Zoetis 10-Q 2021-09-30

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

(973) 822-7000

Securities registered pursuant to Section 12(b) of the Act:

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. ☒ Yes ☐ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). ☒ Yes ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.

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 ☒ No

At October 29, 2021, there were 473,125,822 shares of common stock outstanding.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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Overview of our business

Zoetis is 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 nearly 70 years, we have been innovating ways to predict, prevent, detect, and treat animal illness, and continue to stand by those raising and caring for animals worldwide - from livestock farmers to veterinarians and pet owners.

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 animal and livestock customers in order to capitalize on local and regional trends and customer needs. See Notes to Condensed Consolidated Financial Statements — Note 16. 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.

Beginning in the first quarter of 2021, certain costs associated with information technology that specifically support our global manufacturing operations, which were previously reported in Other unallocated, are now reported in Corporate. In addition, in the first quarter of 2021, 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) certain diagnostics costs, which were previously reported in Corporate, are now reported in our U.S. results; and (ii) certain other miscellaneous costs, which were previously reported in our U.S. results, are now reported in Corporate.

Certain reclassifications of prior year information have been made to conform to the current year's presentation.

A summary of our 2021 performance compared with the comparable 2020 period follows:

(a) Operational growth and adjusted net income are non-GAAP financial measures. See the Non-GAAP financial measures section of this Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) for more information.

Our operating environment

For a description of our operating environment, including factors which could materially affect our business, financial condition, or future results, see "Our Operating Environment" in the MD&A of our 2020 Annual Report on Form 10-K. Set forth below are updates to certain of the factors disclosed in our 2020 Form 10-K.

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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. Although we are unable to fully predict the impact that the COVID-19 pandemic will ultimately have on our future financial position and operating results, we continue to monitor the potential effects, including impacts on our supply chain, the effect on customer demand, and 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.

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.

For

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A significant portion of our revenue and costs are exposed to changes in foreign exchange rates. In addition, our outstanding borrowings may be subject to risk from changes in interest rates and foreign exchange rates. The overall objective of our financial risk management program is to seek to minimize the impact of foreign exchange rate movements and interest rate movements on our earnings. We manage these financial exposures through operational means and by using certain financial instruments. These practices may change as economic conditions change.

For a complete discussion of our exposure to interest rate and foreign exchange risk, refer to Item 7A. Quantitative and Qualitative Disclosures About Market Risk in our Annual Report on Form 10-K for the year ended December 31, 2020. There have been no significant changes from the information discussed therein.

Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of the company's management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation as of September 30, 2021, the company's Chief Executive Officer and Chief Financial Officer concluded that the company's disclosure controls and procedures are effective at a reasonable level of assurance in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC.

Changes in Internal Control over Financial Reporting

During our most recent fiscal quarter, there has not been any change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

The information required by this Item is incorporated herein by reference to Notes to Condensed Consolidated Financial Statements—Note 15. Commitments and Contingencies in Part I— Item 1, of this Quarterly Report on Form 10-Q.

In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed in the "Our Operating Environment" and "Forward-Looking Statements and Factors That May Affect Future Results" sections of the MD&A and in Part I, Item 1A. "Risk Factors," of our 2020 Annual Report on Form 10-K, which could materially affect our business, financial condition, or future results and which are incorporated by reference herein. Set forth below are updates to certain of the risk factors disclosed in our 2020 Annual Report on Form 10-K.

Risks related to our business and industry

The COVID-19 pandemic has negatively affected the global economy; has disrupted our and our customers', suppliers', and vendors' operations; has significantly affected our business and operations; and may materially adversely affect our business, financial condition, results of operations and/or cash flows.

The spread of the novel coronavirus (COVID-19) has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place orders and shutdowns of non-essential businesses. While some of these restrictions have been lifted or eased in certain jurisdictions, other jurisdictions have seen increases in new COVID-19 cases, resulting in restrictions being reinstated or new restrictions being imposed.

Even though we are currently designated as an essential business and have continued physical operations with respect to manufacturing and supply chain globally, these measures have impacted and may further impact all or portions of our workforce and operations, the operations and workforce of our customers, and those of our respective vendors and suppliers. There is no certainty that measures taken by governmental authorities will be sufficient to mitigate the risks posed by the virus, and our ability to continue to perform critical functions could be harmed.

There continues to be considerable uncertainty regarding such measures and potential future measures. In particular, we, and the contract manufacturing organizations (CMOs) we work with, could be asked or ordered to perform certain activities for human health that would divert significant manufacturing and other resources away from our business and could expose us to additional liability. For example, in February 2021, the Biden Administration invoked the Defense Production Act (DPA) to require U.S. vaccine and component manufacturers to prioritize supply for the U.S. human COVID-19 vaccination program and, as a result, the supply of certain components used in several of our products was disrupted for a short while. It is still uncertain what the ultimate impact from the DPA will be. Any related component shortages or supply chain disruption may result in manufacturing or R&D delays that could materially adversely impact our revenue. Future restrictions on our access to or control over our manufacturing facilities or on our support operations or workforce, or similar limitations on our vendors or suppliers, and restrictions or disruptions of transportation, such as reduced availability of air transport, port closures and increased border controls or closures, or export bans could limit our ability to meet customer demand and have a material adverse effect on our business, financial condition, results of operations and/or cash flows.

The COVID-19 pandemic also has and may continue to reduce demand for our products as a result of the negative impact it has had and may continue to have on our livestock and companion animal customers. Our livestock customers have been and may continue to be challenged by voluntary or mandatory facility closures, reduced packing plant capacity, travel bans and quarantines inhibiting consumption of protein and transportation of live animals, and labor shortages negatively impacting their operations. For example, a number of significant meat processing plants were closed temporarily during the COVID-19 pandemic after employees tested positive for COVID-19. In addition, our companion animal customers’ businesses in certain geographies have been and may continue to be negatively impacted by reduced demand for their veterinary services. The resulting reduction in demand for our products, has negatively impacted our business, financial condition, results of operations and cash flows and may have a material adverse effect on our business, financial condition, results of operations and/or cash flows, if such demand reduction accelerates or is prolonged.

Moreover, while our research and development organization has continued to operate as an essential business, future measures imposed by governments and other authorities to try to contain the COVID-19 pandemic could impede the ability of our R&D organization to complete clinical studies required to register new products in the manner and on the timeline we anticipate and current and future product approvals may be delayed, which could have a material adverse effect on our business, financial condition, results of operations and/or cash flows.

The COVID-19 pandemic has also significantly increased economic uncertainty and has led to continued disruption and volatility in the global capital markets, which could increase the cost of capital and adversely impact access to capital. The economic impact of the ongoing COVID-19 pandemic has resulted in a global recession that may continue for an unknown period of time. In order to preserve liquidity, we issued debt securities in May 2020 and we may incur additional indebtedness, whether through the issuance of debt securities, drawdowns under our credit facility or otherwise in the future. An increase in our outstanding indebtedness will result in additional interest expense. We may also seek to conserve cash by reducing or canceling future dividends or delaying capital expenditures. Risks related to negative economic conditions are described in Part I, Item 1A. "Risk Factors," of our 2020 Annual Report on Form 10-K titled, "Our business is subject to risk based on global economic conditions.”

Additionally, many of our workforce continue to work remotely as a result of the pandemic. Remote working arrangements could increase operational risks, including, but not limited to, risks associated with information technology and systems, including service interruptions, misappropriation of data, or breaches of security, any of which could have a material adverse effect on our business. Working outside of the typical work environment may also introduce additional complexity or inefficiency into our normal processes for key areas like the preparation of financial statements or marketing and sales, which could negatively impact our business. In addition, actions we have taken or may take, or decisions we have

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made or may make, as a consequence of the COVID-19 pandemic, including as part of the reopening process, may also result in employee disruption, legal claims or litigation against us.

We cannot at this time predict the full impact of the COVID-19 pandemic, but we anticipate that the COVID-19 pandemic is likely to continue to impact our business, financial condition, results of operations and/or cash flows in 2021. The impact of the COVID-19 pandemic may also exacerbate the other risks discussed in Part I, Item 1A. "Risk Factors," of our 2020 Annual Report on Form 10-K, any of which could have a material effect on us. This situation continues to change rapidly and additional impacts may arise that we are not aware of currently.

Generic and other products may be viewed as more cost-effective than our products.

We face competition from products produced by other companies, including generic alternatives to our products. We depend on patents and regulatory data exclusivity periods to provide us with exclusive marketing rights for some of our products. Patents for individual products expire at different times based on the date of the patent filing (or sometimes the date of patent grant) and the legal term of patents in the countries where such patents are obtained. The extent of protection afforded by our patents varies from country to country and is limited by the scope of the claimed subject matter of our patents, the term of the patent and the availability and enforcement of legal remedies in the applicable country. As a result, we face competition from lower-priced generic alternatives to many of our products that no longer have patent protection. In certain circumstances, we have been forced to lower our prices and provide discounts or rebates in order to compete with generic products. Generic competitors are becoming more aggressive in terms of launching at risk before patent rights expire and, because of their pricing, are an increasing percentage of overall animal health sales in certain regions. For example, several companies have launched generic versions of our Rimadyl chewable product. As a result of generic and other competition, sales of our Rimadyl chewable product in the U.S. have declined by approximately 23% in the years since their introduction. Sales of our Clavamox products in the U.S. also continue to be negatively impacted by generic competition.

Although the impact of generic competition in the animal health industry to date has not typically mirrored that seen in human health, in certain markets, the impact of generic competition in the future may more closely mirror human health as a result of changes in industry dynamics, such as channel expansion, customer consolidation, an increase in the availability and use of pet insurance and the potential for generic competition by established animal health businesses. If animal health customers increase their use of new or existing generic products, our operating results and financial condition could be materially adversely affected.

Some of our products' patents have expired, and over the next few years, additional products' patents will expire as described below. Draxxin, Revolution/Revolution Plus/Stronghold, and the ceftiofur product line contributed approximately 15% of our revenue in 2020.

• Draxxin, containing the active ingredient tulathromycin, is covered by a formulation patent in the U.S. that expired in February 2021. Corresponding formulation patents in Europe, Canada, Australia and other key markets expired in late 2020, with the exception of the formulation patents in Japan that expire in 2025. The active ingredient tulathromycin is protected in Japan until 2023. In Brazil, the status of our patents for the Draxxin formulation and active ingredient tulathromycin is currently uncertain. Generic or other competing tulathromycin products are now marketed in many markets including the U.S., Europe, Canada, Mexico and Australia, as well as in many smaller markets and for swine in Brazil. Additional marketing authorizations for generic tulathromycin products may be granted in various markets in the future. Sales of Draxxin has been negatively affected by generic competition in the markets where the patents have expired.

• Several patents covering Excede/Naxcel, part of the ceftiofur antibiotic product line, began expiring in the U.S. in 2015. The patent covering the commercial formulation of Excede in the U.S. extends to 2024, but expired in September 2021 in Europe, Canada and Australia. Corresponding patents in Japan and Brazil expire in 2026 and 2027, respectively. The commercial method of administration patent relevant to the product line expires in 2023 in the U.S., Europe and Australia. Generic versions of Excede have entered the market in Mexico and Russia. At this time, the market entry of a generic version of Excede in the U.S. is not anticipated before 2024.

• The compound patent for selamectin, the active ingredient in our parasiticides Revolution/Stronghold and one of the active ingredients in our combination parasiticide product, Revolution/Stronghold Plus, expired in 2014. Formulation patents covering Revolution/Stronghold products expired in important markets in 2019. Generic versions of selamectin are now sold in markets including the U.S., Europe, Australia and Canada.

• In addition, the patent for the active ingredient of Convenia® has expired; however, there are formulation patents relevant to the product line which expire between November 2022 and October 2023.

• The patent for the active ingredient of Cerenia has expired; however, there are formulation patents relevant to the injectable product line which expire between 2025 and 2028. Generic versions of Cerenia have been registered and marketed in Europe and we are aware that regulatory approval of at least one generic version of Cerenia is currently being pursued in the U.S. There is also a pending registration for generic version of Cerenia in Australia.

• The formulation patent covering ProHeart 12 expired in the U.S. in 2019, and expired in Australia, Canada and Japan in October 2021.

Zoetis typically enforces its patents whenever appropriate both within and outside the U.S., including by filing infringement claims against other parties.

Risks related to tax matters

The Company could be subject to changes in its tax rates, the adoption of new U.S. or foreign tax legislation or exposure to additional tax liabilities.

The multinational nature of our business subjects us to taxation in the U.S. and numerous foreign jurisdictions. Due to economic and political conditions, tax rates in various jurisdictions may be subject to significant change. The company’s future effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, or changes in tax laws or their interpretation.

For example, in October 2021, the Organisation for Economic Co-operation and Development (OECD) announced that its members have agreed on a two-pillar approach to address the tax challenges of the digital economy. Pillar One would amend profit allocation and nexus rules to grant more taxing rights to countries where consumers are located regardless of the physical presence of the business. Pillar Two introduces common global

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minimum tax rules across the countries participating in the OECD Inclusive Framework. Such rules, when implemented, would operate through top-up taxes and other measures if a multinational group’s income is not subject to a sufficient level of tax in a particular jurisdiction. These two pillars combined may represent a significant change in the international tax regime. The OECD/G20 Inclusive Framework will now work to develop the model rules and multilateral instruments, which would then need to be enacted on a country-by-country basis, in order to ensure global adoption by 2023. There is risk of an adverse impact to our effective tax rate as a result of these agreements, but the amount of such impact remains uncertain at this time.

Furthermore, President Biden's administration has put forth comprehensive corporate tax reform proposals which may have an adverse impact to our effective tax rate. At this time, we are properly reflecting the provision for taxes on income using all current enacted global tax laws in every jurisdiction in which we operate.

In addition, our effective tax rate is subject to potential risks that various taxing authorities may challenge the pricing of our cross-border arrangements and subject us to additional tax, adversely impacting our effective tax rate and our tax liability. The company is also subject to the examination of its tax returns and other tax matters by the Internal Revenue Service and other tax authorities and governmental bodies. The company regularly assesses the likelihood of an adverse outcome resulting from these examinations to determine the adequacy of its provision for taxes. There can be no assurance as to the outcome of these examinations. If the company’s effective tax rates were to increase, particularly in the U.S. or other material foreign jurisdictions, or if the ultimate determination of the company’s taxes owed is for an amount in excess of amounts previously accrued, the company’s operating results, cash flows and financial condition could be adversely affected.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table provides information with respect to the shares of the company’s common stock repurchased during the quarter ended

September 30, 2021:

(a) The company repurchased 14,160 shares during the three-month period ended September 30, 2021 that were not part of the publicly announced share repurchase authorization. These shares were reacquired from employees to satisfy tax withholding requirements on the vesting of restricted shares from equity-based awards.

(b) 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.

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

None

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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