Item 1. Financial Statements

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Item 1. Financial Statements

ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)	2021		2020		2021		2020
Revenue	$	1,990	$	1,786	$	5,809	$	4,868
Costs and expenses:
Cost of sales	586		546		1,703		1,456
Selling, general and administrative expenses	504		424		1,408		1,206
Research and development expenses	132		112		370		330
Amortization of intangible assets	40		40		121		120
Restructuring charges and certain acquisition-related costs	9		5		39		22
Interest expense, net of capitalized interest	56		62		170		173
Other (income)/deductions—net	4		—		16		(15)
Income before provision for taxes on income	659		597		1,982		1,576
Provision for taxes on income	107		118		361		298
Net income before allocation to noncontrolling interests	552		479		1,621		1,278
Less: Net loss attributable to noncontrolling interests	—		—		(2)		(1)
Net income attributable to Zoetis Inc.	$	552	$	479	$	1,623	$	1,279
Earnings per share attributable to Zoetis Inc. stockholders:
Basic	$	1.16	$	1.01	$	3.42	$	2.69
Diluted	$	1.16	$	1.00	$	3.40	$	2.67
Weighted-average common shares outstanding:
Basic	474.0		475.5		474.8		475.5
Diluted	476.3		478.5		477.1		478.5
Dividends declared per common share	$	—	$	—	$	0.500	$	0.400

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Net income before allocation to noncontrolling interests	$	552	$	479	$	1,621	$	1,278
Other comprehensive (loss)/income, net of tax:
Unrealized gains/(losses) on derivatives for cash flow hedges, net	1		5		21		(27)
Unrealized gains/(losses) on derivatives for net investment hedges, net	16		(30)		33		(27)
Foreign currency translation adjustments, net	(61)		147		9		46
Benefit plans: Actuarial loss, net	—		(1)		—		(1)
Total other comprehensive (loss)/income, net of tax	(44)		121		63		(9)
Comprehensive income before allocation to noncontrolling interests	508		600		1,684		1,269
Less: Comprehensive loss attributable to noncontrolling interests	—		—		(2)		(1)
Comprehensive income attributable to Zoetis Inc.	$	508	$	600	$	1,686	$	1,270

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


	September 30,		December 31,
	2021		2020
(MILLIONS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)	(Unaudited)
Assets
Cash and cash equivalents(a)	$	3,274	$	3,604

Accounts receivable, less allowance for doubtful accounts of $17 in 2021 and $20 in 2020	1,152		1,013
Inventories	1,875		1,628

Other current assets	381		366
Total current assets	6,682		6,611
Property, plant and equipment, less accumulated depreciation of $2,113 in 2021 and $1,952 in 2020	2,338		2,202
Operating lease right of use assets	188		192
Goodwill	2,703		2,694
Identifiable intangible assets, less accumulated amortization	1,572		1,710
Noncurrent deferred tax assets	110		94
Other noncurrent assets	112		106
Total assets	$	13,705	$	13,609

Liabilities and Equity
Short-term borrowings	$	—	$	4
Current portion of long-term debt	—		600
Accounts payable	387		457
Dividends payable	—		119
Accrued expenses	618		556
Accrued compensation and related items	314		295
Income taxes payable	91		46
Other current liabilities	61		93
Total current liabilities	1,471		2,170
Long-term debt, net of discount and issuance costs	6,592		6,595
Noncurrent deferred tax liabilities	291		378
Operating lease liabilities	160		163
Other taxes payable	259		260
Other noncurrent liabilities	251		270
Total liabilities	9,024		9,836
Commitments and contingencies (Note 15)
Stockholders' equity:

Common stock, $0.01 par value: 6,000,000,000 authorized; 501,891,243 and 501,891,243 shares issued; 473,374,057 and 475,317,751 shares outstanding at September 30, 2021, and December 31, 2020, respectively	5		5
Treasury stock, at cost, 28,517,186 and 26,573,492 shares of common stock at September 30, 2021, and December 31, 2020, respectively	(2,759)		(2,230)
Additional paid-in capital	1,056		1,065
Retained earnings	7,044		5,659
Accumulated other comprehensive loss	(667)		(730)
Total Zoetis Inc. equity	4,679		3,769
Equity attributable to noncontrolling interests	2		4
Total equity	4,681		3,773
Total liabilities and equity	$	13,705	$	13,609

(a) As of September 30, 2021 and December 31, 2020, includes $2 million of restricted cash.

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(UNAUDITED)


Three months ended September 30, 2021
	Zoetis
												Accumulated		Equity
								Additional				Other		Attributable to
		Common Stock			Treasury Stock			Paid-in		Retained		Comprehensive		Noncontrolling		Total
(MILLIONS OF DOLLARS AND SHARES)		Shares (a)	Amount		Shares (a)	Amount		Capital		Earnings		Loss		Interests		Equity
Balance, June 30, 2021		501.9	$	5	27.7	$	(2,568)	$	1,044	$	6,492	$	(623)	$	2	$	4,352
Net income		—	—		—	—		—		552		—		—		552
Other comprehensive loss		—	—		—	—		—		—		(44)		—		(44)

Share-based compensation awards (b)		—	—		(0.2)	7		11		—		—		—		18
Treasury stock acquired (c)		—	—		1.0	(198)		—		—		—		—		(198)
Employee benefit plan contribution from Pfizer Inc. (d)		—	—		—	—		1		—		—		—		1

Balance, September 30, 2021		501.9	$	5	28.5	$	(2,759)	$	1,056	$	7,044	$	(667)	$	2	$	4,681

Three months ended September 30, 2020
	Zoetis
												Accumulated		Equity
								Additional				Other		Attributable to
		Common Stock			Treasury Stock			Paid-in		Retained		Comprehensive		Noncontrolling		Total
(MILLIONS OF DOLLARS AND SHARES)		Shares (a)	Amount		Shares (a)	Amount		Capital		Earnings		Loss		Interests		Equity
Balance, June 30, 2020		501.9	$	5	26.9	$	(2,245)	$	1,030	$	5,048	$	(856)	$	5	$	2,987
Net income		—	—		—	—		—		479		—		—		479
Other comprehensive income		—	—		—	—		—		—		121		—		121

Share-based compensation awards (b)		—	—		(0.3)	11		9		(1)		—		—		19

Employee benefit plan contribution from Pfizer Inc.(d)		—	—		—	—		1		—		—		—		1

Balance, September 30, 2020		501.9	$	5	26.6	$	(2,234)	$	1,040	$	5,526	$	(735)	$	5	$	3,607

(a) Shares may not add due to rounding.

(b) Includes the issuance of shares of Zoetis Inc. common stock and the reacquisition of shares of treasury stock associated with exercises of employee share-based awards. Also includes the reacquisition of shares of treasury stock associated with the vesting of employee share-based awards to satisfy tax withholding requirements. For additional information, see Note 12. Share-based Payments and Note 13. Stockholders' Equity.

(c) Reflects the acquisition of treasury shares in connection with the share repurchase program. For additional information, see Note 13. Stockholders' Equity.

(d) 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 notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY - Continued

(UNAUDITED)


Nine months ended September 30, 2021
	Zoetis
												Accumulated		Equity
								Additional				Other		Attributable to
		Common Stock			Treasury Stock			Paid-in		Retained		Comprehensive		Noncontrolling		Total
(MILLIONS OF DOLLARS AND SHARES)		Shares (a)	Amount		Shares (a)	Amount		Capital		Earnings		Loss		Interests		Equity
Balance, December 31, 2020		501.9	$	5	26.6	$	(2,230)	$	1,065	$	5,659	$	(730)	$	4	$	3,773
Net income		—	—		—	—		—		1,623		—		(2)		1,621
Other comprehensive income		—	—		—	—		—		—		63		—		63

Share-based compensation awards (b)		—	—		(1.2)	16		(11)		—		—		—		5
Treasury stock acquired (c)		—	—		3.1	(545)		—		—		—		—		(545)
Employee benefit plan contribution from Pfizer Inc. (d)		—	—		—	—		2		—		—		—		2
Dividends declared		—	—		—	—		—		(238)		—		—		(238)
Balance, September 30, 2021		501.9	$	5	28.5	$	(2,759)	$	1,056	$	7,044	$	(667)	$	2	$	4,681

Nine months ended September 30, 2020
	Zoetis
												Accumulated		Equity
								Additional				Other		Attributable to
		Common Stock			Treasury Stock			Paid-in		Retained		Comprehensive		Noncontrolling		Total
(MILLIONS OF DOLLARS AND SHARES)		Shares (a)	Amount		Shares (a)	Amount		Capital		Earnings		Loss		Interests		Equity
Balance, December 31, 2019		501.9	$	5	26.4	$	(2,042)	$	1,044	$	4,427	$	(726)	$	—	$	2,708
Net income		—	—		—	—		—		1,279		—		(1)		1,278
Other comprehensive loss		—	—		—	—		—		—		(9)		—		(9)
Consolidation of noncontrolling interests		—	—		—	—		—		—		—		6		6
Share-based compensation awards (b)		—	—		(1.6)	58		(6)		10		—		—		62
Treasury stock acquired (c)		—	—		1.8	(250)		—		—		—		—		(250)
Employee benefit plan contribution from Pfizer Inc.(d)		—	—		—	—		2		—		—		—		2
Dividends declared		—	—		—	—		—		(190)		—		—		(190)
Balance, September 30, 2020		501.9	$	5	26.6	$	(2,234)	$	1,040	$	5,526	$	(735)	$	5	$	3,607

(a) Shares may not add due to rounding.

(c) Reflects the acquisition of treasury shares in connection with the share repurchase program. For additional information, see Note 13. Stockholders' Equity.

See notes to condensed consolidated financial statements.

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ZOETIS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


	Nine Months Ended
	September 30,
(MILLIONS OF DOLLARS)	2021		2020
Operating Activities
Net income before allocation to noncontrolling interests	$	1,621	$	1,278
Adjustments to reconcile net income before noncontrolling interests to net cash provided by operating activities:
Depreciation and amortization expense	331		332
Share-based compensation expense	44		46
Asset write-offs and asset impairments	19		12
Net loss/(gain) on sale of assets	3		(19)
Provision for losses on inventory	36		56
Deferred taxes	(121)		(40)
Employee benefit plan contribution from Pfizer Inc.	2		2
Loss on treasury locks	—		(6)
Other non-cash adjustments	4		9
Other changes in assets and liabilities, net of acquisitions and divestitures:
Accounts receivable	(143)		69
Inventories	(299)		(294)
Other assets	8		(150)
Accounts payable	(71)		49
Other liabilities	62		(49)
Other tax accounts, net	38		113
Net cash provided by operating activities	1,534		1,408
Investing Activities
Capital expenditures	(309)		(301)

Acquisitions, net of cash acquired	(14)		(108)

Purchase of investments	(10)		—
Settlement on swaps designated as net investment hedges	17		(8)
Net proceeds from sale of assets	1		21
Other investing activities	(1)		1
Net cash used in investing activities	(316)		(395)
Financing Activities
Increase in short-term borrowings, net	(4)		1
Proceeds from issuance of long-term debt—senior notes, net of discount	—		1,240
Principal payments on long-term debt	(600)		—
Payment of consideration related to previous acquisitions	(5)		—
Acquisition of a noncontrolling interest, net of cash acquired	—		3
Share-based compensation-related proceeds, net of taxes paid on withholding shares	(37)		23
Purchases of treasury stock	(545)		(250)
Cash dividends paid	(357)		(285)
Payment of debt issuance costs	—		(12)
Net cash (used in)/provided by financing activities	(1,548)		720
Effect of exchange-rate changes on cash and cash equivalents	—		(13)
Net (decrease)/increase in cash and cash equivalents	(330)		1,720
Cash and cash equivalents at beginning of period	3,604		1,934
Cash and cash equivalents at end of period	$	3,274	$	3,654

Supplemental cash flow information
Cash paid during the period for:
Income taxes	$	412	$	305
Interest, net of capitalized interest	221		217
Amounts included in the measurement of lease liabilities	34		31
Non-cash transactions:
Capital expenditures	3		3

Lease obligations obtained in exchange for right-of-use assets	30		38

See notes to condensed consolidated financial statements.

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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 animal health industry, focused on the discovery, development, manufacture and commercialization of medicines, vaccines, diagnostic products, biodevices, genetic tests and precision livestock farming technology. 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: dogs, cats and horses (collectively, companion animals) and cattle, swine, poultry, fish and sheep (collectively, livestock); and within seven major product categories: vaccines, parasiticides, anti-infectives, dermatology, other pharmaceutical products, medicated feed additives and animal health diagnostics.

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 U.S. are as of and for the three and nine months ended August 31, 2021 and August 31, 2020.

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.

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

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 2020 Annual Report on Form 10-K.

3. Accounting Standards

Recently Issued Accounting Standards

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting and subsequent amendment to the initial guidance: ASU No. 2021-01, Reference Rate Reform (Topic 848). The new guidance provides temporary optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. Adoption of the guidance is optional and effective as of March 12, 2020, but only available through December 31, 2022. We are currently evaluating the impact that the new guidance will have on our consolidated financial statements and related disclosures, as well as the timing of the potential adoption.

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, retailers and e-commerce outlets. 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 research and development (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, vaccines and diagnostics, complemented by biodevices, genetic tests and a range of services. 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 companion animals and livestock across each of our major 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;
parasiticides**: products that prevent or eliminate external and internal parasites such as fleas, ticks and worms;
anti-infectives: products that prevent, kill or slow the growth of bacteria, fungi or protozoa;
dermatology products**: products that relieve itch associated with allergic conditions and atopic dermatitis;
other pharmaceutical products**: pain and sedation, antiemetic, reproductive, and oncology products;
medicated feed additives**: products added to animal feed that provide medicines to livestock; and

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animal health diagnostics**: portable blood and urine analysis systems and point-of-care diagnostic products, including instruments and reagents, rapid immunoassay tests, reference laboratory kits, blood glucose monitors and reference laboratory services.

Our remaining revenue is derived from other non-pharmaceutical product categories, such as nutritionals and agribusiness, as well as products and services in biodevices, genetic tests and precision livestock farming.

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, vaccines and diagnostics 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, deepening the human-animal bond, receiving increased medical treatment and benefiting from advances in animal health medicine, vaccines and diagnostics.

Our livestock products primarily help prevent or treat diseases and conditions to allow veterinarians and producers to care for their animals and 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 demand for improved nutrition, particularly through increased consumption of animal protein. Second, population growth leads to greater natural resource constraints driving a need for enhanced productivity. Finally, as standards of living improve and the global food chain faces increased scrutiny, there is more focus on food quality, safety, and reliability of supply.

The following tables present our revenue disaggregated by geographic area, species, and major product category:

Revenue by geographic area


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
United States	$	1,065	$	996	$	3,002	$	2,605
Australia	70		60		196		154
Brazil	78		62		227		181
Canada	56		50		169		144
Chile	32		24		100		72
China	72		66		289		198
France	31		29		98		82
Germany	47		38		135		112
Italy	30		28		87		63
Japan	43		39		140		133
Mexico	31		26		98		84
Spain	33		31		97		83
United Kingdom	61		44		173		125
Other developed markets	127		105		350		282
Other emerging markets	193		165		591		490
	1,969		1,763		5,752		4,808
Contract manufacturing & human health	21		23		57		60
Total Revenue	$	1,990	$	1,786	$	5,809	$	4,868

Revenue by major species


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
U.S.
Companion animal	$	775	$	664	$	2,227	$	1,757
Livestock	290		332		775		848
	1,065		996		3,002		2,605
International
Companion animal	427		331		1,280		917
Livestock	477		436		1,470		1,286
	904		767		2,750		2,203
Contract manufacturing & human health	21		23		57		60
Total Revenue	$	1,990	$	1,786	$	5,809	$	4,868

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Revenue by species


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Companion Animal:
Dogs and Cats	$	1,142	$	947	$	3,319	$	2,524
Horses	60		48		188		150
	1,202		995		3,507		2,674
Livestock:
Cattle	403		417		1,144		1,107
Swine	153		151		504		454
Poultry	124		129		389		412
Fish	56		45		132		101
Sheep and other	31		26		76		60
	767		768		2,245		2,134
Contract manufacturing & human health	21		23		57		60
Total Revenue	$	1,990	$	1,786	$	5,809	$	4,868

Revenue by major product category


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Vaccines	$	421	$	401	$	1,251	$	1,086
Parasiticides	396		305		1,246		867
Anti-infectives	329		349		909		870
Dermatology	326		257		859		681
Other pharmaceuticals	243		208		717		597
Medicated feed additives	99		102		314		336
Animal health diagnostics	95		87		283		216
Other non-pharmaceuticals	60		54		173		155
	1,969		1,763		5,752		4,808
Contract manufacturing & human health	21		23		57		60
Total Revenue	$	1,990	$	1,786	$	5,809	$	4,868

B. Revenue from Contracts with Customers

Contract liabilities reflected within Other current liabilities as of December 31, 2020 and December 31, 2019, and subsequently recognized as revenue during the first nine months of 2021 and 2020 were approximately $4 million and $6 million, respectively. Contract liabilities as of September 30, 2021 and December 31, 2020 were approximately $12 million and $13 million, respectively.

Estimated future revenue expected to be generated from long-term contracts with unsatisfied performance obligations as of September 30, 2021 is not material.

5. Acquisitions and Divestitures

A. Acquisitions

In the third quarter of 2021, we entered into an agreement to acquire Jurox, a privately held animal health company based in Australia, which develops, manufactures and markets a wide range of veterinary medicines for treating companion animals and livestock. The transaction is subject to customary closing conditions and the satisfaction of regulatory requirements. We expect to complete the acquisition in the first half of 2022.

In the second quarter of 2021, we acquired certain assets to expand our portfolio of equine care products. This transaction did not have a significant impact on our consolidated financial statements.

During 2020, we completed the acquisitions of Fish Vet Group, a diagnostics company for aquaculture, Virtual Recall, a veterinary engagement software company, Performance Livestock Analytics, a cloud-based technology company in the precision livestock business, and Ethos Diagnostic Science, a veterinary reference laboratory business with labs across the U.S. We also entered into an option purchase agreement as part of a research and development arrangement with a Belgian company, a variable interest entity of which Zoetis is the primary beneficiary and now consolidating within our results. These transactions did not have a significant impact on our consolidated financial statements.

B. Divestitures

During the nine months ended September 30, 2020, we received a cash payment of $20 million pursuant to an agreement related to the 2016 sale of certain U.S. manufacturing sites.

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6. Restructuring Charges and Other Costs Associated with Acquisitions, Cost-Reduction and 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 R&D, as well as functions such as information technology, shared services and corporate operations.

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,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Restructuring charges and certain acquisition-related costs:

Integration costs(a)	$	1	$	3	$	6	$	15
Restructuring charges(b):
Employee termination costs	7		2		17		7

Asset impairment charges	—		—		13		—
Exit costs	1		—		3		—
Total Restructuring charges and certain acquisition-related costs	$	9	$	5	$	39	$	22

(a) 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.

(b) The restructuring charges for the three months ended September 30, 2021 primarily represents employee termination costs associated with the realignment of our international operations. The restructuring charges for the nine months ended September 30, 2021 primarily represents employee termination costs associated with our international operations and other costs associated with cost-reduction and productivity initiatives, as well as asset impairment charges related to the consolidation of manufacturing sites in China.

The restructuring charges for the three months ended September 30, 2020 primarily relate to other cost-reduction and productivity initiatives which are associated with Manufacturing/research/corporate. The restructuring charges for the nine months ended September 30, 2020 primarily relate to CEO transition-related costs and other cost-reduction and productivity initiatives which are associated with Manufacturing/research/corporate.



(MILLIONS OF DOLLARS)	Accrual(a)
Balance, December 31, 2020(b)	$	21
Provision	33
Non-cash activity	(13)
Utilization and other(c)	(14)

Balance, September 30, 2021(b)	$	27

(a) Changes in our restructuring accrual represents employee termination and exit costs.

(b) At September 30, 2021 and December 31, 2020, included in Accrued expenses ($12 million and $6 million, respectively) and Other noncurrent liabilities ($15 million).

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7. Other (Income)/Deductions—Net

The components of Other (income)/deductions—net are as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Royalty-related income	$	(3)	$	(3)	$	(7)	$	(9)
Interest income	(1)		(1)		(4)		(9)
Identifiable intangible asset impairment charges	—		—		—		3
Other asset impairment charges	3		—		3		—
Net (gain) loss on sale of assets(a)	—		(1)		3		(19)
Foreign currency loss(b)	8		3		20		14
Impairment of an equity investment	—		—		—		4
Other, net	(3)		2		1		1
Other (income)/deductions—net	$	4	$	—	$	16	$	(15)

(a) For the nine months ended September 30, 2021, represents a net loss related to the sale of certain assets of our poultry automation business located in the U.S. and Canada.

For the nine months ended September 30, 2020, primarily represents a net gain resulting from a cash payment received pursuant to an agreement related to the 2016 sale of certain U.S. manufacturing sites.

(b) Primarily driven by costs related to hedging and exposures to certain emerging and developed market currencies.

8. Income Taxes

A. Taxes on Income

Our effective tax rate was 16.2% for the three months ended September 30, 2021, compared with 19.8% for the three months ended September 30, 2020. The lower effective tax rate for the three months ended September 30, 2021, was primarily attributable to:

changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings from operations and repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions, operating fluctuations in the normal course of business and the impact of non-deductible items and non-taxable items. In addition, the three months ended September 30, 2021 includes a tax benefit related to foreign-derived intangible income; and
a $4 million discrete tax benefit recorded in the three months ended September 30, 2021, related to the effective settlement of certain issues with tax authorities.

Our effective tax rate was 18.2% for the nine months ended September 30, 2021, compared with 18.9% for the nine months ended September 30, 2020. The lower effective tax rate for the nine months ended September 30, 2021, was primarily attributable to:

changes in the jurisdictional mix of earnings, which includes the impact of the location of earnings from operations and repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions, operating fluctuations in the normal course of business and the impact of non-deductible items and non-taxable items. In addition, the nine months ended September 30, 2021 includes a tax benefit related to foreign-derived intangible income; and
a $4 million discrete tax benefit recorded in the nine months ended September 30, 2021, related to the effective settlement of certain issues with tax authorities,

partially offset by:

a $21 million and a $29 million discrete tax benefit recorded in the nine months ended September 30, 2021 and 2020, respectively, related to the excess tax benefits for share-based payments; and
a $7 million discrete tax benefit recorded in the nine months ended September 30, 2020, related to a remeasurement of deferred taxes resulting from the integration of acquired businesses.

B. Deferred Taxes

As of September 30, 2021, the total net deferred income tax liability of $181 million is included in Noncurrent deferred tax assets ($110 million) and Noncurrent deferred tax liabilities ($291 million).

As of December 31, 2020, the total net deferred income tax liability of $284 million is included in Noncurrent deferred tax assets ($94 million) and Noncurrent deferred tax liabilities ($378 million).

C. Tax Contingencies

As of September 30, 2021, the net tax liabilities associated with uncertain tax positions of $191 million (exclusive of interest and penalties related to uncertain tax positions of $16 million) are included in Noncurrent deferred tax assets and Other noncurrent assets ($1 million) and Other taxes payable ($190 million).

As of December 31, 2020, the net tax liabilities associated with uncertain tax positions of $188 million (exclusive of interest and penalties related to uncertain tax positions of $14 million) are included in Noncurrent deferred tax assets and Other noncurrent assets ($1 million) and Other taxes payable ($187 million).

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Our tax liabilities for uncertain tax positions relate primarily to issues common among multinational corporations. Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Substantially all of these unrecognized tax benefits, if recognized, would impact our effective income tax rate. We do not expect that within the next twelve months any of our uncertain tax positions could significantly decrease as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of uncertain tax positions and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant.

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 multi-year $1.0 billion senior unsecured revolving credit facility (the credit facility). In December 2018, the maturity for the amended and restated credit agreement was extended through December 2023. Subject to certain conditions, we have the right to increase the credit facility to up to $1.5 billion. The credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio (the ratio of consolidated net debt as of the end of the period to consolidated Earnings Before Interest, Income Taxes, Depreciation and Amortization (EBITDA) for such period) of 3.50:1. Upon entering into a material acquisition, the maximum total leverage ratio increases to 4.00:1, and extends until the fourth full consecutive fiscal quarter ended immediately following the consummation of a material acquisition.

The credit facility also contains a 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, 2021 and December 31, 2020. There were no amounts drawn under the credit facility as of September 30, 2021 or December 31, 2020.

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, 2021, we had access to $71 million of lines of credit which expire at various times through 2021 and are generally renewed annually. There were no borrowings outstanding related to these facilities as of September 30, 2021 and $4 million of borrowings outstanding related to these facilities as of December 31, 2020.

Commercial Paper Program

In February 2013, we entered into a commercial paper program with a capacity of up to $1.0 billion. As of September 30, 2021 and December 31, 2020, there was no commercial paper outstanding under this program.

Senior Notes and Other Long-Term Debt

On August 20, 2021, we redeemed, upon maturity, the $300 million aggregate principal amount of our 2018 floating rate senior notes due 2021 and the $300 million aggregate principal amount of our 2018 senior notes due 2021.

On May 12, 2020, we issued $1.25 billion aggregate principal amount of our senior notes (2020 senior notes), with an original issue discount of $10 million. These notes are comprised of $750 million aggregate principal amount of 2.000% senior notes due 2030 and $500 million aggregate principal amount of 3.000% senior notes due 2050. On October 13, 2020, the net proceeds were used to repay the $500 million aggregate principal amount of our 3.450% 2015 senior notes due 2020 and the remainder will be used for general corporate purposes.

On August 20, 2018, we issued $1.5 billion aggregate principal amount of our senior notes (2018 senior notes), with an original issue discount of $4 million. On September 12, 2017, we issued $1.25 billion aggregate principal amount of our senior notes (2017 senior notes), with an original issue discount of $7 million. On November 13, 2015, we issued $1.25 billion aggregate principal amount of our senior notes (2015 senior notes), with an original issue discount of $2 million. On January 28, 2013, we issued $3.65 billion aggregate principal amount of our senior notes (2013 senior notes) in a private placement, with an original issue discount of $10 million.

The 2013, 2015, 2017, 2018 and 2020 senior notes are governed by an indenture and supplemental indenture (collectively, the indenture) between us and Deutsche Bank Trust Company Americas, as trustee. The indenture contains certain covenants, including limitations on our and certain of our subsidiaries' ability to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets. In addition, the indenture contains other customary terms, including certain events of default, upon the occurrence of which the 2013, 2015, 2017, 2018 and 2020 senior notes may be declared immediately due and payable.

Pursuant to the indenture, we are able to redeem the 2013, 2015, 2017, 2018 and 2020 senior notes of any series, in whole or in part, at any time by paying a “make whole” premium, plus accrued and unpaid interest to, but excluding, the date of redemption. Pursuant to our tax matters agreement with Pfizer, we will not be permitted to redeem the 2013 senior notes due 2023 pursuant to this optional redemption provision, except under limited circumstances. Upon the occurrence of a change of control of us and a downgrade of the 2013, 2015, 2017, 2018 and 2020 senior notes below an investment grade rating by each of Moody's Investors Service, Inc. and Standard & Poor's Ratings Services, we are, in certain circumstances, required to make an offer to repurchase all of the outstanding 2013, 2015, 2017, 2018 and 2020 senior notes at a price equal to 101% of the aggregate principal amount of the 2013, 2015, 2017, 2018 and 2020 senior notes together with accrued and unpaid interest to, but excluding, the date of repurchase.

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The components of our long-term debt are as follows:


	September 30,		December 31,
(MILLIONS OF DOLLARS)	2021		2020
2018 floating rate (three-month USD LIBOR plus 0.44%) senior notes due 2021	$	—	$	300
3.250% 2018 senior notes due 2021	—		300
3.250% 2013 senior notes due 2023	1,350		1,350
4.500% 2015 senior notes due 2025	750		750
3.000% 2017 senior notes due 2027	750		750
3.900% 2018 senior notes due 2028	500		500
2.000% 2020 senior notes due 2030	750		750
4.700% 2013 senior notes due 2043	1,150		1,150
3.950% 2017 senior notes due 2047	500		500
4.450% 2018 senior notes due 2048	400		400
3.000% 2020 senior notes due 2050	500		500
	6,650		7,250
Unamortized debt discount / debt issuance costs	(62)		(66)
Less current portion of long-term debt	—		600
Cumulative fair value adjustment for interest rate swap contracts	4		11
Long-term debt, net of discount and issuance costs	$	6,592	$	6,595

The fair value of our long-term debt was $7,457 million and $7,835 million as of September 30, 2021 and December 31, 2020, respectively, and has been determined using a third-party matrix-pricing model that uses significant inputs derived from, or corroborated by, observable market data and Zoetis’ credit rating (Level 2 inputs).

The principal amount of long-term debt outstanding, as of September 30, 2021, matures in the following years:


											After
(MILLIONS OF DOLLARS)	2021		2022		2023		2024		2025		2025		Total
Maturities	$	—	$	—	$	1,350	$	—	$	750	$	4,550	$	6,650

Interest Expense

Interest expense, net of capitalized interest, was $56 million and $170 million for the three and nine months ended September 30, 2021, respectively, and $62 million and $173 million for the three and nine months ended September 30, 2020, respectively. Capitalized interest expense was $5 million and $14 million for the three and nine months ended September 30, 2021, respectively, and $4 million and $12 million for the three and nine months ended September 30, 2020, respectively.

B. Derivative Financial Instruments

Foreign Exchange Risk

A significant portion of our revenue, earnings and net investment in foreign affiliates is exposed to changes in foreign exchange rates. We seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenue in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Depending on market conditions, foreign exchange risk is also managed through the use of various derivative financial instruments. These derivative financial instruments serve to manage the exposure of our net investment in certain foreign operations to changes in foreign exchange rates and protect net income against the impact of translation into U.S. dollars of certain foreign exchange-denominated transactions.

All derivative financial instruments used to manage foreign currency risk are measured at fair value and are reported as assets or liabilities on the condensed consolidated balance sheet. The derivative financial instruments primarily offset exposures in the Canadian dollar, Chinese yuan, Danish krone, euro, Japanese yen, and Norwegian krone. Changes in fair value are reported in earnings or in Accumulated other comprehensive income/(loss), depending on the nature and purpose of the financial instrument, as follows:

For foreign exchange contracts not designated as hedging instruments, we recognize the gains and losses on forward-exchange contracts that are used to offset the same foreign currency assets or liabilities immediately into earnings along with the earnings impact of the items they generally offset. These contracts essentially take the opposite currency position of that reflected in the month-end balance sheet to counterbalance the effect of any currency movement. The vast majority of the foreign exchange derivative financial instruments mature within 60 days and all mature within three years.
For cross-currency interest rate swaps, which are designated as a hedge against our net investment in foreign operations, changes in the fair value are recorded as a component of cumulative translation adjustment within Accumulated other comprehensive income/(loss) and reclassified into earnings when the foreign investment is sold or substantially liquidated. Gains and losses excluded from the assessment of hedge effectiveness are recognized in earnings (Interest expense—net of capitalized interest). The cash flows from these contracts are reflected within the investing section of our Condensed Consolidated Statement of Cash Flows. These cross-currency interest rate swap contracts have varying maturities of up to four years.

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Interest Rate Risk

The company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rates and to reduce its overall cost of borrowing.

In anticipation of issuing fixed-rate debt, we may use forward-starting interest rate swaps that are designated as cash flow hedges to hedge against changes in interest rates that could impact expected future issuances of debt. Unrealized gains or losses on the forward-starting interest rate swaps are reported in Accumulated other comprehensive loss and are recognized in earnings over the life of the future fixed rate notes. When the company discontinues hedge accounting because it is no longer probable that an anticipated transaction will occur within the originally expected period of execution, or within an additional two-month period thereafter, changes to fair value accumulated in other comprehensive income are recognized immediately in earnings.
As of September 30, 2021, we had outstanding forward-starting interest rate swaps, having an effective date and mandatory termination date in March 2023, to hedge against interest rate exposure related principally to the anticipated future issuance of fixed-rate debt to be used primarily to refinance our 3.250% 2013 senior notes due 2023, and a forward-starting interest rate swap, having an effective date and mandatory termination date in March 2026, to hedge against interest rate exposure related principally to the anticipated future issuance of fixed-rate debt to be used primarily to refinance our 4.500% 2015 senior notes due 2025.
We may use fixed-to-floating interest rate swaps that are designated as fair value hedges to hedge against changes in the fair value of certain fixed-rate debt attributable to changes in the benchmark LIBOR rate. These derivative instruments effectively convert a portion of the company’s long-term debt from fixed rate to floating rate debt based on three-month LIBOR plus a spread. Gains or losses on the fixed to floating interest rate swaps due to changes in LIBOR are recorded in Interest expense, net of capitalized interest. Changes in the fair value of the fixed-to-floating interest rate swaps are offset by changes in the fair value of the underlying fixed rate debt. As of September 30, 2021, we had outstanding fixed-to-floating interest rate swaps that correspond to a portion of the 3.900% 2018 senior notes due 2028. The amounts recorded during the three and nine months ended September 30, 2021 for changes in the fair value of these hedges are not material to our consolidated financial statements.

Outstanding Positions

The aggregate notional amounts of derivative instruments are as follows:


	Notional
	September 30,		December 31,
(MILLIONS)	2021		2020
Foreign currency forward-exchange contracts	$	1,659	$	1,633

Cross-currency interest rate swap contracts (in foreign currency):
Euro	650		650
Danish krone	600		600
Swiss franc	25		25


Forward-starting interest rate swaps	$	550	$	550

Fixed-to-floating interest rate swap contracts	$	150	$	150

Fair Value of Derivative Instruments

The classification and fair values of derivative instruments are as follows:


		Fair Value of Derivatives
		September 30,		December 31,
(MILLIONS OF DOLLARS)	Balance Sheet Location	2021		2020
Derivatives Not Designated as Hedging Instruments
Foreign currency forward-exchange contracts	Other current assets	$	9	$	10
Foreign currency forward-exchange contracts	Other current liabilities	(12)		(16)
Total derivatives not designated as hedging instruments		$	(3)	$	(6)

Derivatives Designated as Hedging Instruments:
Forward-starting interest rate swap contracts	Other noncurrent assets	$	19	$	6
Forward-starting interest rate swap contracts	Other noncurrent liabilities	(4)		(17)
Cross-currency interest rate swap contracts	Other current assets	24		2
Cross-currency interest rate swap contracts	Other noncurrent assets	12		5
Cross-currency interest rate swap contracts	Other current liabilities	—		(21)

Fixed-to-floating interest rate swap contracts	Other noncurrent assets	4		11
Total derivatives designated as hedging instruments		55		(14)
Total derivatives		$	52	$	(20)

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The company’s cross-currency interest rate swaps are subject to master netting arrangements to mitigate credit risk by permitting net settlement of transactions with the same counterparty. We may also enter into collateral security arrangements with certain of our counterparties to exchange cash collateral when the net fair value of certain derivative instruments fluctuates from contractually established thresholds. At September 30, 2021, there was $24 million of collateral received related to interest rate swap contracts and cross-currency interest rate swaps recorded in Other noncurrent assets.

We use a market approach in valuing financial instruments on a recurring basis. Our derivative financial instruments are measured at fair value on a recurring basis using Level 2 inputs in the calculation of fair value.

The amounts of net (losses)/gains on derivative instruments not designated as hedging instruments, recorded in Other (income)/deductions—net, are as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Foreign currency forward-exchange contracts	$	(2)	$	—	$	(13)	$	10

These amounts were substantially offset in Other (income)/deductions—net by the effect of changing exchange rates on the underlying foreign currency exposures.

The amounts of unrecognized net gains/(losses) on interest rate swap contracts, recorded, net of tax, in Accumulated other comprehensive income/(loss), are as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Forward-starting interest rate swap contracts	$	1	$	5	$	20	$	(22)
Cross-currency interest rate swap contracts	$	16	$	(30)	$	33	$	(27)

Gains on cross-currency interest rate swap contracts, recognized within Interest expense, net of capitalized interest, are as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Cross-currency interest rate swap contracts	$	3	$	4	$	9	$	14

The net amount of deferred losses related to derivative instruments designated as cash flow hedges that is expected to be reclassified from Accumulated other comprehensive income/(loss) into earnings over the next 12 months is $1 million.

10. Inventories

The components of inventory are as follows:


	September 30,		December 31,
(MILLIONS OF DOLLARS)	2021		2020
Finished goods	$	886	$	805
Work-in-process	675		594
Raw materials and supplies	314		229
Inventories	$	1,875	$	1,628

11. Goodwill and Other Intangible Assets

A. Goodwill

The components of, and changes in, the carrying amount of goodwill are as follows:


(MILLIONS OF DOLLARS)	U.S.		International		Total
Balance, December 31, 2020	$	1,425	$	1,269	$	2,694
Adjustments	(1)		4		3
Other(a)	—		6		6
Balance, September 30, 2021	$	1,424	$	1,279	$	2,703

(a) Includes adjustments for foreign currency translation.

The gross goodwill balance was $3,239 million and $3,230 million as of September 30, 2021 and December 31, 2020, respectively. Accumulated goodwill impairment losses were $536 million as of September 30, 2021 and December 31, 2020.

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B. Other Intangible Assets

The components of identifiable intangible assets are as follows:


	As of September 30, 2021						As of December 31, 2020
					Identifiable						Identifiable
	Gross				Intangible Assets		Gross				Intangible Assets
	Carrying		Accumulated		Less Accumulated		Carrying		Accumulated		Less Accumulated
(MILLIONS OF DOLLARS)	Amount		Amortization		Amortization		Amount		Amortization		Amortization
Finite-lived intangible assets:
Developed technology rights	$	1,981	$	(925)	$	1,056	$	1,968	$	(809)	$	1,159
Brands and tradenames	428		(258)		170		427		(243)		184
Other	476		(329)		147		474		(306)		168
Total finite-lived intangible assets	2,885		(1,512)		1,373		2,869		(1,358)		1,511
Indefinite-lived intangible assets:
Brands and tradenames	104		—		104		104		—		104
In-process research and development	88		—		88		88		—		88
Product rights	7		—		7		7		—		7
Total indefinite-lived intangible assets	199		—		199		199		—		199
Identifiable intangible assets	$	3,084	$	(1,512)	$	1,572	$	3,068	$	(1,358)	$	1,710

C. Amortization

Amortization expense related to finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in Amortization of intangible assets as it benefits multiple business functions. Amortization expense related to finite-lived acquired intangible assets that are associated with a single function is included in Cost of sales, Selling, general and administrative expenses or Research and development expenses, as appropriate. Total amortization expense for finite-lived intangible assets was $51 million and $154 million for the three and nine months ended September 30, 2021, respectively, and $56 million and $178 million for the three and nine months ended September 30, 2020, respectively.

12. Share-based Payments

The Zoetis 2013 Equity and Incentive Plan (the Equity Plan) provides long-term incentives to our employees and non-employee directors. The principal types of share-based awards available under the Equity Plan may include, but are not limited to, stock options, restricted stock and restricted stock units (RSUs), deferred stock units (DSUs), performance-vesting restricted stock units (PSUs) and other equity-based or cash-based awards.

The components of share-based compensation expense are as follows:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(MILLIONS OF DOLLARS)	2021		2020		2021		2020
Stock options / stock appreciation rights	$	2	$	2	$	7	$	7
RSUs / DSUs	8		7		25		24
PSUs	5		5		12		15
Share-based compensation expense—total(a)	$	15	$	14	$	44	$	46

(a) Amounts capitalized to inventory were insignificant for the three and nine months ended September 30, 2021 and 2020.

During the nine months ended September 30, 2021, the company granted 284,198 stock options with a weighted-average exercise price of $160.73 per stock option and a weighted-average fair value of $37.81 per stock option. The fair-value based method for valuing each Zoetis stock option grant on the grant date uses the Black-Scholes-Merton option-pricing model, which incorporates a number of valuation assumptions. The weighted-average fair value was estimated based on the following assumptions: risk-free interest rate of 0.53%; expected dividend yield of 0.62%; expected stock price volatility of 27.94%; and expected term of 5.0 years. In general, stock options vest after three years of continuous service and the values determined through this fair-value based method generally are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.

During the nine months ended September 30, 2021, the company granted 257,293 RSUs, with a weighted-average grant date fair value of $163.62 per RSU. RSUs are accounted for using a fair-value-based method that utilizes the closing price of Zoetis common stock on the date of grant. In general, RSUs vest after three years of continuous service from the grant date and the values generally are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.

During the nine months ended September 30, 2021, the company granted 103,759 PSUs with a weighted-average grant date fair value of $208.81 per PSU. PSUs are accounted for using a Monte Carlo simulation model. The units underlying the PSUs will be earned and vested over a three-year performance period, based upon the total shareholder return of the company in comparison to the total shareholder return of the companies comprising the S&P 500 stock market index at the start of the performance period, excluding companies that during the performance period are acquired or no longer publicly traded (Relative TSR). The weighted-average fair value was estimated based on volatility assumptions of Zoetis common stock and an average of the S&P 500 companies, which were 28.9% and 38.1%, respectively. Depending on the company’s Relative TSR performance at the end of the performance period, the recipient may earn from 0% to 200% of the target number of units. Vested units are settled in

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shares of the company’s common stock. PSU values are amortized on a straight-line basis over the vesting term into Cost of sales, Selling, general and administrative expenses, or Research and development expenses, as appropriate.

13. Stockholders' Equity

Zoetis is authorized to issue 6 billion shares of common stock and 1 billion shares of preferred stock.

In December 2018, the company's Board of Directors authorized a $2.0 billion share repurchase program. As of September 30, 2021, there was approximately $879 million remaining under this authorization. Purchases of Zoetis shares may be made at the discretion of management, depending on market conditions and business needs. 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.

Accumulated other comprehensive loss

Changes, net of tax, in accumulated other comprehensive loss, were as follows:



			Currency Translation Adjustments
					Other Currency				Accumulated Other
	Cash Flow		Net Investment		Translation				Comprehensive
(MILLIONS OF DOLLARS)	Hedges		Hedges		Adjustments		Benefit Plans		Loss
Balance, December 31, 2020	$	(15)	$	(37)	$	(655)	$	(23)	$	(730)
Other comprehensive income, net of tax	21		33		9		—		63

Balance, September 30, 2021	$	6	$	(4)	$	(646)	$	(23)	$	(667)

Balance, December 31, 2019	$	—	$	21	$	(724)	$	(23)	$	(726)
Other comprehensive (loss)/income, net of tax	(27)		(27)		46		(1)		(9)

Balance, September 30, 2020	$	(27)	$	(6)	$	(678)	$	(24)	$	(735)

14. Earnings per Share

The following table presents the calculation of basic and diluted earnings per share:


		Three Months Ended						Nine Months Ended
(MILLIONS OF DOLLARS AND SHARES, EXCEPT PER SHARE DATA)		September 30,						September 30,
	2021			2020			2021			2020
Numerator
Net income before allocation to noncontrolling interests		$	552		$	479		$	1,621		$	1,278
Less: Net loss attributable to noncontrolling interests		—			—			(2)			(1)
Net income attributable to Zoetis Inc.		$	552		$	479		$	1,623		$	1,279
Denominator
Weighted-average common shares outstanding		474.0			475.5			474.8			475.5
Common stock equivalents: stock options, RSUs, PSUs and DSUs		2.3			3.0			2.3			3.0
Weighted-average common and potential dilutive shares outstanding		476.3			478.5			477.1			478.5

Earnings per share attributable to Zoetis Inc. stockholders—basic		$	1.16		$	1.01		$	3.42		$	2.69
Earnings per share attributable to Zoetis Inc. stockholders—diluted		$	1.16		$	1.00		$	3.40		$	2.67

The number of stock options outstanding under the company's Equity Plan that were excluded from the computation of diluted earnings per share, as the effect would have been antidilutive, were de minimis for the three and nine months ended September 30, 2021 and 2020.

15. Commitments and Contingencies

We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business. For a discussion of our tax contingencies, see Note 8. Income Taxes.

A. Legal Proceedings

Our non-tax contingencies include, among others, the following:

Product liability and other product-related litigation, which can include injury, consumer, off-label promotion, antitrust and breach of contract claims.
Commercial and other matters, which can include product-pricing claims and environmental claims and proceedings.
Patent litigation, which typically involves challenges to the coverage and/or validity of our patents or those of third parties on various products or processes.
Government investigations, which can involve regulation by national, state and local government agencies in the U.S. and in other countries.

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Certain of these contingencies could result in losses, including damages, fines and/or civil penalties, and/or criminal charges, which could be substantial.

We believe that we have strong defenses in these types of matters, but litigation is inherently unpredictable and excessive verdicts do occur. We do not believe that any of these matters will have a material adverse effect on our financial position. However, we could incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations or cash flows in the period in which the amounts are paid.

We have accrued for losses that are both probable and reasonably estimable. Substantially all of these contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. Consequently, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but the assessment process relies on estimates and assumptions that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions.

Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely on estimates and assumptions.

The principal matters to which we are a party are discussed below. In determining whether a pending matter is significant for financial reporting and disclosure purposes, we consider both quantitative and qualitative factors in order to assess materiality, such as, among other things, the amount of damages and the nature of any other relief sought in the proceeding, if such damages and other relief are specified; our view of the merits of the claims and of the strength of our defenses; whether the action purports to be a class action and our view of the likelihood that a class will be certified by the court; the jurisdiction in which the proceeding is pending; any experience that we or, to our knowledge, other companies have had in similar proceedings; whether disclosure of the action would be important to a reader of our financial statements, including whether disclosure might change a reader’s judgment about our financial statements in light of all of the information about the company that is available to the reader; the potential impact of the proceeding on our reputation; and the extent of public interest in the matter. In addition, with respect to patent matters, we consider, among other things, the financial significance of the product protected by the patent.

Ulianopolis, Brazil

In February 2012, the Municipality of Ulianopolis (State of Para, Brazil) filed a complaint against Fort Dodge Saúde Animal Ltda. (FDSAL), a Zoetis entity, and five other large companies alleging that waste sent to a local waste incineration facility for destruction, but that was not ultimately destroyed as the facility lost its operating permit, caused environmental impacts requiring cleanup.

The Municipality is seeking recovery of cleanup costs purportedly related to FDSAL's share of all waste accumulated at the incineration facility awaiting destruction, and compensatory damages to be allocated among the six defendants. We believe we have strong arguments against the claim, including defense strategies against any claim of joint and several liability.

At the request of the Municipal prosecutor, in April 2012, the lawsuit was suspended for one year. Since that time, the prosecutor has initiated investigations into the Municipality's actions in the matter as well as the efforts undertaken by the six defendants to remove and dispose of their individual waste from the incineration facility. On October 3, 2014, the Municipal prosecutor announced that the investigation remained ongoing and outlined the terms of a proposed Term of Reference (a document that establishes the minimum elements to be addressed in the preparation of an Environmental Impact Assessment), under which the companies would be liable to withdraw the waste and remediate the area.

On March 5, 2015, we presented our response to the prosecutor’s proposed Term of Reference, arguing that the proposed terms were overly general in nature and expressing our interest in discussing alternatives to address the matter. The prosecutor agreed to consider our request to engage a technical consultant to conduct an environmental diagnostic of the contaminated area. On May 29, 2015, we, in conjunction with the other defendant companies, submitted a draft cooperation agreement to the prosecutor, which outlined the proposed terms and conditions for the engagement of a technical consultant to conduct the environmental diagnostic. On August 19, 2016, the parties and the prosecutor agreed to engage the services of a third-party consultant to conduct a limited environmental assessment of the site. The site assessment was conducted during June 2017, and a written report summarizing the results of the assessment was provided to the parties and the prosecutor in November 2017. The report noted that waste is still present on the site and that further (Phase II) environmental assessments are needed before a plan to manage that remaining waste can be prepared. On April 1, 2019, the defendants met with the Prosecutor to discuss the conclusions set forth in the written report. Following that discussion, on April 10, 2019, the Prosecutor issued a procedural order requesting that the defendants prepare and submit a technical proposal outlining the steps needed to conduct the additional Phase II environmental assessments. The defendants presented the technical proposal to the Prosecutor on October 21, 2019. On March 3, 2020, the Prosecutor notified the defendants that he submitted the proposal to the Ministry of the Environment for its review and consideration by the Prosecutor. On July 15, 2020, the Prosecutor recommended certain amendments to the proposal for the Phase II testing. On September 28, 2020, the parties and the Prosecutor agreed to the final terms and conditions concerning the cooperation agreement with respect to the Phase II testing. We anticipate that the Phase II testing will begin in the latter part of 2021 or in 2022.

Lascadoil Contamination in Animal Feed

An investigation by the U.S. Food and Drug Administration (FDA) and the Michigan Department of Agriculture into the alleged contamination of the feed supply of certain turkey and hog feed mills in Michigan led to the recall of certain batches of soy oil (intended for use as an animal feed additive) that had originated with Shur-Green Farms LLC, a producer of soy oil, and that had been contaminated with lascadoil, an industrial by-product of certain Zoetis manufacturing processes. The contaminated feed is believed to have caused the deaths of approximately 50,000 turkeys and the contamination (but not death) of at least 20,000 hogs in August 2014. The investigation posited that Shur-Green inadvertently contaminated soy oil with lascadoil which it purchased from Zoetis for use as a bio-fuel ingredient, and then sold the contaminated soy oil to fat recycling vendors, who in turn unknowingly sold to feed mills for use in animal feed.

During the course of its investigation, the FDA identified the process used to manufacture Zoetis’ Avatec® (lasalocid sodium) and Bovatec® (lasalocid sodium) products as the possible source of the lascadoil, since lascadoil contains small amounts of lasalocid, the active ingredient found in both products. Zoetis sold the industrial lascadoil byproduct to Shur-Green, through its broker, Heritage Interactive Services, LLC. Under the terms

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of the sale agreement, the lascadoil could only be incinerated or resold for use in biofuel and the agreement expressly prohibited the reselling of lascadoil for use as a component in food. The FDA inspected the Zoetis site where Avatec and Bovatec are manufactured, and found no evidence that Zoetis was involved in the contamination of the animal feed.

On March 10, 2015, plaintiffs Restaurant Recycling, LLC (Restaurant Recycling) and Superior Feed Ingredients, LLC (Superior), both of whom are in the fat recycling business, filed a complaint in the Seventeenth Circuit Court for the State of Michigan against Shur-Green Farms alleging negligence and breach of warranty claims arising from their purchase of soy oil allegedly contaminated with lascadoil. Plaintiffs resold the allegedly contaminated soy oil to turkey feed mills for use in feed ingredient. Plaintiffs also named Zoetis as a defendant in the complaint alleging that Zoetis failed to properly manufacture its products and breached an implied warranty that the soy oil was fit for use at turkey and hog mills. Zoetis was served with the complaint on June 3, 2015, and we filed our answer, denying all allegations, on July 15, 2015. On August 10, 2015, several of the turkey feed mills filed a joint complaint against Restaurant Recycling, Superior, Shur-Green Farms and others, alleging claims for negligence, misrepresentation, and breach of warranty, arising out of their alleged purchase and use of the contaminated soy oil. The complaint raises only one count against Zoetis for negligence. We filed an answer to the complaint on November 2, 2015, denying the allegation. On May 16, 2016, two additional turkey producers filed a complaint in the Seventeenth Circuit Court for the State of Michigan against the company, Restaurant Recycling, Superior, Shur-Green Farms and others, alleging claims for negligence and breach of warranties. We filed an answer to the complaint on June 20, 2016, denying the allegations. The Court has consolidated all three cases in Michigan for purposes of discovery and disposition. On July 28, 2017, we filed a motion for summary disposition on the grounds that no genuine issues of material fact exist and that Zoetis is entitled to judgment as a matter of law. On October 19, 2017, the Court granted our motion and dismissed all claims against Zoetis. On October 31, 2017, the plaintiffs filed motions for reconsideration of the Court's decision granting summary disposition. The Court, denied all such motions on December 6, 2017, for the same reasons cited in the Court’s original decision. On December 27, 2017, the plaintiffs filed a request with the Michigan Court of Appeals seeking an interlocutory (or interim) appeal of the lower Court’s decision, which we opposed on January 17, 2018. On July 5, 2018, the Court of Appeals denied the plaintiffs’ request for an interlocutory appeal. The case was remanded back to the lower Court, where it was scheduled to proceed to trial by jury. We have been advised that the remaining parties have reached an agreement to settle the dispute, and on June 24, 2020, the remaining parties jointly stipulated to the dismissal of all remaining claims. On July 13, 2020, Plaintiffs filed a claim of appeal with Michigan State Circuit Court seeking reversal of the lower Court’s decision granting Zoetis’ motion for summary disposition. Plaintiffs’ filed their appeal brief on October 29, 2020, and we filed our reply brief on December 3, 2020. This appeal remains pending before the Circuit Court.

Belgium Excess Profit Tax Regime

On February 14, 2019, the General Court of the European Union (General Court) annulled the January 11, 2016 decision of the European Commission (EC) that selective tax advantages granted by Belgium under its "excess profit" tax scheme constitute illegal state aid. As a result of the 2016 decision, the company recorded a net tax charge of approximately $35 million in the first half of 2016. On May 8, 2019, the EC filed an appeal to the decision of the General Court. On September 16, 2019, the EC opened separate in-depth investigations to assess whether Belgium excess profit rulings granted to 39 multinational companies, including Zoetis, constituted state aid for those companies. On September 16, 2021, the European Court of Justice upheld the EC’s decision that the Belgium excess profit ruling system is considered an aid scheme and referred the case back to the General Court to rule on open questions. The company has not reflected any potential benefits in its consolidated financial statements as of September 30, 2021 as a result of the 2019 annulment. We will continue to monitor the developments of the appeal and its ultimate resolution.

Alpharma

The EC published a decision on alleged competition law infringements by several human health pharmaceutical companies on June 19, 2013. One of the involved legal entities is Alpharma LLC (previously having the name Zoetis Products LLC). Alpharma LLC's involvement is solely related to its human health activities prior to Pfizer's acquisition of King/Alpharma. Zoetis paid a fine in the amount of euro 11 million (approximately $14 million) and was reimbursed in full by Pfizer in accordance with the Global Separation Agreement between Pfizer and Zoetis, which provides that Pfizer is obligated to indemnify Zoetis for any liabilities arising out of claims not related to its animal health assets. We filed an appeal of the decision on September 6, 2013, to the General Court of the European Union. On September 8, 2016, the General Court upheld the decision of the European Commission. On November 25, 2016, we filed an appeal to the Court of Justice of the European Union. On January 24, 2019, the Court heard oral argument on the merits of the appeal. On June 4, 2020, the Advocate General issued his non-binding opinion, which largely confirmed the decision of the General Court. On March 25, 2021, the Court of Justice affirmed the decision of the General Court. Since the penalty has already been paid, no further action is needed, and the proceedings involving the EC are now concluded.

We anticipate that claims from publicly-funded healthcare systems and health insurance companies seeking compensation for losses allegedly resulting from the competition-infringement finding will be filed before the Competition Appeal Tribunal as follow-on claims. We anticipate that proceedings involving such claims will commence later this year or early January 2022. In accordance with the Global Separation Agreement, Pfizer would be obligated to indemnify Zoetis for any liabilities arising out of such follow-on claims.

B. Guarantees and Indemnifications

In the ordinary course of business and in connection with the sale of assets and businesses, we indemnify our counterparties against certain liabilities that may arise in connection with the transaction or related to activities prior to the transaction. These indemnifications typically pertain to environmental, tax, employee and/or product-related matters and patent-infringement claims. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we would be required to reimburse the loss. These indemnifications are generally subject to threshold amounts, specified claim periods and other restrictions and limitations. Historically, we have not paid significant amounts under these provisions and, as of September 30, 2021, recorded amounts for the estimated fair value of these indemnifications were not significant.

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16. Segment Information

Operating Segments

We manage our operations through two geographic operating segments: the U.S. and International. Each operating segment has responsibility for its commercial activities. Within each of these operating segments, we offer a diversified product portfolio, including vaccines, parasiticides, anti-infectives, dermatology, medicated feed additives, animal health diagnostics and other pharmaceuticals, for both companion animal and livestock customers. Our chief operating decision maker uses the revenue and earnings of the two operating segments, among other factors, for performance evaluation and resource allocation.

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.

Other Costs and Business Activities

Certain costs are not allocated to our operating segment results, such as costs associated with the following:

Other business activities, includes our Client Supply Services (CSS) contract manufacturing results, our human health business, and expenses associated with our dedicated veterinary medicine research and development organization, research alliances, U.S. regulatory affairs and other operations focused on the development of our products. Other R&D-related costs associated with non-U.S. market and regulatory activities are generally included in the international commercial segment.
Corporate, includes platform functions such as information technology, facilities, legal, finance, human resources, business development, certain diagnostic costs and communications, among others. These costs also include compensation costs and other miscellaneous operating expenses not charged to our operating segments, as well as interest income and expense.
Certain transactions and events such as (i) Purchase accounting adjustments, where we incur expenses associated with the amortization of fair value adjustments to inventory, intangible assets and property, plant and equipment; (ii) Acquisition-related activities, where we incur costs associated with acquiring and integrating newly acquired businesses, such as transaction costs and integration costs; and (iii) Certain significant items, which comprise substantive, unusual items that, either as a result of their nature or size, would not be expected to occur as part of our normal business on a regular basis, such as restructuring charges and implementation costs associated with our cost-reduction/productivity initiatives that are not associated with an acquisition, certain asset impairment charges, certain legal and commercial settlements and the impact of divestiture-related gains and losses.
Other unallocated includes (i) certain overhead expenses associated with our global manufacturing operations not charged to our operating segments; (ii) certain costs associated with finance that specifically support our global manufacturing operations; (iii) certain supply chain and global logistics costs; and (iv) procurement costs.

Segment Assets

We manage our assets on a total company basis, not by operating segment. Therefore, our chief operating decision maker does not regularly review any asset information by operating segment and, accordingly, we do not report asset information by operating segment.

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Selected Statement of Income Information


	Earnings						Depreciation and Amortization(a)
	Three Months Ended						Three Months Ended
	September 30,						September 30,
(MILLIONS OF DOLLARS)	2021			2020			2021		2020
U.S.
Revenue	$	1,065		$	996
Cost of sales	199			194
Gross profit	866			802
Gross margin	81.3		%	80.5		%
Operating expenses	183			157
Other (income)/deductions-net	—			—
U.S. Earnings	683			645			$	13	$	15

International
Revenue(b)	904			767
Cost of sales	273			245
Gross profit	631			522
Gross margin	69.8		%	68.1		%
Operating expenses	152			122
Other (income)/deductions-net	(4)			—
International Earnings	483			400			17		15

Total operating segments	1,166			1,045			30		30

Other business activities	(106)			(87)			6		6
Reconciling Items:
Corporate	(252)			(222)			29		27
Purchase accounting adjustments	(45)			(48)			45		48
Acquisition-related costs	(1)			(1)			—		—
Certain significant items(c)	(12)			(9)			—		—
Other unallocated	(91)			(81)			—		—
Total Earnings(d)	$	659		$	597		$	110	$	111

(a) Certain production facilities are shared. Depreciation and amortization is allocated to the reportable operating segments based on estimates of where the benefits of the related assets are realized.

(b) Revenue denominated in euros was $204 million and $186 million for the three months ended September 30, 2021 and 2020, respectively.

(c) For the three months ended September 30, 2021, primarily represents employee termination costs associated with the realignment of our international operations and asset impairment charges related to a dairy product termination.

For the three months ended September 30, 2020, primarily represents CEO transition-related costs of $5 million.

(d) Defined as income before provision for taxes on income.

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	Earnings						Depreciation and Amortization(a)
	Nine Months Ended						Nine Months Ended
	September 30,						September 30,
(MILLIONS OF DOLLARS)	2021			2020			2021		2020
U.S.
Revenue	$	3,002		$	2,605
Cost of sales	575			515
Gross profit	2,427			2,090
Gross margin	80.8		%	80.2		%
Operating expenses	484			418
Other (income)/deductions-net	2			4
U.S. Earnings	1,941			1,668			$	40	$	40

International
Revenue(b)	2,750			2,203
Cost of sales	833			697
Gross profit	1,917			1,506
Gross margin	69.7		%	68.4		%
Operating expenses	429			364
Other (income)/deductions-net	(4)			1
International Earnings	1,492			1,141			52		41

Total operating segments	3,433			2,809			92		81

Other business activities	(301)			(264)			20		19
Reconciling Items:
Corporate	(744)			(603)			84		75
Purchase accounting adjustments	(133)			(155)			133		155
Acquisition-related costs	(8)			(15)			—		—
Certain significant items(c)	(44)			(4)			—		—
Other unallocated	(221)			(192)			2		2
Total Earnings(d)	$	1,982		$	1,576		$	331	$	332

(b) Revenue denominated in euros was $605 million and $517 million for the nine months ended September 30, 2021 and 2020, respectively.

(c) For the nine months ended September 30, 2021, primarily represents primarily represents asset impairment charges related to the consolidation of manufacturing sites in China and a dairy product termination, as well as employee termination costs associated with our international operations and other costs associated with cost-reduction and productivity initiatives.

(d) Defined as income before provision for taxes on income.

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Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors

Zoetis Inc.:

Results of Review of Interim Financial Information

We have reviewed the condensed consolidated balance sheet of Zoetis Inc. and subsidiaries (the Company) as of September 30, 2021, the related condensed consolidated statements of income, comprehensive income, and equity for the three-month and nine-month periods ended September 30, 2021 and 2020, the related condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2021 and 2020, and the related notes (collectively, the consolidated interim financial information). Based on our reviews, we are not aware of any material modifications that should be made to the consolidated interim financial information for it to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2020, and the related consolidated statements of income, comprehensive income, equity, and cash flows for the year then ended (not presented herein); and in our report dated February 16, 2021, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2020, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

This consolidated interim financial information is the responsibility of the Company’s management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our reviews in accordance with the standards of the PCAOB. A review of consolidated interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

/s/ KPMG LLP

Short Hills, New Jersey

November 4, 2021

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