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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)

02/16/2021 | 02:28pm 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 2020 compared to fiscal 2019 is presented below. A discussion regarding
our financial condition and results of operations for fiscal 2019 compared to
fiscal 2018 can be found under Item 7 of Part II of our Annual Report on Form
10-K for the fiscal year ended December 31, 2019, filed with the SEC on February
13, 2020 (our "2019 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 animal health industry, focused on the discovery,
development, manufacture and commercialization of medicines, vaccines,
diagnostic products, biodevices, genetic tests and precision livestock farming
technology. 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 companion animals and livestock
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, Chile, China and
Mexico, we believe we are one of the largest animal health medicines and
vaccines businesses 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 companion animal and livestock
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 2020 performance compared with the comparable 2019 and 2018
periods follows:
                                               Years Ended December 31,                   % Change
(MILLIONS OF DOLLARS)                            2020         2019         2018      20/19          19/18
Revenue                                $   6,675$ 6,260$ 5,825         7               7
Net income attributable to Zoetis          1,638           1,500        1,428         9               5
Adjusted net income(a)                     1,844           1,755        1,525         5              15


(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 companion animals and
livestock, is a growing industry that impacts billions of people worldwide. 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.
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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
•increased focus on food safety and food security.
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 companion animals and livestock, including products in diagnostics,
genetics, precision livestock farming 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 $1.1 billion for
the year ended December 31, 2020.
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 and has been accelerated by the increase in e-commerce during the
COVID-19 pandemic. 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
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customers, which may result in reduced demand for our products, which could have
a material adverse effect on our operating results and financial condition.
Competition
The animal health industry is highly 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. We also compete with companies
that produce generic products, following our products' loss of exclusivity in a
given market. For example, Draxxin currently competes with generic products in
key markets including Europe, Canada, Mexico and Australia and we expect generic
competition in the U.S. in 2021. For more information regarding the generic
competition we currently have and expect to encounter as patents on certain of
our key products expire, see Item 1. Business - Intellectual Property.
Weather conditions, climate change 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, weather conditions,
including excessive cold or heat, natural disasters and other events, could
negatively impact our livestock customers by impairing the health or growth of
their animals or the production or availability of feed, as well as disrupting
their normal operations. For example, 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,
climate change or floods, droughts or other weather conditions. In the event of
adverse weather conditions, climate-change related impacts 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.
Adverse weather conditions, natural disasters and climate change 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.
Uncertainty Relating to COVID-19
We continue to closely monitor the impact of the coronavirus (COVID-19) pandemic
and the resulting global recession on all aspects of our business across
geographies, including how it has and may continue to impact our customers,
workforce, suppliers and vendors. We are currently designated an essential
business globally and have continued physical operations with respect to
research and development, manufacturing and our supply chain. As the pandemic
continues to progress, the severity of the impact across markets remains
uncertain as the number of cases rises and falls in various jurisdictions
leading to changes in the imposition of restrictive measures intended to contain
the virus.
Due to numerous uncertainties regarding the continuing COVID-19 pandemic, we are
unable to fully predict the impact that it will ultimately have on our future
financial position and operating results. These uncertainties include the
severity of the virus, the duration of the outbreak and number of recurrences,
the effectiveness of measures to contain and treat the virus, including the
timing of widespread vaccinations, governmental, business or other actions in
response to the pandemic (which could include actions that result in limitations
on, or disruptions to, our manufacturing, transportation and other operations,
or mandates to provide products or services), impacts on our supply chain, the
effect on customer demand, or changes to our operations. We cannot predict the
impact that the COVID-19 pandemic will have on our customers, vendors and
suppliers; however, any material effect on these parties could adversely impact
us. In particular, our livestock customers have been, and may continue to be,
negatively impacted by facility closures, reduced packing plant capacity,
quarantines, travel bans and labor shortages, and the shift in protein
production from foodservice to grocery, among other impacts. In addition, our
companion animal customers have been, and may in the future be, negatively
impacted by lack of demand for veterinary services in areas where lockdown and
stay-at-home orders are in place. The impact of COVID-19 on our customers has
reduced and could continue to reduce the demand for our products, which could
continue to adversely impact our revenue. The health of our workforce, and our
ability to meet staffing needs in our manufacturing operations and other
critical functions also cannot be predicted and is vital to our operations.
Further, the impacts of a prolonged global recession and the continued
disruptions to, and volatility in, the credit and financial markets, as well as
other unanticipated consequences, remain unknown. In addition, in order to
preserve liquidity, we issued debt securities in May 2020 and we may in the
future incur additional indebtedness, whether through the issuance of debt
securities, drawdowns under our credit facility or otherwise. An increase in our
outstanding indebtedness will result in additional interest expense.
The situation surrounding COVID-19 remains fluid, and we will continue to
actively monitor the situation and may take actions that alter our business
operations that we determine are in the best interests of our workforce,
customers, vendors, suppliers, and other stakeholders, or as required by
federal, state, or local authorities. It is not clear what the potential effects
any such alterations or modifications may ultimately have on our business,
including the effects on our customers, workforce, and prospects, or on our
financial results in fiscal 2021.

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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, 2020, approximately 42% 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, 2020,
approximately 58% of our total revenue was in U.S. dollars. Our year-over-year
total revenue growth was unfavorably impacted by 2% 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:
•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, most
diverse talent in the industry. We are further committed to sustaining a
diverse, equitable and inclusive work environment for our colleagues;
•champion a healthier, more sustainable future - As the world's leading animal
health company, our business purpose is well aligned with our social purpose. We
strive to make a meaningful difference in society through the three pillars of
our sustainability approach: (1) by caring and collaborating with our customers,
colleagues, and communities, and the animals that depend on them by improving
access to care for animals, by creating a diverse, equitable, and inclusive work
environment, and by supporting the veterinary profession; (2) by leveraging our
innovation capabilities to develop solutions that improve productivity, keep
animals healthy, and fight emerging infectious diseases; and (3) by taking
actions to protect our planet that reduce our footprint on the environment.
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 companion
animals and livestock. 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
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2020, our top two selling products, Apoquel and Simparica/Simparica Trio,
contributed approximately 10% and 6%, respectively, of our revenue, and combined
with our next three top selling products, Revolution/Revolution Plus/Stronghold,
Draxxin and the ceftiofur line, these five contributed approximately 31% of our
revenue. Our top ten product lines contributed 44% 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
2020, 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.
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.
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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, 2020, 2019
and 2018.
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 $88 million as of
December 31, 2020). 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 periodic 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
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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 2020, we performed a periodic quantitative impairment assessment as of
September 30, 2020, which did not result in the impairment of goodwill
associated with any of our reporting units.
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.
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.
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.
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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)                                    2020             2019             2018             20/19               19/18
Revenue                                            $ 6,675$ 6,260$ 5,825                 7                  7
Costs and expenses:
Cost of sales(a)                                     2,057            1,992            1,911                 3                  4
% of revenue                                            31  %            32  %            33  %
Selling, general and administrative                  1,726            1,638            1,484                 5                 10

expenses(a)

% of revenue                                            26  %            26  %            25  %
Research and development expenses(a)                   463              457              432                 1                  6
% of revenue                                             7  %             7  %             7  %
Amortization of intangible assets(a)                   160              155              117                 3                 32
Restructuring charges and certain                       25               51               68               (51)               (25)
acquisition-related costs
Interest expense, net of capitalized                                                                         4                  8
interest                                               231              223              206
Other (income)/deductions-net                           17              (57)             (83)                   *             (31)
Income before provision for taxes on income          1,996            1,801            1,690                11                  7
% of revenue                                            30  %            29  %            29  %
Provision for taxes on income                          360              301              266                20                 13
Effective tax rate                                    18.0  %          16.7  %          15.7  %
Net income before allocation to                      1,636            1,500            1,424                 9                  5
noncontrolling interests
Less: Net income attributable to                        (2)               -               (4)                   *                   *
noncontrolling interests
Net income attributable to Zoetis                  $ 1,638$ 1,500$ 1,428                 9                  5
% of revenue                                            25  %            24  %            25  %


* 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)                               2020         2019         2018      20/19          19/18
U.S.                                         $   3,557$ 3,203$ 2,877        11              11
International                                    3,035        2,972        2,890         2               3
Total operating segments                         6,592        6,175        5,767         7               7
Contract manufacturing & human health               83           85           58        (2)             47
Total Revenue                                $   6,675$ 6,260$ 5,825         7               7


On a global basis, the mix of revenue between companion animal and livestock
products was as follows:
                                                    Year Ended December 31,                  % Change
(MILLIONS OF DOLLARS)                               2020         2019      
  2018      20/19          19/18
Companion animal                             $   3,652$ 3,145$ 2,613        16              20
Livestock                                        2,940        3,030        3,154        (3)             (4)
Contract manufacturing & human health               83           85           58        (2)             47
Total Revenue                                $   6,675$ 6,260$ 5,825         7               7


2020 vs. 2019
Total revenue increased by $415 million, or 7%, in 2020 compared with 2019
reflecting operational revenue growth of $546 million, or 9%. Operational
revenue growth was primarily due to the following:
•volume growth from new products of approximately 3%;
•volume growth from in-line products, including key dermatology products, of
approximately 3%;
•price growth of approximately 2%; and
•recent acquisitions which contributed approximately 1%.

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Costs and Expenses
Cost of sales
                                  Year Ended December 31,                   % Change
(MILLIONS OF DOLLARS)            2020          2019          2018      20/19          19/18
Cost of sales              $ 2,057$ 1,992$ 1,911          3               4
% of revenue                    31  %         32  %         33  %


2020 vs. 2019
Cost of sales as a percentage of revenue decreased from 32% to 31% in 2020
compared with 2019, primarily as a result of:
•a change in estimate related to inventory costing in 2019;
•favorable product mix;
•price increases; and
•favorable manufacturing costs,
partially offset by:
•higher inventory obsolescence, scrap and other charges, including costs related
to the COVID-19 pandemic;
•unfavorable foreign exchange; and
•the inclusion of recent acquisitions.
Selling, general and administrative expenses
                                                       Year Ended December 31,                               % Change
(MILLIONS OF DOLLARS)                             2020              2019              2018              20/19                19/18

Selling, general and administrative $ 1,726$ 1,638

   $  1,484                  5                  10
expenses
% of revenue                                     26  %             26  %             25  %


2020 vs. 2019
SG&A expenses increased $88 million, or 5%, in 2020 compared with 2019,
primarily as a result of:
•investments to support revenue growth;
•expenses related to recent acquisitions;
•an increase in depreciation;
•freight and logistics; and
•certain compensation-related costs,
partially offset by:
•lower travel and entertainment expenses as a result of decreases in travel and
events related to the COVID-19 pandemic; and
•favorable foreign exchange.
Research and development expenses
                                                Year Ended December 31,                    % Change
(MILLIONS OF DOLLARS)                          2020             2019        2018      20/19          19/18
Research and development expenses      $    463$ 457$ 432          1               6
% of revenue                                  7   %             7  %        7  %


2020 vs. 2019
R&D expenses increased $6 million, or 1%, in 2020 compared with 2019, primarily
as a result of:
•an increase in certain compensation-related expenses; and
•increased spending driven by project investments,
partially offset by:
•lower travel and entertainment expenses as a result of decreases in travel and
events related to the COVID-19 pandemic; and
•favorable foreign exchange.
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Amortization of intangible assets
                                                Year Ended December 31,                    % Change
(MILLIONS OF DOLLARS)                                 2020       2019       2018      20/19          19/18
Amortization of intangible assets      $     160$ 155$ 117         3              32


2020 vs. 2019
Amortization of intangible assets increased $5 million, or 3%, in 2020 compared
with 2019, primarily as a result of certain intangible assets acquired during
2020 and 2019.
Restructuring charges and certain acquisition-related costs
                                                           Year Ended December 31,                                % Change
(MILLIONS OF DOLLARS)                                  2020              2019              2018              20/19                19/18
Restructuring charges and certain              $      25$     51$     68                (51)                (25)

acquisition-related costs



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.
2020 vs. 2019
Restructuring charges and certain acquisition-related costs decreased by $26
million in 2020 compared with 2019. Restructuring charges and certain
acquisition-related costs in 2020 consisted of integration costs related to
recent acquisitions, restructuring charges related to CEO transition-related
costs and employee termination costs related to other cost-reduction and
productivity initiatives. Restructuring charges and certain acquisition-related
costs in 2019 included integration costs and employee termination costs incurred
as a result of the acquisition of Abaxis in the third quarter of 2018.
Interest expense, net of capitalized interest
                                                    Year Ended December 31,                                % Change
(MILLIONS OF DOLLARS)                           2020              2019              2018              20/19                19/18
Interest expense, net of
capitalized interest                    $     231$    223$    206                  4                   8


2020 vs. 2019
Interest expense, net of capitalized interest, increased by $8 million, or 4%,
in 2020 compared with 2019, primarily as a result of the issuance of $1.25
billion aggregate principal amount of our senior notes in May 2020, partially
offset by the redemption of $500 million aggregate principal amount of our
senior notes in October 2020 and an increase in capitalized interest in 2020
compared with 2019.
Other (income)/deductions-net
                                            Year Ended December 31,                    % Change
(MILLIONS OF DOLLARS)                             2020       2019       2018      20/19          19/18
Other (income)/deductions-net       $    17$ (57)$ (83)

* (31)



* Calculation not meaningful.
2020 vs. 2019
The change in Other (income)/deductions-net from net other deductions of $17
million in 2020 compared with net other income of $57 million in 2019, is
primarily as a result of:
•asset impairment charges related to developed technology rights in our
precision livestock farming and aquatic health businesses;
•lower interest income due to lower interest rates as compared to the prior year
period;
•higher foreign currency losses;
•an impairment of an equity investment; and
•other asset impairment charges.
Provision for taxes on income
                                             Year Ended December 31,                    % Change
(MILLIONS OF DOLLARS)                       2020             2019        2018      20/19          19/18
Provision for taxes on income       $    360$ 301$ 266         20              13
Effective tax rate                      18.0   %          16.7  %     15.7  %


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.
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2020 vs. 2019
The higher effective tax rate in 2020 compared with 2019 is primarily due to the
following components:
•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 and the impact of non-deductible
and non-taxable items;
•a $5 million discrete tax expense and an $18 million discrete tax benefit
recorded in 2020 and 2019, respectively, related to changes in valuation
allowances;
•a $14 million net discrete deferred tax benefit recorded in 2019 due to a
change in tax basis related to purchase accounting;
•a $4 million and $10 million net discrete tax benefit recorded in 2020 and
2019, respectively, related to the effective settlement of certain issues with
tax authorities; and
•a $4 million and $8 million discrete tax benefit recorded in 2020 and 2019,
respectively, related to a remeasurement of deferred taxes as a result of
changes in statutory tax rates,
partially offset by:
•a $29 million and $20 million discrete tax benefit recorded in 2020 and 2019,
respectively, related to the excess tax benefits for share-based payments;
•a $19 million and $12 million discrete tax benefit recorded in 2020 and 2019,
respectively, related to changes in various other tax items; and
•a $7 million discrete tax benefit recorded in 2020 related to a remeasurement
of deferred taxes resulting from the integration of acquired businesses.
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 2020, 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 our international commercial
segment, are now reported in Other business activities; (ii) certain other
miscellaneous costs, which were previously reported in international commercial
segment results, are now reported in Corporate; and (iii) certain diagnostics
and other miscellaneous costs, which were previously reported in our U.S.
results, are now reported in Corporate.
On a global basis, the mix of revenue between companion animal and livestock
products was as follows:
                                                                                                                                % Change
                                                                                                20/19                                                             19/18
                                                                                                      Related to                                                        Related to
                                  Year Ended December 31,                                Foreign                                                          Foreign
(MILLIONS OF DOLLARS)                2020       2019       2018         Total           Exchange               Operational               Total           Exchange                 Operational
U.S.
Companion animal             $   2,391$ 1,984$ 1,608              21                   -                        21                 23                  -                           23
Livestock                        1,166      1,219      1,269              (4)                  -                        (4)                (4)                 -                           (4)
                                 3,557      3,203      2,877              11                   -                        11                 11                  -                           11
International
Companion animal                 1,261      1,161      1,005               9                  (3)                       12                 16                 (5)                          21
Livestock                        1,774      1,811      1,885              (2)                 (5)                        3                 (4)                (6)                           2
                                 3,035      2,972      2,890               2                  (5)                        7                  3                 (6)                           9
Total
Companion animal                 3,652      3,145      2,613              16                  (1)                       17                 20                 (3)                          23
Livestock                        2,940      3,030      3,154              (3)                 (3)                        -                 (4)                (3)                          (1)
Contract manufacturing &
human health                        83         85         58              (2)                  1                        (3)                47                 (1)                          48
                             $   6,675$ 6,260$ 5,825               7                  (2)                        9                  7                 (3)                          10


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Earnings by segment and the operational and foreign exchange changes versus the
comparable prior year period were as follows:
                                                                                                                           % Change
                                                                                                     20/19                                           19/18
                                                                                                        Related to                                     Related to
                                               Year Ended December 31,                          Foreign                                          Foreign
(MILLIONS OF DOLLARS)                             2020       2019       2018         Total     Exchange       Operational             Total     Exchange      Operational
U.S.                                      $   2,239$ 2,005$ 1,815              12            -               12                 10             -           10
International                                 1,547      1,487      1,399               4           (5)               9                  6            (4)          10
Total reportable segments                     3,786      3,492      3,214               8           (3)              11                  9            (1)          10
Other business activities                      (372)      (348)      (337)              7                                                3
Reconciling Items:
Corporate                                      (820)      (707)      (666)             16                                                6
Purchase accounting adjustments                (198)      (234)      (162)            (15)                                              44
Acquisition-related costs                       (18)       (43)       (63)            (58)                                             (32)
Certain significant items                       (43)       (67)        43             (36)                                                  *
Other unallocated                              (339)      (292)      (339)             16                                              (14)
Income before income taxes                $   1,996$ 1,801$ 1,690              11                                                7


* Calculation not meaningful.
2020 vs. 2019
U.S. operating segment
U.S. segment revenue increased by $354 million, or 11%, in 2020 compared with
2019, of which $407 million resulted from growth in companion animal products,
offset by a $53 million decline in livestock products.
•Companion animal revenue growth was driven primarily by increased sales of
parasiticides including Simparica Trio, our new triple combination parasiticide,
the key dermatology portfolio, and recent acquisitions of Platinum Performance
and a number of regional diagnostic reference labs.
•Livestock revenue decreased due to disruptions in the food supply chain
attributable to the negative impact of COVID-19, including reduced producer
processing capacity and continued channel migration from dining out to at-home
consumption that impacted producer profitability. The negative impact resulted
in a decline across each of the cattle, swine and poultry portfolios. The
decline in the cattle portfolio was also the result of continued unfavorable
market conditions in beef and dairy, while swine was also impacted by export
restrictions on the use of certain products in our portfolio that limited our
customers' access to global markets.
U.S. segment earnings increased by $234 million, or 12%, in 2020 compared with
2019, primarily due to revenue and gross margin growth, partially offset by
higher operating expenses for investments to support revenue growth.
International operating segment
International segment revenue increased by $63 million, or 2%, in 2020 compared
with 2019. Operational revenue increased $194 million, or 7%, reflecting growth
of $134 million in companion animal products and $60 million in livestock
products.
•Companion animal operational revenue growth resulted primarily from increased
sales of our parasiticide products including the Simparica franchise with the
launch of Simparica Trio in the EU, Canada and Australia, as well as the
Revolution/Revolution Plus/Stronghold franchise. Key dermatology products also
contributed to growth with increased sales of Apoquel and Cytopoint.
•Livestock operational revenue growth was driven by increased sales in swine and
fish while cattle and poultry declined. Sales of swine products grew as a result
of expanding herd production and increased biosecurity measures in the wake of
African Swine Fever in China. Alpha Flux, a recently launched parasiticide that
controls sea lice in salmon, increased market share and the recent acquisition
of Fish Vet Group were the primary drivers of growth in fish. Sales of cattle
products declined due to decreased demand attributable to the impact of COVID-19
in certain markets as well as the discontinuation of non-core products in
Brazil. Poultry declined due to the negative impacts of COVID-19 on poultry
consumption.
•Additionally, International segment revenue was unfavorably impacted by foreign
exchange which decreased revenue by approximately $130 million, or 5%, primarily
driven by the depreciation of the Brazilian real, Argentine peso, Mexican peso
and Turkish lira.
International segment earnings increased by $60 million, or 4%, in 2020 compared
with 2019. Operational earnings growth was $136 million, or 9%, primarily due to
higher revenue and lower operating expenses, partially offset by higher cost of
sales.
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.
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2020 vs. 2019
Other business activities net loss increased by $24 million, or 7%, in 2020
compared with 2019, reflecting an increase in R&D costs due to an increase in
compensation-related costs and in project investments, partially offset by lower
travel and entertainment expenses as a result of decreases in travel and events
related to the COVID-19 pandemic and favorable foreign exchange.
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.
2020 vs. 2019
Corporate expenses increased by $113 million, or 16%, in 2020 compared with
2019, primarily due to an increase in expenses related to depreciation and
recent acquisitions, partially offset by a decrease in certain
compensation-related costs and favorable foreign exchange.
Other unallocated expenses increased by $47 million, or 16%, in 2020 compared
with 2019, primarily due to higher inventory obsolescence and other charges and
unfavorable foreign exchange, partially offset by continued cost improvements
and efficiencies in our manufacturing network.
See Notes to Consolidated Financial Statements- Note 19. Segment Information for
further information.
Adjusted net income
General description of adjusted net income (a non-GAAP financial measure)
Adjusted net income is an alternative view of performance used by management,
and we believe that investors' understanding of our performance is enhanced by
disclosing this performance measure. 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.
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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.
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)                                2020              2019              2018              20/19                19/18
GAAP reported net income attributable
to Zoetis                                    $   1,638$  1,500$  1,428                  9                   5
Purchase accounting adjustments-net of
tax                                                142               156               119                 (9)                 31
Acquisition-related costs-net of tax                19                36                50                (47)                (28)
Certain significant items-net of tax                45                63               (72)               (29)                      *
Non-GAAP adjusted net income(a)              $   1,844$  1,755$  1,525                  5                  15


* Calculation not meaningful.
(a)  The effective tax rate on adjusted pretax income is 18.3%, 18.2% and 18.8%
in 2020, 2019 and 2018, respectively. The higher effective tax rate for 2020,
compared with 2019, was primarily attributable to (i) changes in the
jurisdictional mix of earnings, which includes the impact of the location of
earnings, repatriation costs, operating fluctuations in the normal course of
business and the impact of non-deductible and non-taxable items, (ii) an $18
million net discrete tax benefit recorded in 2019 related to changes in
valuation allowances, and (iii) a $4 million and $10 million net discrete tax
benefit recorded in 2020 and 2019, respectively, related to the effective
settlement of certain issues with tax authorities, partially offset by (i) a $20
million and $4 million net discrete tax benefit recorded in 2020 and 2019,
respectively, related to changes in other tax items, and (ii) a $29 million and
$20 million discrete tax benefit recorded in 2020 and 2019, respectively,
related to the excess tax benefits for share-based payments.
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, repatriation costs, operating fluctuations in the normal
course of business and the impact of non-deductible and non-taxable items, (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 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 payments,
partially offset by the impact of the GILTI tax, a new provision to the Tax Cuts
and Jobs Act, which became effective for the company in the first quarter of
2019.
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
                                                         2020              2019              2018              20/19                19/18
Earnings per share-diluted(a):
GAAP reported EPS attributable to
Zoetis-diluted                               $    3.42$   3.11$   2.93                 10                   6
Purchase accounting adjustments-net of
tax                                               0.30                  0.32              0.24                 (6)                 33
Acquisition-related costs-net of tax              0.04                  0.08              0.10                (50)                (20)
Certain significant items-net of tax              0.09                  0.13             (0.14)               (31)                      *
Non-GAAP adjusted EPS-diluted                $    3.85$   3.64$   3.13                  6                  16


* 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.
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Adjusted net income includes the following charges for each of the periods
presented:
                                                            Year Ended December 31,
(MILLIONS OF DOLLARS)                                             2020       2019       2018
Interest expense, net of capitalized interest      $     231$ 223$ 206
Interest income                                          (12)               (37)       (31)
Income taxes                                             413                390        351
Depreciation                                             202                166        146
Amortization                                              40                 27         19

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

                                                                                  Year Ended December 31,
(MILLIONS OF DOLLARS)                                                         2020              2019              2018
Purchase accounting adjustments:
Amortization and depreciation(a)                                      $     190$    210$    135
Cost of sales(b)                                                              8                24                27
Total purchase accounting adjustments-pre-tax                               198               234               162
Income taxes(c)                                                              56                78                43
Total purchase accounting adjustments-net of tax                            142               156               119
Acquisition-related costs:
Integration costs                                                            17                18                21
Transaction costs                                                             -                 -                21
Restructuring charges(d)                                                      1                25                21

Total acquisition-related costs-pre-tax                                      18                43                63
Income taxes(c)                                                              (1)                7                13
Total acquisition-related costs-net of tax                                   19                36                50
Certain significant items:
Operational efficiency initiative(e)                                        (18)              (20)               (1)
Supply network strategy(f)                                                    4                 7                10

Other restructuring charges and cost-reduction/productivity initiatives(g)

                                                                7                 8                 7

Certain asset impairment charges(h)                                          37                 -                 -

Gain on sale of assets(i)                                                     -                 -               (42)

Other(j)                                                                     13                72               (17)
Total certain significant items-pre-tax                                      43                67               (43)
Income taxes(c)                                                              (2)                4                29
Total certain significant items-net of tax                                   45                63               (72)

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

                       $     

206 $ 255$ 97



(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 2020, a tax benefit related to a remeasurement of deferred taxes resulting
from the integration of acquired businesses and changes in statutory tax rates.
•For 2019, tax benefits related to a remeasurement of deferred taxes as a result
of changes in statutory tax rates and an adjustment related to a change in tax
basis.
•For 2018, a tax benefit related to a remeasurement of deferred taxes as a
result of changes in statutory tax rates.
  Income taxes in Acquisition-related costs also includes:
•For 2020, a tax expense related to a remeasurement of deferred taxes resulting
from the integration of acquired businesses.
•For 2018, a tax expense related to the non-deductibility of certain costs
associated with the acquisition of Abaxis.
  Income taxes in Certain significant items also includes:
•For 2020, a tax expense related to changes in valuation allowances related to
impairments of acquired assets.
•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 expense
of approximately $17 million related to the disposal of certain assets.
(d)  Primarily represents employee termination costs related to the 2018
acquisition of Abaxis.
(e)  For 2020 and 2019, represents income resulting from payments 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 2020 and 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 2020, primarily represents asset impairment charges related to:
•Developed technology rights in our precision livestock farming and aquatic
health businesses, included in Other (income)/deductions-net;
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•Inventory in our precision livestock farming business, included in Cost of
sales; and
•Property, plant and equipment in our precision livestock farming business,
included in Other (income)/deductions-net.
(i)  For 2018, represents a net gain related to the divestiture of certain
agribusiness products within our International segment.
(j)  For 2020, primarily represents CEO transition-related costs. 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.
The classification of the above items excluded from adjusted net income are as
follows:
                                                                              Year Ended December 31,
(MILLIONS OF DOLLARS)                                                 2020              2019              2018
Cost of sales:
Purchase accounting adjustments                                   $       8$     24$     27
Inventory write-offs                                                     15                 -                 1
Consulting fees                                                           4                 7                 8
Other                                                                     -                70                (1)
  Total Cost of sales                                                    27               101                35

Selling, general & administrative expenses:
Purchase accounting adjustments                                          54                72                32

Other                                                                    13                 2                 2
  Total Selling, general & administrative expenses                       67                74                34

Research & development expenses:
Purchase accounting adjustments                                           1                 2                 2

  Total Research & development expenses                                   1                 2                 2

Amortization of intangible assets:
Purchase accounting adjustments                                         135               136               101
  Total Amortization of intangible assets                               135               136               101

Restructuring charges and certain acquisition-related
costs:
Integration costs                                                        17                18                21
Transaction costs                                                         -                 -                21
Employee termination costs                                                8                33                25

Exit costs                                                                -                 -                 1
  Total Restructuring charges and certain
acquisition-related costs                                                25                51                68

Other (income)/deductions-net:
Net gain on sale of assets                                              (18)              (20)              (40)

Certain asset impairment charges                                         22                 -                 -

Other                                                                     -                 -               (18)
  Total Other (income)/deductions-net                                     4               (20)              (58)

Provision for taxes on income                                            53                89                85

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

                   $     206

$ 255$ 97



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, 2020 vs. December 31, 2019
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.
Accounts Receivable, less allowance for doubtful accounts decreased as a result
of timing of customer payments, an increase in rebate credits issued to
customers and the impact of foreign exchange, partially offset by higher sales
in the current period.
Inventories increased for a new product launch, increases in safety stock levels
and lower sales than anticipated for certain products. See Notes to Consolidated
Financial Statements - Note 11. Inventories.
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Other current assets increased primarily as a result of higher value-added tax
receivables for our international markets and the timing of income tax payments.
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 currency. See Notes to Consolidated Financial Statements -
Note 12. Property, Plant and Equipment
Identifiable intangible assets, less accumulated amortization decreased
primarily due to amortization expense and the impairment of certain intangible
assets, partially offset by intangible asset additions from acquisitions and the
impact of foreign exchange. See Notes to Consolidated Financial Statements -
Note 13. Goodwill and Other Intangible Assets
Accounts payable increased as a result of the timing of payments.
Dividends payable increased as a result of an increase in the dividend rate for
the first quarter 2021 dividend, which was declared on December 9, 2020.
Accrued compensation and related items increased primarily due to the accrual of
2020 annual bonuses and savings plan contributions to eligible employees, as
well as the timing of payments of payroll taxes and bi-weekly payroll, partially
offset by the payments of the 2019 annual bonuses and savings plan contributions
to eligible employees.
The net changes in Noncurrent deferred tax assets, Noncurrent deferred tax
liabilities, Income taxes payable and Other taxes payable primarily reflect
adjustments to the accrual for the income tax provision, the timing of income
tax payments, the tax impact of various acquisitions, the impact of the
remeasurement of deferred taxes as a result of changes in tax rates and the
integration of acquired businesses.
Other current liabilities increased primarily due to the mark-to-mark adjustment
of cross-currency interest rate swaps and foreign currency forward-exchange
contracts.
Other noncurrent liabilities increased primarily due to the mark-to-mark
adjustment of forward starting interest rate swaps, increase in deferred
compensation due to net investment gains and the deferral of FICA payroll taxes
to be paid in 2022 under the CARES Act.
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)                                2020             2019             2018             20/19               19/18
Net cash provided by (used in):
Operating activities                         $   2,126$ 1,795$ 1,790                18                  0
Investing activities                              (572)            (504)          (2,259)               13                (78)
Financing activities                               123             (951)             533                    *                   *
Effect of exchange-rate changes on                                   (8)             (26)              (13)               (69)
cash and cash equivalents                           (7)
Net increase in cash and cash                $   1,670$   332$    38                    *                   *

equivalents



*  Calculation not meaningful.
Operating activities
2020 vs. 2019
Net cash provided by operating activities was $2,126 million in 2020 compared
with $1,795 million in 2019. The increase in operating cash flows was primarily
attributable to higher cash earnings and the timing of receipts and payments in
the ordinary course of business, partially offset by higher inventory and higher
interest payments.
Investing activities
2020 vs. 2019
Net cash used in investing activities was $572 million in 2020 compared with
$504 million in 2019. The net cash used in investing activities for 2020 was
primarily attributable to capital expenditures, acquisitions and net payments
for cross-currency interest rate swaps, partially offset by proceeds from the
sale of assets, including a contingent 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 2019 was primarily due to capital expenditures and
the acquisition of Platinum Performance in the third quarter of 2019, partially
offset by proceeds from the maturities of debt securities, proceeds from
cross-currency interest rate swaps and proceeds received pursuant to an
agreement related to the 2016 sale of certain U.S. manufacturing sites.
Financing activities
2020 vs. 2019
Net cash provided by financing activities was $123 million in 2020 compared with
net cash used in financing activities of $951 million in 2019. The net cash
provided by financing activities for 2020 was primarily attributable to the
proceeds received from the issuance of senior notes in May 2020 and net proceeds
in connection with the issuance of common stock under our equity incentive plan,
partially offset by the repayment of the $500 million aggregate principal amount
of 3.450% 2015 senior notes due 2020, payment of dividends and the purchase of
treasury shares. 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-
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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.
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)                                         2020               2019
Cash and cash equivalents                          $       3,604$       1,934
Accounts receivable, net(a)                                1,013              1,086
Short-term borrowings                                          4                  -
Current portion of long-term debt                            600                500
Long-term debt                                             6,595              5,947
Working capital                                            4,441              2,942
Ratio of current assets to current liabilities              3.05:1          

2.63:1



(a)  Accounts receivable are usually collected over a period of 45 to 75 days.
For the years ended December 31, 2020 and 2019, the number of days that accounts
receivables were outstanding have remained within this range. 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, 2020 and
December 31, 2019. There were no amounts drawn under the credit facility as of
December 31, 2020 or December 31, 2019.
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, 2020, we had access to $79 million of
lines of credit which expire at various times through 2021, and are generally
renewed annually. We had $4 million borrowings outstanding related to these
facilities as of December 31, 2020 and no borrowings outstanding 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 changes imposed
by the Tax Act resulted in a one-time deemed repatriation tax on previously
untaxed accumulated earnings and profits of our foreign subsidiaries in 2018,
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, 2020, are set
forth below:
                                                                                            2022-            2024-           There-
(MILLIONS OF DOLLARS)                                       Total           2021             2023             2025            after
Long-term debt, including interest
obligations(a)                                        $ 10,686          $ 

852 $ 1,811$ 1,145$ 6,878 Other liabilities reflected on our Consolidated Balance Sheets under U.S. GAAP(b)

                          101              8               25               20               48
Operating lease commitments                                222             46               71               48               57
Purchase obligations(c)                                    376            153              162               39               22
Benefit plans - continuing service credit
obligations(d)                                               8              4                4                -                -
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 $169 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 October 13, 2020, we redeemed in full the $500 million aggregate principal
amount of our 3.450% 2015 senior notes due 2020 at a redemption price equal to
100% of the principal amount, plus accrued interest to, but not including, the
redemption date.
On May 12, 2020, we issued $1.25 billion aggregate principal amount of our
senior notes (2020 senior notes), with an original issue discount of $10
million. These notes are comprised of $750 million aggregate principal amount of
2.000% senior notes due 2030 and $500 million aggregate principal amount of
3.000% senior notes due 2050. On October 13, 2020, the net proceeds were used to
repay the $500 million aggregate principal amount of 3.450% 2015 senior notes
due 2020 and the remainder will be used for general corporate purposes.
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.
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.
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, 2018 and 2020 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, 2018 and 2020 senior notes may be declared
immediately due and payable.
Pursuant to the indenture, we are able to redeem the 2013, 2015, 2017 and 2020
senior notes and the 2018 fixed rate senior notes or any series, in whole or in
part, at any time by paying a "make whole" premium, plus accrued and unpaid
interest to, but excluding, the date of redemption. The 2018 floating rate
senior notes are not redeemable at our option prior to their maturity date.
Pursuant to our tax matters agreement with Pfizer, we will not be permitted to
redeem the 2013 senior notes due 2023 pursuant to this optional redemption
provision, except under limited circumstances. Upon the occurrence of a change
of control of us and a downgrade of the 2013, 2015, 2017, 2018 and 2020 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
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to repurchase all of the outstanding 2013, 2015, 2017, 2018 and 2020 senior
notes at a price equal to 101% of the aggregate principal amount of the 2013,
2015, 2017, 2018 and 2020 senior notes together with accrued and unpaid interest
to, but excluding, the date of repurchase.
Our outstanding debt securities are as follows:
Description               Principal Amount          Interest Rate     Terms

2018 Floating Rate Senior                          Three-month USD    

Interest due quarterly, not subject to amortization, Notes due 2021

            $300 million             LIBOR plus 0.44%   

aggregate principal due on August 20, 2021

                                                                      Interest due semi annually, not subject to
2018 Senior Notes due                                                 

amortization, aggregate principal due on August 20, 2021

                      $300 million                  3.250%        2021
                                                                      Interest due semi annually, not subject to
2013 Senior Notes due                                                 

amortization, aggregate principal due on February 1, 2023

                      $1,350 million                3.250%        2023
                                                                      Interest due semi annually, not subject to
2015 Senior Notes due                                                 

amortization, aggregate principal due on November 13, 2025

                      $750 million                  4.500%        2025
                                                                      Interest due semi annually, not subject to
2017 Senior Notes due                                                 

amortization, aggregate principal due on September 2027

                      $750 million                  3.000%        12, 

2027

                                                                      Interest due semi annually, not subject to
2018 Senior Notes due                                                 

amortization, aggregate principal due on August 20, 2028

                      $500 million                  3.900%        2028
2020 Senior Notes due                                                 Interest due semi annually, not subject to
2030                      $750 million                  2.000%        

amortization, aggregate principal due on May 15, 2030

                                                                      Interest due semi annually, not subject to
2013 Senior Notes due                                                 

amortization, aggregate principal due on February 1, 2043

                      $1,150 million                4.700%        2043
                                                                      Interest due semi annually, not subject to
2017 Senior Notes due                                                 

amortization, aggregate principal due on September 2047

                      $500 million                  3.950%        12, 

2047

                                                                      Interest due semi annually, not subject to
2018 Senior Notes due                                                 

amortization, aggregate principal due on August 20, 2048

                      $400 million                  4.450%        2048
2020 Senior Notes due                                                 Interest due semi annually, not subject to
2050                      $500 million                  3.000%        

amortization, aggregate principal due on May 15, 2050



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,
2020, the remaining payments due to Pfizer (approximately $8 million in the
aggregate) are to be paid over the next 2 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 $7 million to these plans in 2021.
As of December 31, 2020, the supplemental savings plan liability was
approximately $60 million.
For additional information, see Notes to Consolidated Financial Statements- Note
14. Benefit Plans.
Share repurchase program
In December 2018, the company's Board of Directors authorized a $2.0 billion
share repurchase program. As of December 31, 2020, there was approximately $1.4
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 the first
three months of 2020, approximately 1.8 million shares were repurchased. The
company temporarily suspended share repurchases beginning in the second quarter
of 2020. In January 2021, the company resumed share repurchases under its share
repurchase program.
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  Table of Contents
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, 2020 and December 31, 2019, 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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  Table of Contents
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 the
impact of the COVID-19 pandemic and any recovery therefrom on our business, our
2021 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 and tax regimes
and any changes thereto, 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:
•the impact of the COVID-19 pandemic on our business, suppliers, customers and
workforce;
•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 or 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 impact of climate change;
•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
2020 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, 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.
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