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EX-32.2 - EXHIBIT 32.2 - Zoetis Inc.a2018q310qex322.htm
EX-32.1 - EXHIBIT 32.1 - Zoetis Inc.a2018q310qex321.htm
EX-31.2 - EXHIBIT 31.2 - Zoetis Inc.a2018q310qex312.htm
EX-31.1 - EXHIBIT 31.1 - Zoetis Inc.a2018q310qex311.htm
EX-15 - EXHIBIT 15 - Zoetis Inc.a2018q310qex15.htm
EX-12 - EXHIBIT 12 - Zoetis Inc.a2018q310qex12.htm
EX-10.1 - EXHIBIT 10.1 - Zoetis Inc.a2018q310qex101.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
 
EXCHANGE ACT OF 1934
 
 
For the quarterly period ended September 30, 2018
 
 
or
 
 
TRANSITION REPORT PURSUANT TO SECTION 13
 
 
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
¨
For the transition period from __________ to __________
 
Commission File Number: 001-35797
Zoetis Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
46-0696167
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
10 Sylvan Way, Parsippany, New Jersey
 
07054
(Address of principal executive offices)
 
(Zip Code)
(973) 822-7000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). ¨ Yes x No
At October 26, 2018, there were 480,450,882 shares of common stock outstanding.





TABLE OF CONTENTS
 
 
 
 
Page
 
Item 1.
 
 
 
 
Condensed Consolidated Statements of Income (Unaudited)
 
 
 
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
 
 
 
Condensed Consolidated Balance Sheets (Unaudited)
 
 
 
Condensed Consolidated Statements of Equity (Unaudited)
 
 
 
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
 
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
 
 
Review Report of Independent Registered Public Accounting Firm
 
Item 2.
 
 
Item 3.
 
 
Item 4.
 
 
 
Item 1.
 
 
Item 1A.
 
 
Item 2.
 
 
Item 3.
 
Defaults Upon Senior Securities
 
Item 4.
 
Mine Safety Disclosures
 
Item 5.
 
Other Information
 
Item 6.
 
 
 





PART I – FINANCIAL INFORMATION
Item 1.
Financial Statements


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)
 
2018

 
2017

 
2018

 
2017

Revenue
 
$
1,480

 
$
1,347

 
$
4,261

 
$
3,847

Costs and expenses:
 
 
 
 
 
 
 
 
Cost of sales
 
473

 
435

 
1,367

 
1,318

Selling, general and administrative expenses
 
367

 
328

 
1,064

 
973

Research and development expenses
 
108

 
96

 
307

 
272

Amortization of intangible assets
 
32

 
23

 
78

 
68

Restructuring charges/(reversals) and certain acquisition-related costs
 
47

 
8

 
54

 
7

Interest expense, net of capitalized interest
 
54

 
43

 
147

 
125

Other (income)/deductions—net
 
(19
)
 
1

 
(28
)
 
(11
)
Income before provision for taxes on income
 
418

 
413

 
1,272

 
1,095

Provision for taxes on income
 
71

 
117

 
193

 
313

Net income before allocation to noncontrolling interests
 
347

 
296

 
1,079

 
782

Less: Net loss attributable to noncontrolling interests
 

 
(2
)
 
(4
)
 
(1
)
Net income attributable to Zoetis Inc.
 
$
347

 
$
298

 
$
1,083

 
$
783

Earnings per share attributable to Zoetis Inc. stockholders:
 
 
 
 
 
 
 
 
 Basic
 
$
0.72

 
$
0.61

 
$
2.24

 
$
1.60

 Diluted
 
$
0.71

 
$
0.61

 
$
2.22

 
$
1.59

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
 Basic
 
482.0

 
489.1

 
483.9

 
490.8

 Diluted
 
485.8

 
492.4

 
487.7

 
493.9

Dividends declared per common share
 
$

 
$

 
$
0.252

 
$
0.210



See notes to condensed consolidated financial statements.
1 |



ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Net income before allocation to noncontrolling interests
 
$
347

 
$
296

 
$
1,079

 
$
782

Other comprehensive (loss)/income, net of taxes and reclassification adjustments:
 
 
 
 
 
 
 
 
Unrealized losses on derivatives, net(a)
 
(1
)
 
(10
)
 
(1
)
 
(11
)
Foreign currency translation adjustments, net
 
(75
)
 
98

 
(113
)
 
154

Benefit plans: Actuarial gains, net(a)
 

 

 

 
1

Total other comprehensive (loss)/income, net of tax
 
(76
)
 
88

 
(114
)
 
144

Comprehensive income before allocation to noncontrolling interests
 
271

 
384

 
965

 
926

Less: Comprehensive (loss)/income attributable to noncontrolling interests
 

 
(1
)
 
(4
)
 

Comprehensive income attributable to Zoetis Inc.
 
$
271

 
$
385

 
$
969

 
$
926

(a) 
Presented net of reclassification adjustments and tax impacts, which are not significant in any period presented. Reclassification adjustments related to benefit plans are generally reclassified, as part of net periodic pension cost, into Other (income)/deductions, beginning in the first quarter of 2018, and into Cost of sales, Selling, general and administrative expenses, and/or Research and development expenses, as appropriate, for periods prior to 2018, in the condensed consolidated statements of income.



See notes to condensed consolidated financial statements.
2 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

 
 
September 30,

 
December 31,

 
 
2018

 
2017

(MILLIONS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
 
(Unaudited)

 
 
Assets
 
 
 
 
Cash and cash equivalents(a)
 
$
1,286

 
$
1,564

Short term investments
 
105

 

Accounts receivable, less allowance for doubtful accounts of $24 in 2018 and $25 in 2017
 
929

 
998

Inventories
 
1,441

 
1,427

Other current assets
 
315

 
228

Total current assets
 
4,076

 
4,217

Property, plant and equipment, less accumulated depreciation of $1,559 in 2018 and $1,471 in 2017
 
1,556

 
1,435

Goodwill
 
2,537

 
1,510

Identifiable intangible assets, less accumulated amortization
 
2,120

 
1,269

Noncurrent deferred tax assets
 
73

 
80

Other noncurrent assets
 
97

 
75

Total assets
 
$
10,459

 
$
8,586

 
 
 
 
 
Liabilities and Equity
 
 
 
 
Accounts payable
 
$
238

 
$
261

Dividends payable
 

 
61

Accrued expenses
 
425

 
432

Accrued compensation and related items
 
226

 
236

Income taxes payable
 
75

 
60

Other current liabilities
 
39

 
44

Total current liabilities
 
1,003

 
1,094

Long-term debt, net of discount and issuance costs
 
6,441

 
4,953

Noncurrent deferred tax liabilities
 
446

 
380

Other taxes payable
 
250

 
172

Other noncurrent liabilities
 
201

 
201

Total liabilities
 
8,341

 
6,800

Commitments and contingencies (Note 16)
 


 


Stockholders' equity:
 
 
 
 
Preferred stock, $0.01 par value: 1,000,000,000 authorized, none issued
 

 

Common stock, $0.01 par value: 6,000,000,000 authorized; 501,891,243 and 501,891,243 shares issued; 480,980,372 and 486,130,461 shares outstanding at September 30, 2018, and December 31, 2017, respectively
 
5

 
5

Treasury stock, at cost, 20,910,871 and 15,760,782 shares of common stock at September 30, 2018, and December 31, 2017, respectively
 
(1,345
)
 
(852
)
Additional paid-in capital
 
1,010

 
1,013

Retained earnings
 
3,067

 
2,109

Accumulated other comprehensive loss
 
(619
)
 
(505
)
Total Zoetis Inc. equity
 
2,118

 
1,770

Equity attributable to noncontrolling interests
 

 
16

Total equity
 
2,118

 
1,786

Total liabilities and equity
 
$
10,459

 
$
8,586

(a) 
As of September 30, 2018, and December 31, 2017, includes $5 million and $6 million, respectively, of restricted cash.

See notes to condensed consolidated financial statements.
3 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(UNAUDITED)

 
Zoetis
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated

 
Equity

 
 
 
 
 
 
 
 
Additional

 
 
 
Other

 
Attributable to

 
 
 
 
Common

 
Treasury

 
Paid-in

 
Retained

 
Comprehensive

 
Noncontrolling

 
Total

(MILLIONS OF DOLLARS)
 
Stock(a)

 
Stock(a)

 
Capital

 
Earnings

 
Loss

 
Interests

 
Equity

Balance, December 31, 2016
 
$
5

 
$
(421
)
 
$
1,024

 
$
1,477

 
$
(598
)
 
$
12

 
$
1,499

Nine months ended October 1, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
783

 

 
(1
)
 
782

Other comprehensive income
 

 

 

 

 
143

 
1

 
144

Consolidation of a noncontrolling interest(b)
 

 

 

 

 

 
18

 
18

Share-based compensation awards(c)
 

 
63

 
6

 
(17
)
 

 

 
52

Treasury stock acquired(d)
 

 
(375
)
 

 

 

 

 
(375
)
Employee benefit plan contribution from Pfizer Inc.(e)
 

 

 
2

 

 

 

 
2

Dividends declared
 

 

 

 
(103
)
 

 

 
(103
)
Balance, October 1, 2017
 
$
5

 
$
(733
)
 
$
1,032

 
$
2,140

 
$
(455
)
 
$
30

 
$
2,019

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
 
$
5

 
$
(852
)
 
$
1,013

 
$
2,109

 
$
(505
)
 
$
16

 
$
1,786

Nine months ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income/(loss)
 

 

 

 
1,083

 

 
(4
)
 
1,079

Other comprehensive loss
 

 

 

 

 
(114
)
 

 
(114
)
Acquisition of a noncontrolling interest(b)
 

 

 
(14
)
 

 

 
(12
)
 
(26
)
Share-based compensation awards (c)
 

 
55

 
9

 
(3
)
 

 

 
61

Treasury stock acquired(d)
 

 
(548
)
 

 

 

 

 
(548
)
Employee benefit plan contribution from Pfizer Inc.(e)
 

 

 
2

 

 

 

 
2

Dividends declared
 

 

 

 
(122
)
 

 

 
(122
)
Balance, September 30, 2018
 
$
5

 
$
(1,345
)
 
$
1,010

 
$
3,067

 
$
(619
)
 
$

 
$
2,118

(a) 
As of September 30, 2018, and October 1, 2017, there were 480,980,372 and 487,832,003 outstanding shares of common stock, respectively, and 20,910,871 and 14,059,240 shares of treasury stock, respectively. Treasury stock is recognized at the cost to reacquire the shares. For additional information, see Note 14. Stockholders' Equity.
(b) 
For the nine months ended October 1, 2017, represents the consolidation of a European livestock monitoring company. For the nine months ended September 30, 2018, represents the acquisition of the noncontrolling interest of a European livestock monitoring company.
(c)
Includes the issuance of shares of Zoetis Inc. common stock and the reissuance of treasury stock in connection with the vesting of employee share-based awards. Upon reissuance of treasury stock, differences between the proceeds from reissuance and the cost of the treasury stock that result in gains are recorded in Additional paid-in capital. Losses are recorded in Additional paid-in capital to the extent that they can offset previously recorded gains. If no such credit exists, the differences are recorded in Retained earnings. Also includes the reacquisition of shares of treasury stock associated with the vesting of employee share-based awards to satisfy tax withholding requirements.and the acquisition date fair value of replacement awards issued in conjunction with the acquisition of Abaxis in 2018 attributable to pre-combination services. For additional information, see Note 5. Acquisitions and Divestitures,.
(d) 
Reflects the acquisition of treasury shares in connection with the share repurchase program. For additional information, see Note 14. Stockholders' Equity.
(e) 
Represents contributed capital from Pfizer Inc. associated with service credit continuation for certain Zoetis Inc. employees in Pfizer Inc.'s U.S. qualified defined benefit and U.S. retiree medical plans. See Note 12. Benefit Plans.




See notes to condensed consolidated financial statements.
4 |


ZOETIS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

 
 
Nine Months Ended
 
 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

Operating Activities
 
 
 
 
Net income before allocation to noncontrolling interests
 
$
1,079

 
$
782

Adjustments to reconcile net income before noncontrolling interests to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization expense
 
207

 
179

Share-based compensation expense
 
36

 
33

Asset write-offs and asset impairments
 
4

 
1

Net loss on sale of assets
 

 
2

Provision for losses on inventory
 
37

 
46

Deferred taxes(a)
 
(155
)
 
(3
)
Employee benefit plan contribution from Pfizer Inc.
 
2

 
2

Other non-cash adjustments
 
(17
)
 
11

Other changes in assets and liabilities, net of acquisitions and divestitures
 
 
 
 
    Accounts receivable
 
37

 
(58
)
    Inventories
 
29

 
(35
)
    Other assets
 
(77
)
 
(132
)
    Accounts payable
 
(39
)
 
(56
)
    Other liabilities
 
(31
)
 
(107
)
    Other tax accounts, net(a)
 
94

 
73

Net cash provided by operating activities
 
1,206

 
738

Investing Activities
 
 
 
 
Purchases of property, plant and equipment
 
(200
)
 
(141
)
Acquisition of Abaxis, net of cash acquired
 
(1,884
)
 

Other acquisitions
 
(108
)
 
(82
)
Net proceeds from sales of assets
 
8

 
1

Other investing activities
 
(1
)
 
6

Net cash used in investing activities
 
(2,185
)
 
(216
)
Financing Activities
 
 
 
 
Proceeds from issuance of long-term debt—senior notes, net of discount and fees
 
1,485

 
1,231

Payment of contingent consideration related to previously acquired assets
 
(12
)
 
(5
)
Acquisition of a noncontrolling interest
 
(26
)
 

Share-based compensation-related proceeds, net of taxes paid on withholding shares
 
14

 
20

Purchases of treasury stock
 
(548
)
 
(375
)
Cash dividends paid
 
(183
)
 
(155
)
Net cash provided by financing activities
 
730

 
716

Effect of exchange-rate changes on cash and cash equivalents
 
(29
)
 
16

Net increase/(decrease) in cash and cash equivalents
 
(278
)
 
1,254

Cash and cash equivalents at beginning of period
 
1,564

 
727

Cash and cash equivalents at end of period
 
$
1,286

 
$
1,981

 
 
 
 
 
Supplemental cash flow information
 
 
 
 
Cash paid during the period for:
 
 
 
 
  Income taxes
 
$
290

 
$
366

  Interest, net of capitalized interest
 
166

 
138

Non-cash transactions:
 
 
 
 
     Purchases of property, plant and equipment
 
3

 
6

(a) 
Reflects the reclassification of the one-time mandatory deemed repatriation tax from Noncurrent deferred tax liabilities to Income taxes payable and Other taxes payable to properly reflect the liability, which became a fixed obligation in 2018 payable over eight years.

See notes to condensed consolidated financial statements.
5 |


ZOETIS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1.
Organization
Zoetis Inc. (including its subsidiaries, collectively, Zoetis, the company, we, us or our) is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. We organize and operate our business in two geographic regions: the United States (U.S.) and International.
We directly market our products in approximately 45 countries across North America, Europe, Africa, Asia, Australia and South America. Our products are sold in more than 100 countries, including developed markets and emerging markets. We have a diversified business, marketing products across eight core species: cattle, swine, poultry, sheep and fish (collectively, livestock) and dogs, cats and horses (collectively, companion animals); and within six major product categories: vaccines, anti-infectives, parasiticides, medicated feed additives, animal health diagnostics and other pharmaceuticals.
2.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements were prepared following the requirements of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (U.S. GAAP) can be condensed or omitted. Balance sheet amounts and operating results for subsidiaries operating outside the United States are as of and for the three and nine-month periods ended August 31, 2018, and August 27, 2017.
Prior to fiscal 2018, the company followed a 13-week quarterly accounting cycle for each of the first three fiscal quarters. The company's fiscal year ends on December 31 for our operations in the United States and on November 30 for subsidiaries operating outside the United States. Beginning in fiscal 2018, the company's first three fiscal quarters will end on the last day of March, June and September in the United States and the last day of February, May and August for subsidiaries operating outside the United States. There is no change to the company's fiscal year-end dates. We did not adjust our results of operations for periods prior to 2018 as the impact was not material.
Revenue, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be representative of those for the full year.
We are responsible for the unaudited condensed consolidated financial statements included in this Form 10-Q. The condensed consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. The information included in this interim report should be read in conjunction with the financial statements and accompanying notes included in our 2017 Annual Report on Form 10-K.
3.
Accounting Standards
Recently Adopted Accounting Standards
In March 2018, the Financial Accounting Standards Board (FASB) issued an accounting standards update to align existing guidance on accounting for income taxes, pursuant to guidance provided by a Staff Accounting Bulletin published by the SEC on December 22, 2017. The update addresses the challenges in accounting for the effects of the Tax Cuts and Jobs Act (the Tax Act), enacted on December 22, 2017, in the period of enactment and required companies to report provisional amounts for those specific income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. Provisional amounts will be subject to adjustment during a measurement period of up to one year from the enactment date. For additional information, see Note 8. Income Taxes.
In August 2017, the FASB issued an accounting standards update which amends the hedge accounting recognition and presentation requirements
and is intended to better align hedge accounting with companies' risk management strategies. The standard eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires that the entire change in fair value of a hedging instrument be presented in the same income statement line item as the respective hedged item. The standard also modifies certain disclosure requirements. The provisions of the update are effective beginning January 1, 2019 for interim and annual periods with early adoption permitted for any interim period after issuance of the update. We elected to early adopt this guidance as of April 1, 2018. There were no hedging contracts in effect as of the date of adoption.
In March 2017, the FASB issued an accounting standards update to simplify and improve the reporting of net periodic pension benefit cost by requiring only present service cost to be presented in the same line item as other current employee compensation costs while remaining components of net periodic benefit cost would be presented within Other (income)/deductions—net outside of operations. We adopted this guidance as of January 1, 2018, the required effective date. The new standard did not have a significant impact on our consolidated financial statements.
In October 2016, the FASB issued an accounting standards update that requires the recognition of the income tax consequences of an intra-entity asset transfer, other than inventory, when the transfer occurs as opposed to when the asset is sold to an outside third party. We adopted this

6 |


guidance as of January 1, 2018, the required effective date. The new standard did not have a significant impact on our consolidated financial statements.
In May 2014, the FASB issued an accounting standards update that outlines a new, single comprehensive model for companies to use in accounting for revenue arising from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted this guidance as of January 1, 2018, the required effective date, using the modified retrospective adoption method. Prior period amounts have not been adjusted and continue to be reported in accordance with our historic accounting policies. Application of the standard using the modified retrospective method did not require an adjustment to opening retained earnings. For additional information, see Note 4. Revenue.
Recently Issued Accounting Standards
In August 2018, the FASB issued an accounting standards update which expands the scope of costs associated with cloud computing arrangements that must be capitalized. Under the new guidance, costs associated with implementing a cloud computing arrangement that is a service contract must be capitalized and expensed over the term of the hosting arrangement. The provisions of the update are effective beginning January 1, 2020 for interim and annual periods with early adoption permitted for any interim period after issuance of the update. We are currently assessing the timing of our adoption as well as the potential impact that the standard will have on our consolidated financial statements.
In February 2018, the FASB issued an accounting standards update which permits companies to reclassify from accumulated other comprehensive income to retained earnings stranded tax effects resulting from the new federal corporate income tax rate. In the period of adoption, a company may choose to either apply the amendments retrospectively to each period in which the effect of the change in federal income tax rate is recognized or to apply the amendments in that reporting period. The provisions of the update are effective beginning January 1, 2019 for interim and annual periods, with early adoption permitted for any interim period after issuance of the update. We are currently assessing the timing of our adoption and do not expect that the new standard will have a significant impact on our consolidated financial statements.
In February 2016, the FASB issued an accounting standards update which requires lessees to recognize most leases on the balance sheet with a corresponding right of use asset. Leases will be classified as financing or operating which will drive the expense recognition pattern. For lessees, the income statement presentation and expense recognition pattern for financing and operating leases is similar to the current model for capital and operating leases, respectively. Companies may elect to exclude short-term leases. The update also requires additional disclosures that will better enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We plan to adopt this guidance as of January 1, 2019, using the effective date as the date of initial application. As permitted, utilizing an optional transition method, a cumulative-effect adjustment to the opening balance of retained earnings will be recognized in the period of adoption, and financial information and disclosure for periods prior to the date of initial application will not be updated. We have selected a lease accounting system which we are in the process of implementing, while continuing to evaluate our lease contracts, accounting policy elections, and the impact of adoption on our consolidated financial statements. While we do not expect adoption of the standard to have a significant impact on our consolidated statements of income, the impact on the assets and liabilities within our consolidated balance sheet will be material.
4.
Revenue
A.
Revenue from Product Sales
We offer a diversified portfolio of products which allows us to capitalize on local and regional customer needs. Generally, our products are promoted to veterinarians and livestock producers by our sales organization which includes sales representatives and technical and veterinary operations specialists, and then sold directly by us or through distributors. The depth of our product portfolio enables us to address the varying needs of customers in different species and geographies. Many of our top selling product lines are distributed across both of our operating segments, leveraging our R&D operations and manufacturing and supply chain network.
Over the course of our history, we have focused on developing a diverse portfolio of animal health products, including medicines and vaccines, complemented by biodevices, diagnostics, and genetics. We refer to a single product in all brands, or its dosage forms for all species, as a product line. We have approximately 300 comprehensive product lines, including products for both livestock and companion animals across each of our major product categories.
In the third quarter of 2018, the company modified the list of major product categories to include a category for animal health diagnostics, which was previously included within other non-pharmaceutical products. The prior period presentation has been revised to reflect the new product categories.
Our major product categories are:
vaccines: biological preparations that help prevent diseases of the respiratory, gastrointestinal and reproductive tracts or induce a specific immune response;
anti-infectives: products that prevent, kill or slow the growth of bacteria, fungi or protozoa;
other pharmaceutical products: allergy and dermatology, pain and sedation, antiemetic, reproductive, and oncology products;
parasiticides: products that prevent or eliminate external and internal parasites such as fleas, ticks and worms;
medicated feed additives: products added to animal feed that provide medicines to livestock; and
animal health diagnostics: portable blood and urine analysis systems and point-of-care diagnostic products, including instruments

7 |


and reagents, rapid immunoassay tests, reference laboratory kits and blood glucose monitors.
Our remaining revenue is derived from other non-pharmaceutical product categories, such as nutritionals and agribusiness, as well as products and services in complementary areas, including biodevices and genetics.
Our livestock products primarily help prevent or treat diseases and conditions to enable the cost-effective production of safe, high-quality animal protein. Human population growth and increasing standards of living are important long-term growth drivers for our livestock products in three major ways. First, population growth and increasing standards of living drive increased demand for improved nutrition, particularly animal protein. Second, population growth leads to increased natural resource constraints driving a need for enhanced productivity. Finally, as standards of living improve, there is increased focus on food quality and safety.
Our companion animal products help extend and improve the quality of life for pets; increase convenience and compliance for pet owners; and help veterinarians improve the quality of their care and the efficiency of their businesses. Growth in the companion animal medicines and vaccines sector is driven by economic development, related increases in disposable income and increases in pet ownership and spending on pet care. Companion animals are also living longer, receiving increased medical treatment and benefiting from advances in animal health medicines and vaccines.
The following tables present our revenue disaggregated by geographic area, species, and major product category.

8 |


Revenue by geographic area
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

United States
 
$
757

 
$
680

 
$
2,068

 
$
1,908

Australia
 
53

 
51

 
152

 
134

Brazil
 
72

 
66

 
210

 
205

Canada
 
42

 
40

 
138

 
123

China
 
46

 
40

 
170

 
137

France
 
29

 
30

 
92

 
85

Germany
 
36

 
35

 
112

 
96

Italy
 
27

 
22

 
80

 
65

Japan
 
34

 
31

 
114

 
101

Mexico
 
24

 
21

 
74

 
60

Spain
 
28

 
24

 
83

 
67

United Kingdom
 
47

 
36

 
135

 
105

Other developed markets
 
98

 
96

 
266

 
240

Other emerging markets
 
173

 
162

 
537

 
485

 
 
1,466

 
1,334

 
4,231

 
3,811

 
 
 
 
 
 
 
 
 
Contract manufacturing & human health diagnostics
 
14

 
13

 
30

 
36

 
 
 
 
 
 
 
 
 
Total Revenue
 
$
1,480

 
$
1,347

 
$
4,261

 
$
3,847

Revenue by major species
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

U.S.
 
 
 
 
 
 
 
 
Livestock
 
$
322

 
$
319

 
$
885

 
$
870

Companion animal
 
435

 
361

 
1,183

 
1,038

 
 
757

 
680

 
2,068

 
1,908

International
 
 
 
 
 
 
 
 
Livestock
 
456

 
435

 
1,397

 
1,276

Companion animal
 
253

 
219

 
766

 
627

 
 
709

 
654

 
2,163

 
1,903

 
 
 
 
 
 
 
 
 
Contract manufacturing & human health diagnostics
 
14

 
13

 
30

 
36

 
 
 
 
 
 
 
 
 
Total Revenue
 
$
1,480

 
$
1,347

 
$
4,261

 
$
3,847


9 |


Revenue by species
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Livestock:
 
 
 
 
 
 
 
 
Cattle
 
$
417

 
$
424

 
$
1,229

 
$
1,192

Swine
 
160

 
147

 
500

 
455

Poultry
 
130

 
119

 
395

 
357

Fish
 
46

 
39

 
92

 
79

Other
 
25

 
25

 
66

 
63

 
 
778

 
754

 
2,282

 
2,146

Companion Animal:
 
 
 
 
 
 
 
 
Dogs and Cats
 
653

 
546

 
1,832

 
1,561

Horses
 
35

 
34

 
117

 
104

 
 
688

 
580

 
1,949

 
1,665

 
 
 
 
 
 
 
 
 
Contract manufacturing & human health diagnostics
 
14

 
13

 
30

 
36

 
 
 
 
 
 
 
 
 
Total Revenue
 
$
1,480

 
$
1,347

 
$
4,261

 
$
3,847

Revenue by major product category
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Vaccines
 
$
382

 
$
363

 
$
1,109

 
$
1,006

Anti-infectives
 
323

 
324

 
906

 
870

Other pharmaceuticals
 
361

 
304

 
1,017

 
858

Parasiticides
 
203

 
191

 
639

 
581

Medicated feed additives
 
111

 
107

 
362

 
351

Animal health diagnostics
 
46

 
11

 
69

 
32

Other non-pharmaceuticals
 
40

 
34

 
129

 
113

 
 
1,466

 
1,334

 
4,231

 
3,811

 
 
 
 
 
 
 
 
 
Contract manufacturing & human health diagnostics
 
14

 
13

 
30

 
36

 
 
 
 
 
 
 
 
 
Total Revenue
 
$
1,480

 
$
1,347

 
$
4,261

 
$
3,847

B.    Revenue Accounting Policy
Below are the significant accounting policies updated as of January 1, 2018 as a result of the adoption of the new revenue recognition guidance. For additional information, see Note 3. Accounting Standards.
We recognize revenue from product sales when control of the goods has transferred to the customer, which is typically once the goods have shipped and the customer has assumed title. Revenue reflects the total consideration to which we expect to be entitled (i.e. the transaction price), in exchange for products sold, after considering various types of variable consideration including rebates, sales allowances, product returns and discounts.
Variable consideration is estimated and recorded at the time that related revenue is recognized. Our estimates reflect the amount by which we expect variable consideration to impact revenue recognized and are generally based on contractual terms or historical experience, adjusted as necessary to reflect our expectations about the future. Our customer payment terms generally range from 45 to 75 days.
Estimates of variable consideration utilize a complex series of judgments and assumptions to determine the amount by which we expect revenue to be reduced, for example;
for sales returns, we perform calculations in each market that incorporate the following, as appropriate: local returns policies and practices; historic returns as a percentage of revenue; estimated shelf life by product; an estimate of the amount of time between shipment and return or lag time; and any other factors that could impact the estimate of future returns, product recalls, discontinuation of products or a changing competitive environment; and

10 |


for revenue incentives, we use our historical experience with similar incentives programs to estimate the impact of such programs on revenue for the current period.
Although the amounts recorded for these revenue deductions are dependent on estimates and assumptions, historically our adjustments to actual results have not been material. The sensitivity of our estimates can vary by program, type of customer and geographic location.
A deferral of revenue may be required in the event that we have not satisfied all customer obligations for which we have been compensated. The transaction price is allocated to the individual performance obligations on the basis of relative stand-alone selling price, which is typically based on actual sales prices. Revenue associated with unsatisfied performance obligations are contract liabilities, is recorded within Other current liabilities, and is recognized once control of the underlying products has transferred to the customer. Contract liabilities reflected within Other current liabilities as of the adoption date and subsequently recognized as revenue during the first nine months of 2018 were approximately $2 million. Contract liabilities as of September 30, 2018 were approximately $7 million.
We do not disclose the transaction price allocated to unsatisfied performance obligations related to contracts with an original expected duration of one year or less, or for contracts for which we recognize revenue in line with our right to invoice the customer. Estimated future revenue expected to be generated from long-term contracts with unsatisfied performance obligations as of September 30, 2018 is insignificant.
Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from Revenue. Shipping and handling costs incurred after control of the purchased product has transferred to the customer are accounted for as a fulfillment cost, within Selling, general and administrative expenses.
5.
Acquisitions and Divestitures
Acquisition of Abaxis, Inc.
On July 31, 2018, we completed the acquisition of Abaxis, Inc. (Abaxis), a California corporation and a leader in the development, manufacture and marketing of diagnostic instruments for veterinary point-of-care services. We acquired all of the outstanding common shares of Abaxis for $83.00 per share in cash resulting in Abaxis becoming our wholly owned subsidiary. The acquisition enhances our presence in veterinary diagnostics.
The acquisition date fair value of the consideration transferred was approximately $1,962 million, which consisted of the following:
(MILLIONS OF DOLLARS)
Amounts

Cash paid to Abaxis' shareholders(a)
$
1,898

Cash paid for equity awards attributable for pre-merger services(b)
54

Fair value of Zoetis equity awards issued in exchange for outstanding Abaxis equity awards pertaining to pre-merger service(c)
10

Total consideration
$
1,962

(a) 
Represents cash paid for cancellation and conversion of each outstanding share of Abaxis' common stock at the acquisition date.
(b) 
Represents cash paid for cancellation and settlement of restricted stock awards that fully vested in July 2018 as a result of service or pre-existing change-in-control provisions and termination provisions. Includes certain awards that will be settled in cash during 2019, reflected in Other current liabilities within the condensed consolidated balance sheet.
(c) 
Represents the fair value of replacement awards issued for Abaxis equity awards outstanding immediately before the acquisition and attributable to the service period prior to the acquisition. The previous Abaxis equity awards were converted into the Zoetis equity awards at an exchange ratio based on the closing prices of shares of Zoetis Common Stock and Abaxis Common Stock for ten full trading days before the closing of the acquisition.

11 |


The acquisition has been accounted for as a business combination with the assets acquired and liabilities assumed measured at estimated fair values as of the acquisition date, primarily using Level 3 inputs, except for investments in debt securities which were valued using Level 2 inputs.
The table below presents the preliminary fair values allocated to Abaxis' assets and liabilities as of the acquisition date.
(MILLIONS OF DOLLARS)
Amounts

Cash and cash equivalents
$
64

Short term investments(a)
107

Accounts receivable(b)
30

Inventories(c)
79
Other current assets
6
Property, plant and equipment(d)
49
Identifiable intangible assets(e)
898
Other noncurrent assets
29
Accounts payable
(21)
Accrued compensation and related items
(10)
Other current liabilities
(26)
Other noncurrent liabilities
(11)
Noncurrent deferred tax liabilities(f)
(215)
Total net assets acquired
979
Goodwill(g)
983
Total consideration
$
1,962

(a) 
Short term investments include investments in debt securities that are classified as available-for-sale and measured at fair value.
(b) 
The fair value approximates the gross contractual amount of accounts receivable. The contractual amount not expected to be collected is immaterial.
(c) 
Acquired inventory is comprised of finished goods, work in process and raw materials. The preliminary estimate of fair value of finished goods was determined based on net realizable value adjusted for the costs of the selling effort, a reasonable profit allowance for the selling effort, and estimated holding costs. The preliminary estimate of fair value of work in process was determined based on net realizable value adjusted for costs to complete the manufacturing process, costs of the selling effort, a reasonable profit allowance for the remaining manufacturing and selling effort, and an estimate of holding costs. The fair value of raw materials was determined to approximate book value.
(d) 
Property, plant and equipment is comprised of machinery and equipment, furniture and fixtures, computer equipment, leasehold improvements and construction in progress. The preliminary estimated fair value was primarily determined using a reproduction/replacement cost approach which measures the value of an asset by estimating the cost to acquire or construct comparable assets adjusted for age and condition of the asset.
(e) 
Identifiable intangible assets primarily consist of developed technology rights, customer relationships, and trademarks and tradenames. The preliminary estimate of fair value of identifiable intangible assets is determined using the income approach, which includes a forecast of expected future cash flows. For additional information regarding identifiable intangible assets, see Note 11. Goodwill and Other Intangible Assets.
(f) 
The acquisition was structured as a stock purchase and therefore we assumed the historical tax basis of Abaxis' assets and liabilities. The preliminary estimate of deferred tax effects resulting from the acquisition include the expected federal, state, and foreign tax consequences associated with temporary differences between the preliminary fair values of the assets acquired and liabilities assumed and the respective tax basis. The components of the Abaxis net deferred tax liability are included within amounts reported in Note 8. Income Taxes.
(g) 
Goodwill represents the excess of consideration transferred over the preliminary estimate of fair values of the assets acquired and liabilities assumed. It is allocated to our existing reportable segments and is primarily attributable to the future potential of the technology platforms, as well as cost and revenue synergies including market share capture, elimination of cost redundancies and gain of cost efficiencies, and intangible assets such as assembled workforce which are not separately recognizable. The primary strategic purpose of the acquisition was to enhance the company’s existing product portfolio by strengthening Zoetis’ presence in veterinary diagnostics. The goodwill recorded is not deductible for tax purposes. The allocation of goodwill to the reporting units is preliminary and will be completed as the company obtains the information necessary to complete the analysis, but no later than one year from the date of the acquisition.
All amounts recorded are subject to final valuation. Any adjustments to our preliminary purchase price allocation identified during the measurement period, which will not exceed one year from the acquisition date, will be accounted for prospectively.
The company incurred acquisition related costs of approximately $39 million and $40 million for the three and nine months ended September 30, 2018, respectively, which are included within Restructuring charges/(reversals) and certain acquisition-related costs and Selling, general and administrative expenses on our condensed consolidated statements of income.

12 |


The following table presents information for Abaxis' operations from the acquisition date through September 30, 2018 which are included in our condensed consolidated statements of income for the three months ended September 30, 2018:
(MILLIONS OF DOLLARS)
July 31 - September 30,
2018

Revenue
$
42

Net loss attributable to Zoetis Inc.(a)
32

(a) 
Included in the net loss are (i) $7 million of cost of goods sold related to the preliminary fair value adjustment for acquisition date inventory estimated to have been sold during the period ended September 30, 2018, (ii) $20 million of amortization expense related to the preliminary fair value of identifiable intangible assets recognized at the acquisition date, (iii) $10 million of severance costs directly related to the acquisition, and (iv) the applicable tax impact of above adjustments based on the statutory tax rates in the various jurisdictions where the adjustments are expected to be incurred.
Supplemental Pro Forma Information:
The following table provides unaudited supplemental pro forma financial information as if the acquisition of Abaxis had occurred on January 1, 2017.
 
Three Months Ended
 
Nine Months Ended
(MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)
September 30,

October 1,

 
September 30,

October 1,

2018

2017

 
2018

2017

Revenue
$
1,500

$
1,406

 
$
4,416

$
4,022

Net income attributable to Zoetis Inc.
348

267

 
1,024

665

Net income per common share - basic
0.72

0.55

 
2.12

1.35

Net income per common share - diluted
0.72

0.54

 
2.10

1.35

The supplemental pro forma financial information has been prepared using the acquisition method of accounting and is based on the historical financial information of Zoetis and Abaxis. The supplemental pro forma financial information does not necessarily represent what the combined company’s revenue or results of operations would have been had the acquisition been completed on January 1, 2017, nor do they intend to be a projection of future operating results of the combined company. It also does not reflect any operating efficiencies or potential cost savings that might be achieved from synergies of combining Zoetis and Abaxis.
The unaudited supplemental pro forma financial information reflect primarily the following pro forma adjustments:
Acquisition related costs incurred by Zoetis and Abaxis of $57 million and $60 million have been removed for each of the three and nine months ended September 30, 2018, respectively. Acquisition related costs of $0 million and $38 million are assumed to be have been incurred during the three and nine months ended October 1, 2017, respectively.
Additional amortization expense of $13 million and $78 million for each of the three and nine months ended September 30, 2018, respectively, and $33 million and $98 million for each of the three and nine months ended October 1, 2017, respectively, related to the preliminary fair value estimate of identified intangible assets acquired.
Additional depreciation expense of $1 million for the nine months ended September 30, 2018, and $1 million for the nine months ended October 1, 2017, related to the preliminary estimate of fair value adjustments to property, plant and equipment acquired.
Adjustments related to the preliminary estimate of the non-recurring fair value adjustment to acquisition date inventory estimated to have been sold, resulting in $7 million removed for each of the three and nine months ended September 30, 2018, respectively, and $11 million and $33 million added to the three and nine months ended October 1, 2017, respectively.
Additional interest expense and amortization of debt issuance costs for the debt issuance to finance the acquisition, resulting in $8 million and $36 million added for the three and nine months ended September 30, 2018, respectively, and $14 million and $43 million added to the three and nine months ended October 1, 2017, respectively.
Adjustments related to the post merger share-based compensation expense of the replacement awards are $0 million and $7 million for the three and nine months ended September 30, 2018, respectively, and $3 million and $10 million for the three and nine months ended October 1, 2017, respectively.
Applicable tax impact of the above adjustments based on the statutory tax rates in the various jurisdictions where the adjustments are expected to be incurred.
Other Acquisitions
In the third quarter of 2018, we completed the acquisition of a manufacturing business in Ireland and the noncontrolling interest of a European livestock monitoring company. These transactions did not have a significant impact on our consolidated financial statements.
Divestitures
On May 11, 2017, we completed the sale of our manufacturing site in Shenzhou, China. We had previously exited operations at this site during the second quarter of 2015 as part of our operational efficiency program. We received total cash proceeds of approximately $3 million and recorded a net pre-tax gain of approximately $2 million within Other (income)/deductions—net.

13 |


Additionally, in the second quarter of 2017, we recorded a $4 million expense within Other (income)/deductions—net related to the February 12, 2016 sale of two of our manufacturing sites in the United Sates: Laurinburg, North Carolina, and Longmonth, Colorado to Huvepharma NV (Huvepharma), a European animal health company.
6.
Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives
In connection with our cost-reduction/productivity initiatives, we typically incur costs and charges associated with site closings and other facility rationalization actions, workforce reductions and the expansion of shared services, including the development of global systems. In connection with our acquisition activity, we typically incur costs and charges associated with executing the transactions, integrating the acquired operations, which may include expenditures for consulting and the integration of systems and processes, product transfers and restructuring the consolidated company, which may include charges related to employees, assets and activities that will not continue in the consolidated company. All operating functions can be impacted by these actions, including sales and marketing, manufacturing and research and development (R&D), as well as functions such as business technology, shared services and corporate operations.
During 2015, we launched a comprehensive operational efficiency program, which was incremental to the previously announced supply network strategy. These initiatives focused on reducing complexity in our product portfolios, changing our selling approach in certain markets, reducing our presence in certain countries, and exiting manufacturing sites over a long term period. We have also continued to optimize our resource allocation and efficiency by reducing resources associated with non-customer facing activities and operating more efficiently as a result of less internal complexity and more standardization of processes. The comprehensive operational efficiency program was substantially completed as of December 31, 2017. We expect to complete the supply network strategy over the next several years.
The components of costs incurred in connection with restructuring initiatives, acquisitions and cost-reduction/productivity initiatives are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Restructuring charges/(reversals) and certain acquisition-related costs:
 
 
 
 
 
 
 
 
Transaction costs(a)
 
$
21

 
$

 
$
21

 
$

Integration costs(b)
 
9

 
2

 
10

 
4

Restructuring charges/(reversals)(c)(d):
 
 
 
 
 
 
 
 
Employee termination costs
 
17

 
7

 
22

 
3

Exit costs
 

 
(1
)
 
1

 

Total Restructuring charges/(reversals) and certain acquisition-related costs
 
$
47

 
$
8

 
$
54

 
$
7

(a) 
Transaction costs represent external costs directly related to acquiring businesses and primarily include expenditures for banking, legal, accounting and other similar services.
(b) 
Integration costs represent external, incremental costs directly related to integrating acquired businesses and primarily include expenditures for consulting and the integration of systems and processes, as well as product transfer costs.
(c) 
The restructuring charges for the three months ended September 30, 2018, are primarily related to:
employee termination costs of $8 million in Europe as a result of initiatives to better align our organizational structure, and
employee termination costs of $10 million related to the acquisition of Abaxis.
The restructuring charges for the nine months ended September 30, 2018, are primarily related to:
employee termination costs of $11 million in Europe as a result of initiatives to better align our organizational structure, and
employee termination costs of $10 million related to the acquisition of Abaxis.
The restructuring charges/(reversals) for the three months ended October 1, 2017, are primarily related to:
employee termination costs of $3 million related to the operational efficiency initiative and supply network strategy, and
employee termination costs of $4 million related to the acquisition of an Irish biologic therapeutics company in the third quarter of 2017.
The restructuring charges/(reversals) for the nine months ended October 1, 2017, are primarily related to:
employee termination costs of $4 million related to the acquisition of an Irish biologic therapeutics company in the third quarter of 2017.
(d) 
The restructuring charges/(reversals) are associated with the following:
For the three months ended September 30, 2018, International of $8 million and Manufacturing/research/corporate of $9 million.
For the nine months ended September 30, 2018, International of $12 million and Manufacturing/research/corporate of $11 million.
For the three months ended October 1, 2017, International of ($1 million reversal) and Manufacturing/research/corporate of $7 million.
For the nine months ended October 1, 2017, International of ($2 million reversal) and Manufacturing/research/corporate of $5 million.

14 |


Charges related to the operational efficiency initiative and supply network strategy are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Restructuring charges/(reversals) and certain acquisition-related costs:
 
 
 
 
 
 
 
 
Operational efficiency initiative
 
 
 
 
 
 
 
 
Employee termination costs
 
$
(1
)
 
$
1

 
$

 
$
2

Exit costs
 

 
(1
)
 

 

 
 
(1
)
 

 

 
2

Supply network strategy:
 
 
 
 
 
 
 
 
Employee termination costs
 

 
2

 
1

 
(3
)
Exit costs
 

 

 
1

 

 
 

 
2

 
2

 
(3
)
 
 
 
 
 
 
 
 
 
Total restructuring charges/(reversals) related to the operational efficiency initiative and supply network strategy
 
(1
)
 
2

 
2

 
(1
)
 
 
 
 
 
 
 
 
 
Other operational efficiency initiative charges
 
 
 
 
 
 
 
 
    Selling, general and administrative expenses:
 
 
 
 
 
 
 
 
        Consulting fees
 

 

 

 
1

    Other (income)/deductions—net:
 
 
 
 
 
 
 
 
        Net (gain)/loss on sale of assets
 

 
(1
)
 

 
1

Total other operational efficiency initiative charges
 

 
(1
)
 

 
2

 
 
 
 
 
 
 
 
 
Other supply network strategy charges
 
 
 
 
 
 
 
 
    Cost of sales:
 
 
 
 
 
 
 
 
        Accelerated depreciation
 

 

 

 
2

        Consulting fees and other costs
 
1

 
1

 
4

 
3

    Other (income)/deductions—net:
 
 
 
 
 
 
 
 
        Net loss on sale of assets(a)
 
2

 
5

 
2

 
5

Total other supply network strategy charges
 
3

 
6

 
6

 
10

 
 
 
 
 
 
 
 
 
Total charges associated with the operational efficiency initiative and supply network strategy
 
$
2

 
$
7

 
$
8

 
$
11

(a) 
For the three and nine months ended October 1, 2017, represents charges related to the agreement to sell a manufacturing site in Guarulhos, Brazil, which includes a $3 million charge to reduce the carrying value of the disposal group to an amount equal to fair value, less costs to sell, as well as $2 million of costs related to the anticipated disposal.
The components of, and changes in, our restructuring accruals are as follows:
 
 
Employee

 
 
 
 
 
 
Termination

 
Exit

 
 
(MILLIONS OF DOLLARS)
 
Costs

 
Costs

 
Accrual

Balance, December 31, 2017(a)
 
$
41

 
$

 
$
41

Provision
 
22

 
1

 
23

Utilization and other(b)
 
(26
)
 
(1
)
 
(27
)
Balance, September 30, 2018(a)
 
$
37

 
$

 
$
37

(a)  
At September 30, 2018, and December 31, 2017, included in Accrued expenses ($15 million and $19 million, respectively) and Other noncurrent liabilities ($22 million and $22 million, respectively).
(b)  
Includes adjustments for foreign currency translation.

15 |


7.
Other (Income)/Deductions—Net
The components of Other (income)/deductions—net are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,

 
October 1,

 
September 30,

 
October 1,

(MILLIONS OF DOLLARS)
 
2018

 
2017

 
2018

 
2017

Royalty-related income
 
$
(5
)
 
$
(7
)
 
$
(18
)
 
$
(19
)
Interest income
 
(6
)
 
(3
)
 
(20
)
 
(8
)
Net (gain)/loss on sale of assets(a)
 
2

 
4

 
2

 
6

Certain legal and other matters, net(b)
 

 

 

 
(4
)
Foreign currency loss(c)
 
9

 
7

 
26

 
17

Other, net(d)
 
(19
)
 

 
(18
)
 
(3
)
Other (income)/deductions—net
 
$
(19
)
 
$
1

 
$
(28
)
 
$
(11
)
(a) 
Represents net losses related to sales of certain manufacturing sites and products as part of our operational efficiency initiative and supply network strategy.
(b) 
For the nine months ended October 1, 2017, represents income associated with an insurance recovery related to commercial settlements in Mexico recorded in 2014 and 2016.
(c) 
Primarily driven by costs related to hedging and exposures to certain emerging market currencies.
(d) 
For the three and nine months ended September 30, 2018, primarily includes a net gain related to the relocation of a manufacturing site in China. For the nine months ended October 1, 2017, primarily includes a settlement refund and reimbursement of legal fees related to costs incurred by Pharmaq prior to the acquisition in 2015 and income associated with certain state business employment tax incentive credits.
8.
Income Taxes
A.
Taxes on Income
On December 22, 2017, the Tax Act was enacted which, among other changes, reduced the U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018. The Tax Act made broad and complex changes to the U.S. tax code and it will take time to fully analyze the impact of the changes. Based on the information available at that time, and the current interpretation of the Tax Act, for the year ended December 31, 2017 the company was able to make a reasonable estimate and recorded an initial provisional net tax expense of $212 million related to the one-time mandatory deemed repatriation tax, payable over eight years, partially offset by the remeasurement of the deferred tax assets and liabilities, as of the date of enactment, due to the reduction in the U.S. federal corporate tax rate. Pursuant to the Staff Accounting Bulletin published by the SEC on December 22, 2017, addressing the challenges in accounting for the effects of the Tax Act in the period of enactment, companies must report provisional amounts for those specific income tax effects of the Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. Those provisional amounts will be subject to adjustment during a measurement period of up to one year from the enactment date (measurement-period adjustment). Pursuant to this guidance, the estimated impact of the Tax Act was based on a preliminary review of the new tax law and projected future financial results and is subject to revision based upon further analysis and interpretation of the Tax Act and to the extent that future results differ from currently available projections.
Our accounting for the following elements of the Tax Act is incomplete. However, in 2018 we were able to further refine our initial reasonable estimate and adjusted the initial provisional net tax expense of $212 million. We recorded the following measurement-period adjustments of $23 million and $58 million net tax benefit during the three and nine months ended September 30, 2018, respectively:
One-Time Mandatory Deemed Repatriation Tax: The one-time mandatory deemed repatriation tax is imposed on previously untaxed accumulated and current earnings and profits (E&P) of our foreign subsidiaries. We were able to reasonably estimate the one-time mandatory deemed repatriation tax and recorded an initial provisional tax obligation, with a corresponding adjustment to income tax expense for the year ended December 31, 2017. We are continuing to gather additional information to more precisely compute the amount of the one-time mandatory deemed repatriation tax. Our accounting for this item is not yet complete due to the fact that the non-U.S. subsidiaries are on a fiscal year ending November 30, and this tax liability will not become a fixed obligation until November 30, 2018. The estimated impact of the Tax Act is based on a preliminary review of the new law and projected future financial results and is subject to revision based upon further analysis and interpretation of the Tax Act and to the extent that future results differ from currently available projections. However, on the basis of revised computations that were calculated during the reporting period, we recognized a measurement-period adjustment of $23 million and $58 million for the three and nine months ended September 30, 2018, respectively, as a decrease to the one-time mandatory deemed repatriation tax obligation, with a corresponding adjustment to income tax benefit during the period. The effect of the measurement-period adjustment to the three and nine months ended September 30, 2018 effective tax rate was a reduction to the rate of approximately 5.4% and 4.6%, respectively. In addition, we reclassified the one-time mandatory deemed repatriation tax from Noncurrent deferred tax liabilities to Income taxes payable and Other taxes payable. We expect to complete our accounting within the prescribed measurement period.
Reduction of U.S. Federal Corporate Tax Rate: The Tax Act reduced the corporate tax rate to 21%, effective January 1, 2018. Consequently, we recorded a decrease related to deferred tax assets and liabilities with a corresponding net adjustment to deferred income tax benefit for the year ended December 31, 2017. We have not made any measurement-period adjustments related to this item during the nine months of 2018. Since the company has recorded provisional amounts related to certain portions of the Tax Act, any

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corresponding deferred tax remeasurement is also provisional. However, we are continuing to gather additional information to complete our accounting for this item and expect to be completed within the prescribed measurement period.
Valuation Allowances: The company must assess whether its valuation allowance analyses are affected by the various aspects of the Tax Act (e.g., one-time mandatory deemed repatriation of deferred foreign income, global intangible low-taxed income inclusions, and new categories of foreign tax credits). We have not made any measurement-period adjustments related to this item during the nine months of 2018. Since the company has recorded provisional amounts related to certain portions of the Tax Act, any corresponding determination of the need for or change in a valuation allowance is also provisional. However, we are continuing to gather additional information to complete our accounting for this item and expect to be completed within the prescribed measurement period.
Global Intangible Low-Taxed Income (GILTI) Policy Election: The GILTI provisions of the Tax Act do not apply to the company until 2019, due to the fact that the non-U.S. subsidiaries are on a fiscal year ending November 30, and we are still evaluating its impact. The FASB allows companies to adopt an accounting policy to either recognize deferred taxes for GILTI or treat such tax cost as a current-period expense when incurred. We have not yet determined our accounting policy because determining the impact of the GILTI provisions requires analysis of our existing legal entity structure, the reversal of our U.S. GAAP and U.S. tax basis differences in the assets and liabilities of our foreign subsidiaries, and our ability to offset any tax with foreign tax credits. As such, we have not made a policy decision whether to record deferred taxes on GILTI or treat such tax cost as a current-period expense.
The effective tax rate was 17.0% for the three months ended September 30, 2018, compared with 28.3% for the three months ended October 1, 2017. The lower effective tax rate for the three months ended September 30, 2018, was primarily attributable to:
the reduction of the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018, pursuant to the Tax Act;
a $23 million net tax benefit recorded in the third quarter of 2018, associated with a measurement-period adjustment related to the provisional one-time mandatory deemed repatriation tax on the company's undistributed non-U.S. earnings pursuant to the Tax Act enacted on December 22, 2017;
changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings from operations and repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and operating fluctuations in the normal course of business and the impact of non-deductible items; and
a $3 million and $1 million discrete tax benefit recorded in the third quarter of 2018 and 2017, respectively, related to the excess tax benefits for share-based payments.
The effective tax rate was 15.2% for the nine months ended September 30, 2018, compared with 28.6% for the nine months ended October 1, 2017. The lower effective tax rate for the nine months ended September 30, 2018, was primarily attributable to:
the reduction of the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018, pursuant to the Tax Act;
a $58 million net tax benefit recorded in the nine months ended 2018, associated with a measurement-period adjustment related to the provisional one-time mandatory deemed repatriation tax on the company's undistributed non-U.S. earnings pursuant to the Tax Act enacted on December 22, 2017;
changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings from operations and repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and operating fluctuations in the normal course of business and the impact of non-deductible items;
a $12 million and $8 million discrete tax benefit recorded in the nine months ended 2018 and 2017, respectively, related to the excess tax benefits for share-based payments; and
an $8 million and $3 million discrete tax benefit recorded in the nine months ended 2018 and 2017, respectively, related to a remeasurement of deferred taxes as a result of a change in non-U.S. statutory tax rates.
B.
Deferred Taxes
As of September 30, 2018, the total net deferred income tax liability of $373 million is included in Noncurrent deferred tax assets ($73 million) and Noncurrent deferred tax liabilities ($446 million).
As of December 31, 2017, the total net deferred income tax liability of $300 million is included in Noncurrent deferred tax assets ($80 million) and Noncurrent deferred tax liabilities ($380 million).
The change in Noncurrent deferred tax liabilities was primarily due to the acquisition of Abaxis, partially offset by the reclassification of the one-time mandatory deemed repatriation tax from Noncurrent deferred tax liabilities to Income taxes payable and Other taxes payable to properly reflect the liability, which became a fixed obligation in 2018, payable over eight years.
C.
Tax Contingencies
As of September 30, 2018, the tax liabilities associated with uncertain tax positions of $184 million (exclusive of interest and penalties related to uncertain tax positions of $11 million) are included in Noncurrent deferred tax assets ($4 million) and Other taxes payable ($180 million).
As of December 31, 2017, the tax liabilities associated with uncertain tax positions of $164 million (exclusive of interest and penalties related to uncertain tax positions of $11 million) are included in Noncurrent deferred tax assets ($3 million) and Other taxes payable ($161 million).
Our tax liabilities for uncertain tax positions relate primarily to issues common among multinational corporations. Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Substantially all of these unrecognized tax benefits, if

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recognized, would impact our effective income tax rate. We do not expect that within the next twelve months any of our uncertain tax positions could significantly decrease as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of uncertain tax positions and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant.
9.
Financial Instruments
A.
Debt
Credit Facilities
In December 2016, we entered into an amended and restated revolving credit agreement with a syndicate of banks providing for a five-year $1.0 billion senior unsecured revolving credit facility (the credit facility). In December 2017, the maturity for the amended and restated revolving credit agreement was extended through December 2022. Subject to certain conditions, we have the right to increase the credit facility to up to $1.5 billion. The credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio (the ratio of consolidated net debt as of the end of the period to consolidated Earnings Before Interest, Income Taxes, Depreciation and Amortization (EBITDA) for such period) of 3.50:1. Upon entering into a material acquisition, the maximum total leverage ratio increases to 4.00:1, and extends until the fourth full consecutive fiscal quarter ended immediately following the consummation of a material acquisition. The credit facility also contains a clause which adds back to Adjusted Consolidated EBITDA, any operational efficiency restructuring charge (defined as charges recorded by the company during the period commencing on October 1, 2016 and ending December 31, 2019, related to operational efficiency initiatives), provided that for any twelve-month period such charges added back to Adjusted Consolidated EBITDA shall not to exceed $100 million in the aggregate.
The credit facility also contains a financial covenant requiring that we maintain a minimum interest coverage ratio (the ratio of EBITDA at the end of the period to interest expense for such period) of 3.50:1. In addition, the credit facility contains other customary covenants.
We were in compliance with all financial covenants as of September 30, 2018, and December 31, 2017. There were no amounts drawn under the credit facility as of September 30, 2018, or December 31, 2017.
We have additional lines of credit and other credit arrangements with a group of banks and other financial intermediaries for general corporate purposes. We maintain cash and cash equivalent balances in excess of our outstanding short-term borrowings. As of September 30, 2018, we had access to $75 million of lines of credit which expire at various times throughout 2018 and 2019 and are generally renewed annually. We did not have any borrowings outstanding related to these facilities as of September 30, 2018, and December 31, 2017.
Commercial Paper Program and Other Short-Term Borrowings
In February 2013, we entered into a commercial paper program with a capacity of up to $1.0 billion. As of September 30, 2018, and December 31, 2017, there was no commercial paper outstanding under this program. As of September 30, 2018, and December 31, 2017, we did not have any other short-term borrowings outstanding.
Senior Notes and Other Long-Term Debt
On August 20, 2018, we issued $1.5 billion aggregate principal amount of our senior notes (2018 senior notes), with an original issue discount of $4 million. These notes are comprised of $300 million aggregate principal amount of floating rate senior notes due 2021 (the "2018 floating rate senior notes"), and $300 million aggregate principal amount of 3.250% senior notes due 2021, $500 million aggregate principal amount of 3.900% senior notes due 2028 and $400 million aggregate principal amount of 4.450% senior notes due 2048 (collectively, the "2018 fixed rate senior notes"). Net proceeds from this offering were partially used to pay down and terminate a revolving credit agreement and repay outstanding commercial paper, which were borrowed to finance a portion of the cash consideration for the acquisition of Abaxis (see Note 5. Acquisitions and Divestitures). The remainder of the net proceeds will be used for general corporate purposes.
On September 12, 2017, we issued $1.25 billion