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ZOETIS

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ZOETIS : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-K)

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02/13/2020 | 03:24pm EST

Introduction

Our management's discussion and analysis of financial condition and results of
operations (MD&A) is provided to assist readers in understanding our
performance, as reflected in the results of our operations, our financial
condition and our cash flows. This MD&A should be read in conjunction with our
consolidated financial statements and notes to consolidated financial statements
included in Item 8. Financial Statements and Supplementary Data. The discussion
in this MD&A contains forward-looking statements that involve substantial risks
and uncertainties. Our future results could differ materially from historical
performance and from those anticipated in the forward-looking statements as a
result of various factors such as those discussed in Item 1A. Risk Factors and
Forward-looking statements and factors that may affect future results sections
of this MD&A.
A discussion regarding our financial condition and results of operations for
fiscal 2019 compared to fiscal 2018 is presented below. A discussion regarding
our financial condition and results of operations for fiscal 2018 compared to
fiscal 2017 can be found under Item 7 of Part II of our Annual Report on Form
10-K for the fiscal year ended December 31, 2018, filed with the SEC on February
12, 2019 (our "2018 Annual Report"), which is available free of charge on the
SEC's website at www.sec.gov.
Overview of our business
We are a global leader in the discovery, development, manufacture and
commercialization of animal health medicines, vaccines, and diagnostic products
with a focus on both livestock and companion animals. For more than 65 years, we
have been committed to enhancing the health of animals and bringing solutions to
our customers who raise and care for them.
We manage our operations through two geographic operating segments: the United
States (U.S.) and International. Within each of these operating segments, we
offer a diversified product portfolio for both livestock and companion animal
customers in order to capitalize on local and regional trends and customer
needs. See Notes to Consolidated Financial Statements-Note 19. Segment
Information.
We directly market our products to veterinarians and livestock producers located
in approximately 45 countries across North America, Europe, Africa, Asia,
Australia and South America, and are a market leader in nearly all of the major
regions in which we operate. Through our efforts to establish an early and
direct presence in many emerging markets, such as Brazil, China and Mexico, we
believe we are one of the largest animal health medicines and vaccines business
as measured by revenue across emerging markets as a whole. In markets where we
do not have a direct commercial presence, we generally contract with
distributors that provide logistics and sales and marketing support for our
products.
We believe our investments in one of the industry's largest sales organizations,
including our extensive network of technical and veterinary operations
specialists, our high-quality manufacturing and reliability of supply, and our
long track record of developing products that meet customer needs, has led to
enduring and valued relationships with our customers. Our research and
development (R&D) efforts enable us to deliver innovative products to address
unmet needs and evolve our product lines so they remain relevant for our
customers.
Our products include over 300 products and product lines that we sell in over
100 countries for the prediction, prevention, detection and treatment of
diseases and conditions that affect various livestock and companion animal
species. The diversity of our product portfolio and our global operations
provides stability to our overall business. For instance, in livestock, impacts
on our revenue that may result from disease outbreaks or weather conditions in a
particular market or region are often offset by increased sales in other regions
from exports and other species as consumers shift to other proteins.
A summary of our 2019 performance compared with the comparable 2018 and 2017
periods follows:
                                          Years Ended December 31,            % Change
(MILLIONS OF DOLLARS)                    2019           2018       2017    19/18    18/17
Revenue                             $   6,260$ 5,825$ 5,307        7       10
Net income attributable to Zoetis       1,500          1,428        864        5       65
Adjusted net income(a)                  1,755          1,525      1,185     

15 29

(a) Adjusted net income is a non-GAAP financial measure. See the Non-GAAP

financial measures and Adjusted net income sections of this MD&A for more

     information.


Our operating environment
Industry
The animal health industry, which focuses on both livestock and companion
animals, is a growing industry that impacts billions of people worldwide. The
primary livestock species for the production of animal protein are cattle (both
beef and dairy), swine, poultry, fish and sheep. Livestock health and production
are essential to meeting the growing demand for animal protein of a global
population. Factors influencing growth in demand for livestock medicines and
vaccines include:
•      human population growth and increasing standards of living, particularly

in many emerging markets;

• increasing demand for improved nutrition, particularly animal protein;

• natural resource constraints, such as scarcity of arable land, fresh water

and increased competition for cultivated land, resulting in fewer

resources that will be available to meet an increasing demand for animal

protein;

• increasing urbanization; and

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• increased focus on food safety and food security.

The primary companion animal species are dogs, cats and horses. Factors influencing growth in demand for companion animal medicines, vaccines and diagnostics include: • economic development and related increases in disposable income,

particularly in many emerging markets;

• increasing pet ownership;

• companion animals living longer;

• increasing medical treatment of companion animals; and

• advances in companion animal medicines, vaccines and diagnostics.



Product development initiatives
Our future success depends on both our existing product portfolio and our
pipeline of new products, including new products that we may develop through
joint ventures and products that we are able to obtain through license or
acquisition. We believe we are an industry leader in animal health R&D, with a
track record of generating new products and product lifecycle innovation. The
majority of our R&D programs focus on product lifecycle innovation, which is
defined as R&D programs that leverage existing animal health products by adding
new species or claims, achieving approvals in new markets or creating new
combinations and reformulations. In addition to traditional medicines and
vaccines, we develop products across additional categories to address the needs
of veterinarians and producers to predict, prevent, detect and treat conditions
in both livestock and companion animals, including products in genetics and
precision livestock farming, diagnostics and digital and data analytics.
Perceptions of product quality, safety and reliability
We believe that animal health customers value high-quality manufacturing and
reliability of supply. The importance of quality and safety concerns to pet
owners, veterinarians and livestock producers also contributes to animal health
brand loyalty, which often continues after the loss of patent-based and
regulatory exclusivity. We depend on positive perceptions of the safety and
quality of our products by our customers, veterinarians and end-users.
In addition, negative beliefs about animal health products generally could
impact demand for our products. For example, the issue of the potential transfer
of increased antibacterial resistance in bacteria from food-producing animals to
human pathogens, and the causality of that transfer, continue to be the subject
of global scientific and regulatory discussion. Antibacterials refer to small
molecules that can be used to treat or prevent bacterial infections and are a
sub-categorization of the products that make up our anti-infectives and
medicated feed additives portfolios. In some countries, this issue has led to
government restrictions and bans on the use of specific antibacterials in some
food-producing animals, regardless of the route of administration (in feed or
injectable). These restrictions are more prevalent in countries where animal
protein is plentiful and governments are willing to take action even when there
is scientific uncertainty. In addition, consumer preferences in some markets
have impacted the use of antibacterials in food producing animals. Such
restrictions and consumer preferences in some cases may negatively impact sales
of our antibacterial products, but in other instances may increase sales of our
products that can be used as antibacterial alternatives. Our total revenue
attributable to antibacterials for livestock was approximately $1.2 billion for
the year ended December 31, 2019.
Similarly, concerns regarding greenhouse gas emissions and other potential
environmental impacts of livestock production have led to some consumers opting
to limit or avoid consuming animal products. However, we believe the impact of
this trend is limited as the livestock industry is still expected to continue to
grow in order to feed a growing global population.
Changing distribution channels for companion animal products
In most markets, companion animal owners typically purchase their animal health
products directly from veterinarians. However, in the U.S. and certain other
markets, companion animal owners increasingly have the option to purchase animal
health products from sources other than veterinarians, such as Internet-based
retailers, "big-box" retail stores or other over-the-counter distribution
channels. This trend has been demonstrated by the shift away from the
veterinarian distribution channel in the sale of flea and tick products in
recent years. We believe the ability of pet owners to purchase our products
online and from retail stores may increase pet owner compliance and result in
increased sales, particularly in the near term. However, over time, we may be
unable to sustain our current margins due to the increased purchasing power of
such retailers as compared to traditional veterinary practices.
In addition, this trend could negatively impact the sales of products we
primarily sell through the veterinarian distribution channel, as any decrease in
visits to veterinarians by companion animal owners could reduce our market share
and sales of such products. A reduction in the number of pet owners who purchase
our products directly from their veterinarian could also lead to increased use
of generic alternatives to our products or the increased substitution of our
products with other animal health products or human health products if such
other products are deemed to be lower-cost alternatives.
The overall economic environment
In addition to industry-specific factors, we, like other businesses, face
challenges related to global economic conditions. Growth in both the livestock
and companion animal sectors is driven by overall economic development and
related growth, particularly in many emerging markets. In the past, certain of
our customers and suppliers have been affected directly by economic downturns,
which decreased the demand for our products and, in some cases, hindered our
ability to collect amounts due from customers.
The cost of medicines and vaccines to our livestock producer customers is small
relative to other production costs, including feed, and the use of these
products is intended to improve livestock producers' economic outcomes. As a
result, demand for our products has historically been more stable than demand
for other production inputs. Similarly, industry sources have reported that pet
owners indicated a preference for reducing spending on other aspects of their
lifestyle, including entertainment, clothing and household goods, before
reducing spending on pet care. While these factors have mitigated the impact of
prior downturns in the global economy, future economic challenges could increase
cost sensitivity among our customers, which may result in reduced demand for our
products, which could have a material adverse effect on our operating results
and financial condition.

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Competition

The animal health industry is competitive. Although our business is the largest
by revenue in the animal health medicines, vaccines and diagnostics industry, we
face competition in the regions in which we operate. Principal methods of
competition vary depending on the particular region, species, product category
or individual product. Some of these methods include new product development,
quality, price, service and promotion to veterinary professionals, pet owners
and livestock producers. Our competitors include standalone animal health
businesses and the animal health businesses of large pharmaceutical companies.
In recent years, there has been an increase in consolidation in the animal
health industry. There are also several start-up companies working in the animal
health area. In addition to competition from established market participants,
there could be new entrants to the animal health medicines, vaccines and
diagnostics industry in the future. In certain markets, we also compete with
companies that produce generic products, but the level of competition from
generic products varies from market to market. For example, the level of generic
competition is higher in Europe and certain emerging markets than in the U.S.
Weather conditions and the availability of natural resources
The animal health industry and demand for many of our animal health products in
a particular region are affected by weather conditions, as usage of our products
follows varying weather patterns and weather-related pressures from pests, such
as ticks. As a result, we may experience regional and seasonal fluctuations in
our results of operations.
In addition, veterinary hospitals and practitioners depend on visits from and
access to the animals under their care. Veterinarians' patient volume and
ability to operate could be adversely affected if they experience prolonged
snow, ice or other severe weather conditions, particularly in regions not
accustomed to sustained inclement weather. Furthermore, livestock producers
depend on the availability of natural resources, including large supplies of
fresh water. Their animals' health and their ability to operate could be
adversely affected if they experience a shortage of fresh water due to human
population growth or floods, droughts or other weather conditions. In the event
of adverse weather conditions or a shortage of fresh water, veterinarians and
livestock producers may purchase less of our products.
For example, drought conditions could negatively impact, among other things, the
supply of corn and the availability of grazing pastures. A decrease in harvested
corn results in higher corn prices, which could negatively impact the
profitability of livestock producers of cattle, pork and poultry. Higher corn
prices and reduced availability of grazing pastures contribute to reductions in
herd or flock sizes that in turn result in less spending on animal health
products. As such, a prolonged drought could have a material adverse impact on
our operating results and financial condition. Factors influencing the magnitude
and timing of effects of a drought on our performance include, but may not be
limited to, weather patterns and herd management decisions.
Adverse weather conditions may also impact the aquaculture business. Changes in
water temperatures could affect the timing of reproduction and growth of various
fish species, as well as trigger the outbreak of certain water borne diseases.
Disease outbreaks
Sales of our livestock products could be adversely affected by the outbreak of
disease carried by animals. Outbreaks of disease may reduce regional or global
sales of particular animal-derived food products or result in reduced exports of
such products, either due to heightened export restrictions or import
prohibitions, which may reduce demand for our products. Also, the outbreak of
any highly contagious disease near our main production sites could require us to
immediately halt production of our products at such sites or force us to incur
substantial expenses in procuring raw materials or products elsewhere.
Alternatively, sales of products that treat specific disease outbreaks may
increase.
Manufacturing and supply
In order to sell our products, we must be able to produce and ship our products
in sufficient quantities. Many of our products involve complex manufacturing
processes and are sole-sourced from certain manufacturing sites. Minor
deviations in our manufacturing or logistical processes, such as temperature
excursions or improper package sealing, could result in delays, inventory
shortages, unanticipated costs, product recalls, product liability and/or
regulatory action. In addition, a number of factors could cause production
interruptions that could result in launch delays, inventory shortages, recalls,
unanticipated costs or issues with our agreements under which we supply third
parties.
Our manufacturing network may be unable to meet the demand for our products or
we may have excess capacity if demand for our products changes. The
unpredictability of a product's regulatory or commercial success or failure, the
lead time necessary to construct highly technical and complex manufacturing
sites, and shifting customer demand increase the potential for capacity
imbalances.
Foreign exchange rates
Significant portions of our revenue and costs are exposed to changes in foreign
exchange rates. Our products are sold in more than 100 countries and, as a
result, our revenue is influenced by changes in foreign exchange rates. For the
year ended December 31, 2019, approximately 44% of our revenue was denominated
in foreign currencies. We seek to manage our foreign exchange risk, in part,
through operational means, including managing same-currency revenue in relation
to same-currency costs and same-currency assets in relation to same-currency
liabilities. As we operate in multiple foreign currencies, including the euro,
Brazilian real, Chinese renminbi, Canadian dollar, Australian dollar, U.K. pound
and other currencies, changes in those currencies relative to the U.S. dollar
will impact our revenue, cost of goods and expenses, and consequently, net
income. Exchange rate fluctuations may also have an impact beyond our reported
financial results and directly impact operations. These fluctuations may affect
the ability to buy and sell our goods and services between markets impacted by
significant exchange rate variances. For the year ended December 31, 2019,
approximately 56% of our total revenue was in U.S. dollars. Our year-over-year
total revenue growth was unfavorably impacted by 3% from changes in foreign
currency values relative to the U.S. dollar.
Our growth strategies
We seek to enhance the health of animals and to bring solutions to our customers
who raise and care for them. We have a global presence in both developed and
emerging markets and across eight major species. We intend to grow our business
by pursuing the following core strategies:

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• drive innovative growth - We seek to deliver new products and solutions as

well as lifecycle innovations across the continuum of care that spans from

disease prediction and prevention to detection and treatment. We are

focused on innovating across vaccines, pharmaceuticals, diagnostics,

genetics, biodevices, and other product segments, and across all major

       species. Where appropriate, we complement internal R&D programs with
       external innovations;

• enhance customer experience - We believe that delighting our customers

with compelling and personalized experiences that enable them to provide

the best care for animals is critical for our success. We are focused on

       providing greater value to our customers through the integration and
       connectedness of our portfolio and by reducing frictions in the way they
       engage with us and our products and solutions;

• lead in digital and data analytics - We believe that healthcare insights

       enabled by data and digital technology and complemented with our
       comprehensive portfolio of products and solutions will be critical in
       enhancing care for animals and improving livestock productivity;


•      cultivate a high-performing organization - We view the strength of our

team and our talented colleagues around the world as a critical component

       of our past and future success. We are committed to continuing to be a
       company our colleagues can be proud of and to attracting, retaining and
       developing the best talent in the industry;

• champion a healthier, more sustainable future - As the world's leading

animal health company, we strive to make a meaningful difference in

society by keeping animals healthy, fighting emerging infectious diseases

that threaten our food supply, and supporting livestock producers and the

veterinary profession. We believe that we have an important role to play

in promoting a safe and sustainable global food supply, taking actions to

protect the environment, and in increasing access to animal care around

the world.



Components of revenue and costs and expenses
Our revenue, costs and expenses are reported for the year ended December 31 for
each year presented, except for operations outside the U.S., for which the
financial information is included in our consolidated financial statements for
the fiscal year ended November 30 for each year presented.
Revenue
Our revenue is primarily derived from our diversified product portfolio of
medicines, vaccines and diagnostic products used to treat and protect livestock
and companion animals. 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, retailers or e-commerce outlets.
The depth of our product portfolio enables us to address the varying needs of
customers in different species and geographies. In 2019, our top two selling
products, Apoquel and Draxxin, contributed approximately 9% and 6%,
respectively, of our revenue, and combined with our next three top selling
products, Revolution/Stronghold, the ceftiofur line and Simparica, these five
contributed approximately 29% of our revenue. Our top ten product lines
contributed 41% of our revenue. For additional information regarding our
products, including descriptions of our product lines that each represented
approximately 1% or more of our revenue in 2019, see Item 1. Business-Products.
Costs and expenses
Costs of sales consist primarily of cost of materials, facilities and other
infrastructure used to manufacture our medicine and vaccine products and royalty
expenses associated with the intellectual property of our products, when
relevant.
Selling, general and administrative (SG&A) expenses consist of, among other
things, the internal and external costs of marketing, promotion, advertising and
shipping and handling as well as certain costs related to business technology,
facilities, legal, finance, human resources, business development, public
affairs and procurement.
Research and development (R&D) expenses consist primarily of project costs
specific to new product R&D and product lifecycle innovation, overhead costs
associated with R&D operations and investments that support local market
clinical trials for approved indications and expenses related to regulatory
approvals for our products. We do not disaggregate R&D expenses by research
stage or by therapeutic area for purposes of managing our business.
Amortization of intangible assets consists primarily of the amortization expense
for identifiable finite-lived intangible assets that have been acquired through
business combinations. These assets consist of, but are not limited to,
developed technology, brands and trademarks.
Restructuring charges and certain acquisition-related costs consist of all
restructuring charges (those associated with acquisition activity and those
associated with cost reduction/productivity initiatives), as well as costs
associated with acquiring and integrating businesses. Restructuring charges are
associated with employees, assets and activities that will not continue in the
company. Acquisition-related costs are associated with acquiring and integrating
acquired businesses, such as Abaxis in 2018, and may include transaction costs
and expenditures for consulting and the integration of systems and processes.
Other (income)/deductions-net consist primarily of various items including net
(gains)/losses on asset disposals, royalty-related income, foreign exchange
translation (gains)/losses and certain asset impairment charges.
Significant accounting policies and application of critical accounting estimates
In presenting our financial statements in conformity with U.S. GAAP, we are
required to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenue, costs and expenses and related disclosures. For a
description of our significant accounting policies, see Notes to Consolidated
Financial Statements- Note 3. Significant Accounting Policies.
We believe that the following accounting policies are critical to an
understanding of our consolidated financial statements as they require the
application of the most difficult, subjective and complex judgments and,
therefore, could have the greatest impact on our financial statements: (i) fair
value; (ii) revenue; (iii) asset impairment reviews; and (iv) contingencies.

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Below are some of our more critical accounting estimates. See also Notes to
Consolidated Financial Statements- Note 3. Significant Accounting Policies:
Estimates and Assumptions for a discussion about the risks associated with
estimates and assumptions.
Fair value
For a discussion about the application of fair value to our long-term debt and
financial instruments, see Notes to Consolidated Financial Statements-
Note 9. Financial Instruments.
For a discussion about the application of fair value to our business
combinations, see Notes to Consolidated Financial Statements- Note 3.
Significant Accounting Policies: Fair Value.
For a discussion about the application of fair value to our asset impairment
reviews, see Asset impairment reviews below.
Revenue
Our gross product revenue is subject to deductions that are generally estimated
and recorded in the same period that the revenue is recognized and primarily
represents sales returns and revenue incentives. For example:
•      for sales returns, we perform calculations in each market that incorporate

the following, as appropriate: local returns policies and practices;

returns as a percentage of revenue; an understanding of the reasons for

past returns; 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.



If any of our ratios, factors, assessments, experiences or judgments are not
indicative or accurate predictors of our future experience, our results could be
materially affected. 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.
Amounts recorded for revenue deductions can result from a complex series of
judgments about future events and uncertainties and can rely on estimates and
assumptions. For further information about the risks associated with estimates
and assumptions, see Notes to Consolidated Financial Statements- Note 3.
Significant Accounting Policies: Estimates and Assumptions.
Asset impairment reviews
We review all of our long-lived assets for impairment indicators throughout the
year and we perform detailed testing whenever impairment indicators are present.
In addition, we perform impairment testing for goodwill and indefinite-lived
intangible assets at least annually. When necessary, we record charges for
impairments of long-lived assets for the amount by which the fair value is less
than the carrying value of these assets.
Our impairment review processes are described below and in Notes to Consolidated
Financial Statements- Note 3. Significant Accounting Policies: Amortization of
Intangible Assets, Depreciation and Certain Long-Lived Assets and, for deferred
tax assets, in Note 3. Significant Accounting Policies: Deferred Tax Assets and
Liabilities and Income Tax Contingencies.
Examples of events or circumstances that may be indicative of impairment
include:
•      a significant adverse change in the extent or manner in which an asset is

used. For example, restrictions imposed by the regulatory authorities

could affect our ability to manufacture or sell a product; and

• a projection or forecast that demonstrates losses or reduced profits

       associated with an asset. This could result, for example, from the
       introduction of a competitor's product that results in a significant loss
       of market share or the inability to achieve the previously projected

revenue growth, or from the lack of acceptance of a product by customers.



For finite-lived identifiable intangible assets, such as developed technology
rights, and for other long-lived assets, such as property, plant and equipment,
whenever impairment indicators are present, we calculate the undiscounted value
of the projected cash flows associated with the asset, or asset group, and
compare this estimated amount to the carrying amount. If the carrying amount is
found to be greater, we record an impairment loss for the excess of book value
over fair value. In addition, in all cases of an impairment review, we
re-evaluate the remaining useful lives of the assets and modify them, as
appropriate.
Our impairment reviews of most of our long-lived assets depend on the
determination of fair value, as defined by U.S. GAAP, and these judgments can
materially impact our results of operations. A single estimate of fair value can
result from a complex series of judgments about future events and uncertainties
and can rely on estimates and assumptions. For information about the risks
associated with estimates and assumptions, see Notes to Consolidated Financial
Statements-Note 3. Significant Accounting Policies: Estimates and Assumptions.
Intangible assets other than goodwill
We test indefinite-lived intangible assets for impairment at least annually, or
more frequently if impairment indicators exist, by first assessing qualitative
factors to determine whether it is more likely than not that the fair value of
the indefinite-lived intangible asset is less than its carrying amount. If we
conclude it is more likely than not that the fair value is less than the
carrying amount, a quantitative test that compares the fair value of the
indefinite-lived intangible asset with its carrying value is performed. If the
fair value is less than the carrying amount, an impairment loss is recognized.
Impairments of identifiable intangible assets other than goodwill, are recorded
in Restructuring charges and certain acquisition-related costs and Other
(income)/deductions-net, as applicable. We did not have any significant
intangible asset impairment charges for the years ended December 31, 2019, 2018
and 2017.

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When we are required to determine the fair value of intangible assets other than
goodwill, we use an income approach, specifically the multi-period excess
earnings method, also known as the discounted cash flow method. We start with a
forecast of all the expected net cash flows associated with the asset, which
includes the application of a terminal value for indefinite-lived assets, and
then we apply an asset-specific discount rate to arrive at a net present value
amount. Some of the more significant estimates and assumptions inherent in this
approach include: the amount and timing of the projected net cash flows, which
includes the expected impact of competitive, legal and/or regulatory forces on
the projections, the impact of technological risk associated with IPR&D assets,
as well as the selection of a long-term growth rate; the discount rate, which
seeks to reflect the risks inherent in the projected cash flows; foreign
currency fluctuations; and the effective tax rate, which seeks to incorporate
the geographic diversity of the projected cash flows.
While all identifiable intangible assets can be impacted by events and thus lead
to impairment, in general, identifiable intangible assets that are at the
highest risk of impairment include IPR&D assets (approximately $105 million as
of December 31, 2019). IPR&D assets are higher-risk assets because R&D is an
inherently risky activity.
For a description of our accounting policy, see Notes to Consolidated Financial
Statements-Note 3. Significant Accounting Policies: Amortization of Intangible
Assets, Depreciation and Certain Long-Lived Assets.
GoodwillGoodwill represents the excess of the consideration transferred over the fair
value of net assets of businesses purchased and is assigned to reporting units.
We test goodwill for impairment on at least an annual basis, or more frequently
if impairment indicators exist, either by assessing qualitative factors to
determine whether it is more likely than not that the fair value of a reporting
unit is less than its carrying amount or by performing a quantitative
assessment.
Factors considered in the qualitative assessment include general macroeconomic
conditions, conditions specific to the industry and market, cost factors which
could have a significant effect on earnings or cash flows, the overall financial
performance of the reporting unit and whether there have been sustained declines
in our share price. Additionally, we evaluate the extent to which the fair value
exceeded the carrying value of the reporting unit at the date of the last
quantitative assessment performed.
When performing a quantitative assessment to test for goodwill impairment we
utilize the income approach, which is forward-looking, and relies primarily on
internal forecasts. Within the income approach, the method that we use is the
discounted cash flow method. We start with a forecast of all the expected net
cash flows associated with the reporting unit, which includes the application of
a terminal value, and then apply a reporting unit-specific discount rate to
arrive at a net present value. Some of the more significant estimates and
assumptions inherent in this approach include: the amount and timing of the
projected net cash flows, which includes the expected impact of technological
risk and competitive, legal and/or regulatory forces on the projections, as well
as the selection of a long-term growth rate; the discount rate, which seeks to
reflect the various risks inherent in the projected cash flows; and the
effective tax rate, which seeks to incorporate the geographic diversity of the
projected cash flows.
In 2019, we performed a qualitative impairment assessment as of September 30,
2019, which did not result in the impairment of goodwill associated with any of
our reporting units.
In 2018, we performed a quantitative impairment assessment as of September 30,
2018, which did not result in the impairment of goodwill associated with any of
our reporting units.
For all of our reporting units, there are a number of future events and factors
that may impact future results and that could potentially have an impact on the
outcome of subsequent goodwill impairment testing. For a list of these factors,
see Forward-looking statements and factors that may affect future results.
For a description of our accounting policy, see Notes to Consolidated Financial
Statements- Note 3. Significant Accounting Policies: Amortization of Intangible
Assets, Depreciation and Certain Long-Lived Assets.
Contingencies
For a discussion about income tax contingencies, see Notes to Consolidated
Financial Statements- Note 8D. Tax Matters: Tax Contingencies.
For a discussion about legal contingencies, guarantees and indemnifications, see
Notes to Consolidated Financial Statement- Note 18. Commitments and
Contingencies.
Non-GAAP financial measures
We report information in accordance with U.S. generally accepted accounting
principles (GAAP). Management also measures performance using non-GAAP financial
measures that may exclude certain amounts from the most directly comparable GAAP
measure. Despite the importance of these measures to management in goal setting
and performance measurement, non-GAAP financial measures have no standardized
meaning prescribed by U.S. GAAP and, therefore, have limits in their usefulness
to investors and may not be comparable to the calculation of similar measures of
other companies. We present certain identified non-GAAP measures solely to
provide investors with useful information to more fully understand how
management assesses performance.
Operational Growth
We believe that it is important to not only understand overall revenue and
earnings growth, but also "operational growth." Operational growth is a non-GAAP
financial measure defined as revenue or earnings growth excluding the impact of
foreign exchange. This measure provides information on the change in revenue and
earnings as if foreign currency exchange rates had not changed between the
current and prior periods to facilitate a period-to-period comparison. We
believe this non-GAAP measure provides a useful comparison to previous periods
for the company and investors, but should not be viewed as a substitute for U.S.
GAAP reported growth.

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Adjusted Net Income and Adjusted Earnings Per Share
Adjusted net income and the corresponding adjusted earnings per share (EPS) are
non-GAAP financial measures of performance used by management. We believe these
financial measures are useful supplemental information to investors when
considered together with our U.S. GAAP financial measures. We report adjusted
net income to portray the results of our major operations, and the discovery,
development, manufacture and commercialization of our products, prior to
considering certain income statement elements. We define adjusted net income and
adjusted EPS as net income attributable to Zoetis and EPS before the impact of
purchase accounting adjustments, acquisition-related costs and certain
significant items.
We recognize that, as an internal measure of performance, the adjusted net
income and adjusted EPS measures have limitations, and we do not restrict our
performance management process solely to these metrics. A limitation of the
adjusted net income and adjusted EPS measures is that they provide a view of our
operations without including all events during a period, such as the effects of
an acquisition or amortization of purchased intangibles, and do not provide a
comparable view of our performance to other companies. The adjusted net income
and adjusted EPS measures are not, and should not be viewed as, a substitute for
U.S. GAAP reported net income attributable to Zoetis and reported EPS. See the
Adjusted Net Income section below for more information.
Analysis of the Consolidated Statements of Income
The following discussion and analysis of our Consolidated Statements of Income
should be read along with our consolidated financial statements, and the notes
thereto.
                                          Year Ended December 31,                  % Change
(MILLIONS OF DOLLARS)                  2019          2018          2017        19/18        18/17
Revenue                           $   6,260$   5,825$   5,307            7           10
Costs and expenses:
Cost of sales(a)                      1,992         1,911         1,775            4            8
% of revenue                             32 %          33 %          33 %
Selling, general and                  1,638         1,484         1,334           10           11
administrative expenses(a)
% of revenue                             26 %          25 %          25 %
Research and development                457           432           382            6           13
expenses(a)
% of revenue                              7 %           7 %           7 %
Amortization of intangible              155           117            91           32           29
assets(a)
Restructuring charges and                51            68            19          (25 )          *
certain acquisition-related
costs
Interest expense, net of                                                           8           18
capitalized interest                    223           206           175
Other (income)/deductions-net           (57 )         (83 )           6          (31 )          *
Income before provision for           1,801         1,690         1,525            7           11
taxes on income
% of revenue                             29 %          29 %          29 %
Provision for taxes on income           301           266           663           13          (60 )
Effective tax rate                     16.7 %        15.7 %        43.5 %
Net income before allocation to       1,500         1,424           862            5           65
noncontrolling interests
Less: Net income attributable             -            (4 )          (2 )          *            *
to noncontrolling interests
Net income attributable to        $   1,500$   1,428$     864            5           65
Zoetis
% of revenue                             24 %          25 %          16 %

* Calculation not meaningful. (a) Amortization expense related to finite-lived acquired intangible assets that

     contribute to our ability to sell, manufacture, research, market and
     distribute products, compounds and intellectual property is included in
     Amortization of intangible assets as these intangible assets benefit

multiple business functions. Amortization expense related to finite-lived

acquired intangible assets that are associated with a single function is

included in Cost of sales, Selling, general and administrative expenses or

Research and development expenses, as appropriate.

Revenue

Total revenue by operating segment was as follows:

                                              Year Ended December 31,           % Change
(MILLIONS OF DOLLARS)                        2019          2018       2017    19/18   18/17
U.S.                                    $   3,203$ 2,877$ 2,620       11      10
International                               2,972         2,890      2,643        3       9
Total operating segments                    6,175         5,767      5,263        7      10

Contract manufacturing & human health          85            58         44       47      32
Total Revenue                           $   6,260$ 5,825$ 5,307        7      10



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On a global basis, the mix of revenue between livestock and companion animal
products was as follows:
                                              Year Ended December 31,            % Change
(MILLIONS OF DOLLARS)                        2019          2018       2017    19/18     18/17
Livestock                               $   3,030$ 3,154$ 3,037       (4 )       4
Companion animal                            3,145         2,613      2,226       20        17
Contract manufacturing & human health          85            58         44       47        32
Total Revenue                           $   6,260$ 5,825$ 5,307        7        10

2019 vs. 2018 Total revenue increased by $435 million, or 7%, in 2019 compared with 2018 reflecting operational revenue growth of $601 million, or 10%. Operational revenue growth was primarily due to the following: • increased volume from in-line products of approximately 4%, including 2%

from our key dermatology products;

• the acquisition of Abaxis in July 2018 which contributed approximately 2%;

• price growth of approximately 2%; and

• volume growth from new products sold of approximately 2%.



Costs and Expenses
Cost of sales
                             Year Ended December 31,          % Change
(MILLIONS OF DOLLARS)      2019        2018        2017     19/18   18/17
Cost of sales           $ 1,992$ 1,911$ 1,775         4       8
% of revenue                 32 %        33 %        33 %


2019 vs. 2018
Cost of sales as a percentage of revenue decreased from 33% to 32% in 2019
compared with 2018, primarily as a result of:
• favorable foreign exchange;


• price increases;

• favorable product mix; and

• cost improvements and efficiencies in our manufacturing network,



partially offset by:
• a change in estimate related to inventory costing;


• the inclusion of Abaxis; and

• tariffs on certain products.

Selling, general and administrative expenses

                                        Year Ended December 31,                   % Change
(MILLIONS OF DOLLARS)                2019           2018           2017         19/18       18/17
Selling, general and           $    1,638$    1,484$    1,334            10          11
administrative expenses
% of revenue                           26 %           25 %           25 %


2019 vs. 2018
SG&A expenses increased $154 million, or 10%, in 2019 compared with 2018,
primarily as a result of:
• an increase in certain compensation-related expenses;


• the inclusion of Abaxis; and

• the inclusion of Platinum Performance,



partially offset by:
• favorable foreign exchange.



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Research and development expenses

                                         Year Ended December 31,          % 

Change

(MILLIONS OF DOLLARS)                   2019         2018      2017     19/18   18/17
Research and development expenses   $    457$  432$ 382         6      13
% of revenue                               7 %          7 %       7 %


2019 vs. 2018
R&D expenses increased $25 million, or 6%, in 2019 compared with 2018, primarily
as a result of:
• increased spending driven by project investments;


• the inclusion of Abaxis; and

• an increase in certain compensation-related expenses,



partially offset by:
• favorable foreign exchange.


Amortization of intangible assets

                                           Year Ended December 31,             % Change
(MILLIONS OF DOLLARS)                    2019               2018     2017    19/18   18/17
Amortization of intangible assets   $     155$ 117$  91

32 29



2019 vs. 2018
Amortization of intangible assets increased $38 million, or 32%, in 2019
compared with 2018, primarily as a result of certain intangible assets acquired
in July 2018 as part of the acquisition of Abaxis.

Restructuring charges and certain acquisition-related costs

                                          Year Ended December 31,                      % Change
(MILLIONS OF DOLLARS)                  2019            2018            2017        19/18         18/17
Restructuring charges and      $         51     $        68$        19          (25 )           *
certain acquisition-related
costs


* Calculation not meaningful.
Our acquisition-related costs primarily relate to restructuring charges for
employees, assets and activities that will not continue in the future, as well
as integration costs. The majority of net restructuring charges are related to
termination costs. Our integration costs are generally comprised of consulting
costs related to the integration of systems and processes, as well as product
transfer costs.
For additional information regarding restructuring charges and
acquisition-related costs, see Notes to Consolidated Financial Statements- Note
6. Restructuring Charges and Other Costs Associated with Acquisitions,
Cost-Reduction and Productivity Initiatives.
2019 vs. 2018
Restructuring charges and certain acquisition-related costs decreased by $17
million in 2019 compared with 2018, primarily as a result of:
•      transaction costs incurred as a result of the acquisition of Abaxis in
       July 2018,


partially offset by:
•CEO transition-related costs.
Interest expense, net of capitalized interest
                                         Year Ended December 31,                   % Change
(MILLIONS OF DOLLARS)                 2019           2018           2017         19/18       18/17
Interest expense, net of       $       223$      206$      175             8          18
capitalized interest


2019 vs. 2018
Interest expense, net of capitalized interest, increased by $17 million, or 8%,
in 2019 compared with 2018, primarily as a result of the issuance of $1.5
billion aggregate principal amount of our senior notes in August 2018, partially
offset by gains on cross-currency interest rate swaps.
Other (income)/deductions-net
                                      Year Ended December 31,            % Change
(MILLIONS OF DOLLARS)               2019           2018       2017    19/18     18/17
Other (income)/deductions-net   $    (57 )$    (83 )$   6      (31 )       *


* Calculation not meaningful.

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2019 vs. 2018
The change in Other (income)/deductions-net from net other income of $57 million
in 2019 compared with $83 million in 2018, is primarily a result of:
•      a gain of $42 million in 2018 on the divestiture of certain agribusiness
       products within our International segment;


•      a net gain of $18 million in 2018 related to the relocation of a
       manufacturing site in China; and


• lower royalty income,


partially offset by: • income of $20 million in 2019 resulting from a payment received pursuant

to an agreement related to the 2016 sale of certain U.S. manufacturing

sites;

• lower foreign currency losses; and

• higher interest income in 2019 due to higher cash balances and higher

short-term interest rates.


Provision for taxes on income
                                     Year Ended December 31,           % Change
(MILLIONS OF DOLLARS)               2019         2018      2017     19/18   18/17
Provision for taxes on income   $    301$  266$ 663        13     (60 )
Effective tax rate                  16.7 %       15.7 %    43.5 %


The income tax provision in the Consolidated Statements of Income includes tax
costs and benefits, such as uncertain tax positions, repatriation decisions and
audit settlements, among others.
2019 vs. 2018
The higher effective tax rate in 2019 compared with 2018 is primarily due to the
following components:
•      the impact of the global intangible low taxed income (GILTI) tax, a new
       provision of the Tax Cuts and Jobs Act (the Tax Act), which became
       effective for the company in the first quarter of 2019;


•      a $45 million net tax benefit recorded in 2018, associated with a
       measurement-period adjustment to the one-time mandatory deemed

repatriation tax on the company's undistributed non-U.S. earnings pursuant

to the Tax Act; and

• 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, operating fluctuations in the normal course of business, the
       impact of non-deductible items, and the extent and location of other

income and expense items, such as gains and losses on asset divestitures,



partially offset by:
•      an $18 million discrete tax benefit recorded in 2019, related to the
       changes in valuation allowances;

• a $14 million net discrete tax benefit recorded in the third quarter of

       2019, due to a change in tax basis related to purchase accounting;


•      a $12 million net discrete tax benefit recorded in 2019, related to
       changes in various other tax items;


•      a $10 million discrete tax benefit recorded in 2019, related to the

effective settlement of certain issues with non-U.S. tax authorities;


•      an $8 million discrete tax benefit recorded in 2019, related to a
       remeasurement of deferred tax assets and liabilities as a result of a
       change in U.S. and non-U.S. statutory tax rates; and

• an additional $5 million discrete tax benefit recorded in 2019, related to

       the excess tax benefits for share-based compensation payments.




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Operating Segment Results
We believe that it is important to not only understand overall revenue and
earnings growth, but also "operational growth." Operational growth is defined as
revenue or earnings growth excluding the impact of foreign exchange.
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 operating segment
results, and ii) certain other miscellaneous costs which were previously
reported in Corporate are now reported in the International operating segment
results.
On a global basis, the mix of revenue between livestock and companion animal
products was as follows:
                                                                                            % Change
                                                                            19/18                                 18/17
                                                                              Related to                            Related to
                           Year Ended December 31,                     Foreign                                Foreign
(MILLIONS OF
DOLLARS)                   2019          2018      2017      Total     Exchange      Operational    Total     Exchange    Operational
U.S.
Livestock            $    1,219$ 1,269$ 1,244        (4 )        -              (4 )           2        -                 2
Companion animal          1,984         1,608     1,376        23          -              23            17        -                17
                          3,203         2,877     2,620        11          -              11            10        -                10
International
Livestock                 1,811         1,885     1,793        (4 )       (6 )             2             5       (1 )               6
Companion animal          1,161         1,005       850        16         (5 )            21            18        1                17
                          2,972         2,890     2,643         3         (6 )             9             9        -                 9
Total
Livestock                 3,030         3,154     3,037        (4 )       (3 )            (1 )           4        -                 4
Companion animal          3,145         2,613     2,226        20         (3 )            23            17        -                17
Contract
manufacturing &
human health                 85            58        44        47         (1 )            48            32        1                31
                     $    6,260$ 5,825$ 5,307         7         (3 )            10            10        -                10


Earnings by segment and the operational and foreign exchange changes versus the comparable prior year period were as follows:

                                                                                     % Change
                                                                       19/18                           18/17
                                                                         Related to                     Related to
                            Year Ended December 31,                 Foreign                        Foreign
(MILLIONS OF DOLLARS)       2019       2018       2017      Total   Exchange  Operational   Total  Exchange Operational
U.S.                   $   2,005$  1,815$  1,637        10        -              10       11        -          11
International              1,487      1,399      1,240         6       (4 )            10       13        -          13
Total reportable
segments                   3,492      3,214      2,877         9       (1 )            10       12        -          12
Other business
activities                  (348 )     (337 )     (313 )       3                                 8
Reconciling Items:
Corporate                   (707 )     (666 )     (625 )       6                                 7
Purchase accounting
adjustments                 (234 )     (162 )      (88 )      44                                84
Acquisition-related
costs                        (43 )      (63 )      (10 )     (32 )                               *
Certain significant
items                        (67 )       43        (25 )       *                                 *
Other unallocated           (292 )     (339 )     (291 )     (14 )                              16
Income before income
taxes                  $   1,801$  1,690$  1,525         7                                11


* Calculation not meaningful.


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2019 vs. 2018
U.S. operating segment
U.S. segment revenue increased by $326 million, or 11%, in 2019 compared with
2018, of which $376 million resulted from growth in companion animal products,
offset by a $50 million decline in livestock products.
•      Companion animal revenue growth was driven primarily by increased sales of

our key dermatology portfolio, the acquisition of Abaxis, which was

acquired in July 2018, increased sales from our parasiticides portfolio

across the ProHeart®, Revolution® and Simparica® franchises, including new

       product introductions Revolution Plus for cats and ProHeart 12 for dogs.


•      Livestock revenue decreased primarily due to continued weakness across
       both the beef and dairy cattle sectors as well as the timing of
       distributor purchasing patterns for medicated feed additive products
       impacting cattle. For poultry, growth was driven by increased sales of
       alternatives to antibiotic medicated feed additive products.


U.S. segment earnings increased by $190 million, or 10%, in 2019 compared with
2018, primarily due to revenue growth and improved gross margin, partially
offset by higher operating expenses.
International operating segment
International segment revenue increased by $82 million, or 3%, in 2019 compared
with 2018. Operational revenue increased $247 million, or 9%, reflecting growth
of $216 million in companion animal products and $31 million in livestock
products.
•      Companion animal operational revenue growth resulted primarily from

increased sales of our key dermatology portfolio across multiple

international markets, growth of sales in parasiticide products, including

Simparica® and Stronghold® Plus, and the acquisition of Abaxis, which was

acquired in July 2018.

• Livestock operational revenue growth was driven primarily by increased

sales in our cattle and poultry portfolios. Cattle products increased due

       to sales of anti-infectives and vaccines. Poultry products also
       contributed to growth with increased sales of vaccines and medicated feed
       additive products. Swine products sales declined due to the negative
       impact of African Swine Fever in China.


International segment earnings increased by $88 million, or 6%, in 2019 compared
with 2018. Operational earnings growth was $143 million, or 10%, primarily due
to higher revenue and improved gross margin.
Other business activities
Other business activities includes our CSS contract manufacturing results, our
human health business and expenses associated with our dedicated veterinary
medicine R&D organization, research alliances, U.S. regulatory affairs and other
operations focused on the development of our products. Other R&D-related costs
associated with non-U.S. market and regulatory activities are generally included
in the International segment.
2019 vs. 2018
Other business activities net loss increased by $11 million, or 3%, in 2019
compared with 2018, reflecting an increase in R&D project investments,
compensation-related costs and the inclusion of Abaxis expenses since
acquisition in July 2018, partially offset by revenue from the acquired Abaxis
human health business and more favorable foreign exchange rates in 2019.
Reconciling items
Reconciling items include certain costs that are not allocated to our operating
segments results, such as costs associated with the following:
•      Corporate, which includes certain costs associated with business

technology, facilities, legal, finance, human resources, business

development and communications, among others. These costs also include

certain compensation costs, certain procurement costs, and other

miscellaneous operating expenses that are not charged to our operating

       segments, as well as interest income and expense;


•      Certain transactions and events such as (i) Purchase accounting

adjustments, which includes expenses associated with the amortization of

fair value adjustments to inventory, intangible assets and property, plant

and equipment; (ii) Acquisition-related activities, which includes costs

for acquisition and integration; and (iii) Certain significant items,

which includes non-acquisition-related restructuring charges, certain

asset impairment charges, stand-up costs, certain legal and commercial

       settlements, and costs associated with cost reduction/productivity
       initiatives; and

• Other unallocated, which 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.


2019 vs. 2018
Corporate expenses increased by $41 million, or 6%, in 2019 compared with 2018,
primarily due to higher interest expense, net of capitalized interest,
associated with the 2018 senior notes issued in August 2018 and an increase in
certain compensation costs not allocated to our operating segments, partially
offset by more favorable foreign exchange rates.
Other unallocated expenses decreased by $47 million, or 14%, in 2019 compared
with 2018, primarily due to the favorable impact of foreign exchange and cost
improvements and efficiencies in our manufacturing network, partially offset by
tariffs on certain products and the inclusion of Abaxis expenses.
See Notes to Consolidated Financial Statements- Note 19. Segment Information for
further information.

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Adjusted net income
General description of adjusted net income (a non-GAAP financial measure)
Adjusted net income is an alternative view of performance used by management,
and we believe that investors' understanding of our performance is enhanced by
disclosing this performance measure. The adjusted net income measure is an
important internal measurement for us. Additionally, we measure our overall
performance on this basis in conjunction with other performance metrics. The
following are examples of how the adjusted net income measure is utilized:
•      senior management receives a monthly analysis of our operating results

that is prepared on an adjusted net income basis;

• our annual budgets are prepared on an adjusted net income basis; and

• other goal setting and performance measurements.



Purchase accounting adjustments
Adjusted net income is calculated prior to considering certain significant
purchase accounting impacts that result from business combinations and net asset
acquisitions. These impacts, primarily associated with the acquisition of Abaxis
(acquired in July 2018), the Pharmaq business (acquired in November 2015),
certain assets of Abbott Animal Health (acquired in February 2015), KAH
(acquired in 2011), FDAH (acquired in 2009), and Pharmacia Animal Health
business (acquired in 2003), include amortization related to the increase in
fair value of the acquired finite-lived intangible assets and depreciation
related to the increase/decrease to fair value of the acquired fixed assets.
Therefore, the adjusted net income measure includes the revenue earned upon the
sale of the acquired products without considering the aforementioned significant
charges.
While certain purchase accounting adjustments can occur through 20 or more
years, this presentation provides an alternative view of our performance that is
used by management to internally assess business performance. We believe the
elimination of amortization attributable to acquired intangible assets provides
management and investors an alternative view of our business results by
providing a degree of parity to internally developed intangible assets for which
R&D costs previously have been expensed.
A completely accurate comparison of internally developed intangible assets and
acquired intangible assets cannot be achieved through adjusted net income. These
components of adjusted net income are derived solely from the impact of the
items listed above. We have not factored in the impact of any other differences
in experience that might have occurred if we had discovered and developed those
intangible assets on our own, and this approach does not intend to be
representative of the results that would have occurred in those circumstances.
For example, our R&D costs in total, and in the periods presented, may have been
different; our speed to commercialization and resulting revenue, if any, may
have been different; or our costs to manufacture may have been different. In
addition, our marketing efforts may have been received differently by our
customers. As such, in total, there can be no assurance that our adjusted net
income amounts would have been the same as presented had we discovered and
developed the acquired intangible assets.
Acquisition-related costs
Adjusted net income is calculated prior to considering transaction and
integration costs associated with significant business combinations or net asset
acquisitions because these costs are unique to each transaction and represent
costs that were incurred to acquire and integrate certain businesses as a result
of the acquisition decision. We have made no adjustments for the resulting
synergies.
We believe that viewing income prior to considering these charges provides
investors with a useful additional perspective because the significant costs
incurred in a business combination result primarily from the need to eliminate
duplicate assets, activities or employees--a natural result of acquiring a fully
integrated set of activities. For this reason, we believe that the costs
incurred to convert disparate systems, to close duplicative facilities or to
eliminate duplicate positions (for example, in the context of a business
combination) can be viewed differently from those costs incurred in the ordinary
course of business.
The integration costs associated with a business combination may occur over
several years, with the more significant impacts generally ending within three
years of the transaction. Because of the need for certain external approvals for
some actions, the span of time needed to achieve certain restructuring and
integration activities can be lengthy. For example, due to the regulated nature
of the animal health medicines and vaccines business, the closure of excess
facilities can take several years, as all manufacturing changes are subject to
extensive validation and testing and must be approved by the FDA and/or other
regulatory authorities.
Certain significant items
Adjusted net income is calculated excluding certain significant items. Certain
significant items represent substantive, unusual items that are evaluated on an
individual basis. Such evaluation considers both the quantitative and the
qualitative aspect of their unusual nature. Unusual, in this context, may
represent items that are not part of our ongoing business; items that, either as
a result of their nature or size, we would not expect to occur as part of our
normal business on a regular basis; items that would be nonrecurring; or items
that relate to products that we no longer sell. While not all-inclusive,
examples of items that could be considered as certain significant items would be
a major non-acquisition-related restructuring charge and associated
implementation costs for a program that is specific in nature with a defined
term, such as those related to our non-acquisition-related cost-reduction and
productivity initiatives; amounts related to disposals of products or facilities
that do not qualify as discontinued operations as defined by U.S. GAAP; certain
intangible asset impairments; adjustments related to the resolution of certain
tax positions; significant currency devaluation; the impact of adopting certain
significant, event-driven tax legislation; costs related to our recent CEO
transition; or charges related to legal matters. See Notes to Consolidated
Financial Statements- Note 18. Commitments and Contingencies. Our normal,
ongoing defense costs or settlements of and accruals on legal matters made in
the normal course of our business would not be considered certain significant
items.

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Reconciliation

A reconciliation of net income attributable to Zoetis, as reported under U.S. GAAP, to adjusted net income follows:

                                         Year Ended December 31,                    % Change
(MILLIONS OF DOLLARS)                   2019           2018           2017      19/18         18/17
GAAP reported net income
attributable to Zoetis         $     1,500$    1,428$      864            5            65
Purchase accounting
adjustments-net of tax                 156            119             51           31             *
Acquisition-related
costs-net of tax                        36             50              7          (28 )           *
Certain significant
items-net of tax                        63            (72 )          263            *             *
Non-GAAP adjusted net
income(a)                      $     1,755$    1,525$    1,185           15            29

* Calculation not meaningful. (a) The effective tax rate on adjusted pretax income is 18.2%, 18.8% and 28.2%

for full year 2019, 2018 and 2017, respectively. The lower effective rate in

2019 compared to 2018 is primarily due to (i) changes in the jurisdictional

mix of earnings, which reflects the impact of the location of earnings as

well as repatriation costs, (ii) an $18 million discrete tax benefit

recorded in 2019, related to the changes in valuation allowances, (iii) a

$10 million discrete tax benefit recorded in 2019, related to the effective

     settlement of certain issues with non-U.S. tax authorities, (iv) a $4
     million net discrete tax benefit recorded in 2019, related to changes in
     various other tax items, and (v) an additional $5 million discrete tax

benefit recorded in 2019, related to the excess tax benefits for share-based

compensation payments, partially offset by the impact of the GILTI tax, a

new provision to the Tax Act, which became effective for the company in the

first quarter of 2019. The lower effective tax rate in 2018 compared to 2017

is primarily due to (i) the reduction of the U.S. federal corporate income

tax rate from 35% to 21%, effective January 1, 2018, pursuant to the Tax

Act, (ii) changes in the jurisdictional mix of earnings, which reflects the

impact of the location of earnings as well as repatriation costs, (iii) a

$23 million discrete tax benefit recorded in 2018 related to the favorable

impact of certain tax accounting method changes, and (iv) an additional $6

     million discrete tax benefit recorded in 2018, related to the excess tax
     benefits for share-based compensation payments.

A reconciliation of reported diluted earnings per share (EPS), as reported under U.S. GAAP, to non-GAAP adjusted diluted EPS follows:

                                           Year Ended December 31,                      % Change
                                            2019           2018           2017      19/18         18/17
Earnings per
share-diluted(a)(b):
GAAP reported EPS
attributable to
Zoetis-diluted                 $      3.11$     2.93$     1.75            6            67
Purchase accounting
adjustments-net of tax                0.32               0.24           0.10           33             *
Acquisition-related
costs-net of tax                      0.08               0.10           0.01          (20 )           *
Certain significant
items-net of tax                      0.13              (0.14 )         0.54            *             *
Non-GAAP adjusted
EPS-diluted                    $      3.64$     3.13$     2.40           16            30

* Calculation not meaningful. (a) Diluted earnings per share was computed using the weighted-average common

     shares outstanding during the period plus the common stock equivalents
     related to stock options, restricted stock units, performance-vesting
     restricted stock units and deferred stock units.


(b)  EPS amounts may not add due to rounding.


Adjusted net income includes the following charges for each of the periods
presented:
                                                     Year Ended December 31,
(MILLIONS OF DOLLARS)                               2019         2018      2017
Interest expense, net of capitalized interest   $    223$  206$ 175
Interest income                                      (37 )        (31 )     (13 )
Income taxes                                         390          351       465
Depreciation                                         166          146       136
Amortization                                          27           19        18



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Adjusted net income, as shown above, excludes the following items:

                                                             Year Ended December 31,
(MILLIONS OF DOLLARS)                                    2019              2018           2017
Purchase accounting adjustments:
Amortization and depreciation(a)                  $       210$       135$       81
Cost of sales(b)                                           24                27              7
Total purchase accounting adjustments-pre-tax             234               162             88
Income taxes(c)                                            78                43             37
Total purchase accounting adjustments-net of              156               119             51
tax
Acquisition-related costs:
Integration costs                                          18                21              6
Transaction costs                                           -                21              -
Restructuring charges(d)                                   25                21              4
Total acquisition-related costs-pre-tax                    43                63             10
Income taxes(c)                                             7                13              3
Total acquisition-related costs-net of tax                 36                50              7
Certain significant items:
Operational efficiency initiative(e)                      (20 )              (1 )            5
Supply network strategy(f)                                  7                10             15
Other restructuring charges and                             8                 7              4
cost-reduction/productivity initiatives(g)
Gain on sale of assets(h)                                   -               (42 )            -
Stand-up costs(i)                                           -                 -              3
Other(j)                                                   72               (17 )           (2 )
Total certain significant items-pre-tax                    67               (43 )           25
Income taxes(c)                                             4                29           (238 )
Total certain significant items-net of tax                 63               (72 )          263
Total purchase accounting adjustments,
acquisition-related costs, and certain
significant items-net of tax                      $       255$        97$      321


(a)  Amortization and depreciation expenses related to Purchase accounting

adjustments with respect to identifiable intangible assets and property,

     plant and equipment.


(b)  Fair value adjustments to acquired inventory, as well as amortization and
     depreciation expense.


(c)  Income taxes include the tax effect of the associated pre-tax amounts,

calculated by determining the jurisdictional location of the pre-tax amounts

and applying that jurisdiction's applicable tax rate.



Income taxes in Purchase accounting adjustments also includes:
•For 2019, a remeasurement of deferred taxes as a result of a change in
statutory tax rates, and an adjustment related to a change in tax basis.
•For 2018, a remeasurement of deferred taxes as a result of a change in non-U.S.
statutory tax rates.
•For 2017, (i) a provisional tax benefit of approximately $17 million related to
the remeasurement of the company's deferred taxes due to the reduction in the
U.S. federal corporate tax rate as provided by the Tax Act enacted on December
22, 2017, (ii) remeasurement of deferred taxes as a result of a change in
non-U.S. statutory tax rates, and (iii) a net tax charge related to prior period
tax adjustments.

Income taxes in Acquisition-related costs also includes:

•For 2018, a tax charge related to the non-deductibility of certain costs associated with the acquisition of Abaxis.

Income taxes in Certain significant items also includes:



•For 2018, (i) a net tax benefit of $45 million related to a measurement-period
adjustment to the one-time mandatory deemed repatriation tax on the company's
undistributed non-U.S. earnings, pursuant to the Tax Act, and (ii) a tax charge
of approximately $17 million related to the disposal of certain assets.
•For 2017, (i) a provisional net tax charge of approximately $229 million
related to the impact of the Tax Act enacted on December 22, 2017, including a
one-time mandatory deemed repatriation tax on the company's undistributed
non-U.S. earnings, partially offset by a net tax benefit related to the
remeasurement of the company's deferred tax assets and liabilities, as of the
date of enactment, due to the reduction in the U.S. federal corporate tax rate,
(ii) a net tax charge of approximately $3 million as a result of the
implementation of certain operational changes, and (iii) a tax charge of
approximately $2 million related to the disposal of certain assets.
(d)  Represents employee termination costs related to the 2018 acquisition of

Abaxis and the 2017 acquisition of an Irish biologic therapeutics company.

(e) For 2019, represents income resulting from a payment received pursuant to an

agreement related to the 2016 sale of certain U.S. manufacturing sites.

(f) Represents consulting fees and product transfer costs, included in Cost of

sales, and employee termination costs and exit costs, included in

Restructuring charges and certain acquisition-related costs, related to

cost-reduction and productivity initiatives.

(g) For 2019, represents employee termination costs incurred as a result of the

CEO transition.

For 2018, represents employee termination costs/(reversals) in Europe as a result of initiatives to better align our organizational structure. (h) For 2018, represents a net gain related to the divestiture of certain

     agribusiness products within our International segment.


(i) Represents certain non-recurring costs related to becoming an independent

     public company, such as the creation of standalone systems and
     infrastructure, site separation, new branding (including changes to the
     manufacturing process for required new packaging), and certain legal
     registration and patent assignment costs.

(j) For 2019, primarily represents a change in estimate related to inventory

costing and CEO transition-related costs. For 2018, primarily represents a

net gain related to the relocation of a manufacturing site in China. For

2017, primarily represents costs associated with changes to our operating

     model.



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The classification of the above items excluded from adjusted net income are as
follows:
                                                             Year Ended December 31,
(MILLIONS OF DOLLARS)                                  2019             2018            2017
Cost of sales:
Purchase accounting adjustments                   $        24$        27$        7
Accelerated depreciation                                    -                 -              2
Inventory write-offs                                        -                 1             (2 )
Consulting fees                                             7                 8              6
Stand-up costs                                              -                 -              3
Other                                                      70                (1 )           (2 )
  Total Cost of sales                                     101                35             14

Selling, general & administrative expenses:
Purchase accounting adjustments                            72                32              5
Consulting fees                                             -                 -              2
Other                                                       2                 2              2
  Total Selling, general & administrative
expenses                                                   74                34              9

Research & development expenses:
Purchase accounting adjustments                             2                 2              2
  Total Research & development expenses                     2                 2              2

Amortization of intangible assets:
Purchase accounting adjustments                           136               101             74
  Total Amortization of intangible assets                 136               101             74

Restructuring charges and certain
acquisition-related costs:
Integration costs                                          18                21              6
Transaction costs                                           -                21              -
Employee termination costs                                 33                25             10
Exit costs                                                  -                 1              3
  Total Restructuring charges and certain
acquisition-related costs                                  51                68             19

Other (income)/deductions-net:
Net (gain)/loss on sale of assets                         (20 )             (40 )           10
Other                                                       -               (18 )           (5 )
  Total Other (income)/deductions-net                     (20 )             (58 )            5

Provision for / (benefit from) taxes on income             89                85           (198 )

Total purchase accounting adjustments,
acquisition-related costs, and certain
significant items-net of tax                      $       255       $       

97 $ 321




Analysis of the Consolidated Statements of Comprehensive Income
Substantially all changes in other comprehensive income for the periods
presented are related to foreign currency translation adjustments. These changes
result from the strengthening or weakening of the U.S. dollar as compared to the
currencies in the countries in which we do business. The gains and losses
associated with these changes are deferred on the balance sheet in Accumulated
other comprehensive loss until realized.
Analysis of the Consolidated Balance Sheets
December 31, 2019 vs. December 31, 2018
For a discussion about the changes in Cash and cash equivalents, Short-term
borrowings, Current portion of long-term debt and Long-term debt, net of
discount and issuance costs, see "Analysis of financial condition, liquidity and
capital resources" below.
Short-term investments decreased as a result of maturities of debt securities.
Other current assets increased primarily as a result of the timing of income tax
payments, higher receivables due to value-added tax for our international
markets and other higher prepaid expenses.

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Property, plant and equipment, less accumulated depreciation increased primarily
as a result of capital spending, partially offset by depreciation expense and
the impact of foreign exchange.
The net change in Operating lease right of use assets, and Operating lease
liabilities relates to the adoption of the new lease accounting standard, which
became effective January 1, 2019. See Notes to Consolidated Financial
Statements-Note 3. Significant Accounting Policies and Note 10. Leases.
Identifiable intangible assets, less accumulated amortization decreased as a
result of amortization expense and the impact of foreign exchange, partially
offset by the acquisitions of Platinum Performance, Phoenix Lab and ZNLabs. See
Notes to Consolidated Financial Statements- Note 5. Acquisitions and
Divestitures and Note 13. Goodwill and Other Intangible Assets.
The net changes in Noncurrent deferred tax assets, Noncurrent deferred tax
liabilities, Income taxes payable and Other taxes payable primarily reflect the
adjustments to the accrual for the income tax benefit, the tax impact of various
acquisitions, and the impact of the remeasurement of deferred taxes as a result
of a change in tax rates. See Notes to Consolidated Financial Statements- Note
8. Tax Matters.
Dividends payable increased as a result of an increase in the dividend rate for
the first quarter 2020 dividend, which was declared on December 11, 2019.
Accrued expenses increased primarily due to higher contract rebate accruals and
accrued costs associated with the CEO transition, partially offset by payment of
employee termination costs primarily associated with the acquisition of Abaxis.
Other current liabilities increased primarily due to short-term lease
liabilities as a result of the adoption of the new lease accounting standard,
which became effective January 1, 2019, partially offset by the payments of
contingent consideration related to the 2016 acquisition of certain intangible
assets related to our livestock product portfolio and the 2018 acquisition of a
manufacturing business in Ireland. See Notes to Consolidated Financial
Statements-Note 3. Significant Accounting Policies and Note 10. Leases.
Other noncurrent liabilities increased as a result of contingent consideration
recorded related to the 2019 acquisitions, increases in deferred compensation
due to gains from investments and accrued pension benefits due to decreases in
the discount rate. See Notes to Consolidated Financial Statements- Note 5.
Acquisitions and Divestitures and Note 14. Benefit Plans.
For an analysis of the changes in Total Equity, see the Consolidated Statements
of Equity and Notes to Consolidated Financial Statements- Note 16. Stockholders'
Equity.
Analysis of the Consolidated Statements of Cash Flows
                                          Year Ended December 31,                  % Change
(MILLIONS OF DOLLARS)                  2019          2018          2017        19/18        18/17
Net cash provided by (used in):
Operating activities              $   1,795$   1,790$   1,346            0           33
Investing activities                   (504 )      (2,259 )        (270 )        (78 )          *
Financing activities                   (951 )         533          (251 )       (278 )          *
Effect of exchange-rate changes                       (26 )          12          (69 )          *
on cash and cash equivalents             (8 )

Net increase/(decrease) in cash $ 332$ 38$ 837

      774          (95 )
and cash equivalents


*  Calculation not meaningful.
Operating activities
2019 vs. 2018
Net cash provided by operating activities was $1,795 million in 2019 compared
with $1,790 million in 2018. The increase in operating cash flows was primarily
attributable to higher cash earnings, partially offset by higher income tax
payments, higher interest payments and higher inventory, as well as the timing
of receipts and payments in the ordinary course of business.
Investing activities
2019 vs. 2018
Net cash used in investing activities was $504 million in 2019 compared with
$2,259 million in 2018. The net cash used in investing activities for 2019 was
primarily attributable to capital expenditures and the acquisitions of Platinum
Performance, Phoenix Lab and ZNLabs, partially offset by proceeds from
maturities of debt securities, proceeds from cross-currency interest rate swaps
and proceeds resulting from a payment received pursuant to an agreement related
to the 2016 sale of certain U.S. manufacturing sites. The net cash used in
investing activities for 2018 was primarily attributable to the acquisitions of
Abaxis and a manufacturing business in Ireland, and purchases of property, plant
and equipment.
Financing activities
2019 vs. 2018
Net cash used in financing activities was $951 million in 2019 compared with net
cash provided by financing activities of $533 million in 2018. The net cash used
in financing activities for 2019 was primarily attributable to the purchase of
treasury shares, the payment of dividends, the payment of short-term borrowings
and the payments of contingent consideration related to the 2016 acquisition of
certain intangible assets related to our livestock product portfolio and the
2018 acquisition of a manufacturing business in Ireland. The net cash provided
by financing activities for 2018

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was primarily attributable to the proceeds received from the issuance of senior
notes in August 2018, partially offset by the purchase of treasury shares and
the payment of dividends.
Analysis of financial condition, liquidity and capital resources
While we believe our cash and cash equivalents on hand, our operating cash flows
and our existing financing arrangements will be sufficient to support our future
cash needs, this may be subject to the environment in which we operate. Risks to
our meeting future funding requirements include global economic conditions
described in the following paragraph.
Global financial markets may be impacted by macroeconomic, business and
financial volatility. As markets change, we will continue to monitor our
liquidity position, but there can be no assurance that a challenging economic
environment or an economic downturn will not impact our liquidity or our ability
to obtain future financing.
Selected measures of liquidity and capital resources
Certain relevant measures of our liquidity and capital resources follow:
                                                December 31,     December 31,
(MILLIONS OF DOLLARS)                                   2019             2018
Cash and cash equivalents                      $       1,934$       1,602
Accounts receivable, net(a)                            1,086            1,036
Short-term borrowings                                      -                9
Current portion of long-term debt                        500                -
Long-term debt                                         5,947            6,443
Working capital                                        2,942            3,176

Ratio of current assets to current liabilities 2.63:1 3.60:1

(a) Accounts receivable are usually collected over a period of 45 to 75 days.

     For the year ended December 31, 2019, compared to the year ended
     December 31, 2018, the number of days that accounts receivables are
     outstanding remained approximately the same. We regularly monitor our
     accounts receivable for collectability, particularly in markets where
     economic conditions remain uncertain. We believe that our allowance for

doubtful accounts is appropriate. Our assessment is based on such factors as

past due aging, historical and expected collection patterns, the financial

condition of our customers, the robust nature of our credit and collection

practices and the economic environment.



For additional information about the sources and uses of our funds, see the
Analysis of the Consolidated Balance Sheets and Analysis of the Consolidated
Statements of Cash Flows sections of this MD&A.
Credit facility and other lines of credit
In December 2016, we entered into an amended and restated revolving credit
agreement with a syndicate of banks providing for a multi-year $1.0 billion
senior unsecured revolving credit facility (the credit facility). In December
2018, the maturity for the amended and restated credit facility was extended
through December 2023. 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 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 December 31, 2019 and
December 31, 2018. There were no amounts drawn under the credit facility as of
December 31, 2019 or December 31, 2018.
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 December 31, 2019, we had access to $76 million of
lines of credit which expire at various times through 2020, and are generally
renewed annually. We had no borrowings outstanding related to these facilities
as of December 31, 2019.
Domestic and international short-term funds
Many of our operations are conducted outside the U.S. The amount of funds held
in the U.S. will fluctuate due to the timing of receipts and payments in the
ordinary course of business and due to other reasons, such as business
development activities. As part of our ongoing liquidity assessments, we
regularly monitor the mix of U.S. and international cash flows (both inflows and
outflows). Actual repatriation of overseas funds can result in additional U.S
and local income taxes, such as U.S. state income taxes, local withholding
taxes, and taxes on currency gains and losses. In addition, the recent changes
imposed by the Tax Act resulted in a one-time deemed repatriation tax of
previously untaxed accumulated and current earnings and profits of our foreign
subsidiaries, which is payable over eight years, with the first installment paid
in 2019. See Notes to Consolidated Financial Statements- Note 8. Tax Matters.

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Global economic conditions
Challenging economic conditions in recent years have not had, nor do we
anticipate that it will have, a significant impact on our liquidity. Due to our
operating cash flows, financial assets, access to capital markets and available
lines of credit and revolving credit agreements, we continue to believe that we
have the ability to meet our liquidity needs for the foreseeable future. As
markets change, we continue to monitor our liquidity position. There can be no
assurance that a challenging economic environment or a further economic downturn
would not impact our ability to obtain financing in the future.
Contractual obligations
Payments due under contractual obligations as of December 31, 2019, are set
forth below:
                                                                     2021-       2023-      There-
(MILLIONS OF DOLLARS)                        Total        2020        2022        2024       after
Long-term debt, including interest
obligations(a)                             $ 9,601$   745$ 1,039$ 1,707$ 6,110
Other liabilities reflected on our
Consolidated Balance Sheets under U.S.
GAAP(b)                                        112          31          26          16          39
Operating lease commitments                    225          42          68          48          67
Purchase obligations(c)                        440         153         221          39          27
Benefit plans - continuing service
credit obligations(d)                           12           4           8           -           -
Uncertain tax positions(e)                       -           -           -           -           -

(a) Long-term debt consists of senior notes and other notes. Our calculations of

     expected interest payments incorporate only current period assumptions for
     interest rates, foreign currency translation rates and Zoetis hedging
     strategies. See Notes to Consolidated Financial Statements- Note 9A.
     Financial Instruments: Debt.

(b) Includes expected employee termination payments that represent contractual

obligations, expected payments related to our unfunded U.S. supplemental

(non-qualified) savings plans, deferred compensation and expected payments

relating to our future benefit payments net of plan assets (included in the

determination of the projected benefit obligation) for pension plans that

are dedicated to Zoetis employees and those transferred to us from Pfizer.

See Notes to Consolidated Financial Statements- Note 5. Acquisitions and

Divestitures, Note 6. Restructuring Charges and Other Costs Associated with

Acquisitions, Cost-Reduction and Productivity Initiatives and Note 14.

Benefit Plans. Excludes approximately $140 million of noncurrent liabilities

related to legal and environmental accruals, certain employee termination

and exit costs, deferred income and other accruals, most of which do not

represent contractual obligations. See Notes to Consolidated Financial

Statements- Note 6. Restructuring Charges and Other Costs Associated with

Acquisitions, Cost-Reduction and Productivity Initiatives and Note 18.

Commitments and Contingencies.

(c) Includes agreements to purchase goods and services that are enforceable and

legally binding and includes amounts relating to advertising, contract

manufacturing, and information technology services.

(d) Includes the cost of service credit continuation for certain Zoetis

employees in the Pfizer U.S. qualified defined benefit pension and U.S.

retiree medical plans, in accordance with the employee matters agreement.

See Notes to Consolidated Financial Statements- Note 14. Benefit Plans.

(e) Except for amounts reflected in Income taxes payable, we are unable to

predict the timing of tax settlements, as tax audits can involve complex

issues and the resolution of those issues may span multiple years,

particularly if subject to negotiation or litigation.



The table above excludes amounts for potential milestone payments unless the
payments are deemed reasonably likely to occur. Payments under these agreements
generally become due and payable only upon the achievement of certain
development, regulatory and/or commercialization milestones, which may span
several years and/or which may never occur. Our contractual obligations in the
table above are not necessarily indicative of our contractual obligations in the
future.
Debt Securities
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 that were borrowed to finance a
portion of the cash consideration for the acquisition of Abaxis (see Notes to
Consolidated Financial Statements- 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 were 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 (2013 senior notes) 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 lease-back 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 (if not cured
or waived), the 2013, 2015, 2017 and 2018 senior notes may be declared
immediately due and payable.

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Pursuant to the indenture, we are able to redeem the 2013, 2015 and 2017 senior
notes and the 2018 fixed rate senior notes of any series, in whole or in part,
at any time by paying a "make whole" premium, plus accrued and unpaid interest
to, but excluding, the date of redemption. Pursuant to our tax matters agreement
with Pfizer, we will not be permitted to redeem the 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.
Our outstanding debt securities are as follows:
                 Principal  Interest
Description      Amount       Rate     Terms

                                       Interest due semi annually, not subject to
2015 Senior      $500                  amortization, aggregate principal due on
Notes due 2020   million     3.450%    November 13, 2020
2018 Floating              Three-month Interest due quarterly, not subject to
Rate Senior      $300       USD LIBOR  amortization, aggregate principal due on
Notes due 2021   million   plus 0.44%  August 20, 2021
                                       Interest due semi annually, not subject to
2018 Senior      $300                  amortization, aggregate principal due on
Notes due 2021   million     3.250%    August 20, 2021
                                       Interest due semi annually, not subject to
2013 Senior      $1,350                amortization, aggregate principal due on
Notes due 2023   million     3.250%    February 1, 2023
                                       Interest due semi annually, not subject to
2015 Senior      $750                  amortization, aggregate principal due on
Notes due 2025   million     4.500%    November 13, 2025
                                       Interest due semi annually, not subject to
2017 Senior      $750                  amortization, aggregate principal due on
Notes due 2027   million     3.000%    September 12, 2027
                                       Interest due semi annually, not subject to
2018 Senior      $500                  amortization, aggregate principal due on
Notes due 2028   million     3.900%    August 20, 2028
                                       Interest due semi annually, not subject to
2013 Senior      $1,150                amortization, aggregate principal due on
Notes due 2043   million     4.700%    February 1, 2043
                                       Interest due semi annually, not subject to
2017 Senior      $500                  amortization, aggregate principal due on
Notes due 2047   million     3.950%    September 12, 2047
                                       Interest due semi annually, not subject to
2018 Senior      $400                  amortization, aggregate principal due on
Notes due 2048   million     4.450%    August 20, 2048


Credit ratings
Two major corporate debt-rating organizations, Moody's and S&P, assign ratings
to our short-term and long-term debt. A security rating is not a recommendation
to buy, sell or hold securities and the rating is subject to revision or
withdrawal at any time by the rating organization. Each rating should be
evaluated independently of any other rating.
The following table provides the current ratings assigned by these rating
agencies to our commercial paper and senior unsecured non-credit-enhanced
long-term debt:
                        Commercial
                          Paper       Long-term Debt       Date of
Name of Rating Agency     Rating     Rating   Outlook    Last Action
Moody's                    P-2        Baa1    Stable     August 2017
S&P                        A-2        BBB     Stable    December 2016


Pension obligations
Our employees ceased to participate in the Pfizer U.S. qualified defined benefit
and U.S. retiree medical plans effective December 31, 2012, and liabilities
associated with our employees under these plans were retained by Pfizer. As part
of the separation from Pfizer, Pfizer continued to credit certain employees'
service with Zoetis generally through December 31, 2017 (or termination of
employment from Zoetis, if earlier), for certain early retirement benefits with
respect to Pfizer's U.S. defined benefit pension and retiree medical plans. In
connection with the employee matters agreement, Zoetis is responsible for
payment of three-fifths of the total cost of the service credit continuation
(approximately $38 million) for these plans. The amount of the service cost
continuation payment to be paid by Zoetis to Pfizer was determined and fixed
based on an actuarial assessment of the value of the grow-in benefits and will
be paid in equal installments over a period of 10 years. As of December 31,
2019, the remaining payments due to Pfizer (approximately $12 million in the
aggregate) are to be paid over the next three years.
As part of the separation from Pfizer, Pfizer transferred to us the net pension
obligations associated with certain international defined benefit plans. We
expect to contribute a total of approximately $6 million to these plans in 2020.
As of December 31, 2019, the supplemental savings plan liability was
approximately $48 million.
For additional information, see Notes to Consolidated Financial Statements- Note
14. Benefit Plans.

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Share repurchase program
In December 2016, the company's Board of Directors authorized a $1.5 billion
share repurchase program. This program was completed as of December 31, 2019. In
December 2018, the company's Board of Directors authorized an additional $2.0
billion share repurchase program. As of December 31, 2019, there was
approximately $1.7 billion remaining under this authorization. Purchases of
Zoetis shares may be made at the discretion of management, depending on market
conditions and business needs. Share repurchases may be executed through various
means, including open market or privately negotiated transactions. During 2019,
approximately 5.8 million shares were repurchased.
Off-balance sheet arrangements
In the ordinary course of business and in connection with the sale of assets and
businesses, we may indemnify our counterparties against certain liabilities that
may arise in connection with a transaction or that are related to activities
prior to a transaction. These indemnifications typically pertain to
environmental, tax, employee and/or product-related matters, and
patent-infringement claims. If the indemnified party were to make a successful
claim pursuant to the terms of the indemnification, we would be required to
reimburse the loss. These indemnifications are generally subject to threshold
amounts, specified claim periods and other restrictions and limitations.
Historically, we have not paid significant amounts under these provisions and,
as of December 31, 2019 and December 31, 2018, recorded amounts for the
estimated fair value of these indemnifications are not significant.
New accounting standards
See Note 3. Significant Accounting Policies in the Notes to Consolidated
Financial Statements for discussion of recent accounting pronouncements,
including the respective dates of adoption or expected adoption and effects or
expected effects on our consolidated financial position, results of operations
and cash flows.



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Forward-looking statements and factors that may affect future results
This report contains "forward-looking" statements. We intend such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934. We generally
identify forward-looking statements by using words such as "anticipate,"
"estimate," "could," "expect," "intend," "project," "plan," "predict,"
"believe," "seek," "continue," "outlook," "objective," "target," "may," "might,"
"will," "should," "can have," "likely" or the negative version of these words or
comparable words or by using future dates in connection with any discussion of
future performance, actions or events.
In particular, forward-looking statements include statements relating to our
2020 financial guidance, future actions, business plans or prospects,
prospective products, product approvals or products under development, product
supply disruptions, R&D costs, timing and likelihood of success, future
operating or financial performance, future results of current and anticipated
products and services, strategies, sales efforts, expenses, production
efficiencies, production margins, anticipated timing of generic market entries,
integration of acquired businesses, interest rates, tax rates, changes in tax
regimes and laws, foreign exchange rates, growth in emerging markets, the
outcome of contingencies, such as legal proceedings, plans related to share
repurchases and dividends, government regulation and financial results. These
statements are not guarantees of future performance, actions or events.
Forward-looking statements are subject to risks and uncertainties, many of which
are beyond our control, and are based on assumptions that could prove to be
inaccurate. Among the factors that could cause actual results to differ
materially from past results and future plans and projected future results are
the following:
• unanticipated safety, quality or efficacy concerns about our products;


• issues with any of our top products;


•      failure of our R&D, acquisition and licensing efforts to generate new
       products and product lifecycle innovations;

• the possible impact and timing of competing products, including generic

       alternatives, on our products and our ability to compete against such
       products;

• disruptive innovations and advances in medical practices and technologies;


•      difficulties and delays in the development, manufacturing and
       commercialization of new products;

• consolidation of our customers and distributors;

• changes in the distribution channel for companion animal products;

• failure to successfully acquire businesses, license rights or products,

integrate businesses, form and manage alliances or divest businesses;

• acquiring or implementing new business lines or offering new products and

services;

• restrictions and bans on the use of and consumer preferences regarding

antibacterials in food-producing animals;

• perceived adverse effects linked to the consumption of food derived from

animals that utilize our products or animals generally;

• adverse global economic conditions;


•      increased regulation or decreased governmental support relating to the
       raising, processing or consumption of food-producing animals;

• fluctuations in foreign exchange rates and potential currency controls;

• changes in tax laws and regulations;

• legal factors, including product liability claims, antitrust litigation

and governmental investigations, including tax disputes, environmental

concerns, commercial disputes and patent disputes with branded and generic

competitors, any of which could preclude commercialization of products or

       negatively affect the profitability of existing products;


•      failure to protect our intellectual property rights or to operate our

business without infringing the intellectual property rights of others;

• product launch delays, inventory shortages, recalls or unanticipated costs

caused by manufacturing problems and capacity imbalances;

• an outbreak of infectious disease carried by animals;

• adverse weather conditions and the availability of natural resources;

• the economic, political, legal and business environment of the foreign

jurisdictions in which we do business;

• a cyber-attack, information security breach or other misappropriation of

our data;

• quarterly fluctuations in demand and costs;

• governmental laws and regulations affecting domestic and foreign

operations, including without limitation, tax obligations and changes

affecting the tax treatment by the U.S. of income earned outside the U.S.

that may result from pending and possible future proposals;

• governmental laws and regulations affecting our interactions with

veterinary healthcare providers; and

• the other factors set forth under "Risk Factors" in Item 1A of Part I of

this 2019 Annual Report.



However, there may also be other risks that we are unable to predict at this
time. These risks or uncertainties may cause actual results to differ materially
from those contemplated by a forward-looking statement. You should not put undue
reliance on forward-looking statements. Forward-looking statements speak only as
of the date on which they are made. We undertake no obligation to publicly
update forward-looking statements,

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whether as a result of new information, future events or otherwise, except as
required by law or by the rules and regulations of the SEC. You are advised,
however, to consult any further disclosures we make on related subjects in our
Form 10-Q and 8-K reports and our other filings with the SEC. You should
understand that it is not possible to predict or identify all such factors.
Consequently, you should not consider the above to be a complete discussion of
all potential risks or uncertainties.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.


A significant portion of our revenue and costs are exposed to changes in foreign
exchange rates. In addition, our outstanding borrowings may be subject to risk
from changes in interest rates and foreign exchange rates. The overall objective
of our financial risk management program is to seek to minimize the impact of
foreign exchange rate movements and interest rate movements on our earnings. We
manage these financial exposures through operational means and by using certain
financial instruments. These practices may change as economic conditions change.
Foreign exchange risk
Our primary net foreign currency translation exposures are the Australian
dollar, Brazilian real, Canadian dollar, Chinese yuan, euro, and U.K. pound. We
seek to manage our foreign exchange risk, in part, through operational means,
including managing same-currency revenue in relation to same-currency costs and
same-currency assets in relation to same-currency liabilities.
Foreign exchange risk is also managed through the use of foreign currency
forward-exchange contracts. These contracts are used to offset the potential
earnings effects from mostly intercompany short-term foreign currency assets and
liabilities that arise from operations.
Our financial instrument holdings at December 31, 2019, were analyzed to
determine their sensitivity to foreign exchange rate changes. The fair values of
these instruments were determined using Level 2 inputs. For additional details,
see Notes to Consolidated Financial Statements- Note 3. Significant Accounting
Policies: Fair Value. The sensitivity analysis of changes in the fair value of
all foreign currency forward-exchange contracts at December 31, 2019, indicates
that if the U.S. dollar were to appreciate against all other currencies by 10%,
the fair value of these contracts would increase by $13 million, and if the U.S.
dollar were to weaken against all other currencies by 10%, the fair value of
these contracts would decrease by $17 million. For additional details, see Notes
to Consolidated Financial Statements- Note 9C. Financial Instruments: Derivative
Financial Instruments.
Interest rate risk
Our outstanding debt balances are predominantly fixed rate debt. While changes
in interest rates will have no impact on the interest we pay on our fixed rate
debt, interest on our $300 million aggregate principal amount of 2018 Floating
Rate Senior Notes due 2021, as well as interest on our commercial paper and
revolving credit facility will be exposed to interest rate fluctuations.
Additionally, as of December 31, 2019, because we held certain interest rate
swap agreements that have the economic effect of modifying the fixed-interest
obligations associated with our 3.9% Senior Notes due 2028, the fixed-rate
interest payable on these senior notes effectively became variable based on
LIBOR. At December 31, 2019, there were no commercial paper borrowings
outstanding and no outstanding principal balance under our revolving credit
facility.
By issuing the Floating-Rate Notes and by entering into the aforementioned swap
arrangements, we have assumed risks associated with variable interest rates
based upon LIBOR. Changes in the overall level of interest rates affect the
interest expense that we recognize in our Consolidated Statements of Income. An
interest rate risk sensitivity analysis is used to measure interest rate risk
by computing estimated changes in cash flows as a result of assumed changes in
market interest rates. As of December 31, 2019, if LIBOR-based interest rates
would have been higher by 100 basis points, the change would have increased our
interest expense annually by approximately $4.5 million, as it relates to our
fixed to floating interest rate swap agreements and floating-rate borrowings.
See Notes to Consolidated Financial Statements- Note 9. Financial Instruments.

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