zoetis was served with the complaint on June 3, 2015, and we filed our answer, denying all allegations, on July 15, 2015. On August 10, 2015, several of the turkey feed mills filed a joint complaint against Restaurant Recycling, Superior, Shur-Green Farms and others, alleging claims for negligence, misrepresentation, and breach of warranty, arising out of their alleged purchase and use of the contaminated soy oil. The complaint raises only
one
count against Zoetis for negligence. We filed an answer to the complaint on November 2, 2015, denying the allegation. On May 16, 2016,
two
additional turkey producers filed a complaint in the Seventeenth Circuit Court for the State of Michigan against the company, Restaurant Recycling, Superior, Shur-Green Farms and others, alleging claims for negligence and breach of warranties. We filed an answer to the complaint on June 20, 2016, denying the allegations. The Court has consolidated all
three
cases in Michigan for purposes of discovery and disposition. On July 28, 2017, we filed a motion for summary disposition on the grounds that no genuine issues of material fact exist and that Zoetis is entitled to judgment as a matter of law. On October 19, 2017, the Court granted our motion and dismissed all claims against Zoetis. On October 31, 2017, the plaintiffs filed motions for reconsideration of the Court's decision granting summary disposition. The Court, denied all such motions on December 6, 2017, for the same reasons cited in the Court’s original decision. On December 27, 2017, the plaintiffs filed a request with the Michigan Court of Appeals seeking an appeal of the lower Court’s decision, which we opposed on January 17, 2018. On July 5, 2018, the Court of Appeals denied the plaintiffs’ applications for leave to appeal. The case has been remanded to the lower Court, where it will proceed without Zoetis. The plaintiffs may attempt to seek a full appeal after the final adjudication of the case before the lower Court.
Other Matters
The European Commission published a decision on alleged competition law infringements by several human health pharmaceutical companies on June 19, 2013. One of the involved companies is Alpharma LLC, a legal entity that was transferred to Zoetis as part of the separation from Pfizer. Alpharma LLC's involvement is solely related to certain discontinued human health activities that occurred prior to Pfizer's acquisition of King/Alpharma. As a result of the decision, a fine in the amount of euro 11 million (approximately $14 million) was imposed on Alpharma. Under the Global Separation Agreement between Pfizer and Zoetis, Pfizer is obligated to indemnify Zoetis for any liabilities arising out of claims not related to its animal health assets, meaning that Pfizer ultimately bears the costs of the penalties in connection with the Commission's decision. Working with Pfizer, we filed an appeal of the decision on September 6, 2013, to the General Court of the European Union, and on September 17, 2013, Pfizer released payment of euro 11 million to the Commission to cover the fine. On September 8, 2016, the General Court upheld the decision of the European Commission. On November 25, 2016, we filed an appeal to the Court of Justice of the European Union and are awaiting a ruling.
|
|
B.
|
Guarantees and Indemnifications
|
In the ordinary course of business and in connection with the sale of assets and businesses, we indemnify our counterparties against certain liabilities that may arise in connection with the transaction or related to activities prior to the transaction. These indemnifications typically pertain to environmental, tax, employee and/or product-related matters and patent-infringement claims. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we would be required to reimburse the loss. These indemnifications are generally subject to threshold amounts, specified claim periods and other restrictions and limitations. Historically, we have not paid significant amounts under these provisions and, as of
September 30, 2018
, recorded amounts for the estimated fair value of these indemnifications were not significant.
Operating Segments
We manage our operations through
two
geographic operating segments: the United States and International. Each operating segment has responsibility for its commercial activities. Within each of these operating segments, we offer a diversified product portfolio, including vaccines, parasiticides, anti-infectives, medicated feed additives, animal health diagnostics and other pharmaceuticals, for both livestock and companion animal customers. Our chief operating decision maker uses the revenue and earnings of the
two
operating segments, among other factors, for performance evaluation and resource allocation.
In the first quarter of 2018, the company realigned certain management responsibilities. These changes did not impact the determination of our operating segments, however they resulted in the reallocation of certain costs between segments. These changes primarily include the following: (i) R&D costs related to our aquaculture business which were previously reported in
Other business activities
are now reported in the international commercial segment results, and (ii) certain other miscellaneous costs which were previously reported in
Corporate
are now reported in the international commercial segment results.
Other Costs and Business Activities
Certain costs are not allocated to our operating segment results, such as costs associated with the following:
|
|
•
|
Other business activities
includes our Client Supply Services (CSS) contract manufacturing results, our human health diagnostics business and 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 our aquaculture business and non-U.S. market and regulatory activities are generally included in the international commercial segment.
|
|
|
•
|
Corporate
, which is responsible for platform functions such as business technology, facilities, legal, finance, human resources, business development, and communications, among others. These costs also include compensation costs, certain procurement costs, and other miscellaneous operating expenses not charged to our operating segments, as well as interest income and expense.
|
|
|
•
|
Certain transactions and events such as (i)
Purchase accounting adjustments
, where we incur expenses associated with the amortization of fair value adjustments to inventory, intangible assets and property, plant and equipment; (ii)
Acquisition-related activities
, where we incur costs associated with acquiring and integrating newly acquired businesses, such as transaction costs and integration costs; and (iii)
Certain significant items
, which comprise substantive, unusual items that, either as a result of their nature or size, would not be expected to occur as part of our normal business on a regular basis, such as certain costs related to becoming an independent public company, restructuring charges and implementation costs associated with our cost-reduction/productivity initiatives that are not associated with an acquisition, certain asset impairment charges, certain legal and commercial settlements and the impact of divestiture-related gains and losses.
|
|
|
•
|
Other unallocated
includes (i) certain overhead expenses associated with our global manufacturing operations not charged to our operating segments; (ii) certain costs associated with business technology and finance that specifically support our global manufacturing operations; (iii) certain supply chain and global logistics costs; and (iv) certain procurement costs.
|
Segment Assets
We manage our assets on a total company basis, not by operating segment. Therefore, our chief operating decision maker does not regularly review any asset information by operating segment and, accordingly, we do not report asset information by operating segment.
Selected Statement of Income Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
|
|
Depreciation and Amortization
(a)
|
|
|
Three Months Ended
|
|
Three Months Ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
U.S.
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
757
|
|
|
$
|
680
|
|
|
|
|
|
Cost of sales
|
|
151
|
|
|
141
|
|
|
|
|
|
Gross profit
|
|
606
|
|
|
539
|
|
|
|
|
|
Gross margin
|
|
80.1
|
%
|
|
79.3
|
%
|
|
|
|
|
Operating expenses
|
|
116
|
|
|
103
|
|
|
|
|
|
Other (income)/deductions
|
|
—
|
|
|
—
|
|
|
|
|
|
U.S. Earnings
|
|
490
|
|
|
436
|
|
|
$
|
9
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
International
|
|
|
|
|
|
|
|
|
Revenue
(b)
|
|
709
|
|
|
654
|
|
|
|
|
|
Cost of sales
|
|
226
|
|
|
213
|
|
|
|
|
|
Gross profit
|
|
483
|
|
|
441
|
|
|
|
|
|
Gross margin
|
|
68.1
|
%
|
|
67.4
|
%
|
|
|
|
|
Operating expenses
|
|
131
|
|
|
132
|
|
|
|
|
|
Other (income)/deductions
|
|
(1
|
)
|
|
—
|
|
|
|
|
|
International Earnings
|
|
353
|
|
|
309
|
|
|
11
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
Total operating segments
|
|
843
|
|
|
745
|
|
|
20
|
|
|
17
|
|
|
|
|
|
|
|
|
|
|
Other business activities
|
|
(84
|
)
|
|
(77
|
)
|
|
6
|
|
|
5
|
|
Reconciling Items:
|
|
|
|
|
|
|
|
|
Corporate
|
|
(178
|
)
|
|
(143
|
)
|
|
15
|
|
|
13
|
|
Purchase accounting adjustments
|
|
(49
|
)
|
|
(23
|
)
|
|
43
|
|
|
22
|
|
Acquisition-related costs
|
|
(40
|
)
|
|
(6
|
)
|
|
—
|
|
|
—
|
|
Certain significant items
(c)
|
|
8
|
|
|
(7
|
)
|
|
—
|
|
|
(1
|
)
|
Other unallocated
|
|
(82
|
)
|
|
(76
|
)
|
|
—
|
|
|
2
|
|
Total Earnings
(d)
|
|
$
|
418
|
|
|
$
|
413
|
|
|
$
|
84
|
|
|
$
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
|
|
Depreciation and Amortization
(a)
|
|
|
Nine months ended
|
|
Nine months ended
|
|
|
September 30,
|
|
|
October 1,
|
|
|
September 30,
|
|
|
October 1,
|
|
(MILLIONS OF DOLLARS)
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
U.S.
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
2,068
|
|
|
$
|
1,908
|
|
|
|
|
|
Cost of sales
|
|
431
|
|
|
412
|
|
|
|
|
|
Gross profit
|
|
1,637
|
|
|
1,496
|
|
|
|
|
|
Gross margin
|
|
79.2
|
%
|
|
78.4
|
%
|
|
|
|
|
Operating expenses
|
|
328
|
|
|
312
|
|
|
|
|
|
Other (income)/deductions
|
|
—
|
|
|
—
|
|
|
|
|
|
U.S. Earnings
|
|
1,309
|
|
|
1,184
|
|
|
$
|
25
|
|
|
$
|
21
|
|
|
|
|
|
|
|
|
|
|
International
|
|
|
|
|
|
|
|
|
Revenue
(b)
|
|
2,163
|
|
|
1,903
|
|
|
|
|
|
Cost of sales
|
|
689
|
|
|
645
|
|
|
|
|
|
Gross profit
|
|
1,474
|
|
|
1,258
|
|
|
|
|
|
Gross margin
|
|
68.1
|
%
|
|
66.1
|
%
|
|
|
|
|
Operating expenses
|
|
411
|
|
|
372
|
|
|
|
|
|
Other (income)/deductions
|
|
2
|
|
|
(1
|
)
|
|
|
|
|
International Earnings
|
|
1,061
|
|
|
887
|
|
|
34
|
|
|
32
|
|
|
|
|
|
|
|
|
|
|
Total operating segments
|
|
2,370
|
|
|
2,071
|
|
|
59
|
|
|
53
|
|
|
|
|
|
|
|
|
|
|
Other business activities
|
|
(247
|
)
|
|
(224
|
)
|
|
17
|
|
|
17
|
|
Reconciling Items:
|
|
|
|
|
|
|
|
|
Corporate
|
|
(470
|
)
|
|
(437
|
)
|
|
42
|
|
|
38
|
|
Purchase accounting adjustments
|
|
(95
|
)
|
|
(66
|
)
|
|
88
|
|
|
65
|
|
Acquisition-related costs
|
|
(41
|
)
|
|
(8
|
)
|
|
—
|
|
|
—
|
|
Certain significant items
(c)
|
|
(2
|
)
|
|
(10
|
)
|
|
—
|
|
|
1
|
|
Other unallocated
|
|
(243
|
)
|
|
(231
|
)
|
|
1
|
|
|
5
|
|
Total Earnings
(d)
|
|
$
|
1,272
|
|
|
$
|
1,095
|
|
|
$
|
207
|
|
|
$
|
179
|
|
|
|
(a)
|
Certain production facilities are shared. Depreciation and amortization is allocated to the reportable operating segments based on estimates of where the benefits of the related assets are realized.
|
|
|
(b)
|
Revenue denominated in euros was
$180 million
and
$555 million
for the
three and nine months ended
September 30, 2018
, respectively, and
$169 million
and
$472 million
for the
three and nine months ended
October 1, 2017
, respectively.
|
|
|
(c)
|
For the
three months ended September 30, 2018
, primarily represents (i) employee termination costs of
$8 million
, and (ii) a net gain of
$18 million
related to the relocation of a manufacturing site in China and (iii) a loss of
$2 million
related to sales of certain manufacturing sites and products as a result of our supply network strategy.
|
For the
three months ended October 1, 2017
,
primarily represents (i) employee termination costs of
$3 million
, a reversal of exit costs of
$1 million
and consulting fees of
$2 million
, (ii) a net loss of
$4 million
related to sales of certain manufacturing sites and products, including the anticipated disposal of our manufacturing site in Guarulhos, Brazil, related to our operational efficiency initiative and supply network strategy, and (iii) an adjustment of
$1 million
related to the requirement to cease depreciation of assets, located at our manufacturing site in Guarulhos Brazil, that were classified as held for sale.
For the
nine months ended September 30, 2018
, primarily represents (i) consulting fees and product transfer costs of
$4 million
, employee termination costs of
$1 million
and exit costs of
$1 million
, related to our operational efficiency initiative and supply network strategy
,
(ii) employee termination costs of
$11 million
in Europe as a result of initiatives to better align our organizational structure, and (iii) a net gain of
$18 million
related to the relocation of a manufacturing site in China, and (iv) a loss of
$2 million
related to sales of certain manufacturing sites and products related to our supply network strategy.
For the
nine months ended October 1, 2017
, primarily includes: (i) a reversal of previously accrued employee termination costs of
$1 million
, accelerated depreciation of
$2 million
and consulting fees of
$5 million
, related to our operational efficiency initiative and supply network strategy; (ii) a net loss of
$6 million
related to sales of certain manufacturing sites and products, including the anticipated disposal of our manufacturing site in Guarulhos, Brazil, related to our operational efficiency initiative and supply network strategy; (iii) charges of
$3 million
associated with changes to our operating model; (iv) income of
$4 million
related to an insurance recovery from commercial settlements in Mexico recorded in 2014 and 2016; and (v) an adjustment of
$1 million
related to the requirement to cease depreciation of assets, located at our manufacturing site in Guarulhos Brazil, that are currently classified as held for sale.
|
|
(d)
|
Defined as income before provision for taxes on income.
|
In September 2018, we received total cash proceeds of approximately
$44 million
related to the divestiture of certain agribusiness products within our international segment. During the fourth quarter of 2018, we recorded a net pre-tax gain of approximately
$40 million
within
Other (income)/deductions— net
, related to this divestiture.