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Zoetis Inc. · IPO:  424B4 · On 2/1/13

Filed On 2/1/13, 9:32pm ET   ·   Accession Number 1193125-13-35094   ·   SEC File 333-183254

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  As Of                Filer                Filing    For/On/As Docs:Size              Issuer               Agent

 2/04/13  Zoetis Inc.                       424B4       2/01/13    1:5.1M                                   RR Donnelley/FA

Initial Public Offering (IPO):  Prospectus   —   Rule 424(b)(4)
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 424B4       Final Prospectus                                    HTML   2.69M 


Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Table of Contents
"Summary
"Risk factors
"Cautionary statement concerning forward-looking statements
"Use of proceeds
"Dividend policy
"Dilution
"Capitalization
"Selected historical combined financial data
"Unaudited pro forma condensed combined financial statements
"The Separation and Distribution transactions
"Management's discussion and analysis of financial condition and results of operations
"Industry
"Business
"Management
"Principal and selling stockholder
"Certain relationships and related party transactions
"Description of certain indebtedness
"Description of capital stock
"Shares eligible for future sale
"Material United States federal income and estate tax consequences to non-U.S. holders
"Underwriting (Conflicts of interest)
"Legal matters
"Experts
"Where you can find more information
"Index to financial statements
"Report of Independent Registered Public Accounting Firm
"Combined Statements of Operations for the Years Ended December 31, 2011, 2010 and 2009
"Combined Statements of Comprehensive Income/(Loss) for the Years Ended December 31, 2011, 2010 and 2009
"Combined Balance Sheets as of December 31, 2011 and 2010
"Combined Statements of Equity for the Years Ended December 31, 2011, 2010 and 2009
"Combined Statements of Cash Flows for the Years Ended December 31, 2011, 2010 and 2009
"Notes to Combined Financial Statements
"Review Report of Independent Registered Public Accounting Firm
"Unaudited Condensed Combined Statements of Operations for the Nine Months Ended September 30, 2012 and October 2, 2011
"Unaudited Condensed Combined Statements of Comprehensive Income for the Nine Months Ended September 30, 2012 and October 2, 2011
"Unaudited Condensed Combined Balance Sheets as of September 30, 2012 and December 31, 2011
"Unaudited Condensed Combined Statements of Equity for the Nine Months Ended September 30, 2012 and October 2, 2011
"Unaudited Condensed Combined Statements of Cash Flows for the Nine Months Ended September 30, 2012 and October 2, 2011
"Notes to Unaudited Condensed Combined Financial Statements

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  Final Prospectus  
Table of Contents

Filed pursuant to Rule 424(b)(4)
Registration No. 333-183254

Prospectus

 

LOGO

86,100,000 Shares

Zoetis Inc.

Class A common stock

 

 

This is the initial public offering of Class A common stock of Zoetis Inc. All of our shares of common stock are currently held by Pfizer Inc.

In connection with this offering, Pfizer will exchange shares of our Class A common stock for indebtedness of Pfizer held by certain of the underwriters, which we refer to, in such role, as the “debt-for-equity exchange parties.” The debt-for-equity exchange parties will then sell these shares pursuant to this offering. As a result, the debt-for-equity exchange parties, and not Pfizer or Zoetis, will receive the net proceeds from the sale of the shares in this offering. Prior to this offering, there has been no public market for our Class A common stock. Our Class A common stock has been approved for listing on the New York Stock Exchange, or NYSE, under the symbol “ZTS.” The initial public offering price is $26.00 per share of Class A common stock.

In connection with this offering, we will have two classes of authorized common stock: Class A common stock and Class B common stock. The rights of the holders of Class A common stock and Class B common stock will be identical, except with respect to voting and conversion rights. The holders of Class A common stock and Class B common stock will each be entitled to one vote per share for all matters submitted to a vote of stockholders other than with respect to the election of directors. With respect to the election of directors, the holders of Class B common stock will be entitled to ten votes per share, and the holders of Class A common stock will be entitled to one vote per share. Each share of Class B common stock held by Pfizer or one of its subsidiaries will be convertible into one share of Class A common stock at any time but will not be convertible if held by any other holder.

Investing in our Class A common stock involves a high degree of risk. See “Risk factors” beginning on page 16.

 

     Per share      Total  

Initial public offering price

   $ 26.00       $ 2,238,600,000   

Underwriting discounts and commissions

   $ 0.962       $ 82,828,200   

Proceeds to the debt-for-equity exchange parties, before expenses(1)

   $ 25.038       $ 2,155,771,800   

 

  (1) We and Pfizer have agreed to reimburse the underwriters for certain FINRA-related expenses. See “Underwriting.”

The debt-for-equity exchange parties have granted the underwriters an option for a period of 30 days to purchase from them up to 12,915,000 additional shares of Class A common stock. The debt-for-equity exchange parties, and not Pfizer or Zoetis, will receive the net proceeds from any shares of Class A common stock sold pursuant to this option to purchase additional shares.

Delivery of the shares of Class A common stock will be made on or about February 6, 2013 through the book-entry facilities of The Depository Trust Company.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

J.P. Morgan   BofA Merrill Lynch   Morgan Stanley

 

Barclays   Citigroup   Credit Suisse   Deutsche Bank Securities   Goldman, Sachs & Co.   Guggenheim Securities   Jefferies

 

BNP PARIBAS   HSBC   Loop Capital Markets   RBC Capital Markets   The Williams Capital Group, L.P.   UBS Investment Bank
Lebenthal Capital Markets   Piper Jaffray   Ramirez & Co., Inc.

 

January 31, 2013


Table of Contents

LOGO


Table of Contents

Table of contents

 

Summary

     1   

Risk factors

     16   

Cautionary statement concerning forward-looking statements

     42   

Use of proceeds

     43   

Dividend policy

     44   

Dilution

     45   

Capitalization

     46   

Selected historical combined financial data

     47   

Unaudited pro forma condensed combined financial statements

     49   

The Separation and Distribution transactions

     58   

Management’s discussion and analysis of financial condition and results of operations

     60   

Industry

     96   

Business

     102   

Management

     124   

Principal and selling stockholder

     152   

Certain relationships and related party transactions

     153   

Description of certain indebtedness

     166   

Description of capital stock

     168   

Shares eligible for future sale

     177   

Material United States federal income and estate tax consequences to non-U.S. holders

     179   

Underwriting (Conflicts of interest)

     182   

Legal matters

     190   

Experts

     190   

Where you can find more information

     190   

Index to financial statements

     F-1   

 

 

Zoetis Inc., Pfizer Inc., the debt-for-equity exchange parties and the underwriters have not authorized anyone to provide any information other than that contained or incorporated by reference in this prospectus or in any free writing prospectus prepared by or on behalf of Zoetis Inc. None of Zoetis Inc., Pfizer Inc., the debt-for-equity exchange parties or the underwriters are making an offer to sell these securities in any jurisdiction where the offer or sale thereof is not permitted. Zoetis Inc., Pfizer Inc., the debt-for-equity exchange parties and the underwriters take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. The information contained in this prospectus is accurate only as of the date of this prospectus.

 

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Unless the context requires otherwise: (a) references to “Zoetis,” our “company,” “we,” “us” or “our” refer to Zoetis Inc., a Delaware corporation, and its subsidiaries after giving effect to the transactions described under “The Separation and Distribution transactions—The Separation;” and (b) references to “Pfizer” refer to Pfizer Inc., a Delaware corporation, and its subsidiaries other than Zoetis and Zoetis’s subsidiaries. Accordingly, unless the context requires otherwise, statements relating to our history in this prospectus describe the history of Pfizer’s animal health business unit.

Currency amounts in this prospectus are stated in United States dollars, unless otherwise indicated.

 

 

Unless otherwise indicated, information contained in this prospectus concerning our industry and the markets in which we operate, including our general expectations and market position, market opportunity and market share, is based on information from Vetnosis Limited, or Vetnosis, a research and consulting firm specializing in global animal health and veterinary medicine, and management estimates. Vetnosis is a leading provider of research products, commercial information and analysis of the global animal health sector. The information from Vetnosis contained in this prospectus was not prepared by Vetnosis on our behalf. Management estimates are derived from publicly available information, our knowledge of our industry and assumptions based on such information and knowledge, which we believe to be reasonable. Our management estimates have not been verified by any independent source, and we have not independently verified any third-party information. In addition, assumptions and estimates of our and our industry’s future performance are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk factors.” These and other factors could cause future performance to differ materially from our assumptions and estimates. See “Cautionary statement concerning forward-looking statements.”

 

 

The name and mark, Pfizer, and other trademarks, trade names and service marks of Pfizer appearing in this prospectus are the property of Pfizer. Prior to the completion of this offering, Zoetis and other trademarks, trade names and service marks of Zoetis appearing in this prospectus are the property of Pfizer, and after the completion of this offering, Zoetis and other trademarks, trade names and service marks of Zoetis appearing in this prospectus will be the property of Zoetis. This prospectus also contains additional trade names, trademarks and service marks belonging to Pfizer and to other companies. We do not intend our use or display of other parties’ trademarks, trade names or service marks to imply, and such use or display should not be construed to imply, a relationship with, or endorsement or sponsorship of us by, these other parties.

 

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Summary

This summary highlights information included elsewhere in this prospectus and does not contain all of the information you should consider in making an investment decision. You should read this entire prospectus carefully, including the sections entitled “Risk factors,” “Cautionary statement concerning forward-looking statements,” “Selected historical combined financial data,” “Unaudited pro forma condensed combined financial statements” and “Management’s discussion and analysis of financial condition and results of operations” and our combined financial statements and the notes thereto before making an investment decision regarding our Class A common stock.

Our company

Zoetis is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. For more than 60 years, as a business unit of Pfizer, we have been committed to enhancing the health of animals and bringing solutions to our customers who raise and care for them. Measured by our revenues of $4.2 billion for the year ended December 31, 2011, we are the largest animal health medicines and vaccines business, with our products sold in more than 120 countries and across eight core species and five major product categories.

With our sales organization of approximately 3,400 employees, we directly market our portfolio of more than 300 product lines to livestock producers and veterinarians located in approximately 70 countries across North America, Europe, Africa, Asia, Australia and Latin America, and are a market leader in nearly all of the major regions in which we operate. Through our efforts to establish an early and direct presence in many emerging markets, such as Brazil, China and India, emerging markets contributed 27% of our revenues for the year ended December 31, 2011, which we believe makes us the largest animal health medicines and vaccines business as measured by revenues 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 the industry’s largest sales organization, which includes an 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, lead to enduring and valued relationships with our customers. From 2004 to 2011, we obtained approximately one-fourth of all animal health medicine approvals granted by the U.S. Food and Drug Administration, or FDA, and approximately one-fifth of all animal health vaccine approvals granted by the U.S. Department of Agriculture, or USDA. The majority of our research and development, or R&D, programs focus on brand lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations.

We believe our ability to successfully position our diverse portfolio of products with high brand recognition in attractive markets and execute our operating plan has contributed to our financial performance over the last several years. For the nine months ended September 30, 2012, our revenues were $3.2 billion, reflecting growth of 2% compared to the nine months ended October 2, 2011. For the years ended December 31, 2011 and 2010, our revenues were $4.2 billion and $3.6 billion, reflecting growth of 18% and 30% compared to the prior year periods.

As a result of the impact of recent significant acquisitions and related government-mandated divestitures on the revenue numbers in our statement of operations, during the nine months ended September 30, 2012 and October 2, 2011 and the years ended December 31, 2011, 2010 and 2009, the growth trend on our existing portfolio from year to year is not readily apparent. We believe that it is not only important to understand overall revenue growth, but also existing portfolio growth year over year. As such, we utilize “base revenue growth.” Base revenue growth is defined as revenue growth excluding the impact of incremental revenues from recent

 

 

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significant acquisitions, government-mandated divestitures and foreign exchange. Our base revenue growth was 5% in the nine months ended September 30, 2012, 7% in 2011 and 7% in 2010 compared to the prior year periods. For a more complete description of base revenue growth, see “Management’s discussion and analysis of financial condition and results of operations—Analysis of the combined statements of operations.”

For the nine months ended September 30, 2012, our Adjusted net income (a non-GAAP financial measure) was $482 million, reflecting growth of 27% compared to the nine months ended October 2, 2011. In 2011 and 2010, our Adjusted net income was $503 million and $275 million, reflecting growth of 83% and 46% compared to the prior year periods. For the nine months ended September 30, 2012, our net income attributable to Zoetis was $446 million, reflecting growth of 89% compared to the nine months ended October 2, 2011. In 2011 and 2010, our net income attributable to Zoetis was $245 million and $110 million, reflecting growth of 123% and 210% compared to the prior year periods. For a reconciliation of Adjusted net income to net income attributable to Zoetis, see “Management’s discussion and analysis of financial condition and results of operations—Adjusted net income.”

Our leadership in animal health medicines and vaccines extends across both livestock and companion animals. The primary livestock species are cattle (both beef and dairy), swine, poultry, sheep and fish, and the primary companion animal species are dogs, cats and horses. Our livestock products primarily prevent or treat conditions in livestock, enabling the cost-effective production of safe, high-quality animal protein, whereas our companion animal products improve the quality of and extend the life of pets and increase convenience and compliance for pet owners. Livestock and companion animal products represented approximately 66% and 34% of our revenues, respectively, for the year ended December 31, 2011.

Our more than 300 product lines include vaccines, parasiticides, anti-infectives, medicinal feed additives and other pharmaceutical products. Our product portfolio is enhanced by complementary businesses, including diagnostics, genetics, devices and services such as dairy data management, e-learning and professional consulting.

Animal health industry

The animal health industry, which focuses on both livestock and companion animals, is a growing industry that impacts billions of people worldwide. Broadly defined, as measured by revenues, the approximately $100 billion animal health industry includes all products and services, other than livestock feed and pet food, that promote livestock productivity and health and companion animal health, such as medicines and vaccines, diagnostics, medical devices, pet supplies, nutritional supplements, veterinary services and other related services.

Within this broad market, medicines and vaccines, our core area of operation, represented a global market of $22 billion, as measured by 2011 revenues, grew at a compound annual growth rate, or CAGR, of 6% between 2006 and 2011 and, excluding the impact of foreign exchange, is projected to grow at a CAGR of 6% per year between 2011 and 2016, according to Vetnosis, a research and consulting firm specializing in global animal health and veterinary medicine.

The livestock medicines and vaccines sector represented $13.1 billion of sales in 2011, or 60% of the total animal health medicines and vaccines market. This sector grew at a CAGR of 7% between 2006 and 2011 and, excluding the impact of foreign exchange, is projected to grow at a CAGR of 6% per year between 2011 and 2016, according to Vetnosis.

Growth in the livestock medicines and vaccines sector is driven by human population growth and increasing standards of living, consequently increasing demand for improved nutrition, particularly animal protein, increasing natural resource constraints driving a need for enhanced productivity, and increased focus on food safety. Livestock health and production are essential to meeting the growing demand for animal protein of a

 

 

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global population that is increasing in size and standard of living, particularly in many emerging markets. As part of the global ecosystem, livestock health is critical to assuring a safe, sustainable global food supply and reducing the outbreak of infectious disease in both humans and animals.

The cost to livestock producers of animal health medicines and vaccines is small relative to other livestock production costs, including feed, and these products help protect producers’ investments by treating and preventing diseases in herds and flocks before they become widespread, thus improving economic outcomes for producers. As a result, demand for animal health medicines and vaccines has typically been more stable than demand for other production inputs.

The companion animal medicines and vaccines sector represented $8.9 billion of sales in 2011, or 40% of the total animal health medicines and vaccines market. This sector grew at a CAGR of 6% between 2006 and 2011 and, excluding the impact of foreign exchange, is projected to grow at a CAGR of 5% per year between 2011 and 2016, according to Vetnosis.

Growth in the companion animal medicines and vaccines sector is driven by economic development and related increases in disposable income, increasing pet ownership, companion animals living longer, increasing medical treatment of companion animals and advances in animal health medicines and vaccines. Industry sources indicate that companion animals improve the physical and emotional well-being of pet owners. Pet ownership and spending per pet are increasing globally, and industry sources report that pet owners indicate a preference for reducing spending on other aspects of their lifestyle, including entertainment, clothing and household goods, before reducing spending on petcare.

Animal health distinctions from human health

The business of developing and marketing animal health medicines and vaccines shares a number of characteristics with the business of developing and marketing medicines and vaccines for human health. These similarities include complex and regulated product manufacturing, products that must be proven efficacious and safe in clinical trials to be approved by regulators, a reliance on new product development through R&D and products that are marketed based on labeled claims regarding impacts on health. However, there are also significant differences between the animal health medicines and vaccines and human health businesses, including:

 

 

R&D is faster, less expensive and more predictable and sustainable. R&D for animal health generally requires fewer clinical studies, involves fewer subjects and is conducted directly in the target species. As a result, decisions on the potential efficacy and safety of products often can be made more quickly, and the likelihood of success often can be established earlier in development than in human health R&D. While the development of new chemical and biological entities through new product R&D continues to play an important role, the majority of animal health R&D investment is focused on brand lifecycle development. These factors generally yield faster, less expensive and more predictable R&D processes and more sustainable R&D pipelines as compared to human health.

 

 

More diverse product portfolios. In general, animal health medicines and vaccines businesses are less reliant on a small number of top selling key products than human health businesses. Animal health products are developed for multiple species and sold across different regions, which may have environmental, cultural, epidemiological and other differences that contribute to distinct product requirements. As a result, animal health products often have a smaller market size, and the performance of any single product typically has less impact on an animal health medicines and vaccines business as compared to a human health business.

 

 

Partnership relationships with customers. While some industry participants rely on distributors to market and sell their products, particularly in certain emerging markets, the animal health industry typically uses a

 

 

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combination of sales representatives to inform customers about the attributes of animal health products and technical and veterinary operations specialists to provide advice regarding local, regional and global trends in animal health. As a result of these relationships, sales and consulting visits are typically longer and more meaningful, and sales representatives have better access to customer decision makers, as compared to human health.

 

 

Primarily self-pay. Livestock producers and pet owners generally pay for animal healthcare out-of-pocket. Purchasers make decisions without the influence of insurance companies or government payors that are often involved in product and pricing decisions in human healthcare. Livestock producers are able to see measurable economic outcomes related to the use of animal health medicines and vaccines, as compared to human health in which outcomes can be less certain and more difficult to demonstrate. Companion animal veterinarians continue to be key decision-makers and dispensers of medicines and vaccines for companion animals. The sale of animal health products directly to pet owners is a meaningful contributor to veterinary practice economics. We believe that these dynamics result in less pricing pressure than in human health.

 

 

Strong brand loyalty and less generic competition. Generic competition in the animal health industry is less than in human health. The reasons for this include the smaller average market size of each product opportunity, the importance of direct distribution and education to veterinarians and livestock producers and the primarily self-pay nature of the business. In addition, companion animal health products are often directly prescribed and dispensed by veterinarians. The importance of quality and safety concerns to pet owners, veterinarians and livestock producers also contributes to animal health brand loyalty, which we believe often continues after the loss of patent-based and regulatory exclusivity.

Our segments

Due to meaningful differences in customer needs across different regions, we organize and operate our business in four regions. Within each of these regional segments, we offer a diversified product portfolio for both livestock and companion animal customers in order to capitalize on local and regional trends and customer needs. Our business segments are:

 

 

United States. Revenues of $1,294 million and $1,659 million represented 41% and 39% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively. We experienced base revenue growth of 7% in 2011 and 13% in 2010 and 6% for the nine months ended September 30, 2012 in this segment.

 

 

Europe/Africa/Middle East. Revenues of $799 million and $1,144 million represented 25% and 27% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively. Key developed markets in this segment include the United Kingdom, Germany and France. Key emerging markets in this segment include Russia, Turkey and South Africa. We experienced base revenue growth of 3% in 2011 and (1)% in 2010 and less than 1% for the nine months ended September 30, 2012 in this segment.

 

 

Canada/Latin America. Revenues of $549 million and $788 million represented 18% and 19% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively. The developed market in this segment is Canada. Key emerging markets in this segment include Brazil and Mexico. We experienced base revenue growth of 9% in 2011 and 5% in 2010 and 4% for the nine months ended September 30, 2012 in this segment.

 

 

Asia/Pacific. Revenues of $518 million and $642 million represented 16% and 15% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively. Key developed markets in this segment include Australia, Japan, New Zealand and South Korea. Key emerging markets in this segment include India and China. We experienced base revenue growth of 12% in 2011 and 15% in 2010 and 8% for the nine months ended September 30, 2012 in this segment.

 

 

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Our competitive strengths

We believe that the following strengths create sustainable competitive advantages that will enable us to continue our growth as a leader in the animal health medicines and vaccines industry:

 

 

Global leader with scale and scope. According to Vetnosis, as measured by revenues in 2011, we are the market leader in all of the major regions in which we operate, with the exception of Western Europe, where we hold the number two position. We believe we have an industry-leading global footprint, with products sold in more than 120 countries. Following this offering, we expect that we will be the largest standalone company exclusively focused on animal health medicines and vaccines.

 

 

Established direct presence in emerging markets. We have an established direct presence in many important emerging markets, and we are a leader in many of the emerging markets in which we operate. We believe this direct presence has enabled us to become the largest animal health medicines and vaccines business as measured by revenues across emerging markets as a whole. Emerging markets contributed approximately 27% of our revenues for the year ended December 31, 2011.

 

 

Diversified product portfolio. We market products across eight core species and five major product categories, and our portfolio contains more than 300 product lines. The depth of our product portfolio enables us to address the varying needs of different customers. Generally, because we have lower product sales concentration than many of our competitors, the performance of any single product has less impact on our business as compared to other, less-diversified animal health medicines and vaccines businesses. In 2011, our top selling product line, the ceftiofur line, contributed less than 8% of our revenues, and our top ten best selling product lines contributed less than 38% of our revenues.

 

 

Leader in direct sales and marketing with strong customer relationships. Our commercial model emphasizes direct selling, and we believe we are less reliant on distributors than our competitors. We believe our sales organization, consisting of approximately 3,400 employees, is the largest in our industry, with direct operations in approximately 70 countries. Our sales organization is supported by our technical and veterinary operations specialists, who advise our customers with in-depth technical and medical expertise and disease education. Our direct relationships and our direct global presence create a high level of local and regional specialization, which allows us to rapidly capitalize on market-specific situations and provides a global platform for R&D and business expansion. We believe we achieve both stronger customer relationships and better economic returns on our products by emphasizing these direct relationships.

 

 

Leader in product development—new product R&D and brand lifecycle development. We believe that we are a leader in animal health R&D. We have a track record of developing products that meet the needs of our customers. From 2004 to 2011, we obtained approximately one-fourth of all animal health medicine approvals granted by the FDA and approximately one-fifth of all animal health vaccine approvals granted by the USDA. While new chemical and biological entities play an important role in our growth, the majority of our R&D investment is in brand lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations.

 

 

High-quality products delivered reliably by our world-class manufacturing operations. We believe that our customers value high-quality manufacturing and reliability of supply. We utilize a diversified network of 29 proprietary manufacturing sites located in 11 countries and numerous third-party contract manufacturing organizations, which we refer to as CMOs, to maximize operational efficiencies and to introduce products quickly and efficiently. Our manufacturing sites experienced approximately 170 regulatory inspections globally between 2007 and 2011, with no findings that required material remediation or other penalties. We believe this reflects the strong quality controls and quality assurance programs in place at our manufacturing sites.

 

 

Dedicated employees and experienced management team. We believe that we have more professionally educated animal health experts on our team than any of our competitors. Our research team has an average

 

 

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tenure of more than ten years, and our sales organization employees have, on average, been with us for more than five years. Several members of our executive team lead and have led important and influential animal health industry organizations.

 

 

Track record of strong top-line revenue growth and significant cash flow generation. We have generated revenue growth at a CAGR of 24% over the three years ended December 31, 2011. Our revenue growth, driven by a diverse product portfolio and acquisitions, has generated significant cash flow. We have generated base revenue growth of 7% and 7% for the years ended December 31, 2011 and December 31, 2010, respectively.

Our growth strategies

We are committed to enhancing the health of animals and bringing solutions to our customers who raise and care for them. We intend to continue to grow our business by pursuing the following core strategies:

 

 

Leverage our direct local presence and strong customer relationships. We believe our direct selling commercial model and the brand loyalty enjoyed by our existing products provide us with operational efficiencies and access to an array of new growth opportunities, including a platform to encourage the adoption by our customers of more sophisticated animal health products. We believe our close contact with customers provides us with an in-depth understanding of their businesses, which allows us to develop products that address unmet customer needs.

 

 

Further penetrate emerging markets. We believe we are well-positioned in many emerging markets, based on our diverse product portfolio and our regional and local focus, and that we have further opportunities to expand in emerging markets by reaching new customers, by introducing more of our products and by supporting the adoption by our customers of more sophisticated medicines and vaccines. Furthermore, we believe that consolidation of livestock producers in certain emerging markets will drive adoption of our products. We intend to continue to efficiently develop and market new products that respond to the needs of these customers and provide them with strong customer service and technical support.

 

 

Pursue new product development and value-added brand lifecycle development to extend our product portfolio. We intend to continue to develop and grow our product portfolio by developing new chemical and biological entities through new product R&D as well as by expanding our product lines by adding new species or claims, achieving approvals in new countries and creating new combinations and reformulations. Our 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. We leverage our strong direct presence in many regions, which we believe allows us to cost-effectively develop and introduce new products, including brand lifecycle development products.

 

 

Remain the partner of choice for access to new products and technologies. We intend to continue to expand our extensive network of research partnerships around the globe in order to gain access to new technologies, pharmaceutical targets and vaccine antigens. Through participation in over 100 research alliances with leading universities and research institutes, we support cutting-edge research and secure the right to develop and commercialize new products and technologies. We also intend to continue to grow our business through smaller scale acquisitions, asset purchases, in-licensing transactions, supply and distribution agreements and other strategic partnerships. Subject to certain restrictions pursuant to the R&D collaboration and license agreement, following this offering, we expect to have access to Pfizer’s proprietary compound library and database to develop new products. We also intend to explore opportunities to enter into collaboration agreements and external alliances with other parties, including parties that may have chosen not to collaborate with us while we were a business unit of Pfizer. As a result, we will continue to offer and develop products that add value for veterinary professionals, livestock producers and pet owners.

 

 

Continue to provide high-quality products and improve manufacturing production margins. We believe that we are a leader in manufacturing quality and in supply reliability. Our manufacturing and supply chain

 

 

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provide us with a global platform for continued expansion, including in emerging markets, and we believe that we will continue to increase our production efficiencies and expand production margins as our business grows. Our operational efficiency initiatives have delivered consistent gross margin improvements for our legacy products, and as we have integrated acquisitions we have also applied these operational efficiency initiatives to improve production margins.

 

 

Expand into complementary businesses to become a more complete, trusted partner in providing solutions. We intend to continue to expand our presence in complementary businesses, including diagnostics, genetics, devices and services. We also intend to expand our complementary services, including dairy data management, e-learning and professional consulting, to help our customers improve their practice management capabilities and production efficiencies. We believe that these expanded offerings, supported by our technical expertise, will drive an outcomes-based approach to animal healthcare that has the potential to generate incremental revenues, as well as increase customer loyalty and sales of our products.

The Separation

Prior to the completion of this offering, we will be a wholly-owned subsidiary of Pfizer, and all of our outstanding shares of common stock will be owned by Pfizer.

Prior to the completion of the senior notes offering described below, through a series of steps, Pfizer transferred to us its subsidiaries holding substantially all of the assets and liabilities of its animal health business. In exchange, we issued or agreed to transfer to Pfizer: (i) all of the issued and outstanding shares of our Class A common stock; (ii) all of the issued and outstanding shares of our Class B common stock; (iii) the Pfizer-owned notes (as described below); and (iv) an amount of cash equal to substantially all of the net proceeds we will receive in the senior notes offering, which amount will be paid immediately prior to the completion of this offering. In addition, immediately prior to the completion of this offering, we and Pfizer intend to enter into, or have entered into, certain agreements that will provide a framework for our ongoing relationship with Pfizer. For a description of these agreements, see “Certain relationships and related party transactions—Relationship with Pfizer.” We refer to the separation transactions, as described in “The Separation and Distribution transactions—The Separation,” as the “Separation.”

The underwriting and the debt-for-equity exchange

Instead of selling shares of our Class A common stock directly to the underwriters for cash, Pfizer will first exchange the shares of our Class A common stock to be sold in this offering with certain of the underwriters, which we refer to, in such role, as the “debt-for-equity exchange parties,” for outstanding indebtedness of Pfizer held by the debt-for-equity exchange parties. The debt-for-equity exchange parties will then sell the shares to the underwriters for cash. This debt-for-equity exchange will occur on the settlement date of this offering immediately prior to the settlement of the debt-for-equity exchange parties’ sale of the shares to the underwriters. If the underwriters exercise their option to purchase additional shares of Class A common stock from the debt-for-equity exchange parties, Pfizer will convert shares of Class B common stock into shares of Class A common stock and exchange such shares of Class A common stock with the debt-for-equity exchange parties. The debt-for-equity exchange parties will then sell such shares of Class A common stock to the underwriters for cash. This debt-for-equity exchange will occur on the settlement date of such option exercise immediately prior to the settlement of the debt-for-equity exchange parties’ sale of such shares to the underwriters. We refer to these exchanges collectively as the “debt-for-equity exchange.”

The indebtedness of Pfizer held by the debt-for-equity exchange parties has an aggregate principal amount of at least $2.5 billion. The amount of indebtedness of Pfizer held by the debt-for-equity exchange parties is expected to be sufficient to acquire all of the shares of our Class A common stock to be sold in this offering, inclusive of the shares that may be sold pursuant to the underwriters’ option to purchase additional shares. Upon

 

 

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completion of the debt-for-equity exchange, the Pfizer indebtedness exchanged in such debt-for-equity exchange will be retired. We do not guarantee or have any other obligations in respect of the Pfizer indebtedness. See “Underwriting—The debt-for-equity exchange.”

Immediately following the completion of this offering, Pfizer will own 100% of our outstanding Class B common stock and no shares of our Class A common stock, giving Pfizer 82.8% of the economic interest and the combined voting power in shares of our outstanding common stock other than with respect to the election of directors and 98.0% of the combined voting power of our outstanding common stock with respect to the election of directors (or 80.2% and 97.6%, respectively, if the underwriters exercise their option to purchase additional shares in full). We refer to the Class A common stock and Class B common stock collectively as our “common stock.”

Senior notes offering

On January 28, 2013, we issued $3,650,000,000 aggregate principal amount of our senior notes in a private placement. The senior notes are comprised of $400,000,000 aggregate principal amount of our 1.150% Senior Notes due 2016, $750,000,000 aggregate principal amount of our 1.875% Senior Notes due 2018, $1,350,000,000 aggregate principal amount of our 3.250% Senior Notes due 2023 and $1,150,000,000 aggregate principal amount of our 4.700% Senior Notes due 2043. We refer to this private placement as the “senior notes offering.”

We sold $2.65 billion aggregate principal amount of our senior notes through the initial purchasers in the senior notes offering and Pfizer transferred $1.0 billion aggregate principal amount of our senior notes, which we issued to Pfizer prior to the completion of the senior notes offering, to certain of the initial purchasers, who sold such senior notes through the initial purchasers in the senior notes offering. We will pay an amount of cash equal to substantially all of the net proceeds that we received in the senior notes offering to Pfizer prior to the completion of this offering. We refer to the $1.0 billion aggregate principal amount of our senior notes that we issued to Pfizer as the “Pfizer-owned notes.” See “Description of certain indebtedness—Senior notes offering.”

Credit facility

In December 2012, we entered into a revolving credit agreement with a syndicate of banks providing for a five-year $1.0 billion senior unsecured revolving credit facility, which we refer to as the “credit facility.” The credit facility will not be available for borrowings until the date on which certain conditions, including the completion of this offering and the receipt of certain investment grade ratings, are satisfied. We expect that these conditions will be met concurrently with the completion of this offering. Subject to certain conditions, we will have the right to increase the credit facility to up to $1.5 billion. See “Description of certain indebtedness—Credit facility.”

Commercial paper program

We expect to enter into a commercial paper program with a capacity of up to $1.0 billion prior to or concurrently with the completion of this offering. While we do not anticipate that any commercial paper will be issued under the commercial paper program at the time of this offering, we may incur indebtedness under this program in the future.

 

 

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The Distribution

Pfizer has informed us that, following this offering, it may make a tax-free distribution to its stockholders of all or a portion of its remaining equity interest in us, which may include one or more distributions effected as a dividend to all Pfizer stockholders, one or more distributions in exchange for Pfizer shares or other securities, or any combination thereof. We refer to any such potential distribution as the “Distribution.”

Pfizer has received a private letter ruling from the Internal Revenue Service, or the IRS, substantially to the effect that, among other things, the Distribution will qualify as a transaction that is tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Internal Revenue Code, or the Code. Pfizer has no obligation to pursue or consummate any further dispositions of its ownership interest in us, including through the Distribution, by any specified date or at all. If pursued, the Distribution would be subject to various conditions, including receipt of any necessary regulatory or other approvals, the existence of satisfactory market conditions and the continuing application of Pfizer’s private letter ruling from the IRS and the receipt of opinions of counsel to the effect that such Distribution would be tax-free to Pfizer and its stockholders. The conditions to the Distribution may not be satisfied, Pfizer may decide not to consummate the Distribution even if the conditions are satisfied or Pfizer may decide to waive one or more of these conditions and consummate the Distribution even if all of the conditions are not satisfied.

Risk factors

There are a number of risks that you should understand before making an investment decision regarding this offering. These risks are discussed more fully in the section entitled “Risk factors” following this prospectus summary. These risks include, but are not limited to:

 

 

emerging restrictions and bans on the use of antibacterials in food-producing animals;

 

 

perceived adverse effects on human health linked to the consumption of food derived from animals that utilize our products;

 

 

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

 

 

an outbreak of infectious disease carried by animals;

 

 

adverse weather conditions and the availability of natural resources;

 

 

adverse global economic conditions;

 

 

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

 

 

failure to achieve the expected benefits of the Separation or the Distribution, which include improved strategic and operational efficiency, the adoption of a capital structure and investment and dividend policies that are best suited to our standalone company, the use of our equity to facilitate future acquisitions and improved alignment of employee incentives with our performance and growth objectives;

 

 

operation as a standalone public company without many of the resources previously available to us as a business unit of Pfizer;

 

 

control of a majority of the voting power of our common stock by Pfizer and, as a result, Pfizer’s ability to determine the outcome of our future corporate actions, including the election of our directors; and

 

 

actual or potential conflicts of interest as a result of the fact that several of our directors will simultaneously serve as employees of Pfizer.

 

 

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Conflicts of interest

The offering is being conducted in accordance with the applicable provisions of Rule 5121 of the Conduct Rules of the Financial Industry Regulatory Authority, Inc., or FINRA, because certain of the underwriters will have a “conflict of interest” pursuant to Rule 5121(f)(5)(C)(ii) by virtue of their role as debt-for-equity exchange parties, since all of the net proceeds of this offering will be received by the debt-for-equity exchange parties. Rule 5121 requires that a “qualified independent underwriter” as defined in Rule 5121 must participate in the preparation of the prospectus and perform its usual standard of diligence with respect to the registration statement and this prospectus. Accordingly, Goldman, Sachs & Co. is assuming the responsibilities of acting as the qualified independent underwriter in the offering. See “Underwriting—Conflicts of interest.”

Corporate information

We were incorporated in Delaware in July 2012. The address of our principal executive offices is currently c/o Pfizer, 5 Giralda Farms, Madison, New Jersey 07940 and we expect that our principal executive offices will be relocated following the completion of this offering. Our website is currently www.pfizerah.com. Prior to the consummation of this offering, our website will be relocated to www.zoetis.com. Information on, or accessible through, our website is not part of this prospectus.

 

 

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The offering

 

Class A common stock offered in this
offering

        
86,100,000 shares (99,015,000 shares if the underwriters exercise their option to purchase additional shares in full)

 

Common stock to be held by Pfizer
immediately after this offering

        
No shares of Class A common stock (no shares if the underwriters exercise their option to purchase additional shares in full)

 

  413,900,000 shares of Class B common stock (400,985,000 shares if the underwriters exercise their option to purchase additional shares in full)

 

Common stock to be outstanding
immediately after this offering

        
86,100,000 shares of Class A common stock (99,015,000 shares if the underwriters exercise their option to purchase additional shares in full)

 

  413,900,000 shares of Class B common stock (400,985,000 shares if the underwriters exercise their option to purchase additional shares in full)

 

Underwriters’ option

The underwriters have an option to purchase up to 12,915,000 additional shares of Class A common stock from the debt-for-equity exchange parties as described in “Underwriting.”

 

Use of proceeds

We will not receive any proceeds from the sale of our Class A common stock in this offering. All of the net proceeds from this offering will be received by the debt-for-equity exchange parties. On the settlement date of this offering immediately prior to the settlement of the debt-for-equity exchange parties’ sale of the shares to the underwriters, the debt-for-equity exchange parties will acquire the Class A common stock being sold in this offering from Pfizer in exchange for outstanding Pfizer indebtedness held by the debt-for-equity exchange parties. See “Use of proceeds.”

 

Voting rights

In connection with this offering, we will have two classes of authorized common stock: Class A common stock and Class B common stock. The rights of the holders of Class A common stock and Class B common stock will be identical, except with respect to voting and conversion rights. The holders of Class A common stock and Class B common stock will each be entitled to one vote per share for all matters submitted to a vote of stockholders other than with respect to the election of directors. With respect to the election of directors, the holders of Class B common stock will be entitled to ten votes per share, and the holders of Class A common stock will be entitled to one vote per share. Each share of Class B common stock held by Pfizer or one of its subsidiaries will be convertible into one share of Class A common stock at any time but will not be convertible if held by any other holder.

 

 

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Selling stockholder

In connection with this offering, Pfizer, as a selling stockholder for purposes of the U.S. securities laws, will exchange all of the shares of our Class A common stock being sold in this offering for indebtedness of Pfizer held by the debt-for-equity exchange parties. The debt-for-equity exchange parties will then sell these shares pursuant to this offering.

 

Conflicts of interest

Certain of the underwriters may be deemed to have a “conflict of interest” under Rule 5121 of the Conduct Rules of FINRA. See “Underwriting—Conflicts of interest.”

 

Stock exchange symbol

Our Class A common stock has been approved for listing on the NYSE under the symbol “ZTS.”

Unless the context requires otherwise, references to the number and percentage of shares of common stock to be outstanding immediately after this offering are based on 86,100,000 shares of Class A common stock and 413,900,000 shares of Class B common stock outstanding as of January 28, 2013 and:

 

 

assume the underwriters’ option to purchase additional shares will not be exercised; and

 

 

exclude 25,000,000 shares of our common stock reserved for issuance under the Zoetis 2013 Equity and Incentive Plan, from which we intend to grant at the time of this offering or shortly following this offering:

 

   

restricted stock units and stock options (or other awards as appropriate with respect to our employees in non-U.S. jurisdictions) with an approximate aggregate target value of $45 million to approximately 1,700 of our employees, including each of our named executive officers. These equity grants at the time of this offering will be comprised of an aggregate of 795,310 restricted stock units and options to purchase an aggregate of 2,935,302 shares of Class A common stock, with an exercise price equal to the initial public offering price per share. See “Management—Compensation discussion and analysis—Proposed Zoetis 2013 equity and incentive plan;” and

 

   

deferred stock units to Michael B. McCallister, Gregory Norden and William C. Steere, Jr., our three director nominees who are not otherwise currently employed by us or Pfizer, with a value of $140,000 for each grant. Each of the three non-employee director grantees will receive 5,384 deferred units. See “Management—Compensation discussion and analysis—Director compensation.”

Unless otherwise indicated, the information presented in this prospectus gives effect to the transactions described under “The Separation and Distribution transactions—The Separation.”

 

 

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Summary historical and

unaudited pro forma combined financial data

The summary historical combined statement of operations data for the years ended December 31, 2011, 2010 and 2009 presented below have been derived from our audited combined financial statements included elsewhere in this prospectus. The summary historical combined statement of operations data for the nine months ended September 30, 2012 and October 2, 2011 and the summary historical combined balance sheet data as of September 30, 2012 have been derived from our unaudited condensed combined financial statements included elsewhere in this prospectus. In the opinion of management, the unaudited condensed combined financial statements for the interim periods included in this prospectus include all normal and recurring adjustments that we consider necessary for a fair presentation of the financial position and operating results for these periods. The operating results for the nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012.

Our combined financial statements include expense allocations for certain support functions that are provided on a centralized basis within Pfizer, such as expenses for business technology, facilities, legal, finance, human resources, and, to a lesser extent, business development, public affairs and procurement, among others, as well as certain manufacturing and supply costs incurred by manufacturing sites that are shared with other Pfizer business units, Pfizer’s global external supply group and Pfizer’s global logistics and support group. Pfizer does not routinely allocate these costs to any of its business units. These allocations are based on either a specific identification basis or, when specific identification is not practicable, proportional cost allocation methods (e.g., using third-party sales, headcount, animal health manufacturing costs, etc.) depending on the nature of the services and/or costs.

The financial statements included in this prospectus may not be indicative of our future performance and do not necessarily reflect what our financial position and results of operations would have been had we operated as a standalone public company during the periods presented, including changes that will occur in our operations and capital structure as a result of this offering and the Separation. Our combined financial statements have been prepared in accordance with United States generally accepted accounting principles, or U.S. GAAP.

The summary unaudited pro forma combined financial data has been derived from the unaudited pro forma condensed combined statements of operations for the nine months ended September 30, 2012 and for the year ended December 31, 2011, and the unaudited pro forma condensed combined balance sheet as of September 30, 2012 included elsewhere in this prospectus. The unaudited pro forma combined financial data gives effect to certain transactions, which we refer to as the “Transactions,” as if they each had occurred on January 1, 2011 for the unaudited pro forma combined statements of operations data and on September 30, 2012 for the unaudited pro forma combined balance sheet data. For an understanding of the pro forma financial statements that give pro forma effect to the Transactions, see “Unaudited pro forma condensed combined financial statements” included elsewhere in this prospectus.

The summary unaudited pro forma combined financial data is for illustrative and informational purposes only and is not intended to represent what our results of operations or financial position would have been had we operated as a standalone public company during the periods presented or if the Transactions had actually occurred as of the dates indicated above. The unaudited pro forma combined financial data should not be considered indicative of our future results of operations or financial position as a standalone public company.

You should read the summary historical and unaudited pro forma combined financial data set forth below in conjunction with the sections entitled “Selected historical combined financial data,” “Unaudited pro forma condensed combined financial statements” and “Management’s discussion and analysis of financial condition and results of operations” and our combined financial statements and notes thereto included elsewhere in this prospectus.

 

 

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Statement of operations data:

 

    Pro Forma     Historical  
    Nine Months
Ended
    Year Ended
December 31,(a)
    Nine Months
Ended
    Year Ended
December 31,(a)
 
(MILLIONS OF DOLLARS, EXCEPT PER
SHARE AMOUNTS)
  September 30,
2012
    2011     September 30,
2012
    October 2,
2011
    2011     2010     2009  

Revenues

  $ 3,160      $ 4,233      $ 3,160      $ 3,106      $ 4,233      $ 3,582      $ 2,760   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses(b)

    2,537        3,771        2,469        2,634        3,685        3,202        2,568   

Restructuring charges and certain acquisition—related costs

 

 

55

  

    154        55        108        154        202        340   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income/(loss) before provision/(benefit) for taxes on income/(loss)

    568        308        636        364        394        178        (148

Provision/(benefit) for taxes on income/(loss)

    164        113        190        126        146        67        (47
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss) before allocation to noncontrolling interests

 

 

404

  

    195        446        238        248        111        (101

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

    —          3        —          2        3        1        (1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss) attributable to Zoetis

  $ 404      $ 192      $ 446      $ 236      $ 245      $ 110      $ (100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per common share—basic(c)

  $ 0.81      $ 0.38        NA        NA        NA        NA        NA   

Earnings per common share—fully diluted(c)

  $ 0.81      $ 0.38        NA        NA        NA        NA        NA   

Balance sheet data:

 

(MILLIONS OF DOLLARS)    At September  30,
2012
 
      Pro Forma      Historical  

Working capital

   $ 1,858       $ 1,818   

Property, plant and equipment, less accumulated depreciation

     1,229         1,204   

Total assets

     5,837         5,904   

Allocated long-term debt(d)

     —           580   

Long-term debt(e)

     3,640         —     

Total liabilities

     4,778         1,795   

Total Zoetis equity(f)

     1,044         4,094   

 

Certain amounts may reflect rounding adjustments.

 

(a) Starting in 2011, includes the King Animal Health business, or KAH, acquired as part of Pfizer’s acquisition of King Pharmaceuticals, Inc., commencing on the acquisition date of January 31, 2011. Starting in 2009, includes Fort Dodge Animal Health, or FDAH, operations, acquired as part of Pfizer’s acquisition of Wyeth, commencing on the acquisition date of October 15, 2009.
(b) Excludes restructuring charges and certain acquisition-related costs.
(c) The weighted-average number of shares used to compute pro forma basic and diluted earnings per share is 500 million, which is also the number of shares of our common stock outstanding immediately following the completion of the Transactions.
(d) Starting in 2009, represents an allocation of Pfizer debt that was issued to partially finance the acquisition of Wyeth (including FDAH) in 2009. The debt has been allocated on a pro-rata basis using the deemed acquisition cost of FDAH as a percentage of the total acquisition cost of Wyeth. The allocated long-term debt will be retained by Pfizer following the completion of the Transactions.
(e) Reflects the incurrence of $3,650 million aggregate principal amount of senior notes in connection with the senior notes offering, net of an original issue debt discount of $10 million.
(f) On a pro forma basis, reflects the legal transfer to us of Pfizer’s subsidiaries holding substantially all of the assets and liabilities of Pfizer’s animal health business in consideration for (i) all of the issued and outstanding shares of our Class A common stock; (ii) all of the issued and outstanding shares of our Class B common stock; (iii) $1 billion aggregate principal amount of senior notes, which Pfizer disposed of in connection with the senior notes offering; and (iv) an amount of cash equal to substantially all of the net proceeds we received in the senior notes offering.

 

 

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Other data:

 

     Nine Months
Ended
     Year Ended
December 31,
 
(MILLIONS OF DOLLARS)    September 30,
2012
     October 2,
2011
     2011      2010      2009  

Adjusted net income(a)

   $ 482       $ 381       $ 503       $ 275       $ 189   

 

Certain amounts may reflect rounding adjustments.

 

(a) Adjusted net income (a non-GAAP financial measure) is defined as reported net income attributable to Zoetis excluding purchase accounting adjustments, acquisition-related costs and certain significant items. Management uses Adjusted net income, among other factors, to set performance goals and to measure the performance of the overall company, as described in “Management’s discussion and analysis of financial condition and results of operations—Adjusted net income.” We believe that investors’ understanding of our performance is enhanced by disclosing this performance measure. Reconciliations of U.S. GAAP reported net income attributable to Zoetis to non-GAAP Adjusted net income for the nine months ended September 30, 2012 and October 2, 2011, as well as reconciliations of the years ended December 31, 2011, 2010 and 2009, are provided in “Management’s discussion and analysis of financial condition and results of operations—Adjusted net income.” The Adjusted net income measure is not, and should not be viewed as, a substitute for U.S. GAAP reported net income attributable to Zoetis.

 

 

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Risk factors

Investing in our Class A common stock involves a high degree of risk. You should consider carefully the following risks, together with all the other information in this prospectus, including our combined financial statements and notes thereto, before you invest in our Class A common stock. If any of the following risks actually materializes, our operating results, financial condition and liquidity could be materially adversely affected. As a result, the trading price of our Class A common stock could decline and you could lose part or all of your investment.

Risks related to our business and industry

Restrictions and bans on the use of antibacterials in food-producing animals may become more prevalent.

The issue of the potential transfer of increased antibacterials resistance in bacteria from food-producing animals to human pathogens, and the causality of that transfer, are the subject of global scientific and regulatory discussion. Antibacterials refer to small molecules that can be used to treat or prevent bacterial infections and are a sub-categorization of the products that make up our anti-infectives and medicinal feed additives portfolios. In some countries, this issue has led to government restrictions and bans on the use of specific antibacterials in some food-producing animals, regardless of the route of administration (in feed or injectable). These restrictions are more prevalent in countries where animal protein is plentiful and governments are willing to take action even when there is scientific uncertainty. For example, in April 2012, the FDA announced guidance calling for the voluntary elimination over a period of time of the use of medically important antibacterials in animal feed for growth promotion in food production animals (medically important antibacterials include classes that are prescribed in animal and human health). The guidance provides for continued use of antibacterials in food-producing animals for treatment, control and prevention of disease under the supervision of a veterinarian. The FDA indicated that they took this action to help preserve the efficacy of medically important antibacterials to treat infections in humans. Our revenues attributable to antibacterials for livestock were approximately $841 million for the nine months ended September 30, 2012 and approximately $1.2 billion for the year ended December 31, 2011. We cannot predict whether antibacterials resistance concerns will result in additional restrictions or bans, expanded regulations or public pressure to discontinue or reduce use of antibacterials in food-producing animals, which could materially adversely affect our operating results and financial condition.

Perceived adverse effects on human health linked to the consumption of food derived from animals that utilize our products could cause a decline in the sales of such products.

Our livestock business depends heavily on a healthy and growing livestock industry. If the public perceives a risk to human health from the consumption of the food derived from animals that utilize our products, there may be a decline in the production of such food products and, in turn, demand for our products. For example, livestock producers may experience decreased demand for their products or reputational harm as a result of evolving consumer views of animal rights, nutrition and health-related or other concerns. Any reputational harm to the livestock industry may also extend to companies in related industries, including our company. Adverse consumer views related to the use of one or more of our products in livestock also may result in a decrease in the use of such products and could have a material adverse effect on our operating results and financial condition.

Increased regulation or decreased governmental financial support relating to the raising, processing or consumption of food-producing animals could reduce demand for our livestock products.

Companies in the livestock industries are subject to extensive and increasingly stringent regulations. If livestock producers are adversely affected by new regulations or changes to existing regulations, they may reduce herd sizes or become less profitable and, as a result, they may reduce their use of our products, which may materially adversely affect our operating results and financial condition. Furthermore, adverse regulations related, directly or indirectly, to the use of one or more of our products may injure livestock producers’ market position. More stringent regulation of the livestock industry or our products could have a material adverse effect on our

 

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operating results and financial condition. Also, many food-producing companies, including livestock producers, benefit from governmental subsidies, and if such subsidies were to be reduced or eliminated, these companies may become less profitable and, as a result, may reduce their use of our products.

An outbreak of infectious disease carried by animals could negatively affect the sale and production of our products.

Sales of our livestock products could be materially adversely affected by the outbreak of disease carried by animals, such as avian influenza, foot-and-mouth disease or bovine spongiform encephalopathy (otherwise known as BSE or mad cow disease), which could lead to the widespread death or precautionary destruction of animals as well as the reduced consumption and demand for animal protein. In addition, outbreaks of disease carried by animals may reduce regional or global sales of particular animal-derived food products or result in reduced exports of such products, either due to heightened export restrictions or import prohibitions, which may reduce demand for our products due to reduced herd or flock sizes. For example, in April 2012, the USDA announced that it had identified a case of BSE in California. This announcement caused certain countries to implement additional inspections of, or suspend the importation of, United States beef. Additionally, in December 2012, the World Animal Health Organization announced that a case of BSE had been identified in Brazil. This announcement similarly caused certain countries to suspend the importation of Brazilian beef. While the restrictions that were implemented as a result of these cases of BSE have not significantly affected demand for our products, the discovery of additional cases of BSE may result in additional restrictions related to, or reduced demand for, animal protein, which may have a material adverse effect on our operating results and financial condition. Also, the outbreak of any highly contagious disease near our main production sites could require us to immediately halt production of our products at such sites or force us to incur substantial expenses in procuring raw materials or products elsewhere.

Consolidation of our customers could negatively affect the pricing of our products.

Veterinarians and livestock producers are our primary customers. In recent years, there has been a trend towards the concentration of veterinarians in large clinics and hospitals. In addition, livestock producers, particularly swine and poultry producers, have seen recent consolidation in their industries. If these trends towards consolidation continue, these customers could attempt to improve their profitability by leveraging their buying power to obtain favorable pricing. The resulting decrease in our prices could have a material adverse effect on our operating results and financial condition.

Our business may be negatively affected by weather conditions and the availability of natural resources.

The animal health industry and demand for many of our animal health products in a particular region are affected by weather conditions, as usage of our products follows varying weather patterns and weather-related pressures from pests, such as ticks. As a result, we may experience regional and seasonal fluctuations in our results of operations.

In addition, livestock producers depend on the availability of natural resources, including large supplies of fresh water. Their animals’ health and their ability to operate could be adversely affected if they experience a shortage of fresh water due to human population growth or floods, droughts or other weather conditions. In the event of adverse weather conditions or a shortage of fresh water, livestock producers may purchase less of our products.

For example, the current drought impacting the United States is considered the worst in many years, impacting both the supply of corn and the availability of grazing pasture. The decrease in harvested corn has resulted in higher corn prices, which has impacted the profitability of livestock producers of cattle, pork and poultry. Higher corn prices may contribute to reductions in herd or flock size that may result in reduced spending on animal health products. Reduced availability of grazing pasture may also force cattle producers to cull their herds. Fewer heads of cattle would result in reduced demand for our products. A prolonged drought could have a material adverse effect on our operating results and financial condition.

 

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Our business is subject to risk based on global economic conditions.

The global financial markets recently have undergone and may continue to experience significant volatility and disruption. The timing and sustainability of an economic recovery is uncertain and additional macroeconomic, business and financial disruptions could have a material adverse effect on our operating results, financial condition and liquidity. Certain of our customers and suppliers have been affected directly by the economic downturn and continue to face credit issues and could experience cash flow problems that have given rise to and could continue to give rise to payment delays, increased credit risk, bankruptcies and other financial hardships that could decrease the demand for our products or hinder our ability to collect amounts due from customers. If one or more of our large customers, including distributors, discontinue their relationship with us as a result of economic conditions or otherwise, our operating results and financial condition may be materially adversely affected. In addition, economic concerns may cause some pet owners to forgo or defer visits to veterinary practices or could reduce their willingness to treat pet health conditions or even to continue to own a pet.

Our business is subject to risk based on customer exposure to rising costs and reduced customer income.

Feed, fuel and transportation and other key costs for livestock producers may increase or animal protein prices or sales may decrease. Either of these trends could cause deterioration in the financial condition of our livestock product customers, potentially inhibiting their ability to purchase our products or pay us for products delivered. Our livestock product customers may offset rising costs by reducing spending on our products, including by switching to lower-cost alternatives to our products. In addition, concerns about the financial resources of pet owners also could cause veterinarians to alter their treatment recommendations in favor of lower-cost alternatives to our products. These shifts could result in a decrease of sales of our companion animal products, especially in developed countries where there is a higher rate of pet ownership.

Changes in distribution channels for companion animal products could negatively impact our market share, margins and distribution of our products.

In most markets, companion animal owners typically purchase their animal health products directly from veterinarians. Companion animal owners increasingly could purchase animal health products from sources other than veterinarians, such as Internet-based retailers, “big-box” retail stores or other over-the-counter distribution channels. This trend has been demonstrated by the significant shift away from the veterinarian distribution channel in the sale of flea and tick products in recent years. Companion animal owners also could decrease their reliance on, and visits to, veterinarians as they rely more on Internet-based animal health information. Because we market our companion animal prescription products through the veterinarian distribution channel, any decrease in visits to veterinarians by companion animal owners could reduce our market share for such products and materially adversely affect our operating results and financial condition. In addition, companion animal owners may substitute human health products for animal health products if human health products are deemed to be lower-cost alternatives.

Legislation has also been proposed in the United States, and may be proposed in the United States or abroad in the future, that could impact the distribution channels for our companion animal products. For example, such legislation may require veterinarians to provide pet owners with written prescriptions and disclosure that the pet owner may fill prescriptions through a third party, which may further reduce the number of pet owners who purchase their animal health products directly from veterinarians. Such requirements may lead to increased use of generic alternatives to our products or the increased substitution of our products with other animal health products or human health products if such other products are deemed to be lower-cost alternatives. Many states already have regulations requiring veterinarians to provide prescriptions to pet owners upon request and the American Veterinary Medical Association has long-standing policies in place to encourage this practice.

Over time, these and other competitive conditions may increase our reliance on Internet-based retailers, “big-box” retail stores or other over-the-counter distribution channels to sell our companion animal products. We may

 

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be unable to sustain our current margins and we may not be adequately prepared or able to distribute our products if an increased portion of our sales is through these channels. Any of these events could materially adversely affect our operating results and financial condition.

The animal health industry is highly competitive.

The animal health industry is highly competitive. We believe many of our competitors are conducting R&D activities in areas served by our products and in areas in which we are developing products. Our competitors include the animal health businesses of large pharmaceutical companies and specialty animal health businesses. These competitors may have access to greater financial, marketing, technical and other resources. As a result, they may be able to devote more resources to developing, manufacturing, marketing and selling their products, initiating or withstanding substantial price competition or more readily taking advantage of acquisitions or other opportunities. In addition to competition from established market participants, new entrants to the animal health medicines and vaccines industry could substantially reduce our market share or render our products obsolete.

To the extent that any of our competitors are more successful with respect to any key competitive factor or we are forced to reduce, or are unable to raise, the price of any of our products in order to remain competitive, our operating results and financial condition could be materially adversely affected. Competitive pressure could arise from, among other things, safety and efficacy concerns, limited demand growth or a significant number of additional competitive products being introduced into a particular market, price reductions by competitors, the ability of competitors to capitalize on their economies of scale, the ability of competitors to produce or otherwise procure animal health products at lower costs than us and the ability of competitors to access more or newer technology than us.

Generic 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 to provide us with exclusive marketing rights for some of our products. Our patent protection for these products extends for varying periods in accordance with the dates of filing or grant and the legal life of patents in countries in which patents are granted. The protection afforded, which varies from country to country, is limited by the scope and applicable terms of our patents and the availability of legal remedies in the applicable country. As a result, we may face competition from lower-priced generic alternatives to many of our products. Generic competitors are becoming more aggressive in terms of pricing, and generic products are an increasing percentage of overall animal health sales in certain regions. In addition, private label products may compete with our products. If animal health customers increase their use of new or existing generic or private label products, our operating results and financial condition could be materially adversely affected. We estimate that approximately 80% of our revenues in 2011 were derived from products that are either unpatented (i.e., never patented or off-patent) or covered by our patents that, while providing a competitive advantage, do not provide market exclusivity. Over the next several years, several of our products’ patents will expire.

We may not successfully acquire and integrate other businesses, license rights to technologies or products, form and manage alliances or divest businesses.

We may pursue acquisitions, technology licensing arrangements, strategic alliances or divestitures of some of our businesses as part of our business strategy. We may not complete these transactions in a timely manner, on a cost-effective basis or at all. In addition, we may be subject to regulatory constraints or limitations or other unforeseen factors that prevent us from realizing the expected benefits. Even if we are successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. We may be unable to integrate acquisitions successfully into our existing business, and we may be unable to achieve expected gross margin improvements or efficiencies. We also could incur or assume significant debt and unknown or contingent liabilities. Our reported

 

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results of operations could be negatively affected by acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. We may be subject to litigation in connection with, or as a result of, acquisitions, dispositions, licenses or other alliances, including claims from terminated employees, customers or third parties, and we may be liable for future or existing litigation and claims related to the acquired business, disposition, license or other alliance because either we are not indemnified for such claims or the indemnification is insufficient. These effects could cause us to incur significant expenses and could materially adversely affect our operating results and financial condition.

We may not successfully implement our business strategies or achieve expected gross margin improvements.

We are and may continue to pursue strategic initiatives that management considers critical to our long-term success, including, but not limited to, increasing sales in emerging markets, base revenue growth through new product development and value added brand lifecycle development; improving operational efficiency through manufacturing efficiency improvement and other programs; using cash flow from operations to service or reduce debt; and expanding our complementary products and services. In addition to base revenue growth, we also have historically grown our business through Pfizer’s acquisitions of large pharmaceutical companies that had animal health businesses, including the Fort Dodge Animal Health business of Wyeth and the Alpharma Animal Health business of King Pharmaceuticals, Inc. However, following the Separation, we will no longer be able to benefit from Pfizer’s acquisition activity. We also have acquired or partnered with a number of smaller animal health businesses, and we intend to continue to do so in the future. There are significant risks involved with the execution of these initiatives, including significant business, economic and competitive uncertainties, many of which are outside of our control. Accordingly, we cannot predict whether we will succeed in implementing these strategic initiatives. It could take several years to realize the anticipated benefits from these initiatives, if any benefits are achieved at all. We may be unable to achieve expected gross margin improvements on our products and technologies, including those acquired and those developed internally. Additionally, our business strategy may change from time to time, which could delay our ability to implement initiatives that we believe are important to our business.

Our business could be affected adversely by labor disputes, strikes or work stoppages.

Some of our employees are members of unions, works councils, trade associations or are otherwise subject to collective bargaining agreements in certain jurisdictions, including the United States. As a result, we are subject to the risk of labor disputes, strikes, work stoppages and other labor-relations matters. We may be unable to negotiate new collective bargaining agreements on similar or more favorable terms and may experience work stoppages or other labor problems in the future at our sites. These risks may be increased by the Separation because we will no longer be able to benefit from Pfizer’s prior relationships and negotiations relating to such agreements. We could experience a disruption of our operations or higher ongoing labor costs, which could have a material adverse effect on our operating results and financial condition, potentially resulting in cancelled orders by customers, unanticipated inventory accumulation or shortages and reduced revenues and net income. In addition, labor problems at our suppliers or CMOs could have a material adverse effect on our operating results and financial condition.

Loss of our executive officers could disrupt our operations.

We depend on the efforts of our executive officers. Our executive officers are not currently, and are not expected to be, subject to non-compete provisions. In addition, we have not entered into employment agreements with our executive officers. Any unplanned turnover or our failure to develop an adequate succession plan for one or more of our executive officer positions could deplete our institutional knowledge base and erode our competitive advantage. The loss or limited availability of the services of one or more of our executive officers, or our inability to recruit and retain qualified executive officers in the future, could, at least temporarily, have a material adverse effect on our operating results and financial condition.

 

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We may be required to write down goodwill or identifiable intangible assets.

Under U.S. GAAP, if we determine goodwill or identifiable intangible assets are impaired, we will be required to write down these assets and record a non-cash impairment charge. As of September 30, 2012, we had goodwill of $981 million and identifiable intangible assets, less accumulated amortization, of $877 million. Identifiable intangible assets consist primarily of developed technology rights, brands, trademarks, license agreements, patents and in-process R&D.

Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment. Future events or new information may change management’s valuation of an intangible asset in a short amount of time. The timing and amount of impairment charges recorded in our combined statements of income and write-downs recorded in our combined balance sheets could vary if management’s conclusions change. Any impairment of goodwill or identifiable intangible assets could have a material adverse effect on our operating results and financial position.

Risks related to research and development

Our R&D, acquisition and licensing efforts may fail to generate new products and brand lifecycle developments.

Our future success depends on both our existing product portfolio and our pipeline of new products, including new products that we may develop through joint ventures and products that we are able to obtain through license or acquisition. We commit substantial effort, funds and other resources to R&D, both through our own dedicated resources and through collaborations with third parties.

We may be unable to determine with accuracy when or whether any of our products now under development will be approved or launched, or we may be unable to develop, license or otherwise acquire product candidates or products. In addition, we cannot predict whether any products, once launched, will be commercially successful or will achieve sales and revenues that are consistent with our expectations. The animal health industry is subject to regional and local trends and regulations and, as a result, products that are successful in some of our markets may not achieve similar success when introduced into new markets. Furthermore, the timing and cost of our R&D may increase, and our R&D may become less predictable. For example, changes in regulations applicable to our industry may make it more time-consuming and/or costly to research, test and develop products.

Products in the animal health industry are sometimes derived from molecules and compounds discovered or developed as part of human health research. In addition to the R&D collaboration and license agreement with Pfizer, we expect to enter into other collaboration or licensing arrangements with third parties to provide us with access to compounds and other technology for purposes of our business. Such agreements are typically complex and require time to negotiate and implement. If we enter into these arrangements, we may not be able to maintain these relationships or establish new ones in the future on acceptable terms or at all. In addition, any collaboration that we enter into may not be successful, and the success may depend on the efforts and actions of our collaborators, which we may not be able to control. If we are unable to access human health-generated molecules and compounds to conduct research and development on cost-effective terms, our ability to develop new products could be limited.

Advances in veterinary medical practices and animal health technologies could negatively affect the market for our products.

The market for our products could be impacted negatively by the introduction and/or broad market acceptance of newly-developed or alternative products that address the diseases and conditions for which we sell products, including “green” or “holistic” health products or specially bred disease-resistant animals. In addition, technological breakthroughs by others may obviate our technology and reduce or eliminate the market for our products. Introduction or acceptance of such products or technologies could materially adversely affect our operating results and financial condition.

 

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Our R&D relies on evaluations in animals, which may become subject to bans or additional regulations.

As an animal health medicines and vaccines business, the evaluation of our existing and new products in animals is required to register our products. Animal testing in certain industries has been the subject of controversy and adverse publicity. Some organizations and individuals have attempted to ban animal testing or encourage the adoption of additional regulations applicable to animal testing. To the extent that the activities of such organizations and individuals are successful, our R&D, and by extension our operating results and financial condition, could be materially adversely affected. In addition, negative publicity about us or our industry could harm our reputation.

Risks related to manufacturing

Manufacturing problems and capacity imbalances may cause product launch delays, inventory shortages, recalls or unanticipated costs.

In order to sell our products, we must be able to produce and ship sufficient quantities. We have a global manufacturing network consisting of 29 manufacturing sites located in 11 countries. In addition, 14 Pfizer sites located in 13 countries will manufacture certain of our products for us. We also employ a network of approximately 200 CMOs. Many of our products involve complex manufacturing processes and are sole-sourced from certain manufacturing sites.

Minor deviations in our manufacturing processes, such as temperature excursions or improper package sealing, could result in delays, inventory shortages, unanticipated costs, product recalls, product liability and/or regulatory action. In addition, a number of factors could cause production interruptions, including:

 

 

the failure of us or any of our vendors or suppliers to comply with applicable regulations and quality assurance guidelines;

 

 

construction delays;

 

 

equipment malfunctions;

 

 

shortages of materials;

 

 

labor problems;

 

 

natural disasters;

 

 

power outages;

 

 

terrorist activities;

 

 

changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, shipping distributions or physical limitations; and

 

 

the outbreak of any highly contagious diseases near our production sites.

These interruptions could result in launch delays, inventory shortages, recalls, unanticipated costs or issues with our agreements under which we supply third parties, which may adversely affect our operating results. For example, our manufacturing site in Medolla, Italy was damaged in an earthquake in May 2012, which resulted in production interruptions at that site.

Our manufacturing network may be unable to meet the demand for our products or we may have excess capacity if demand for our products changes. The unpredictability of a product’s regulatory or commercial success or failure, the lead time necessary to construct highly technical and complex manufacturing sites, and shifting customer demand (including as a result of market conditions or entry of branded or generic competition) increase the potential for capacity imbalances. In addition, construction of sites is expensive, and our ability to recover costs will depend on the market acceptance and success of the products produced at the new sites, which is uncertain.

 

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We rely on third parties to provide us with materials and services and are subject to increased labor and material costs.

The materials used to manufacture our products may be subject to availability constraints and price volatility caused by changes in demand, weather conditions, supply conditions, government regulations, economic climate and other factors. In addition, labor costs may be subject to volatility caused by the supply of labor, governmental regulations, economic climate and other factors. Increases in the demand for, availability or the price of, materials used to manufacture our products and increases in labor costs could increase the costs to manufacture our products. We may not be able to pass all or a material portion of any higher material or labor costs on to our customers, which could materially adversely affect our operating results and financial condition.

In addition, certain third-party suppliers are the sole source of certain materials necessary for production of our products. We may be unable to meet demand for certain of our products if any of our third-party suppliers cease or interrupt operations or otherwise fail to meet their obligations to us.

Risks related to legal matters and regulation

We may incur substantial costs and receive adverse outcomes in litigation and other legal matters.

Our operating results, financial condition and liquidity could be materially adversely affected by unfavorable results in pending or future litigation matters. These matters include, among other things, allegations of violation of United States and foreign competition law, labor laws, consumer protection laws, and environmental laws and regulations, as well as claims or litigations relating to product liability, intellectual property, securities, breach of contract and tort. In addition, changes in the interpretations of laws and regulations to which we are subject, or in legal standards in one or more of the jurisdictions in which we operate, could increase our exposure to liability. For example, in the United States, attempts have been made to allow damages for emotional distress and pain and suffering in connection with the loss of, or injury to, a companion animal. If such attempts were successful, our exposure with respect to product liability claims could increase materially.

Litigation matters, regardless of their merits or their ultimate outcomes, are costly, divert management’s attention and may materially adversely affect our reputation and demand for our products. We cannot predict with certainty the eventual outcome of pending or future litigation matters. An adverse outcome of litigation or legal matters could result in our being responsible for significant damages. Any of these negative effects resulting from litigation matters could materially adversely affect our operating results and financial condition.

The misuse or off-label use of our products may harm our reputation or result in financial or other damages.

Our products have been approved for use under specific circumstances for the treatment of certain diseases and conditions in specific species. There may be increased risk of product liability if veterinarians, livestock producers, pet owners or others attempt to use our products off-label, including the use of our products in species (including humans) for which they have not been approved. For example, Ketamine, the active pharmaceutical ingredient in our Ketaset product, is a commonly abused hallucinogen. Furthermore, the use of our products for indications other than those indications for which our products have been approved may not be effective, which could harm our reputation and lead to an increased risk of litigation. If we are deemed by a governmental or regulatory agency to have engaged in the promotion of any of our products for off-label use, such agency could request that we modify our training or promotional materials and practices and we could be subject to significant fines and penalties, and the imposition of these sanctions could also affect our reputation and position within the industry. Any of these events could materially adversely affect our operating results and financial condition.

Animal health products are subject to unanticipated safety or efficacy concerns, which may harm our reputation.

Unanticipated safety or efficacy concerns can arise with respect to animal health products, whether or not scientifically or clinically supported, leading to product recalls, withdrawals or suspended or declining sales, as

 

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well as product liability, and other claims. For example, as a result of safety concerns related to our product, PregSure BVD, in 2010, we voluntarily suspended sales of the product and withdrew the marketing authorization in the EU and, in 2011, we also suspended sales and withdrew the marketing authorization for the product in New Zealand.

In addition, we depend on positive perceptions of the safety and quality of our products, and animal health products generally, by our customers, veterinarians and end-users, and such concerns may harm our reputation. These concerns and the related harm to our reputation could materially adversely affect our operating results and financial condition, regardless of whether such reports are accurate.

Our business is subject to substantial regulation.

We will not be able to market new products unless and until we have obtained all required regulatory approvals in each jurisdiction where we propose to market those products. Even after a product reaches market, it may be subject to re-review and may lose its approvals. In connection with the Separation, we will likely change the location of the manufacture of certain of our products and, because of these changes, may be required to obtain new regulatory approvals. Our failure to obtain approvals, delays in the approval process, or our failure to maintain approvals in any jurisdiction, may prevent us from selling products in that jurisdiction until approval or reapproval is obtained, if ever.

In addition, we cannot predict the nature of future laws or regulations, nor can we determine the effect that additional laws or regulations or changes in existing laws or regulations could have on our business when and if promulgated, or the impact of changes in the interpretation of these laws and regulations, or of disparate federal, state, local and foreign regulatory schemes. Changes to such laws or regulations may include, among other things, changes to taxation requirements, such as tax-rate changes and changes affecting the taxation by the United States of income earned outside the United States.

Changes in applicable federal, state, local and foreign laws and regulations could have a material adverse effect on our operating results and financial condition. For example, regulatory agencies have recently increased their focus on the potential for vaccines to induce immunity anomalies. Absent a clear understanding of these anomalies, regulatory scrutiny of vaccines may become stricter. Additional scrutiny or regulation of our vaccine products could materially adversely affect our operating results and financial condition.

We are subject to complex environmental, health and safety laws and regulations.

We are subject to various federal, state, local and foreign environmental, health and safety laws and regulations. These laws and regulations govern matters such as the emission and discharge of hazardous materials into the ground, air or water; the generation, use, storage, handling, treatment, packaging, transportation, exposure to, and disposal of hazardous and biological materials, including recordkeeping, reporting and registration requirements; and the health and safety of our employees. Due to our operations, these laws and regulations also require us to obtain, and comply with, permits, registrations or other authorizations issued by governmental authorities. These authorities can modify or revoke our permits, registrations or other authorizations and can enforce compliance through fines and injunctions.

Given the nature of our business, we have incurred, are currently incurring and may in the future incur liabilities under the United States Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or CERCLA, or under other federal, state, local and foreign environmental cleanup laws, with respect to our current or former sites, adjacent or nearby third-party sites, or offsite disposal locations. See “Business—Environmental, health and safety.” The costs associated with future cleanup activities that we may be required to conduct or finance could be material. Additionally, we may become liable to third parties for damages, including personal injury and property damage, resulting from the disposal or release of hazardous materials into the environment. Such liability could materially adversely affect our operating results and financial condition.

 

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Furthermore, regulatory agencies are showing increasing concern over the impact of animal health products and livestock operations on the environment. This increased regulatory scrutiny may necessitate that additional time and resources be spent to address these concerns in both new and existing products.

Our failure to comply with the environmental, health and safety laws and regulations to which we are subject, including any permits issued thereunder, may result in environmental remediation costs, loss of permits, fines, penalties or other adverse governmental or private actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of pollution control equipment or remedial measures. We could also be held liable for any and all consequences arising out of human exposure to hazardous materials or environmental damage. Environmental laws and regulations are complex, change frequently, have tended to become more stringent and stringently enforced over time and may be subject to new interpretation. We cannot assure you that our costs of complying with current and future environmental, health and safety laws, and our liabilities arising from past or future releases of, or exposure to, hazardous materials will not materially adversely affect our business, results of operations or financial condition.

Risks related to our international operations

A significant portion of our operations are conducted in foreign jurisdictions and are subject to the economic, political, legal and business environments of the countries in which we do business.

Our international operations could be limited or disrupted by any of the following:

 

 

volatility in the international financial markets;

 

 

compliance with governmental controls;

 

 

difficulties enforcing contractual and intellectual property rights;

 

 

compliance with a wide variety of laws and regulations, such as the Foreign Corrupt Practices Act and similar non-U.S. laws and regulations;

 

 

compliance with foreign labor laws;

 

 

burdens to comply with multiple and potentially conflicting foreign laws and regulations, including those relating to environmental, health and safety requirements;

 

 

changes in laws, regulations, government controls or enforcement practices with respect to our business and the businesses of our customers;

 

 

political and social instability, including crime, civil disturbance, terrorist activities and armed conflicts;

 

 

trade restrictions and restrictions on direct investments by foreign entities, including restrictions administered by the Office of Foreign Assets Control of the U.S. Department of the Treasury;

 

 

changes in tax laws and tariffs;

 

 

costs and difficulties in staffing, managing and monitoring international operations; and

 

 

longer payment cycles and increased exposure to counterparty risk.

The multinational nature of our business subjects us 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.

In addition, international transactions may involve increased financial and legal risks due to differing legal systems and customs. Compliance with these requirements may prohibit the import or export of certain products and technologies or may require us to obtain a license before importing or exporting certain products or technology. A failure to comply with any of these laws, regulations or requirements could result in civil or criminal legal proceedings, monetary or non-monetary penalties, or both, disruptions to our business, limitations

 

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on our ability to import and export products and services, and damage to our reputation. In addition, variations in the pricing of our products between jurisdictions may result in the unauthorized importation of our products between jurisdictions. While the impact of these factors is difficult to predict, any of them could materially adversely affect our operating results and financial condition. Changes in any of these laws, regulations or requirements, or the political environment in a particular country, may affect our ability to engage in business transactions in certain markets, including investment, procurement and repatriation of earnings.

Foreign exchange rate fluctuations and potential currency controls affect our results of operations, as reported in our financial statements.

We conduct operations in many areas of the world, involving transactions denominated in a variety of currencies. In 2011, we generated approximately 61% of our revenues in currencies other than the U.S. dollar, principally the euro, Australian dollar and Brazilian real. We are subject to currency exchange rate risk to the extent that our costs are denominated in currencies other than those in which we earn revenues. In addition, because our financial statements are reported in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies have had, and will continue to have, an impact on our results of operations.

We also face risks arising from currency devaluations and the imposition of cash repatriation restrictions and exchange controls. Currency devaluations result in a diminished value of funds denominated in the currency of the country instituting the devaluation. Cash repatriation restrictions and exchange controls may limit our ability to convert foreign currencies into U.S. dollars or to remit dividends and other payments by our foreign subsidiaries or businesses located in or conducted within a country imposing restrictions or controls. While we currently have no need, and do not intend, to repatriate or convert cash held in countries that have significant restrictions or controls in place, should we need to do so to fund our operations, we may be unable to repatriate or convert such cash, or unable to do so without incurring substantial costs. We currently have substantial operations in countries that have cash repatriation restrictions or exchange controls in place, including China and Venezuela, and, if we were to need to repatriate or convert such cash, these controls and restrictions may have a material adverse effect on our operating results and financial condition.

We may not be able to realize the expected benefits of our investments in emerging markets.

We have been taking steps to increase our presence in emerging markets, including by expanding our manufacturing presence, sales organization and product offerings in these markets. Failure to continue to maintain and expand our business in emerging markets could also materially adversely affect our operating results and financial condition.

Some countries within emerging markets may be especially vulnerable to periods of local, regional or global economic, political or social instability or crisis. For example, our sales in certain emerging markets have suffered from extended periods of disruption due to natural disasters. Furthermore, we have also experienced lower than expected sales in certain emerging markets due to local, regional and global restrictions on banking and commercial activities in those countries. In addition, certain emerging markets have currencies that fluctuate substantially, which may impact our financial performance. For example, in the past, our revenues in certain emerging markets in Latin America have been adversely impacted by currency fluctuations and devaluations. For all these and other reasons, sales within emerging markets carry significant risks.

Risks related to intellectual property

The actual or purported intellectual property rights of third parties may negatively affect our business.

A third party may sue us or otherwise make a claim, alleging infringement or other violation of the third-party’s patents, trademarks, trade dress, copyrights, trade secrets, domain names or other intellectual property rights. If we do not prevail in this type of litigation, we may be required to:

 

 

pay monetary damages;

 

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obtain a license in order to continue manufacturing or marketing the affected products, which may not be available on commercially reasonable terms, or at all; or

 

 

stop activities, including any commercial activities, relating to the affected products, which could include a recall of the affected products and/or a cessation of sales in the future.

The costs of defending an intellectual property claim could be substantial and could materially adversely affect our operating results and financial condition, even if we successfully defend such claims.

The intellectual property positions of animal health medicines and vaccines businesses frequently involve complex legal and factual questions, and an issued patent does not guarantee us the right to practice the patented technology or develop, manufacture or commercialize the patented product. We cannot be certain that a competitor or other third party does not have or will not obtain rights to intellectual property that may prevent us from manufacturing, developing or marketing certain of our products, regardless of whether we believe such intellectual property rights are valid and enforceable or we believe we would be otherwise able to develop a more commercially successful product, which may harm our operating results and financial condition.

If our intellectual property rights are challenged or circumvented, competitors may be able to take advantage of our research and development efforts.

Our long-term success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements with our employees and others, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be approved on a timely basis, or at all. Similarly, any term extensions that we seek may not be approved on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have their own patent laws. For example, some countries only permit the issuance of patents covering a novel chemical compound itself, and its first use, and thus further methods of use for the same compound, may not be patentable. We may be subject to challenges by third parties regarding our intellectual property, including claims regarding validity, enforceability, scope and effective term. The validity, enforceability, scope and effective term of patents can be highly uncertain and often involve complex legal and factual questions and proceedings. Our ability to enforce our patents also depends on the laws of individual countries and each country’s practice with respect to enforcement of intellectual property rights. In addition, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, including because such agreements expire or are terminated, our operating results and financial condition could be materially adversely affected.

In addition, patent law reform in the United States and other countries may also weaken our ability to enforce our patent rights, or make such enforcement financially unattractive. For instance, in September 2011, the United States enacted the America Invents Act, which will permit enhanced third-party actions for challenging patents and implement a first-to-invent system, and, in April 2012, Australia enacted the Intellectual Property Laws Amendment (Raising the Bar) Act, which provides higher standards for obtaining patents. These reforms could result in increased costs to protect our intellectual property or limit our ability to patent our products in these jurisdictions.

Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies, which could diminish or eliminate sales and profits from those regions and materially adversely affect our operating results and financial condition.

 

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Likewise, in the United States and other countries, we currently hold issued trademark registrations and have trademark applications pending, any of which may be the subject of a governmental or third party objection, which could prevent the maintenance or issuance of the same and thus create the potential need to rebrand or relabel a product. As our products mature, our reliance on our trademarks to differentiate us from our competitors increases and as a result, if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our trademark rights, our business could be materially adversely affected.

Many of our vaccine products and other products are based on or incorporate proprietary information, including proprietary master seeds and proprietary or patented adjuvant formulations. We actively seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their employment, engagement or other relationship. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise.

The misappropriation and infringement of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States, may occur even when we take steps to prevent it. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming, and if resolved adversely, could have a significant impact on our business and financial condition. In the future, we may not be able to enforce intellectual property that relates to our products for various reasons, including licensor restrictions and other restrictions imposed by third parties, and that the costs of doing so may outweigh the value of doing so, and this could have a material adverse impact on our business and financial condition.

Risks related to information technology

We may be unable to successfully manage our online ordering sites.

In many markets around the world, such as the United States and Brazil, we provide online ordering sites to customers, often through third-party service providers. The operation of our online business depends on our ability to maintain the efficient and uninterrupted operation of our online order-taking and fulfillment operations. Risks associated with our online business include: disruptions in telephone service or power outages; failures of the computer systems that operate our website, including inadequate system capacity, computer viruses, human error, changes in programming, security breaches, system upgrades or migration of these services to new systems; reliance on third parties for computer hardware and software as well as delivery of merchandise to our customers; rapid technology changes; credit card fraud; natural disasters or adverse weather conditions; power and network outages; changes in applicable federal and state regulations; liability for online content; and consumer privacy concerns. Problems in any one or more of these areas could have a material adverse effect on our operating results and financial condition and could damage our reputation.

We depend on sophisticated information technology and infrastructure.

We rely on various information systems to manage our operations, and we increasingly depend on third parties and applications on virtualized, or “cloud,” infrastructure to operate and support our information technology systems. These third parties include large established vendors as well as many small, privately owned companies. Failure by these providers to adequately service our operations or a change in control or insolvency of these providers could have an adverse effect on our business, which in turn may materially adversely affect our operating results and financial condition.

 

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Prior to the completion of this offering and in connection with the Separation, we will substantially change a number of our business processes, including changes in our financial reporting and supply chain processes. In order to support the new business processes under the terms of our transitional services agreement with Pfizer, we will make significant configuration and data changes within some of our information technology systems. If our information technology and processes are not sufficient to support our business and financial reporting functions, or if we fail to properly implement our new business processes, our financial reporting may be delayed or inaccurate and our operations may be adversely affected and, as a result, our operating results and financial condition may be materially adversely affected.

In addition, over the next few years, we expect to begin implementing a new enterprise resource planning system to better integrate our manufacturing, financial, commercial and business operations. Transitioning to new systems, integrating new systems into current systems or any disruptions or malfunctions (including from circumstances beyond our control) affecting our information systems could cause critical information upon which we rely to be delayed, unreliable, corrupted, insufficient or inaccessible. Any of these potential issues, individually or in aggregation, could have a material adverse effect on our operating results and financial condition.

Even if we are able to implement these systems successfully, all technology systems, despite implementation of security measures, are vulnerable to disability, failures or unauthorized access. If our information technology systems were to fail or be breached, this could materially adversely affect our ability to perform critical business functions and sensitive and confidential data could be compromised.

We may be unable to adequately protect our customers’ privacy or we may fail to comply with privacy laws.

The protection of customer, employee and company data is critical and the regulatory environment surrounding information security, storage, use, processing, disclosure and privacy is demanding, with the frequent imposition of new and changing requirements. In addition, our customers expect that we will adequately protect their personal information. Any actual or perceived significant breakdown, intrusion, interruption, cyber-attack or corruption of customer, employee or company data or our failure to comply with federal, state, local and foreign privacy laws could damage our reputation and result in lost sales, fines and lawsuits. Despite our considerable efforts and technology to secure our computer network, security could be compromised, confidential information could be misappropriated or system disruptions could occur. Our systems and procedures meet the payment card industry, or PCI, data security standards, which require periodic audits by independent third parties to assess compliance. Failure to comply with the security requirements or rectify a security issue may result in fines and the imposition of restrictions on our ability to accept payment by credit or debit cards. In addition, PCI is controlled by a limited number of vendors that have the ability to impose changes in PCI’s fee structure and operational requirements on us without negotiation. Such changes in fees and operational requirements may result in our failure to comply with PCI security standards, as well as significant unanticipated expenses. Such failures could materially adversely affect our operating results and financial condition.

Risks related to our indebtedness

We have substantial indebtedness.

We have a significant amount of indebtedness, which could materially adversely affect our operating results, financial condition and liquidity. We incurred approximately $3.65 billion aggregate principal amount of senior indebtedness in connection with the senior notes offering. As of September 30, 2012, after giving pro forma effect to the Transactions, which include the senior notes offering, our total debt would have been approximately $3.64 billion (net of original issue debt discount of $10 million). Immediately prior to the completion of this offering, we will transfer an amount of cash equal to substantially all of the net proceeds we received in the senior notes offering to Pfizer. In addition, $1.0 billion aggregate principal amount of our senior notes was transferred to Pfizer and subsequently disposed of by Pfizer in connection with the senior notes offering. See “Unaudited pro forma condensed combined financial statements.” In addition, we have entered into an agreement for a $1.0 billion five-year revolving credit facility and expect to enter into a commercial paper program with a

 

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capacity of up to $1.0 billion prior to or concurrently with the completion of this offering. The credit facility will not be available for borrowings until the date on which certain conditions, including the completion of this offering and the receipt of certain investment grade ratings, are satisfied. We expect that these conditions will be met concurrently with the completion of this offering, which we refer to as the “credit facility effective date.” While we do not anticipate that any amounts will be drawn under the credit facility or that any commercial paper will be issued under the commercial paper program at the time of this offering, we may incur indebtedness under these arrangements in the future.

We may incur substantial additional debt from time to time to finance working capital, capital expenditures, investments or acquisitions, or for other purposes. If we do so, the risks related to our high level of debt could intensify. Specifically, our high level of debt could have important consequences, including:

 

 

making it more difficult for us to satisfy our obligations with respect to our debt;

 

 

limiting our ability to obtain additional financing to fund future working capital, capital expenditures, business development or other general corporate requirements, including dividends;

 

 

increasing our vulnerability to general adverse economic and industry conditions;

 

 

exposing us to the risk of increased interest rates as certain of our borrowings are and may in the future be at variable rates of interest;

 

 

limiting our flexibility in planning for and reacting to changes in the animal health industry;

 

 

placing us at a competitive disadvantage to other, less leveraged competitors;

 

 

impacting our effective tax rate; and

 

 

increasing our cost of borrowing.

In addition, the instruments governing our indebtedness contain restrictive covenants that will limit our ability to engage in activities that may be in our long-term best interest. For example, our credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio and, unless on the credit facility effective date certain investment grade ratings specified in the revolving credit agreement are received, to maintain a minimum interest coverage ratio. In addition, the credit facility contains covenants that, among other things, limit or restrict our and our subsidiaries’ ability, subject to certain exceptions, to incur liens, merge, consolidate or sell, transfer or lease assets, transact with subsidiaries and incur priority indebtedness. Our failure to comply with such covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all our debt.

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or refinance our debt obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business, legislative, regulatory and other factors beyond our control. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal and interest on our indebtedness.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures, or to dispose of material assets or operations, alter our dividend policy, seek additional debt or equity capital or restructure or refinance our indebtedness. We may not be able to effect any such alternative measures on commercially reasonable terms or at all and, even if successful, those alternative actions may not allow us to meet our scheduled debt service obligations. The instruments that will govern our indebtedness may restrict our ability to dispose of assets and may restrict the use of proceeds from those dispositions and may also restrict our ability to raise debt or equity capital to be used to repay other indebtedness when it becomes due. We may not be able to consummate those dispositions or to obtain proceeds in an amount sufficient to meet any debt service obligations when due.

 

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In addition, we conduct our operations through our subsidiaries. Accordingly, repayment of our indebtedness will depend on the generation of cash flow by our subsidiaries, including our international subsidiaries, and their ability to make such cash available to us, by dividend, debt repayment or otherwise. Our subsidiaries may not have any obligation to pay amounts due on our indebtedness or to make funds available for that purpose. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness. Each subsidiary is a distinct legal entity, and under certain circumstances, legal, tax and contractual restrictions may limit our ability to obtain cash from our subsidiaries. In the event that we do not receive distributions from our subsidiaries, we may be unable to make required principal and interest payments on our indebtedness.

Our inability to generate sufficient cash flows to satisfy our debt obligations, or to refinance our indebtedness on commercially reasonable terms or at all, may materially adversely affect our operating results, financial condition and liquidity and our ability to satisfy our obligations under our indebtedness or pay dividends on our common stock.

Risks related to our relationship with Pfizer

The Separation and Distribution, if any, may not be successful and we may not achieve some or all of the expected benefits of the Separation and Distribution.

We may not be successful in implementing the Separation and Distribution. In addition, we may not be able to achieve the full strategic and financial benefits expected to result from the Separation and Distribution, or such benefits may be delayed or not occur at all. These benefits include the following:

 

 

improving strategic and operational flexibility, increasing management focus and streamlining decision-making by providing the flexibility to implement our strategic plan and to respond more effectively to different customer needs and the changing economic environment;

 

 

allowing us to adopt the capital structure, investment policy and dividend policy best suited to our financial profile and business needs, without competing for capital with Pfizer’s other businesses;

 

 

creating an independent equity structure that will facilitate our ability to effect future acquisitions utilizing our common stock; and

 

 

facilitating incentive compensation arrangements for employees more directly tied to the performance of our business, and enhancing employee hiring and retention by, among other things, improving the alignment of management and employee incentives with performance and growth objectives of our business.

We may not achieve the anticipated benefits of the Separation and Distribution for a variety of reasons. In addition, the Separation and Distribution could adversely affect our operating results and financial condition.

Pfizer controls the direction of our business, and the concentrated ownership of our common stock will prevent you and other stockholders from influencing significant decisions.

Immediately following the completion of this offering, Pfizer will own 100% of our outstanding Class B common stock and no shares of our Class A common stock, giving Pfizer 82.8% of the economic interest and the combined voting power in shares of our outstanding common stock other than with respect to the election of directors and 98.0% of the combined voting power of our outstanding common stock with respect to the election of directors (or 80.2% and 97.6%, respectively, if the underwriters exercise their option to purchase additional shares in full). As long as Pfizer beneficially controls a majority of the voting power of our outstanding common stock with respect to a particular matter, it will generally be able to determine the outcome of all corporate actions requiring stockholder approval, including the election and removal of directors. Even if Pfizer were to control less than a majority of the voting power of our outstanding common stock, it may be able to influence the outcome of such corporate actions so long as it owns a significant portion of our common stock. If Pfizer does not complete the Distribution or otherwise dispose of its shares of our common stock, it could remain our controlling stockholder for an extended period of time or indefinitely.

 

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Pfizer’s interests may not be the same as, or may conflict with, the interests of our other stockholders. Investors in this offering will not be able to affect the outcome of any stockholder vote while Pfizer controls the majority of the voting power of our outstanding common stock. As a result, Pfizer will be able to control, directly or indirectly and subject to applicable law, all matters affecting us, including:

 

 

any determination with respect to our business direction and policies, including the appointment and removal of officers and directors;

 

 

any determinations with respect to mergers, business combinations or disposition of assets;

 

 

our financing and dividend policy;

 

 

compensation and benefit programs and other human resources policy decisions;

 

 

termination of, changes to or determinations under our agreements with Pfizer relating to the Separation;

 

 

changes to any other agreements that may adversely affect us;

 

 

the payment of dividends on our common stock; and

 

 

determinations with respect to our tax returns.

Because Pfizer’s interests may differ from ours or from those of our other stockholders, actions that Pfizer takes with respect to us, as our controlling stockholder, may not be favorable to us or our other stockholders.

The Distribution may not occur.

Pfizer has no obligation to complete the Distribution. Whether Pfizer proceeds with the Distribution, in whole or in part, is subject to a number of conditions, including the receipt of any necessary regulatory or other approvals, the existence of satisfactory market conditions and the continuing application of Pfizer’s private letter ruling from the IRS and the receipt of opinions of counsel to the effect that such Distribution would be tax-free to Pfizer and its stockholders. Even if Pfizer elects to pursue the Distribution, Pfizer has the right to abandon or change the structure of the Distribution if Pfizer determines, in its sole discretion, that the Distribution is not in the best interest of Pfizer or its stockholders.

Furthermore, if the Distribution does not occur, or if Pfizer does not otherwise dispose of its shares of our common stock, the risks relating to Pfizer’s control of us and the potential business conflicts of interest between Pfizer and us will continue to be relevant to our stockholders. The liquidity of shares of our common stock in the market may be constrained for as long as Pfizer continues to hold a significant position in our stock. A lack of liquidity in our Class A common stock could depress the price of our Class A common stock.

Our Class B common stock may remain as a separate class.

Each share of Class B common stock held by Pfizer or a subsidiary of Pfizer will be convertible at any time into one share of Class A common stock at Pfizer’s option but will not be convertible if held by any other holder. As a result, if Pfizer were to distribute shares of Class B common stock in the Distribution, or otherwise dispose of its shares of Class B common stock, the new holders of such shares would not be able to convert the shares of Class B common stock into Class A common stock. In such event, we may apply to have our Class B common stock listed on a securities exchange. The existence of multiple classes of publicly traded common stock could depress the price of our Class A common stock.

If Pfizer were to distribute shares of Class B common stock in the Distribution, or otherwise dispose of its shares of Class B common stock, our board of directors may in the future consider a proposal to amend our certificate of incorporation to mandatorily convert Class B common stock to Class A common stock on a share-for-share basis, subject to the receipt of the required approval by our stockholders. If the proposal is approved by our board of directors and presented to our stockholders, a vote by (i) a majority of the shares of Class A common stock and

 

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Class B common stock, voting together as a single class, and (ii) a majority of the shares of the Class B common stock, voting as a separate class, will be required for the proposal to be approved. There will be no binding commitment by the board to, and our board of directors may elect not to consider the issue or resolve to present any such proposal to our stockholders at any stockholders’ meeting. Moreover, if presented, our stockholders may not approve any such conversion.

If Pfizer sells a controlling interest in our company to a third party in a private transaction, you may not realize any change-of-control premium on shares of our common stock and we may become subject to the control of a presently unknown third party.

Following the completion of this offering, Pfizer will continue to own a significant equity interest in our company. Pfizer will have the ability, should it choose to do so, to sell some or all of its shares of our common stock in a privately negotiated transaction, which, if sufficient in size, could result in a change of control of our company.

The ability of Pfizer to privately sell its shares of our common stock, with no requirement for a concurrent offer to be made to acquire all of the shares of our Class A common stock that will be publicly traded hereafter, could prevent you from realizing any change-of-control premium on your shares of our Class A common stock that may otherwise accrue to Pfizer on its private sale of our common stock. Additionally, if Pfizer privately sells its significant equity interest in our company, we may become subject to the control of a presently unknown third party. Such third party may have conflicts of interest with those of other stockholders. In addition, if Pfizer sells a controlling interest in our company to a third party, our indebtedness may be subject to acceleration, Pfizer may terminate the R&D collaboration agreement and license agreement, and other transitional arrangements, and our other commercial agreements and relationships could be impacted, all of which may adversely affect our ability to run our business as described herein and may have a material adverse effect on our operating results and financial condition.

The Distribution or future sales by Pfizer or others of our common stock, or the perception that the Distribution or such sales may occur, could depress our Class A common stock price.

Immediately following the completion of this offering, Pfizer will own 100% of our outstanding Class B common stock and no shares of our Class A common stock, giving Pfizer 82.8% of the economic interest and the combined voting power in shares of our outstanding common stock other than with respect to the election of directors and 98.0% of the combined voting power of our outstanding common stock with respect to the election of directors (or 80.2% and 97.6%, respectively, if the underwriters exercise their option to purchase additional shares in full). Subject to the restrictions described in the paragraph below, future sales of these shares in the public market will be subject to the volume and other restrictions of Rule 144 under the Securities Act of 1933, or the Securities Act, for so long as Pfizer is deemed to be our affiliate, unless the shares to be sold are registered with the Securities and Exchange Commission, or SEC. We are unable to predict with certainty whether or when Pfizer will sell a substantial number of shares of our common stock to the extent it retains shares following the Distribution or in the event the Distribution does not occur. The Distribution or sale by Pfizer of a substantial number of shares after this offering, or a perception that the Distribution or such sales could occur, could significantly reduce the market price of our Class A common stock. Upon completion of this offering, except as otherwise described herein, all shares that are being offered hereby will be freely tradable without restriction, assuming they are not held by our affiliates.

We, our officers and directors and Pfizer have agreed with the underwriters that, without the prior written consent of J.P. Morgan Securities LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. LLC, we and they will not, subject to certain exceptions and extensions, during the period ending 180 days after the date of this prospectus, offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, or enter into any swap or other agreement that transfers to another, in

 

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whole or in part, any of the economic consequences of ownership of shares of our common stock or any securities convertible into or exercisable or exchangeable for shares of our common stock or publicly disclose the intention to make any such offer, sale, pledge or disposition. J.P. Morgan Securities LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Morgan Stanley & Co. LLC may, in their sole discretion and at any time without notice, release all or any portion of the shares of our common stock subject to the lock-up.

Immediately following this offering, we intend to file a registration statement registering under the Securities Act the shares of our common stock reserved for issuance under the Zoetis 2013 Equity and Incentive Plan. If equity securities granted under the Zoetis 2013 Equity and Incentive Plan are sold or it is perceived that they will be sold in the public market, the trading price of our Class A common stock could decline substantially. These sales also could impede our ability to raise future capital.

We will be a “controlled company” within the meaning of the rules of the NYSE and, as a result, will qualify for, and intend to rely on, exemptions from certain corporate governance requirements. You will not have the same protections afforded to stockholders of companies that are subject to such requirements.

Upon completion of this offering, Pfizer will continue to control a majority of the voting power of our outstanding common stock. As a result, we will be a “controlled company” within the meaning of the corporate governance standards of the NYSE. Under these rules, a listed company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain corporate governance requirements, including:

 

 

the requirement that a majority of the board of directors consist of independent directors;

 

 

the requirement that our corporate governance committee be composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities;

 

 

the requirement that our compensation committee be composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

 

 

the requirement for an annual performance evaluation of our corporate governance and compensation committees.

While Pfizer controls a majority of the voting power of our outstanding common stock, we may not have a majority of independent directors or corporate governance and compensation committees consisting entirely of independent directors and we will not be required to have written charters addressing these committees’ purposes and responsibilities or have annual performance evaluations of these committees. Accordingly, you will not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NYSE.

As a result of the Separation, we will lose Pfizer’s brand, reputation, capital base and other resources.

Prior to the completion of this offering, as a business unit of Pfizer, we have generally used the name “Pfizer Animal Health,” and we believe the association with Pfizer has contributed to our building relationships with our customers due to Pfizer’s globally recognized brand and perceived high-quality products. This offering, the Separation and Distribution could adversely affect our ability to attract and retain customers, which could result in reduced sales of our products.

The loss of Pfizer’s scale, capital base and financial strength may also prompt suppliers to reprice, modify or terminate their relationships with us. In addition, Pfizer’s reduction of its ownership of our company may cause some of our existing agreements and licenses to be terminated. We cannot predict with certainty the effect that this offering, the Separation or the Distribution will have on our business, our clients, vendors or other persons, or whether our new brand, Zoetis, will be accepted in the marketplace.

 

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Pfizer may compete with us.

Pfizer will not be restricted from competing with us in the animal health business, including as a result of acquiring a company that operates an animal health business. Due to the significant resources of Pfizer, including financial resources, name recognition and know-how resulting from the previous management of our business, Pfizer could have a significant competitive advantage over us should it decide to engage in the type of business we conduct, which may cause our operating results and financial condition to be materially adversely affected.

Certain of our directors may have actual or potential conflicts of interest because of their positions with Pfizer.

Following this offering, Frank A. D’Amelio (Executive Vice President, Chief Financial Officer and Business Operations for Pfizer), Geno J. Germano (President and General Manager, Specialty Care and Oncology for Pfizer), Douglas E. Giordano (Senior Vice President, Worldwide Business Development for Pfizer), Charles H. Hill (Executive Vice President, Worldwide Human Resources for Pfizer) and Amy W. Schulman (Executive Vice President and General Counsel, Business Unit Lead, Consumer Healthcare for Pfizer) will serve on our board of directors and retain their positions with Pfizer. In addition, such directors may own Pfizer common stock, options to purchase Pfizer common stock or other Pfizer equity awards. These individual’s holdings of Pfizer common stock, options to purchase common stock of Pfizer or other equity awards may be significant for some of these persons compared to these persons’ total assets. Their position at Pfizer and the ownership of any Pfizer equity or equity awards creates, or may create the appearance of, conflicts of interest when these directors are faced with decisions that could have different implications for Pfizer than the decisions have for us.

Pfizer and its directors and officers will have limited liability to us or you for breach of fiduciary duty.

Our certificate of incorporation provides that, subject to any contractual provision to the contrary, Pfizer will have no obligation to refrain from:

 

 

engaging in the same or similar business activities or lines of business as we do;

 

 

doing business with any of our clients or consumers; or

 

 

employing or otherwise engaging any of our officers or employees.

Under our certificate of incorporation, neither Pfizer nor any officer or director of Pfizer, except as provided in our certificate of incorporation, is liable to us or to our stockholders for breach of any fiduciary duty by reason of any of these activities.

To preserve the tax-free treatment to Pfizer and/or its stockholders of the Separation, the debt-for-debt exchange, the debt-for-equity exchange, the transfer of cash proceeds of the senior notes offering to Pfizer and the potential Distribution, we may not be able to engage in certain transactions.

To preserve the tax-free treatment to Pfizer and/or its stockholders of the Separation, the debt-for-debt exchange, the debt-for-equity exchange, the transfer of cash proceeds of the senior notes offering to Pfizer, the potential Distribution and certain related transactions, under the tax matters agreement, we will be restricted from taking any action that prevents the Separation, the debt-for-debt exchange, the debt-for-equity exchange, the transfer of cash proceeds of the senior notes offering to Pfizer, the potential Distribution and certain related transactions from being tax-free for U.S. federal, state, local and foreign income tax purposes. These restrictions may limit our ability to pursue certain strategic transactions or engage in other transactions, including taking certain actions with respect to our 3.250% Senior Notes due 2023, which we refer to as the “2023 notes” and the use of our common stock to make acquisitions and equity capital market transactions that might increase the value of our business. See “Certain relationships and related party transactions—Relationship with Pfizer—Tax matters agreement.”

 

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The assets and resources that we acquire from Pfizer in the Separation may not be sufficient for us to operate as a standalone company, and we may experience difficulty in separating our assets and resources from Pfizer.

Because we have not operated as a standalone company in the past, we may have difficulty doing so. We may need to acquire assets and resources in addition to those provided by Pfizer to our company, and in connection with the Separation, may also face difficulty in separating our assets from Pfizer’s assets and integrating newly acquired assets into our business. Our business, financial condition and results of operations could be harmed if we have difficulty operating as a standalone company, fail to acquire assets that prove to be important to our operations or incur unexpected costs in separating our assets from Pfizer’s assets or integrating newly acquired assets.

We will incur significant charges in connection with this offering and the Separation and incremental costs as a standalone public company.

We will need to replicate or replace certain functions, systems and infrastructure to which we will no longer have the same access after this offering. We may also need to make investments or hire additional employees to operate without the same access to Pfizer’s existing operational and administrative infrastructure. These initiatives may be costly to implement. Due to the scope and complexity of the underlying projects relative to these efforts, the amount of total costs could be materially higher than our estimate, and the timing of the incurrence of these costs is subject to change.

Pfizer currently performs or supports many important corporate functions for our company. Our combined financial statements reflect charges for these services on an allocation basis. Following this offering, many of these services will be governed by our transitional services agreement with Pfizer. Under the transitional services agreement we will be able to use these Pfizer services for a fixed term established on a service-by-service basis. However, we generally will have the right to terminate a service earlier if we give notice to Pfizer. Partial reduction in the provision of any service requires Pfizer’s consent. In addition, either party will be able to terminate the agreement due to a material breach of the other party, upon prior written notice, subject to limited cure periods.

We will pay Pfizer mutually agreed-upon fees for these services, which will be based on Pfizer’s costs of providing the services. During the two years following the completion of this offering, the markup for these services will be 0% and, for the remainder of the term of the agreement, Pfizer may introduce a markup of 7%, which we believe is consistent with arm’s length pricing for the services provided. However, since our transitional services agreement was negotiated in the context of a parent-subsidiary relationship, the terms of the agreement, including the fees charged for the services, may be higher or lower than those that would be agreed to by parties bargaining at arm’s length for similar services and may be higher or lower than the costs reflected in the allocations in our historical financial statements. Third party costs will be passed through to us at Pfizer’s or its affiliates’ cost. In addition, while these services are being provided to us by Pfizer, our operational flexibility to modify or implement changes with respect to such services or the amounts we pay for them will be limited. Prior to the Distribution, if effected, Pfizer will have the unilateral right to resolve disputes under the transitional services agreement.

We may not be able to replace these services or enter into appropriate third-party agreements on terms and conditions, including cost, comparable to those that we will receive from Pfizer under our transitional services agreement. Additionally, after the agreement terminates, we may be unable to sustain the services at the same levels or obtain the same benefits as when we were receiving such services and benefits from Pfizer. When we begin to operate these functions separately, if we do not have our own adequate systems and business functions in place, or are unable to obtain them from other providers, we may not be able to operate our business effectively or at comparable costs, and our profitability may decline. In addition, we have historically received informal support from Pfizer, which may not be addressed in our transitional services agreement. The level of this informal support will diminish or be eliminated following this offering.

 

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We may not be able to fully realize the expected benefits of our R&D agreement with Pfizer.

Prior to the Separation, as a business unit of Pfizer, we had the ability to leverage Pfizer’s proprietary compound library and database to identify, research and develop compounds suitable as new product candidates for the animal health field. As part of the Separation, we intend to enter into an R&D collaboration and license agreement with Pfizer, which we refer to as the “R&D agreement.” Pursuant to the R&D agreement, subject to certain restrictions, we will have continued access to Pfizer’s compound library and database for a period of seven years and will have, subject to Pfizer’s approval, the possibility to exclusively license compounds from Pfizer that we develop under the R&D agreement.

While the R&D agreement is intended to bolster our post-Separation R&D capabilities, certain terms of the R&D agreement may limit our ability to achieve this expected benefit, including:

 

 

Pfizer will retain ownership of, and license to us, the intellectual property that we develop under the R&D agreement. In many circumstances, the intellectual property we license from Pfizer will be non-exclusive as to Pfizer and third parties.

 

 

We are not assured access to Pfizer’s newest programs.

 

 

Pfizer can prevent us from progressing pre-development compounds and, under certain circumstances, Pfizer may terminate our rights to a development stage compound by paying us the fair market value for such compound.

 

 

The R&D agreement may be terminated before the expiration of the seven year term in certain circumstances, including if we acquire an interest in or assets of a human pharmaceutical business, we enter into a definitive agreement relating to or undergo a change of control other than the Distribution or Pfizer acquires, or is acquired by, an animal health business.

Each of the foregoing terms and Pfizer’s other rights under the R&D agreement and related licenses (if any), could limit our ability to realize the expected benefits of the R&D agreement. If we fail to achieve the expected benefits of the R&D agreement, it may be more difficult, time consuming or expensive for us to develop and commercialize certain new products, or may result in our products being later to market than those of our competitors. We may experience delays in new product development, which may result in our loss of the first-in-class products in a given therapeutic area.

For a summary description of the terms of the R&D collaboration and license agreement, see “Certain relationships and related party transactions—Relationship with Pfizer—Research and development collaboration and license agreement.”

We are dependent on Pfizer to prosecute, maintain and enforce certain intellectual property.

Under the patent and know-how license agreement (Pfizer as licensor), Pfizer will be responsible for filing, prosecuting and maintaining patents that Pfizer licenses to us. Pfizer also has the first right, and in some cases the sole right, to enforce such patents. In addition, under the patent and know-how license agreement (Zoetis as licensor), subject to certain exceptions, Pfizer will have the sole right to enforce the licensed patents if the enforcement relates to the human health field. If Pfizer fails to fulfill its obligations or chooses to not enforce the licensed patents under these agreements, we may not be able to prevent competitors from making, using and selling competitive products.

Pfizer’s rights as licensor under the patent and know-how license could limit our ability to develop and commercialize certain products.

Under the patent and know-how license, Pfizer licenses to us certain of its intellectual property. If we fail to comply with our obligations under this license agreement and Pfizer exercises its right to terminate it, our ability to continue to research, develop and commercialize products incorporating that intellectual property will be

 

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limited. In addition, in circumstances where Pfizer has an interest in the licensed intellectual property in connection with its human health development programs, our rights to use the licensed intellectual property are restricted and/or in limited instances, subject to Pfizer’s right to terminate such license at will. These limitations and termination rights may make it more difficult, time consuming or expensive for us to develop and commercialize certain new products, or may result in our products being later to market than those of our competitors.

For a summary description of the terms of the patent and know-how license (Pfizer as licensor), see “Certain relationships and related party transactions—Relationship with Pfizer—Intellectual property license agreements.”

Risks related to this offering and ownership of our Class A common stock

An active trading market for our Class A common stock may not develop, and you may not be able to sell your Class A common stock at or above the initial public offering price.

Prior to the completion of this offering, there has been no public market for our common stock. An active trading market for shares of our Class A common stock may never develop or be sustained following this offering. If an active trading market does not develop, you may have difficulty selling your shares of Class A common stock at an attractive price, or at all. The price for our Class A common stock in this offering will be determined by negotiations among Pfizer, us and representatives of the underwriters, and it may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell your Class A common stock at or above the initial public offering price or at any other price or at the time that you would like to sell. An inactive market may also impair our ability to raise capital by selling our common stock, and it may impair our ability to attract and motivate our employees through equity incentive awards and our ability to acquire other companies, products or technologies by using our common stock as consideration.

The price of our Class A common stock may fluctuate substantially.

You should consider an investment in our Class A common stock to be risky, and you should invest in our Class A common stock only if you can withstand a significant loss and wide fluctuations in the market value of your investment. Some factors that may cause the market price of our Class A common stock to fluctuate, in addition to the other risks mentioned in this section of the prospectus, are:

 

 

our announcements or our competitors’ announcements regarding new products or services, enhancements, significant contracts, acquisitions or strategic investments;

 

 

changes in earnings estimates or recommendations by securities analysts, if any, who cover our common stock;

 

 

failures to meet external expectations or management guidance;

 

 

fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us;

 

 

changes in our capital structure or dividend policy, including as a result of the Distribution, future issuances of securities, sales of large blocks of common stock by our stockholders, including Pfizer, or our incurrence of additional debt;

 

 

reputational issues;

 

 

changes in general economic and market conditions in or any of the regions in which we conduct our business;

 

 

changes in industry conditions or perceptions;

 

 

changes in applicable laws, rules or regulations and other dynamics; and

 

 

announcements or actions taken by Pfizer as our principal stockholder.

 

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In addition, if the market for stocks in our industry or industries related to our industry, or the stock market in general, experiences a loss of investor confidence, the trading price of our Class A common stock could decline for reasons unrelated to our business, financial condition and results of operations. If any of the foregoing occurs, it could cause our stock price to fall and may expose us to lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.

You will incur immediate dilution as a result of this offering.

If you purchase Class A common stock in this offering, you will pay more for your shares than the pro forma net tangible book value of your shares. As a result, you will incur immediate dilution of $27.60 per share, representing the difference between the initial public offering price of $26.00 per share and our pro forma net tangible book deficit per share as of September 30, 2012 after giving effect to the Transactions, as defined in “Unaudited pro forma condensed combined financial statements” of $(1.60). Accordingly, should we be liquidated at our book value, you would not receive the full amount of your investment.

Our historical combined financial data is not necessarily representative of the results we would have achieved as a standalone company and may not be a reliable indicator of our future results.

Our historical combined financial data included in this prospectus does not reflect the financial condition, results of operations or cash flows we would have achieved as a standalone company during the periods presented or those we will achieve in the future. This is primarily the result of the following factors:

 

 

our historical combined financial data does not reflect the Separation;

 

 

our historical combined financial data reflects expense allocations for certain support functions that are provided on a centralized basis within Pfizer, such as expenses for business technology, facilities, legal, finance, human resources, business development, public affairs and procurement, as well as certain manufacturing and supply costs incurred by manufacturing sites that are shared with other Pfizer business units that may be higher or lower than the comparable expenses we would have actually incurred, or will incur in the future, as a standalone company;

 

 

our cost of debt and our capital structure will be different from that reflected in our historical combined financial statements;

 

 

significant increases may occur in our cost structure as a result of this offering, including costs related to public company reporting, investor relations and compliance with the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act; and

 

 

this offering may have a material effect on our customers and other business relationships, including supplier relationships, and may result in the loss of preferred pricing available by virtue of our reduced relationship with Pfizer.

Our financial condition and future results of operations, after giving effect to the Separation, will be materially different from amounts reflected in our historical combined financial statements included elsewhere in this prospectus. As a result of the Separation, it may be difficult for investors to compare our future results to historical results or to evaluate our relative performance or trends in our business.

As a standalone public company, we may expend additional time and resources to comply with rules and regulations that do not currently apply to us, and failure to comply with such rules may lead investors to lose confidence in our financial data.

As a standalone public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, and regulations of the NYSE. Such requirements will increase our legal, accounting and financial compliance costs, will make some activities more difficult, time-consuming and costly and could be burdensome on our personnel, systems and resources. We will devote significant

 

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resources to address these public company-associated requirements, including compliance programs and investor relations, as well as our financial reporting obligations. Complying with these rules and regulations has and will substantially increase our legal and financial compliance costs and make some activities more time-consuming and costly.

In particular, as a public company, our management will be required to conduct an annual evaluation of our internal controls over financial reporting and include a report of management on our internal controls in our annual reports on Form 10-K. Under current rules, we will be subject to these requirements beginning with our annual report on Form 10-K for the year ended December 31, 2013. In addition, we will be required to have our independent registered public accounting firm attest to the effectiveness of our internal controls over financial reporting pursuant to Auditing Standard No. 5 beginning with our annual report on Form 10-K for the year ended December 31, 2014. If we are unable to conclude that we have effective internal controls over financial reporting, or if our registered public accounting firm is unable to provide us with an attestation and an unqualified report as to the effectiveness of our internal controls over financial reporting, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our Class A common stock.

While we currently intend to pay a quarterly cash dividend to our common stockholders, we may change our dividend policy at any time.

Although we currently intend to pay a quarterly cash dividend to our Class A common stockholders and Class B common stockholders, we have no obligation to do so, and our dividend policy may change at any time without notice to our stockholders. We currently intend to pay a quarterly cash dividend on our common stock of $0.065 per share. Returns on your investment will primarily depend on the appreciation, if any, in the price of our Class A common stock. We anticipate that we will retain most of our future earnings, if any, for use in the development and expansion of our business, repayment of indebtedness and for general corporate purposes. The declaration and payment of dividends to holders of our Class A common stock and Class B common stock will be at the discretion of our board of directors in accordance with applicable law after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs, cash flows available in the United States, impact on our effective tax rate, indebtedness, legal requirements and other factors that our board of directors deems relevant.

Provisions in our amended and restated certificate of incorporation, amended and restated by-laws and Delaware law may prevent or delay an acquisition of us, which could decrease the trading price of our Class A common stock.

Our amended and restated certificate of incorporation, which we refer to as “our certificate of incorporation,” and amended and restated by-laws, which we refer to as “our by-laws,” contain provisions that are intended to deter coercive takeover practices and inadequate takeover bids and to encourage prospective acquirers to negotiate with our board of directors rather than to attempt a hostile takeover. These provisions include:

 

 

a board of directors that is divided into three classes with staggered terms;

 

 

a dual class equity structure;

 

 

rules regarding how our stockholders may present proposals or nominate directors for election at stockholder meetings;

 

 

the right of our board of directors to issue preferred stock without stockholder approval; and

 

 

limitations on the right of stockholders to remove directors.

In addition, Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. These provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that our board of directors determines is not in our and our stockholders’ best interests.

 

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If Pfizer makes the Distribution, and there is later a determination that the Separation, the debt-for-debt exchange, the debt-for-equity exchange, the transfer of cash proceeds of the senior notes offering to Pfizer and/or the Distribution is taxable for U.S. federal income tax purposes because the facts, assumptions, representations or undertakings underlying the IRS private letter ruling and/or any tax opinion are incorrect or for any other reason, then Pfizer and its stockholders could incur significant U.S. federal income tax liabilities, and we could incur significant liabilities.

Pfizer has received a private letter ruling from the IRS substantially to the effect that, among other things, the Distribution will qualify as a transaction that is tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code. If pursued, completion by Pfizer of the Distribution would be conditioned on, among other things, the continuing application of Pfizer’s private letter ruling from the IRS and the receipt of opinions of tax counsel, to the effect that, among other things, the Distribution will qualify as a transaction that is tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code. The ruling relies and the opinions will rely on certain facts, assumptions, representations and undertakings from Pfizer and us regarding the past and future conduct of the companies’ respective businesses and other matters. If any of these facts, assumptions, representations or undertakings are incorrect or not otherwise satisfied, Pfizer and its stockholders may not be able to rely on the ruling or the opinions of tax counsel and could be subject to significant tax liabilities. Notwithstanding the private letter ruling and opinions of tax counsel, the IRS could determine on audit that the Separation, the debt-for-debt exchange, the debt-for-equity exchange, the transfer of cash proceeds of the senior notes offering to Pfizer and/or the Distribution is taxable if it determines that any of these facts, assumptions, representations or undertakings are not correct or have been violated or if it disagrees with the conclusions in the opinions that are not covered by the private letter ruling, or for other reasons, including as a result of certain significant changes in the stock ownership of Pfizer or us after the Distribution. If the Separation, the debt-for-debt exchange, the debt-for-equity exchange, the transfer of cash proceeds of the senior notes offering to Pfizer and/or the Distribution is determined to be taxable for U.S. federal income tax purposes, Pfizer and/or its stockholders could incur significant U.S. federal income tax liabilities, and we could incur significant liabilities under applicable law or as a result of certain agreements we intend to enter into with Pfizer.

 

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Cautionary statement concerning forward-looking statements

This prospectus contains “forward-looking” statements. Forward-looking statements reflect our current views with respect to, among other things, future events and performance. We generally identify forward-looking statements by words such as “anticipate,” “estimate,” “expect,” “intend,” “project,” “plan,” “predict,” “believe,” “seek,” “continue,” “outlook,” “may,” “might,” “will,” “should,” “can have,” “likely” or the negative version of these words or comparable words or by using future dates in connection with any discussion of future performance, actions or events. Forward-looking statements are based on beliefs and assumptions made by management using currently available information.

These statements are not guarantees of future performance, actions or events. In particular, forward-looking statements include statements relating to future actions, business plans or prospects, prospective products, product approvals or products under development, R&D costs, timing and likelihood of success, future operating or financial performance, future results of current and anticipated products and services, strategies, sales efforts, expenses, production efficiencies, production margins, interest rates, foreign exchange rates, growth in emerging markets, the outcome of contingencies, such as legal proceedings, dividend plans, the Distribution, our agreements with Pfizer, Pfizer’s control of our company, government regulation and financial results. Forward-looking statements are subject to risks and uncertainties, many of which are beyond our control and potentially inaccurate assumptions. These risks and uncertainties include those set forth under “Risk factors.” However, there may also be other risks that we are unable to predict at this time. If one or more of these risks or uncertainties materialize, or if management’s underlying beliefs and assumptions prove to be incorrect, actual results may differ materially from those contemplated by a forward-looking statement. You should not put undue reliance on forward-looking statements. Forward-looking statements speak only as of the date on which they are made. We expressly disclaim any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

 

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Use of proceeds

We will not receive any proceeds from the sale of our Class A common stock in this offering. All of the net proceeds from this offering will be received by the debt-for-equity exchange parties. On the settlement date of this offering immediately prior to the settlement of the debt-for-equity exchange parties’ sale of the shares to the underwriters, the debt-for-equity exchange parties will acquire the Class A common stock being sold in this offering from Pfizer in exchange for outstanding Pfizer indebtedness held by the debt-for-equity exchange parties. See “Summary—The underwriting and the debt-for-equity exchange,” “Underwriting—The debt-for-equity exchange” and “Underwriting—Conflicts of interest.”

 

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Dividend policy

We initially expect to pay quarterly cash dividends to holders of our Class A common stock and Class B common stock of $0.065 per share, subject to the discretion of our board of directors. The declaration and payment of dividends to holders of our Class A common stock and Class B common stock will be at the discretion of our board of directors in accordance with applicable law after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs, cash flows available in the United States, impact on our effective tax rate, indebtedness, legal requirements and other factors that our board of directors deems relevant. In addition, the instruments governing our indebtedness may limit our ability to pay dividends. Therefore, no assurance is given that we will pay any dividends to our common stockholders, or as to the amount of any such dividends if our board of directors determines to do so.

Because we are a holding company, our ability to pay cash dividends on our common stock will depend on the receipt of dividends or other distributions from our subsidiaries.

 

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Dilution

If you invest in our Class A common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of Class A common stock and the pro forma net tangible book deficit per share of our Class A common stock and Class B common stock after giving effect to the Transactions, as defined in “Unaudited pro forma condensed combined financial statements.” Pro forma net tangible book deficit per share represents:

 

 

total pro forma assets less intangible assets;

 

 

reduced by our total pro forma liabilities; and

 

 

divided by the number of shares of our common stock outstanding.

Dilution per share represents the difference between the amount per share paid by purchasers of our Class A common stock in this offering and the pro forma net tangible book deficit per share after giving effect to the Transactions. As of September 30, 2012, after giving effect to the Transactions, our pro forma net tangible book deficit was approximately $(799) million, or $(1.60) per share based on 86.1 million shares of our Class A common stock and 413.9 million shares of our Class B common stock outstanding immediately prior to this offering. This represents an immediate dilution of $27.60 per share to investors purchasing shares of our Class A common stock in this offering. The following table illustrates this dilution per share:

 

Initial public offering price per share

     $ 26.00   

Pro forma net tangible book deficit per share as of September 30, 2012 after giving effect to the Transactions

   $ (1.60  
  

 

 

   

Dilution per share to new investors in this offering

     $ 27.60   
    

 

 

 

 

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Capitalization

The following table sets forth our cash and cash equivalents and capitalization as of September 30, 2012 on a historical basis, and on a pro forma basis to reflect the Transactions, as defined in “Unaudited pro forma condensed combined financial statements.”

As the net proceeds of this offering are received by the debt-for-equity exchange parties, this offering has no impact on our capitalization.

The information below is not necessarily indicative of what our cash and cash equivalents and capitalization would have been had the Transactions been completed as of September 30, 2012. In addition, it is not indicative of our future cash and cash equivalents and capitalization. This table is derived from, and is qualified in its entirety by reference to, our historical and pro forma financial statements and the notes thereto included elsewhere in this prospectus, and should be read in conjunction with “Unaudited pro forma condensed combined financial statements,” “Management’s discussion and analysis of financial condition and results of operations” and our combined financial statements and notes thereto included elsewhere in this prospectus.

 

     As of
September 30, 2012
 
     Actual     Pro forma  
(MILLIONS, EXCEPT PER SHARE AMOUNTS)       

Cash and cash equivalents

   $ 133      $ 300   
  

 

 

   

 

 

 

Allocated long-term debt

   $ 580      $ —     

Revolving credit facility(1)

     —          —     

Senior notes(2)

     —          3,640   

Equity(3):

    

Business unit equity

     4,263        —     

Class A common stock, $0.01 par value, 5,000 shares authorized; 86.1 issued and outstanding on a pro forma basis

     —          1   

Class B common stock, $0.01 par value, 1,000 shares authorized; 413.9 issued and outstanding on a pro forma basis

     —          4   

Additional paid-in capital

       1,234   

Accumulated other comprehensive loss

     (169     (195
  

 

 

   

 

 

 

Total Zoetis equity

     4,094        1,044   

Equity attributable to noncontrolling interests

     15        15   
  

 

 

   

 

 

 

Total equity

   $ 4,109      $ 1,059   
  

 

 

   

 

 

 

Total capitalization

   $ 4,689      $ 4,699   
  

 

 

   

 

 

 

 

(1) In December 2012, we entered into a $1.0 billion five-year revolving credit facility. The credit facility will not be available for borrowings until the date on which certain conditions, including the completion of this offering and the receipt of certain investment grade ratings, are satisfied. We expect that these conditions will be met concurrently with the completion of this offering. Subject to certain conditions, we will have the right to increase the credit facility to up to $1.5 billion. No borrowings under the revolving credit facility are assumed on a pro forma basis.
(2) Reflects an original issue debt discount of $10 million.
(3) The number of shares of Class A common stock and Class B common stock issued and outstanding on a pro forma basis assumes the underwriters’ option to purchase 12.9 million additional shares is not exercised. We have authorized preferred stock, but no preferred shares are assumed to be issued and outstanding on a pro forma basis.

 

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Selected historical combined financial data

The following table sets forth our selected historical combined financial data for the periods indicated.

The selected historical combined statement of operations data for the years ended December 31, 2011, 2010 and 2009 and the selected historical combined balance sheet data as of December 31, 2011 and 2010 presented below have been derived from our audited combined financial statements included elsewhere in this prospectus. The selected historical combined balance sheet data as of December 31, 2009 and 2008 have been derived from unaudited combined financial information not included in this prospectus.

The revenue data for the years ended December 31, 2008 and 2007 are derived from unaudited combined financial information not included in this prospectus.

The selected historical combined statement of operations data for the nine months ended September 30, 2012 and October 2, 2011 and the selected historical combined balance sheet data as of September 30, 2012 have been derived from our unaudited condensed combined financial statements included elsewhere in this prospectus. The selected historical combined balance sheet data as of October 2, 2011 has been derived from unaudited combined financial information not included in this prospectus. In the opinion of management, the unaudited condensed combined financial statements for the interim periods included in this prospectus include all normal and recurring adjustments that we consider necessary for a fair presentation of the financial position and operating results for these periods. The operating results for the nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012.

Our combined financial statements include expense allocations for certain support functions that are provided on a centralized basis within Pfizer, such as expenses for business technology, facilities, legal, finance, human resources, and, to a lesser extent, business development, public affairs and procurement, among others, as well as certain manufacturing and supply costs incurred by manufacturing sites that are shared with other Pfizer business units, Pfizer’s global external supply group and Pfizer’s global logistics and support group. Pfizer does not routinely allocate these costs to any of its business units. These allocations are based on either a specific identification basis or, when specific identification is not practicable, proportional cost allocation methods (e.g., using third-party sales, headcount, animal health identified manufacturing costs, etc.), depending on the nature of the services and/or costs.

The financial statements included in this prospectus may not be indicative of our future performance and do not necessarily reflect what our financial position and results of operations would have been had we operated as a standalone public company during the periods presented, including changes that will occur in our operations and capital structure as a result of this offering and the Separation.

 

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You should read the selected historical combined financial data set forth below in conjunction with the sections entitled “Management’s discussion and analysis of financial condition and results of operations” and our combined financial statements and notes thereto included elsewhere in this prospectus.

 

      Nine Months Ended(a)    Year Ended
December 31,(a)
(MILLIONS OF DOLLARS)    September 30,
2012
   October 2,
2011
   2011    2010    2009   2008(b)    2007(b)

Statement of operations data:

                                 

Revenues

     $ 3,160        $ 3,106        $ 4,233        $ 3,582        $ 2,760       $ 2,825        $ 2,639  

Net income/(loss) before allocation to noncontrolling interests(c)

       446          238          248          111          (101 )       NA          NA  

Balance sheet data:

                                 

Total assets

     $ 5,904        $ 5,844        $ 5,711        $ 5,284        $ 5,598       $ 2,993          NA  

Long-term obligations(d)

       580          689          575          673          728         —            NA  

Other data:

                                 

Adjusted net income(e)

     $ 482        $ 381        $ 503        $ 275        $ 189         NA          NA  

 

NA: Not Available

Certain amounts may reflect rounding adjustments.

 

(a) Starting in 2011, includes the KAH business acquired as part of Pfizer’s acquisition of King Pharmaceuticals, Inc., commencing on the acquisition date of January 31, 2011. Starting in 2009, includes FDAH operations, acquired as part of Pfizer’s acquisition of Wyeth, commencing on the acquisition date of October 15, 2009.
(b) Certain information for 2007 and 2008 is not available. Over the last five years, there have been significant changes in Pfizer’s corporate structure and a number of restructurings and personnel changes which have impacted our business. As such, it is not practicable for us to determine net income/(loss) for the years ended December 31, 2008 and 2007 or to determine Total assets and Long-term obligations at December 31, 2007.
(c) Defined as net income/(loss) before allocation to noncontrolling interests.
(d) Starting in 2009, primarily includes an allocation of Pfizer debt that was issued to partially finance the acquisition of Wyeth (including FDAH) in 2009. The debt has been allocated on a pro-rata basis using the deemed acquisition cost of FDAH as a percentage of the total acquisition cost of Wyeth.
(e) Adjusted net income (a non-GAAP financial measure) is defined as reported net income attributable to Zoetis excluding purchase accounting adjustments, acquisition-related costs and certain significant items. Management uses Adjusted net income, among other factors, to set performance goals and to measure the performance of the overall company, as described in “Management’s discussion and analysis of financial condition and results of operations—Adjusted net income.” We believe that investors’ understanding of our performance is enhanced by disclosing this performance measure. Reconciliations of U.S. GAAP reported net income attributable to Zoetis to non-GAAP Adjusted net income for the nine months ended September 30, 2012 and October 2, 2011, as well as reconciliations of the years ended December 31, 2011, 2010 and 2009, are provided in “Management’s discussion and analysis of financial condition and results of operations—Adjusted net income.” The Adjusted net income measure is not, and should not be viewed as, a substitute for U.S. GAAP reported net income attributable to Zoetis.

 

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Unaudited pro forma condensed combined financial statements

The following unaudited pro forma condensed combined financial statements should be read in conjunction with the section entitled “Management’s discussion and analysis of financial condition and results of operations” and our audited combined annual and unaudited condensed combined interim financial statements and accompanying notes included elsewhere in this prospectus.

Our unaudited pro forma condensed combined financial statements consist of unaudited pro forma condensed combined statements of operations for the nine months ended September 30, 2012 and for the year ended December 31, 2011, and an unaudited pro forma condensed combined balance sheet as of September 30, 2012. The unaudited pro forma condensed combined financial statements are based on and have been derived from our historical combined annual and condensed combined interim financial statements included elsewhere in this prospectus.

In management’s opinion, the unaudited pro forma condensed combined financial statements reflect certain adjustments that are necessary to present fairly our unaudited pro forma condensed combined results of operations and our unaudited pro forma condensed combined balance sheet as of and for the periods indicated. The pro forma adjustments give effect to events that are (i) directly attributable to the transactions described below, (ii) factually supportable; and, with respect to the statement of operations, (iii) expected to have a continuing impact on us. The pro forma adjustments are based on assumptions that management believes are reasonable given the best information currently available.

The unaudited pro forma condensed combined financial statements are for illustrative and informational purposes only and are not intended to represent what our results of operations or financial position would have been had we operated as a standalone public company during the periods presented or if the transactions described below had actually occurred as of the dates indicated. The unaudited pro forma condensed combined financial statements should not be considered indicative of our future results of operations or financial position as a standalone public company.

The unaudited pro forma condensed combined financial statements give effect to the following transactions, which we refer to as the “Transactions,” as if they each had occurred on January 1, 2011 for the unaudited pro forma condensed combined statements of operations and on September 30, 2012 for the unaudited pro forma condensed combined balance sheet:

 

   

Pfizer’s transfer to us of its subsidiaries holding substantially all of the assets and liabilities of its animal health business in consideration for (i) all of the issued and outstanding shares of our Class A common stock; (ii) all of the issued and outstanding shares of our Class B common stock; (iii) $1 billion aggregate principal amount of senior notes with a stated interest rate of 3.25%, which Pfizer disposed of in connection with the senior notes offering; and (iv) an amount of cash equal to substantially all of the net proceeds we received in the senior notes offering;

 

   

the incurrence of $2.650 billion aggregate principal amount of senior notes in connection with the senior notes offering with a weighted-average stated interest rate of 3.17% (this debt is in addition to the $1 billion of senior notes mentioned above);

 

   

the incurrence of $25 million of costs related to the issuance of senior notes in the senior notes offering and the establishment of a $1.0 billion five-year revolving credit facility; and

 

   

certain transactions contemplated by certain agreements between us and Pfizer described in “Certain relationships and related party transactions—Relationship with Pfizer,” and the provisions contained therein.

Due to local regulatory and operational requirements, in certain non-U.S. jurisdictions, the transfer of certain assets and liabilities of Pfizer’s animal health business may not legally occur prior to this offering. We have not adjusted the accompanying unaudited pro forma condensed combined balance sheet for the potential impact of the delayed transfers because these assets and liabilities are not material to our unaudited pro forma condensed combined financial statements, individually or in the aggregate.

 

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Our historical condensed combined financial statements include expense allocations for certain support functions that are provided on a centralized basis within Pfizer, such as expenses for business technology, facilities, legal, finance, human resources, and, to a lesser extent, business development, public affairs and procurement, among others. Following this offering, pursuant to agreements with Pfizer, we expect that Pfizer will continue to provide us with some of the services related to these functions on a transitional basis in exchange for agreed-upon fees, and we expect to incur other costs to replace the services and resources that will not be provided by Pfizer. We will also incur additional costs related to being a standalone public company. As a standalone public company, our total costs related to such support functions may differ from the costs that were historically allocated to us from Pfizer. We estimate that these costs may exceed the allocated amounts for full year 2011 by a range of approximately $15 million to $25 million in 2013. In addition, we expect to incur internal costs to implement certain new systems, including infrastructure and an enterprise resource planning system, while our legacy systems are being fully supported by Pfizer under the transitional services agreement. We expect these costs to range between approximately $30 million to $40 million in 2013 and 2014. We have not adjusted the accompanying unaudited pro forma condensed combined statements of operations for any of these estimated costs as they are projected amounts based on estimates and, therefore, are not factually supportable.

The unaudited pro forma condensed combined statements of operations exclude certain non-recurring costs that we expect to incur related to the separation, including new branding (which includes changes to the manufacturing process for new packaging required), the creation of a standalone infrastructure, site separation and certain legal registration and patent assignment costs. We expect these costs to range between approximately $170 million to $200 million in 2013 and $70 million to $100 million in 2014. These estimates exclude the impact of any depreciation or amortization of capitalized separation expenditures.

Some of our products are manufactured at sites that will be retained by Pfizer or that will be operated by Pfizer under a sale-leaseback arrangement. Following this offering, pursuant to the master manufacturing and supply agreement with Pfizer, we expect to purchase these products from Pfizer. The historical condensed combined statements of operations include allocations of certain manufacturing and supply costs incurred by the manufacturing sites that would not have been charged to us under the master manufacturing and supply agreement with Pfizer had such agreement been in effect in the periods presented, such as operating variances as well as purchase price and volume variances under a certain threshold. The costs allocated in the historical condensed combined statements of operations are higher than the amounts that would have been charged by Pfizer under the master manufacturing and supply agreement, had it been in effect during the periods presented, by approximately $10 million for the nine months ended September 30, 2012 and approximately $14 million for the year ended December 31, 2011. We have not adjusted the accompanying unaudited pro forma condensed combined statements of operations for the aforementioned differences. Such an adjustment is not factually supportable due to the unpredictability and variability of such costs, which could be gains or losses in any particular period, and due to the fact that, as a standalone company, we will operate under our own supply manufacturing network, which may be different than the one operated by Pfizer.

 

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ZOETIS INC.

(THE ANIMAL HEALTH BUSINESS UNIT OF PFIZER INC.)

UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF OPERATIONS

NINE MONTHS ENDED SEPTEMBER 30, 2012

 

(MILLIONS, EXCEPT PER SHARE AMOUNTS)    Historical     Pro Forma
Adjustments
    Notes     Pro
Forma
 

 

 

Revenues

   $ 3,160      $   —          $ 3,160   

Costs and expenses:

        

Cost of sales(1)

     1,130        —            1,130   

Selling, general and administrative expenses(1)

     1,017        —            1,017   

Research and development expenses(1)

     288        —            288   

Amortization of intangible assets

     48        —            48   

Restructuring charges and certain acquisition-related costs

     55        —            55   

Other (income)/deductions—net

     (14     68        (a ),(b)      54   

 

 

Income before provision for taxes on income

     636        (68       568   

Provision for taxes on income

     190        (26     (c     164   

 

 

Net income before allocation to noncontrolling interests

     446        (42       404   

Less: Net income attributable to noncontrolling interests

     —          —            —     

 

 

Net income attributable to Zoetis

   $ 446      $ (42     $ 404   

 

 

Earnings per common share—basic

     N/A          (d   $ 0.81   

Earnings per common share—fully diluted

     N/A          (d   $ 0.81   

 

 

Weighted average shares outstanding:

        

Basic

     N/A          (d     500   

Diluted

     N/A          (d     500   

 

 
(1) Exclusive of amortization of intangible assets, except as disclosed in Note 8C. Goodwill and Other Intangible Assets: Amortization in the Notes to Unaudited Condensed Combined Financial Statements.

Certain amounts may reflect rounding adjustments.

See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements.

 

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ZOETIS INC.

(THE ANIMAL HEALTH BUSINESS UNIT OF PFIZER INC.)

UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2011

 

(MILLIONS, EXCEPT PER SHARE AMOUNTS)    Historical(1)      Pro Forma
Adjustments
    Notes     Pro
Forma
     

 

Revenues

   $ 4,233       $   —          $ 4,233     

Costs and expenses:

           

Cost of sales(2)

     1,652         —            1,652     

Selling, general and administrative expenses(2)

     1,453         —            1,453     

Research and development expenses(2)

     427         —            427     

Amortization of intangible assets

     69         —            69     

Restructuring charges and certain acquisition-related costs

     154         —            154     

Other deductions—net

     84         86        (a),(b)        170     

 

Income before provision for taxes on income

     394         (86       308     

Provision for taxes on income

     146         (33     (c)        113     

 

Net income before allocation to noncontrolling interests

     248         (53       195     

Less: Net income attributable to noncontrolling interests

     3         —            3     

 

Net income attributable to Zoetis

   $ 245       $ (53     $ 192     

 

Earnings per common share—basic

     N/A           (d   $ 0.38     

Earnings per common share—fully diluted

     N/A           (d   $ 0.38     

 

Weighted average shares outstanding:

           

Basic

     N/A           (d     500     

Diluted

     N/A           (d     500     

 

(1) Includes revenues and expenses from acquisitions from the acquisition date, see Note 2. Basis of Presentation in the Notes to Combined Financial Statements.

 

(2) Exclusive of amortization of intangible assets, except as disclosed in Note 3J. Significant Accounting Policies: Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets in the Notes to Combined Financial Statements.

Certain amounts may reflect rounding adjustments.

 

See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements.

 

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ZOETIS INC.

(THE ANIMAL HEALTH BUSINESS UNIT OF PFIZER INC.)

UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET

AS OF SEPTEMBER 30, 2012

 

(MILLIONS, EXCEPT PER SHARE AMOUNTS)    Historical     Pro Forma
Adjustments
    Notes    Pro
Forma
 

 

 

Assets

         

Cash and cash equivalents

   $ 133      $ 167      (m),(n)    $ 300   

Accounts receivable, less allowance for doubtful accounts

     848        —             848   

Inventories

     1,272        (136   (e),(f)      1,136   

Current deferred tax assets

     72        (4   (e),(f)      68   

Other current assets

     230        (5   (e),(f)      225   

 

 

Total current assets

     2,555        22           2,577   

Property, plant and equipment, less accumulated depreciation

     1,204        25      (e),(f)      1,229   

Identifiable intangible assets, less accumulated amortization

     877        —             877   

Goodwill

     981        —             981   

Noncurrent deferred tax assets

     218        (118   (e),(h),(i),(k)      100   

Other noncurrent assets

     69        4      (i),(l),(m),(n)      73   

 

 

Total assets

   $ 5,904      $ (67      $ 5,837   

 

 

Liabilities and Equity

         

Accounts payable

   $ 195      $ (3   (e)    $ 192   

Income taxes payable

     42        3      (i)      45   

Accrued compensation and related items

     145        (4   (e)      141   

Other current liabilities

     355        (14   (e),(l)      341   

 

 

Total current liabilities

     737        (18        719   

Allocated long-term debt

     580        (580   (l)      —     

Long-term debt

     —          3,640      (m),(n)      3,640   

Noncurrent deferred tax liabilities

     299        (45   (e),(g),(h),(j),(k)      254   

Other taxes payable

     88        (65   (i)      23   

Other noncurrent liabilities

     91        51      (e),(g)      142   

 

 

Total liabilities

     1,795        2,983           4,778   

 

 

Commitments and Contingencies

         

Business unit equity

     4,263        (4,263   (e),(f),(g),(h),(i),

(j),(k),(l),(m),(n)

     —     

Class A common stock, $0.01 par value, 5,000 shares authorized; 86.1 issued and outstanding on a pro forma basis

     —          1      (n)      1   

Class B common stock, $0.01 par value, 1,000 shares authorized; 413.9 issued and outstanding on a pro forma basis

     —          4      (n)      4   

Additional paid-in capital

     —          1,234      (n)      1,234   

Accumulated other comprehensive loss

     (169     (26   (g)      (195

 

 

Total Zoetis equity

     4,094        (3,050        1,044   

Equity attributable to noncontrolling interests

     15        —             15   

 

 

Total equity

     4,109        (3,050        1,059   

 

 

Total liabilities and equity

   $ 5,904      $ (67      $ 5,837   

 

 

See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Statements.

 

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ZOETIS INC.

(THE ANIMAL HEALTH BUSINESS UNIT OF PFIZER INC.)

NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

Certain amounts and percentages may reflect rounding adjustments.

 

(a) Reflects the elimination of net interest expense of $23 million and $36 million for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively, related to the portion of Pfizer’s net interest expense allocated to us and included in our historical combined statements of operations. The associated Allocated long-term debt will be retained by Pfizer following the completion of the Transactions.

 

(b) Reflects the addition of interest expense (which includes amortization of deferred issuance costs) of $91 million and $122 million for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively, related to the senior notes issued in connection with the senior notes offering at a weighted-average effective interest rate of 3.30%, and costs associated with the revolving credit facility.

 

(c) Reflects the tax effect of the pre-tax pro forma adjustments impacting Income before provision for taxes on income, calculated using the applicable statutory tax rate in the relevant jurisdictions.

 

(d) The weighted-average number of shares used to compute pro forma basic and diluted earnings per share is 500 million, which is also the number of shares of our common stock outstanding immediately following the completion of the Transactions.

 

(e) Reflects the elimination of assets and liabilities at certain manufacturing sites that will be retained by Pfizer following the completion of the Transactions. These assets and liabilities are included in the historical condensed combined balance sheet as they are specifically identifiable to the animal health business. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)   

Debit/
(Credit)

 

 

 

Inventories

   $ (98

Current deferred tax assets*

     (3

Other current assets

     (3

Property, plant and equipment, less accumulated depreciation

     (28

Noncurrent deferred tax assets*

     (1

Accounts payable

     3   

Accrued compensation and related items

     4   

Other current liabilities

     8   

Noncurrent deferred tax liabilities*

     2   

Other noncurrent liabilities

     7   

Business unit equity

     109   

 

 
   $     —     

 

 
  * Calculated using the applicable statutory tax rate in the relevant jurisdictions.

 

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(f) Reflects the addition of property, plant and equipment (PP&E) at the Guarulhos, Brazil manufacturing site, that will be transferred to us by Pfizer and then leased back to Pfizer under operating leases, and the elimination of inventory, at that site, that will be retained by Pfizer, following the completion of the Transactions. The PP&E are excluded from the historical condensed combined balance sheet as they are not specifically identifiable to the animal health business, while the inventory is included as it is specifically identifiable to the animal health business. Pfizer will use the site to manufacture, among other things, animal health products for us pursuant to the master manufacturing and supply agreement. Pfizer will pay us lease income equivalent to the depreciation expense that we expect to record for the PP&E and, as such, we do not expect the arrangement to have a significant impact on our combined statements of operations. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)   

Debit/
(Credit)

 

 

 

Inventories

   $ (38

Current deferred tax assets*

     (1

Other current assets

     (2

Property, plant and equipment, less accumulated depreciation

     53   

Business unit equity

     (12

 

 
   $     —     

 

 
  * Calculated using the applicable statutory tax rate in the relevant jurisdictions.

 

(g) Reflects the addition of net benefit plan liabilities that will be transferred to us by Pfizer following the completion of the Transactions. These net benefit plan liabilities are excluded from the historical condensed combined balance sheet as the related benefit plans are not dedicated to animal health employees. The benefit plan expenses associated with these liabilities are included in our historical condensed combined statements of operations. Specifically, this adjustment reflects the transfer of certain defined benefit pension liabilities, net of related assets, in several countries outside the U.S., as well as certain unfunded postretirement benefit liabilities in the U.S. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)     
 
Debit/
(Credit)
 
  

 

 

Noncurrent deferred tax liabilities*

   $ 19   

Other noncurrent liabilities

     (58

Business unit equity

     13   

Accumulated other comprehensive loss

     26   

 

 
   $     —     

 

 
  * Calculated using the applicable statutory tax rate in the relevant jurisdictions.

 

(h) Represents the elimination of noncurrent deferred tax assets (which may be included within noncurrent deferred tax liabilities due to jurisdictional netting) related to net operating loss and tax credit carryforwards that will be retained by Pfizer following the completion of the Transactions. These tax assets are included in the historical condensed combined balance sheet as they are considered in the computation of the historical provision for taxes on income. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)     
 
Debit/
(Credit)
 
  

 

 

Noncurrent deferred tax assets

   $ (139

Noncurrent deferred tax liabilities

     (66

Business unit equity

     205   

 

 
   $     —     

 

 

 

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(i) Reflects the elimination of net tax liabilities associated with uncertain tax positions that will be retained by Pfizer following the completion of the Transactions. These tax liabilities are included in the historical condensed combined balance sheet as they are considered in the computation of the historical provision for taxes on income. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)     
 
Debit/
(Credit)
 
  

 

 

Noncurrent deferred tax assets

   $ 4   

Other noncurrent assets

     (19

Income taxes payable

     (3

Other taxes payable

     65   

Business unit equity

     (47

 

 
   $     —     

 

 

 

(j) Reflects the elimination of noncurrent deferred tax liabilities relating to deferred income taxes on unremitted earnings that will be retained by Pfizer following the completion of the Transactions. These tax liabilities are included in the historical condensed combined balance sheet as they are considered in the computation of the historical provision for taxes on income. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)     
 
Debit/
(Credit)
 
  

 

 

Noncurrent deferred tax liabilities

   $ 86   

Business unit equity

     (86

 

 
   $     —     

 

 

 

(k) Reflects the recognition of deferred tax assets, on the temporary differences between the financial reporting and tax bases of certain assets and liabilities, that will be created as a result of various legal entity reorganization transactions within Pfizer. These reorganization transactions are performed in preparation for the legal transfer to us of Pfizer subsidiaries that hold substantially all of the assets and liabilities of Pfizer’s animal health business. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)    Debit/
(Credit)
 

 

 

Noncurrent deferred tax assets

   $ 18   

Noncurrent deferred tax liabilities

     4   

Business unit equity

     (22

 

 
   $     —     

 

 

 

(l) Reflects the elimination of allocated long-term debt, allocated accrued interest payable and allocated unamortized deferred debt issuance costs that will be retained by Pfizer following the completion of the Transactions. These assets and liabilities are included in the historical condensed combined balance sheet. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)   

Debit/
(Credit)

 

 

 

Other noncurrent assets

   $ (2

Other current liabilities

     6   

Allocated long-term debt

     580   

Business unit equity

     (584

 

 
   $     —     

 

 

 

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(m) Reflects the incurrence of $2,650 million aggregate principal amount of senior notes in connection with the senior notes offering (net of an original issue debt discount of $9 million) with a weighted-average stated interest rate of 3.17%, as well as the deferred costs associated with both the incurrence of the senior notes and the establishment of a $1.0 billion five-year revolving credit facility. The deferred issuance costs associated with the five-year revolving credit facility in the amount of $1 million were paid by Pfizer. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)   

Debit/
(Credit)

 

 

 

Cash and cash equivalents

   $ 2,624   

Other noncurrent assets*

     18   

Long-term debt*

     (2,641

Business unit equity

     (1

 

 
   $ —     

 

 
  * The long-term debt net of deferred issuance costs of $18 million has a weighted-average effective interest rate of 3.28%.

 

(n) Reflects the legal transfer to us of Pfizer’s subsidiaries holding substantially all of the assets and liabilities of Pfizer’s animal health business in consideration for (i) all of the issued and outstanding shares of our Class A common stock; (ii) all of the issued and outstanding shares of our Class B common stock; (iii) $1 billion aggregate principal amount of senior notes (net of an original issue debt discount of $1 million) with a stated interest rate of 3.25%, which Pfizer disposed of in connection with the senior notes offering (the issuance of these senior notes is in addition to the senior notes mentioned in (m) above; and (iv) an amount of cash equal to substantially all of the net proceeds we received in the senior notes offering. The adjustment follows:

 

 

 
(MILLIONS OF DOLLARS)    Debit/
(Credit)
 

 

 

Cash and cash equivalents

   $ (2,457

Other noncurrent assets*

     7   

Long-term debt*

     (999

Business unit equity

     4,688   

Common stock**

     (5

Additional paid-in capital

     (1,234

 

 
   $ —     

 

 
  * The long-term debt net of deferred issuance costs of $7 million has an effective interest rate of 3.34%
  ** Represents 500 million shares of Class A and Class B common stock at a par value per share of $0.01.

We and Pfizer have agreed that our cash balance on the date of the completion of this offering will be at least $300 million. As such, our pro forma condensed combined balance sheet as of September 30, 2012 includes a balance of $300 million in Cash and cash equivalents.

 

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The Separation and Distribution transactions

The Separation

Pfizer formed Zoetis in July 2012. Prior to the completion of this offering, we will be a wholly-owned subsidiary of Pfizer, and all of our outstanding shares of common stock will be owned by Pfizer. In addition, as a result of a series of steps which occurred prior to the date of the senior notes offering, Pfizer transferred substantially all of the assets and liabilities of its animal health business to various segregated subsidiaries.

In connection with this offering, we and Pfizer intend to enter into, or have entered into, agreements and take certain actions to transfer substantially all of the assets and liabilities of Pfizer’s animal health business to us and separate our business from Pfizer. We refer to these separation transactions, collectively, as the “Separation.” The following are the principal steps of the Separation:

 

 

In September 2012, the agreements related to our facility in Brazil described in “Certain relationships and related party transactions—Relationship with Pfizer—Brazil lease agreements” were entered into.

 

 

In October 2012, the master manufacturing and supply agreements described in “Certain relationships and related party transactions—Relationship with Pfizer—Master manufacturing and supply agreements” were entered into.

 

 

In January 2013, Pfizer transferred to us its subsidiaries holding substantially all of the assets and liabilities of its animal health business. In exchange, we issued or agreed to transfer to Pfizer: (i) all of the issued and outstanding shares of our Class A common stock; (ii) all of the issued and outstanding shares of our Class B common stock; (iii) the Pfizer-owned notes; and (iv) an amount of cash equal to substantially all of the net proceeds we received in the senior notes offering, which amount will be paid immediately prior to the completion of this offering.

 

 

Immediately prior to the completion of this offering, we intend to enter into the additional agreements with Pfizer described in “Certain relationships and related party transactions—Relationship with Pfizer.”

 

 

Following this offering, Pfizer intends to transfer to us certain assets and liabilities of the animal health business that, due to business, regulatory or other legal constraints, could not be transferred prior to this offering.

Following the Separation, we will own or have the right to use substantially all of the assets that were used, or held for use, exclusively in Pfizer’s animal health business, including the following:

 

 

Intellectual Property. As part of the Separation, Pfizer will assign to us ownership of approximately 4,000 patents, 2,000 pending patent applications, and more than 9,500 trademark applications and registrations. In addition, Pfizer will license to us the right to use certain intellectual property rights in the animal health field. We will license to Pfizer the right to use certain of our trademarks and substantially all of our other intellectual property rights in the human health field and all other fields outside of animal health. In addition, Pfizer will grant us a transitional license to use certain of Pfizer’s trademarks and we will grant Pfizer a transitional license to use certain of our trademarks for a period of time following the completion of this offering.

 

 

Manufacturing Facilities. Our global manufacturing network consists of 13 “anchor” manufacturing sites and 16 “satellite” manufacturing sites. Ownership of, or the existing leasehold interest in, these facilities will be conveyed to us by Pfizer as part of the Separation. Among these 29 manufacturing sites is our facility in Guarulhos, Brazil, which we will lease back to Pfizer. Certain of our products are currently manufactured at 14 manufacturing sites that will be retained by Pfizer. The products manufactured by Pfizer at these sites and at our Guarulhos, Brazil facility will continue to be supplied to us under the terms of a manufacturing and supply agreement we entered into with Pfizer.

 

 

R&D Facilities. We have R&D operations co-located with certain of our manufacturing sites in Australia, Brazil, Belgium, Canada, China, Spain and the United States to facilitate the efficient transfer of production

 

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processes from our laboratories to manufacturing sites. In addition, we maintain R&D operations at non-manufacturing locations in Brazil, Belgium, India and the United States. As part of the Separation, Pfizer conveyed to us its interest in each of these R&D facilities, with the exception of our Mumbai, India facility, which we expect Pfizer to transfer to us for agreed upon cash consideration after the completion of this offering, and, in the interim, we will lease this facility from Pfizer.

 

 

Employees. Following the Separation, we expect that we will have more than 9,500 employees worldwide. We expect that as part of the Separation, substantially all employees of Pfizer who were substantially dedicated to the animal health business will become our employees. However, labor and employment laws or other business considerations in some jurisdictions may impede or delay Pfizer from transferring to us employees who are substantially dedicated to the animal health business. In those instances, to the extent permissible under applicable law, we and Pfizer intend to enter into a mutually-acceptable arrangement, such as a staffing agreement, to provide for continued operation of the business until such time as the employees in those jurisdictions can be transitioned to us.

For more information regarding the agreements we and Pfizer intend to enter into, or have entered into, see “Certain relationships and related party transactions—Relationship with Pfizer.”

The Distribution

Pfizer has informed us that, following this offering, it may make a tax-free distribution to its stockholders of all or a portion of its remaining equity interest in us, which may include one or more distributions effected as a dividend to all Pfizer stockholders, one or more distributions in exchange for Pfizer shares or other securities, or any combination thereof. We refer to any such potential distribution as the “Distribution.”

Pfizer has no obligation to pursue or consummate any further dispositions of its ownership interest in us, including through the Distribution, by any specified date or at all. If pursued, the Distribution would be subject to various conditions, including receipt of any necessary regulatory or other approvals, the existence of satisfactory market conditions and the continuing application of Pfizer’s private letter ruling from the IRS and the receipt of opinions of counsel to the effect that such Distribution would be tax-free to Pfizer and its stockholders. The conditions to the Distribution may not be satisfied, Pfizer may decide not to consummate the Distribution even if the conditions are satisfied or Pfizer may decide to waive one or more of these conditions and consummate the Distribution even if all of the conditions are not satisfied.

 

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Management’s discussion and analysis of

financial condition and results of operations

Introduction

Our management’s discussion and analysis of financial condition and results of operations, or MD&A, is provided to assist readers in understanding our performance, as reflected in the results of our operations, our financial condition and our cash flows. This MD&A should be read in conjunction with our combined financial statements and notes thereto included elsewhere in this prospectus. The discussion in this MD&A contains a description of our historical performance for periods in which we operated as a business unit of Pfizer. Our future results could differ materially from historical performance as a result of various factors such as those discussed in “Risk factors,” “The Separation and Distribution transactions” and “—Comparability of historical results.”

This MD&A is organized as follows:

 

 

Overview of our business. This section, beginning on page 61, provides a general description of our business and the industry in which we operate. For more information regarding our business and the animal health industry, see “Business” and “Industry.”

 

 

Factors affecting our performance. This section, beginning on page 61, provides information regarding certain factors that may affect our financial performance.

 

 

Components of revenues and costs and expenses. This section, beginning on page 64, provides an explanation of the components of our combined statements of operations.

 

 

Comparability of historical results and our relationship with Pfizer. This section, beginning on page 65, provides information about the limitations of the predictive value of the combined financial statements.

 

 

Analysis of the combined statements of operations. This section, beginning on page 67, consists of the following for all periods presented:

 

   

Revenues. This section, beginning on page 68, provides an analysis of our revenues in total, by operating segment and by sector.

 

   

Costs and expenses. This section, beginning on page 74, provides a discussion about the drivers of our costs and expenses.

 

   

Provision for taxes on income. This section, beginning on page 79, provides a discussion of items impacting our effective tax rates.

 

 

Adjusted net income. This section, beginning on page 81, provides a discussion of Adjusted net income, an alternative view of performance used by management. Adjusted net income is a non-GAAP financial measure.

 

 

Analysis of the combined statements of comprehensive income/(loss). This section, beginning on page 85, provides an analysis of the components of comprehensive income for all periods presented.

 

 

Analysis of the combined balance sheets. This section, beginning on page 85, provides a discussion of changes in certain balance sheet accounts for all balance sheets presented.

 

 

Analysis of the combined statements of cash flows. This section, beginning on page 86, provides an analysis of the drivers of our operating, investing and financing cash flows for all periods presented.

 

 

Analysis of financial condition, liquidity and capital resources. This section, beginning on page 88, provides an analysis of our ability to meet our short-term and long-term financing needs.

 

 

New accounting standards. This section, beginning on page 91, discusses accounting standards that we have recently adopted.

 

 

Significant accounting policies and application of critical accounting estimates. This section, beginning on page 91, discusses those accounting policies and estimates that we consider important to an understanding our combined financial statements.

 

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Contingencies. This section, beginning on page 94, discusses contingencies related to legal and tax matters.

 

 

Qualitative and quantitative disclosures about market risk. This section, beginning on page 95, discusses financial risk management, specifically with respect to foreign currency risk.

Overview of our business

We are a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. For more than 60 years, as a business unit of Pfizer, we have been committed to enhancing the health of animals and bringing solutions to our customers who raise and care for them. Measured by our revenues of $4.2 billion for the year ended December 31, 2011, we are the largest animal health medicines and vaccines business, with our products sold in more than 120 countries.

The animal health medicines and vaccines industry is characterized by meaningful differences in customer needs across different regions. As a result of these differences, among other things, we manage our operations through four geographic regions. Within each of these regional segments, we offer a diversified product portfolio for both livestock and companion animal customers in order to capitalize on local and regional trends and customer needs. Our four regional operating segments are the United States (“U.S.”), Europe/Africa/Middle East (“EuAfME”), Canada/Latin America (“CLAR”) and Asia/Pacific (“APAC”). See Notes to Combined Financial Statements—Note 16. Segment, Geographic and Revenue Information.

With our sales organization of approximately 3,400 employees, we directly market our portfolio of more than 300 product lines to livestock producers and veterinarians located in approximately 70 countries across North America, Europe, Africa, Asia, Australia and Latin America, and are a market leader in nearly all of the major regions in which we operate. Through our efforts to establish an early and direct presence in many emerging markets, such as Brazil, China and India, we believe we are the largest animal health medicines and vaccines business as measured by revenues across emerging markets as a whole. Emerging markets contributed 27% of our revenues for the year ended December 31, 2011. 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 the industry’s largest sales organization, 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 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.

For the year ended December 31, 2011, our revenues, Adjusted net income (a non-GAAP financial measure, see page 81) and Net income attributable to Zoetis were $4.2 billion, $503 million and $245 million, respectively; for the year ended December 31, 2010, our revenues, Adjusted net income and Net income attributable to Zoetis were $3.6 billion, $275 million and $110 million, respectively. As a result, growth in revenue, Adjusted net income and Net income attributable to Zoetis in 2011 were 18%, 83% and 123%, respectively, when compared to 2010.

Factors affecting our performance

Industry growth

According to Vetnosis, a research and consulting firm specializing in global animal health and veterinary medicine, the animal health medicines and vaccines market for livestock and companion animals represented a global market of $22 billion, as measured by 2011 revenues. The market grew at a compound annual growth rate, or CAGR, of 6% between 2006 and 2011 and, excluding the impact of foreign exchange, the market is projected to grow at a CAGR of 6% per year between 2011 and 2016. As discussed below, we believe several trends have supported and will continue to support this growth.

 

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The livestock medicines and vaccines sector represented $13.1 billion of sales in 2011, or 60% of the total animal health medicines and vaccines market. This sector grew at a CAGR of 7% between 2006 and 2011 and, excluding the impact of foreign exchange, this sector is projected to grow at a CAGR of 6% per year between 2011 and 2016, according to Vetnosis. Factors influencing growth in demand for livestock medicines and vaccines include:

 

 

human population growth and increasing standards of living, particularly in many emerging markets;

 

 

consequently increasing demand for improved nutrition, particularly animal protein;

 

 

natural resource constraints, such as scarcity of arable land, fresh water and increased competition for cultivated land, resulting in fewer resources that will be available to meet this increased demand for animal protein; and

 

 

increased focus on food safety.

The companion animal medicines and vaccines sector represented $8.9 billion of sales in 2011, or 40% of the total animal health medicines and vaccines market. This sector grew at a CAGR of 6% between 2006 and 2011 and, excluding the impact of foreign exchange, this sector is projected to grow at a CAGR of 5% per year between 2011 and 2016, according to Vetnosis. Factors influencing growth in demand for companion animal medicines and vaccines include:

 

 

economic development and related increases in disposable income, particularly in many emerging markets;

 

 

increasing pet ownership; and

 

 

companion animals living longer, increasing medical treatment of companion animals and advances in companion animal medicines and vaccines.

Product development initiatives

Our future success depends on both our existing product portfolio and our pipeline of new products, including new products that we may develop through joint ventures and products that we are able to obtain through license or acquisition. We believe we are an industry leader in animal health R&D, with a track record of generating new products and brand lifecycle developments. From 2004 to 2011, we obtained approximately one-fourth of all animal health medicine approvals granted by the FDA, and approximately one-fifth of all animal health vaccine approvals granted by the USDA. The majority of our R&D programs focus on brand lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations.

Perceptions of product quality, safety and reliability

We believe that animal health medicines and vaccines customers value high-quality manufacturing and reliability of supply. The importance of quality and safety concerns to pet owners, veterinarians and livestock producers also contributes to animal health brand loyalty, which we believe often continues after the loss of patent-based and regulatory exclusivity. We depend on positive perceptions of the safety and quality of our products, and animal health products generally, by our customers, veterinarians and end-users.

The issue of the potential transfer of increased antibacterial resistance in bacteria from food-producing animals to human pathogens, and the causality of that transfer, are the subject of global scientific and regulatory discussion. In some countries, this issue has led to government restrictions and bans on the use of specific antibacterials in some food-producing animals, regardless of the route of administration (topical, oral, intramuscular/subcutaneous injections, or intravenous). These restrictions are more prevalent in countries where animal protein is plentiful and governments are willing to take restrictive actions even when there is scientific uncertainty. Historically, antibacterials for livestock have represented a significant portion of our revenues. We cannot predict whether antibacterial resistance concerns will result in additional restrictions or bans, expanded regulations or public pressure to discontinue or reduce use of antibacterials in food-producing animals.

 

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The overall economic environment

In addition to industry-specific factors, we, like other businesses, continue to face the effects of the current challenging economic environment. Growth in both the livestock and companion animal sectors is driven by overall economic development and related growth, particularly in many emerging markets. Certain of our customers and suppliers have been affected directly by the economic downturn, which could decrease the demand for our products or hinder our ability to collect amounts due from customers.

However, the cost of medicines and vaccines to our livestock producer customers is small relative to other production costs, including feed, and the use of these products improves livestock producers’ economic outcomes. As a result, demand for our products has typically been more stable than demand for other production inputs. Similarly, industry sources report that pet owners indicate a preference for reducing spending on other aspects of their lifestyle, including entertainment, clothing and household goods, before reducing spending on petcare.

Weather conditions and the availability of natural resources

The animal health industry and demand for many of our animal health products in a particular region are affected by weather conditions, as usage of our products follows varying weather patterns and weather-related pressures from pests, such as ticks. As a result, we may experience regional and seasonal fluctuations in our results of operations.

In addition, livestock producers depend on the availability of natural resources, including large supplies of fresh water. Their animals’ health and their ability to operate could be adversely affected if they experience a shortage of fresh water due to human population growth or floods, droughts or other weather conditions. In the event of adverse weather conditions or a shortage of fresh water, livestock producers may purchase less of our products.

For example, the current drought impacting the United States is considered the worst in many years, impacting both the supply of corn and the availability of grazing pasture. The decrease in harvested corn has resulted in higher corn prices, which has impacted the profitability of livestock producers of cattle, pork and poultry. Higher corn prices may contribute to reductions in herd or flock size that may result in reduced spending on animal health products. Reduced availability of grazing pasture may also force cattle producers to cull their herds. Fewer heads of cattle would result in reduced demand for our products. A prolonged drought could have a material adverse effect on our operating results and financial condition. Our current expectations are that the drought will have an impact on our performance through the first half of 2013 with second half recovery dependent on a normalization of weather patterns.

Competition

The animal health industry is competitive. Although our business is the largest by revenues in the animal health medicines and vaccines industry, we face competition in the regions and sectors in which we compete. Principal methods of competition vary depending on the particular region, species, product category or individual product. Some of these methods include new product development, quality, price, service and promotion to veterinary professionals, pet owners and livestock producers. Our competitors include the animal health businesses of large pharmaceutical companies and specialty animal health businesses. In addition to competition from established market participants, there could be new entrants to the animal health medicines and vaccines industry in the future. In certain markets, we also compete with companies that produce generic products, but the level of competition from generic products varies from market to market. For example, the level of generic competition is higher in Europe and certain emerging markets than in the United States. However, there is no large, well-capitalized company focused on generic animal health products that exists as a global competitor in the industry.

Disease outbreaks in livestock

Our livestock products could be adversely affected by the outbreak of disease carried by animals. Outbreaks of disease may reduce regional or global sales of particular animal-derived food products or result in reduced exports of such products, either due to heightened export restrictions or import prohibitions, which may reduce

 

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demand for our products. Also, the outbreak of any highly contagious disease near our main production sites could require us to immediately halt production of our products at such sites or force us to incur substantial expenses in procuring raw materials or products elsewhere.

Foreign exchange rates

Significant portions of our revenues and costs are exposed to changes in foreign exchange rates. Our products are sold in more than 120 countries and, as a result, our revenues are influenced by changes in foreign exchange rates. In 2011, approximately 61% of our revenues were denominated in foreign currencies. As a business unit of Pfizer and under Pfizer’s global cash management system, we have sought to manage our foreign exchange risk in part through operating means, including managing same-currency revenues in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Going forward, we will evaluate if a similar approach to managing foreign exchange risk is appropriate for our company. As we operate in multiple foreign currencies, including the euro, the Brazilian real, the Australian dollar and other currencies, changes in those currencies relative to the U.S. dollar will impact our revenues and expenses, and consequently, net income. Exchange rate fluctuations may also have an impact beyond our reported financials and directly impact operations. These fluctuations may affect the ability to buy and sell our goods and services between markets impacted by significant exchange rate variances. Approximately 39% of our total revenues occur in U.S. dollars and, in 2011 our year-over-year revenue growth benefited by 3% from changes in foreign currency values relative to the U.S. dollar. In the first nine months of 2012, our period-over-period revenue growth was unfavorably impacted by 4% from changes in foreign currency.

Execution of our growth strategies

We seek to enhance the health of animals and to bring solutions to our customers who raise and care for them. We have a global presence in both developed and emerging markets and we intend to grow our business by pursuing the following core strategies:

 

 

leverage our direct local presence and strong customer relationships—Through our direct selling commercial model, we can deepen our understanding of our customers’ businesses and can encourage the adoption by our customers of more sophisticated animal health products;

 

 

further penetrate emerging markets—We seek to maximize our presence where economic development is driving increased demand for animal protein and increased demand for and spending on companion animals;

 

 

pursue new product development and value-added brand lifecycle development to extend our product portfolio—New product R&D and brand lifecycle development enable us to deliver innovative products to address unmet needs and evolve our product lines so they remain relevant for our customers. We seek to leverage our strong direct presence in many regions and cost-effectively develop new products;

 

 

remain the partner of choice for access to new products and technologies—We seek to continue to support cutting-edge research and secure the right to develop and commercialize new products and technologies;

 

 

continue to provide high-quality products and improve manufacturing production margins—We believe our manufacturing and supply chain provides us with a global platform for continued expansion, including in emerging markets, and that our quality and reliability differentiate us from our competitors; and

 

 

expand into complementary businesses to become a more complete, trusted partner in providing solutions—We believe we have the potential to generate incremental and complementary revenues, in the areas of diagnostics, genetics, devices and services such as dairy data management, e-learning and professional consulting, which could also enhance the loyalty of our customer base and may lead to increased product sales.

For additional discussion of our growth strategies, see “Business—Our growth strategies.”

Components of revenues and costs and expenses

Our revenues, costs and expenses are reported for the fiscal year ended December 31 for each year presented, except for operations outside the U.S., for which the financial information is included in our combined financial statements for the fiscal year ended November 30 for each year presented.

 

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Revenues

Our revenues are primarily derived from our diversified product portfolio of medicines and vaccines used to treat livestock and companion animals. Our portfolio contains more than 300 product lines. Generally, our products are sold to veterinarians and livestock producers, by our sales organization which includes sales representatives and technical and veterinary operations specialists. The depth of our product portfolio enables us to address the varying needs of different customers. In 2011, our top selling product line, the ceftiofur line, contributed less than 8% of our revenues, and our top ten best selling product lines contributed less than 38% of our revenues. For additional information regarding our products, including descriptions of our product lines that each represented approximately 1% or more of our revenues in 2011, see “Business—Our products.”

Costs and expenses

Costs of sales consist primarily of cost of materials, facilities and other infrastructure used to manufacture our medicine and vaccine products and royalty expenses associated with the intellectual property of our products, when relevant.

Selling, general and administrative, or SG&A, expenses consist of, among other things, the internal and external costs of marketing, promotion, advertising and shipping and handling as well as certain costs related to business technology, facilities, legal, finance, human resources, business development, public affairs and procurement.

Research and development, or R&D, expenses consist primarily of project costs specific to new product R&D and brand lifecycle development, overhead costs associated with R&D operations and investments that support local market clinical trials for approved indications. We do not disaggregate R&D expenses by research stage or by therapeutic area for purposes of managing our business.

Amortization of intangible assets consists primarily of the amortization expense for identifiable finite-life intangible assets that have been acquired through business combinations. These assets consist of, but are not limited to, developed technology, brands and trademarks.

Restructuring charges and certain acquisition-related costs consist of all restructuring charges (those associated with acquisition activity and those associated with cost reduction/productivity initiatives) as well as costs associated with acquiring and integrating businesses. Restructuring charges are associated with employees, assets and activities that will not continue in the company. Acquisition-related costs are associated with acquiring and integrating acquired businesses, such as the King Animal Health business in 2011 and the Fort Dodge Animal Health business in 2009 and may include transaction costs and expenditures for consulting and the integration of systems and processes.

Other (income)/deductionsnet consist primarily of various items including net interest (income)/expense, net (gains)/losses on asset disposals, royalty-related income and certain asset impairment charges.

Comparability of historical results and our relationship with Pfizer

We currently operate as a business unit of Pfizer. The combined financial statements have been derived from the consolidated financial statements and accounting records of Pfizer and include allocations for direct costs and indirect costs attributable to the operations of the animal health business of Pfizer. These combined financial statements do not purport to reflect what the results of operations, comprehensive income/(loss), financial position, equity or cash flows would have been had we operated as a standalone public company during the periods presented.

For a detailed description of the basis of presentation and an understanding of the limitations of the predictive value of the historical combined financial statements, see Notes to Combined Financial Statements—Note 2. Basis of Presentation and see Notes to Unaudited Condensed Combined Financial Statements—Note 1. Basis of Presentation.

 

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In addition, the historical combined financial statements may not be reflective of what our results of operations, comprehensive income/(loss), financial position, equity or cash flows might be in the future as a standalone public company.

For example, our historical expenses are not necessarily indicative of the expenses we may incur in the future as a standalone public company. In connection with this offering and the Separation, we and Pfizer intend to enter into, or have entered into, certain agreements that will provide a framework for our ongoing relationship with Pfizer. See “Certain relationships and related party transactions—Relationship with Pfizer.”

With respect to support functions, for example, our historical condensed combined financial statements include expense allocations for certain support functions that are provided on a centralized basis within Pfizer, such as expenses for business technology, facilities, legal, finance, human resources, and, to a lesser extent, business development, public affairs and procurement, among others. Following this offering, pursuant to agreements with Pfizer, we expect that Pfizer will continue to provide us with some of the services related to these functions on a transitional basis in exchange for agreed-upon fees, and we expect to incur other costs to replace the services and resources that will not be provided by Pfizer. We will also incur additional costs as a standalone public company. As a standalone public company, our total costs related to such support functions may differ from the costs that were historically allocated to us from Pfizer. We estimate that these costs may exceed the allocated amounts for full year 2011 by a range of approximately $15 million to $25 million in 2013. In addition, we expect to incur internal costs to implement certain new systems, including infrastructure and an enterprise resource planning system, while our legacy systems are being fully supported by Pfizer under the transitional services agreement. We estimate these costs to range between approximately $30 million to $40 million in 2013 and 2014.

Another example is that the historical balance sheets may not be comparable to the opening balance sheet of the standalone company, which we expect will reflect the transfer by Pfizer of substantially all of its animal health business to us. Non-comparable elements will include, for example, the allocation of Pfizer debt, which will not be transferred, and may include, for example, cash and cash equivalents, which may be adjusted other than by operations prior to or concurrently with the completion of this offering. For a detailed description of our unaudited pro forma condensed combined financial statements, see Unaudited pro forma condensed combined financial statements.”

Compensation

We expect to institute competitive compensation policies and programs as a standalone public company, the expense for which may differ from the compensation expense allocated by Pfizer in our combined financial statements. For a detailed description of our current compensation policies as a business unit of Pfizer and anticipated compensation policies following this offering, see “Management—Compensation discussion and analysis.”

Public company expenses

As a result of this offering, we will become subject to the reporting requirements of the Exchange Act and the Sarbanes-Oxley Act. We will have additional procedures and practices to establish as a standalone public company. As a result, we will incur additional costs including internal audit, investor relations, stock administration and regulatory compliance costs.

Recent significant acquisitions and government-mandated divestitures

The assets, liabilities, operating results and cash flows of acquired businesses are included in our results commencing from their respective acquisition dates.

 

 

The King Animal Health business, or KAH, was acquired by Pfizer as part of its acquisition of King Pharmaceuticals, Inc. (acquired on January 31, 2011), strengthening our position in the poultry business with a medicinal feed additives business and other poultry products and further strengthening our position in

 

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the cattle and swine businesses. See Notes to Combined Financial Statements—Note 4A. Acquisitions, Divestitures and Certain Investments: Acquisition of King Animal Health.

 

 

The Fort Dodge Animal Health business, or FDAH, was acquired by Pfizer as part of its acquisition of Wyeth (acquired on October 15, 2009), adding to our portfolio a broad array of companion animal and livestock brands and strengthening our vaccine portfolio, including a complementary poultry vaccines business. In connection with this acquisition, we made certain government-mandated divestitures. See Notes to Combined Financial Statements—Note 4B. Acquisitions, Divestitures and Certain Investments: Acquisition of Fort Dodge Animal Health and Note 4D. Acquisitions, Divestitures and Certain Investments: Divestitures.

Our combined financial statements for the year ended December 31, 2011 reflect eleven months of KAH’s U.S. operations and ten months of KAH’s international operations and for the nine months ended October 2, 2011 our unaudited condensed combined financial statements reflect eight months of KAH’s U.S. operations and seven months of KAH’s international operations. Our combined financial statements for the year ended December 31, 2009 reflect approximately two-and-a-half months of FDAH’s U.S. operations and approximately one-and-a-half months of FDAH’s international operations.

Analysis of the combined statements of operations

The following discussion and analysis of our combined statements of operations should be read along with our combined financial statements and the notes thereto as well as our unaudited condensed combined financial statements and the notes thereto included elsewhere in this prospectus, which reflect the results of operations of the business transferred to us from Pfizer. For more information on the carve-out basis of presentation, see Notes to Combined Financial Statements—Note 2. Basis of Presentation and see Notes to Unaudited Condensed Combined Financial Statements—Note 1. Basis of Presentation.

 

    Nine Months
Ended
    %
Change
    Year Ended
December 31,
    %
Change
 
(MILLIONS OF DOLLARS)   September  30,
2012
(a)
    October  2,
2011
(a)
    12/11     2011(a)     2010(a)     2009(a)     11/10     10/09  

Revenues

  $ 3,160      $ 3,106        2      $ 4,233      $ 3,582      $ 2,760        18        30   

Costs and expenses:

               

Cost of sales(b)

    1,130        1,233        (8     1,652        1,444        1,078        14        34   

% of revenues

    36     40       39     40     39    

Selling, general and administrative expenses(b)

    1,017        1,026        (1     1,453        1,382        1,066        5        30   

% of revenues

    32     33       34     39     39    

Research and development expenses(b)

    288        308        (6     427        411        368        4        12   

% of revenues

    9     10       10     11     13    

Amortization of intangible assets

    48        51        (6     69        58        33        19        76   

Restructuring charges and certain acquisition-related costs

    55        108        (49     154        202        340        (24     (41

Other (income)/deductions—net(c)

    (14     16        *        84        (93     23        *        *   

Income/(loss) before provision/(benefit) for taxes on income

  $ 636      $ 364        75      $ 394      $ 178        ($148     121        *   

% of revenues

    20     12       9     5     (5 %)     

Provision/(benefit) for taxes on income/(loss)

    190        126        51        146        67        (47     118        *   

Effective tax rate

    29.9     34.6       37.1     37.6     (31.8 %)     

Net income/(loss) before allocation to noncontrolling interests

  $ 446      $ 238        87      $ 248      $ 111        ($101     123        *   

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

           2        *        3        1        (1     200        *   

Net income/(loss) attributable to Zoetis

    446        236        89        245        110        (100     123        *   

% of revenues

    14     8       6     3     (4 %)     

 

Certain amounts and percentages may reflect rounding adjustments.

 

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* Calculation not meaningful.
(a) Includes revenues and expenses from acquisitions from the acquisition date. For the years ended December 31, 2011, 2010 and 2009, see Notes to Combined Financial Statements—Note 2. Basis of Presentation and for the nine months ended September 30, 2012 and October 2, 2011, see Notes to Unaudited Condensed Combined Financial Statements—Note 1. Basis of Presentation.
(b) Exclusive of amortization of intangible assets, except as disclosed in Notes to Combined Financial Statements—Note 3J. Significant Accounting Policies: Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets.
(c) Includes interest expense on allocated long-term debt of $36 million, $37 million and $26 million for the years ended December 31, 2011, 2010 and 2009, respectively. See Notes to Combined Financial Statements—Note 6. Other (Income)/Deductions—Net. For the nine months ended September 30, 2012 and October 2, 2011 includes interest expense on allocated long-term debt of $23 million and $27 million, respectively. See Notes to Unaudited Condensed Combined Financial Statements—Note 4. Other (Income)/Deductions—Net.

Revenues

Revenues-Overview

Global revenues by operating segment were as follows:

 

     Nine Months
Ended
     % Change     Year Ended
December 31,
     % Change  

(MILLIONS OF DOLLARS)

   September 30,
2012
     October 2,
2011
     12/11     2011      2010      2009      11/10      10/09  

U.S.

   $ 1,294       $ 1,210         7      $ 1,659       $ 1,384       $ 1,105         20         25   

EuAfME

     799         851         (6     1,144         1,020         880         12         16   

CLAR

     549         565         (3     788         664         451         19         47   

APAC

     518         480         8        642         514         324         25         59   
  

 

 

    

 

 

      

 

 

    

 

 

    

 

 

       

Total

   $ 3,160       $ 3,106         2      $ 4,233       $ 3,582       $ 2,760         18         30   
  

 

 

    

 

 

      

 

 

    

 

 

    

 

 

       

 

Certain amounts and percentages may reflect rounding adjustments.

On a global basis, the mix of our revenues between livestock and companion animal products was as follows:

 

     Nine Months
Ended
     % Change      Year Ended
December 31,
     % Change  

(MILLIONS OF DOLLARS)

   September 30,
2012
     October 2,
2011
     12/11      2011      2010      2009      11/10      10/09  

Livestock

   $ 2,015       $ 2,017         —         $ 2,778       $ 2,233       $ 1,686         24         32   

Companion Animal

     1,145         1,089         5         1,455         1,349         1,074         8         26   
  

 

 

    

 

 

       

 

 

    

 

 

    

 

 

       

Total

   $ 3,160       $ 3,106         2       $ 4,233       $ 3,582       $ 2,760         18         30   
  

 

 

    

 

 

       

 

 

    

 

 

    

 

 

       

 

Certain amounts and percentages may reflect rounding adjustments.

 

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As a result of the impact of recent significant acquisitions and related government-mandated divestitures on the revenue numbers in our statement of operations, during the nine months ended September 30, 2012 and October 2, 2011 and the years ended December 31, 2011, 2010 and 2009 the growth trend on our existing portfolio from year to year is not readily apparent. We believe that it is not only important to understand overall revenue growth, but also existing portfolio growth year over year. As such, we utilize “base revenue growth.” Base revenue growth is defined as revenue growth excluding the impact of incremental revenues from recent significant acquisitions, government-mandated divestitures and foreign exchange.

 

% Change in Revenue:

increases/(decreases)

   Reported               Resulting from
Base Revenue
Growth(a)
    Resulting
from
Acquisitions(b)
     Resulting from
Government-
Mandated
Divestitures(c)
    Resulting from
Foreign
Exchange
 

First nine months of 2012 vs. first nine months of 2011

                  

Total revenues

     2               5        1         —          (4

U.S.

     7               6        1         —          —     

EuAfME

     (6            —          1         —          (7

CLAR

     (3            4        1         —          (8

APAC

     8               8        2         —          (2

2011 vs. 2010

                  

Total revenues

     18               7        9         (1     3   

U.S.

     20               7        13         —          —     

EuAfME

     12               3        6         —          3   

CLAR

     19               9        7         (1     4   

APAC

     25               12        7         (2     8   

2010 vs. 2009

                  

Total revenues

     30               7        23         (3     3   

U.S.

     25               13        13         (1     —     

EuAfME

     16               (1     26         (8     (1

CLAR

     47               5        32         —          10   

APAC

     59               15        36         (2     10   

 

Certain amounts and percentages may reflect rounding adjustments.

(a) Reflects changes in reported growth excluding the impact of incremental revenues from recent significant acquisitions, government-mandated divestitures and foreign exchange.
(b) Reflects the acquisition of KAH, acquired by Pfizer on January 31, 2011, and FDAH, acquired by Pfizer on October 15, 2009.
(c) Reflects government-mandated divestitures of legacy FDAH and our legacy products in connection with the FDAH acquisition.

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

Total revenues increased $54 million, or 2%, in the first nine months of 2012 compared to the first nine months of 2011, due to:

 

 

base revenue growth of $136 million, or 5%, primarily from growth in the U.S., APAC and CLAR segments; and

 

 

the inclusion of an incremental one month of U.S. and two months of international revenues of $37 million, or 1%, from the KAH acquisition;

partially offset by:

 

 

the unfavorable impact of foreign exchange, which decreased revenues by approximately $119 million, or (4%).

2011 vs. 2010

Total revenues increased $651 million, or 18%, in 2011 compared to 2010, due to:

 

 

base revenue growth of $239 million, or 7%, from growth across all operating segments;

 

 

the inclusion of revenues of $329 million, or 9%, from the acquisition of KAH; and

 

 

the favorable impact of foreign exchange, which increased revenues by approximately $104 million, or 3%;

 

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partially offset by:

 

 

the unfavorable impact of government-mandated divestitures of $21 million, or (1%).

2010 vs. 2009

Total revenues increased, $822 million, or 30%, in 2010 compared to 2009, due to:

 

 

base revenue growth of $208 million, or 7%, primarily from growth in the U.S. and APAC segments;

 

 

the inclusion of incremental revenues of $640 million, or 23%, from the full year impact of the acquisition of FDAH; and

 

 

the favorable impact of foreign exchange, which increased revenues by approximately $69 million, or 3%;

partially offset by:

 

 

the unfavorable impact of government-mandated divestitures of $95 million, or (3%).

Revenues-Operating segment

Nine months ended September 30, 2012 vs. Nine months ended October 2, 2011

U.S. operating segment

U.S. segment revenues increased by $84 million, or 7%, in the first nine months of 2012 compared to the first nine months of 2011. Base revenue growth was $70 million, or 6%, of which approximately $23 million in growth came from livestock products and approximately $47 million in growth came from companion animal products.

 

 

Livestock product revenue growth was due principally to increased demand for medicinal feed additives in swine, which was partially due to an outbreak of gut infections in late stage pigs. There was also increased demand for premium anti-infectives in cattle and swine as a result of new promotional campaigns focused on superior efficacy supported by economic outcomes studies. Additionally, revenue growth was positively impacted by the launch of an improved formulation of a swine vaccine that prevents porcine circovirus type 2. This revenue growth was partially offset by the impact of the drought in the U.S.

 

 

Companion animal product revenue growth was driven by parasiticides, benefiting from an extended flea and tick season caused by unusually warm weather and by a temporary competitor supply disruption. Companion animal products also benefited from continued growth in canine vaccines and the success of targeted marketing efforts for anti-infectives and other pharmaceutical products.

Segment revenues were also favorably impacted by the inclusion of $14 million, or 1%, attributable to an additional one month of revenues from KAH.

EuAfME operating segment

EuAfME segment revenues decreased by $52 million, or (6%), in the first nine months of 2012 compared to the first nine months of 2011. Base revenue growth was $3 million, or less than 1%, of which $1 million in decline came from livestock products and was more than offset by approximately $4 million in growth from companion animal products.

 

 

Livestock product revenues were negatively impacted by continued adverse macroeconomic conditions throughout Western Europe and pressure from the ongoing restrictions on the use of certain antibacterials. Results were partially offset by performance in emerging markets, which continue to benefit from growing demand for animal protein.

 

 

Companion animal product revenues were favorably impacted by parasiticides and the launch of new branded generic products throughout the region. Revenue was also favorably impacted by equine vaccines due to a temporary competitor supply disruption. Results were partially offset by continued adverse macroeconomic conditions throughout Western Europe.

 

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Segment revenues were also favorably impacted by the inclusion of $8 million, or 1%, attributable to an additional two months of revenues from KAH. Additionally, revenues were unfavorably impacted by 7% due to foreign exchange.

CLAR operating segment

CLAR segment revenues decreased by $16 million, or (3%), in the first nine months of 2012 compared to the first nine months of 2011. Base revenue growth was $25 million, or 4%, of which approximately $7 million in growth came from livestock products and approximately $18 million in growth came from companion animal products.

 

 

Livestock product revenues were favorably impacted by swine vaccines, which benefited from the launch in multiple markets, of an improved formulation of a swine vaccine that prevents porcine circovirus type 2. Swine vaccines also benefited from continued demand for Improvac/Improvest, a product that reduces boar taint without the need for surgical castration, in Brazil. Additionally, marketing initiatives focused on legacy KAH products drove increased demand for poultry medicinal feed additives in Brazil. Results were partially offset by increased competition in the Brazil cattle market. Also, certain markets within the region continue to feel the impact of the North American drought.

 

 

Companion animal product revenue growth was attributable to canine vaccines especially in Brazil and parasiticides in Canada. Parasiticides in Canada benefited from an extended flea and tick season caused by unusually warm weather and by a temporary competitor supply disruption.

Segment revenues were also favorably impacted by the inclusion of $7 million, or 1%, attributable to an additional two months of revenues from KAH. Additionally, revenues were unfavorably impacted by 8% due to foreign exchange.

APAC operating segment

APAC segment revenues increased by $38 million, or 8%, in the first nine months of 2012 compared to the first nine months of 2011. Base revenue growth was $38 million, or 8%, of which approximately $21 million in growth came from livestock products and approximately $17 million in growth came from companion animal products.

 

 

Livestock product revenues were favorably impacted by growth in Australia, China and India. Australia experienced growth in the dairy cattle segment due to higher sales of intramammary products. Increased sales force presence in China drove growth in premium priced swine products. The launch, in multiple markets, of an improved formulation of a swine vaccine that prevents porcine circovirus type 2 was also a key growth driver.

 

 

Companion animal product revenues benefited from promotional campaigns in Japan and the resulting increased adoption of our products into veterinarian treatment protocols. Australia benefited from growth in parasiticides as a result of focused sales force efforts that drove demand for these products. China experienced growth in canine vaccines due to expansion of the sales organization.

Segment revenues were also favorably impacted by the inclusion of $8 million, or 2%, attributable to an additional two months of revenues from KAH. Additionally, revenues were unfavorably impacted by 2% due to foreign exchange.

2011 vs. 2010

U.S. operating segment

U.S. segment revenues increased by $275 million, or 20%, in 2011 compared to 2010. Base revenue growth was $89 million, or 7%, of which approximately $65 million in growth came from livestock products and approximately $24 million came from growth in companion animal products.

 

 

Livestock product revenue growth was in large part due to increased demand for anti-infectives in cattle and swine as a result of new promotional campaigns focused on superior efficacy supported by economic

 

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outcomes studies, as well as general growth in the cattle market. Cattle vaccine growth was driven by FDA approvals for new treatment indications. Additionally, the re-launch of Inovocox, a poultry vaccine, contributed to growth.

 

 

Companion animal product revenue growth was primarily attributable to Rimadyl, an anti-inflammatory, Convenia, a single-injection anti-infective, and canine respiratory vaccines. In addition, we benefited from the full year impact of contracts signed with large veterinary clinic networks during 2010.

Segment revenues were also favorably impacted by the inclusion of $186 million, or 13%, from the acquisition of KAH.

EuAfME operating segment

EuAfME segment revenues increased by $124 million, or 12%, in 2011 compared to 2010. Base revenue growth in the EuAfME operating segment was $31 million, or 3%, of which approximately $13 million in growth came from livestock products and approximately $18 million in growth came from companion animal products. Adverse macroeconomic conditions throughout Western Europe negatively impacted growth rates for both livestock and companion animal product sales.

 

 

Livestock product revenues were driven by emerging markets, including Turkey, Russia and North Africa, due to strong demand for animal health products used in swine and poultry production. Additionally, growth was driven by Draxxin, a premium anti-infective used in cattle and swine. Livestock product revenues were negatively impacted by $22 million due to the loss of government subsidies of a FDAH product in France, Germany and Spain for the eradication of blue tongue virus in cattle and sheep.

 

 

Companion animal product revenue growth was primarily driven by increased use of Convenia and Clavamox across the region, and by other anti-infective medicines in Germany, France and emerging markets. Increases in vaccine utilization drove additional growth in the U.K. and emerging markets.

Segment revenues were also favorably impacted by the inclusion of $59 million, or 6%, from the acquisition of KAH. Additionally, revenues were favorably impacted by 3% due to foreign exchange.

CLAR operating segment

CLAR segment revenues increased by $124 million, or 19%, in 2011 compared to 2010. Base revenue growth was $56 million, or 9%, of which approximately $38 million in growth came from livestock products and approximately $18 million in growth came from companion animal products.

 

 

Livestock product revenue growth was driven by the demand for Improvac/Improvest, a product that reduces boar taint without the need for surgical castration, in Brazil and Colombia. Growth also resulted from the implementation of marketing initiatives in Brazil and Mexico, which increased demand for Draxxin and Lincospectin for cattle and poultry, respectively, across the region.

 

 

Companion animal product revenue growth was driven by the demand for canine vaccines, primarily in Brazil and other emerging Latin America markets, and demand for parasiticides in Brazil and Canada.

Segment revenues were also favorably impacted by the inclusion of $49 million, or 7%, from the acquisition of KAH and were negatively impacted by government-mandated divestitures in 2011 related to the acquisition of FDAH, which decreased revenues by 1%. Additionally, revenues were favorably impacted by 4% due to foreign exchange.

 

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APAC operating segment

APAC segment revenues increased $128 million, or 25%, in 2011 compared to 2010. Base revenue growth in the APAC operating segment was $63 million, or 12%, of which approximately $38 million in growth came from livestock products and approximately $25 million in growth came from companion animal products.

 

 

Livestock product revenue growth was broad-based, driven by both developed and emerging markets. Sales organization investments in China and India further accelerated growth in anti-infectives and vaccines in these two countries. Growth also continued in sheep and cattle vaccines in Australia.

 

 

Companion animal product revenue growth was impacted by broad-based demand for parasiticides, canine vaccines and anti-infectives due to favorable market conditions in developed and emerging markets.

Segment revenues were also favorably impacted by the inclusion of $35 million, or 7%, from the acquisition of KAH and were negatively impacted by government-mandated divestitures in 2011 related to the acquisition of FDAH, which decreased revenues by 2%. Additionally, revenues were favorably impacted by 8% due to foreign exchange.

2010 vs. 2009

U.S. operating segment

U.S. segment revenues increased by $279 million, or 25%, in 2010 compared to 2009. Base revenue growth was $145 million, or 13%, of which approximately $117 million in growth came from livestock products and approximately $28 million came from companion animal products.

 

 

Livestock product revenue growth was driven by rising beef prices and a strong export market, which resulted in increased utilization of cattle products across all product categories. Increased demand for Draxxin by cattle producers was an additional driver of segment growth.

 

 

Companion animal product revenue growth was driven by promotional efforts targeted toward veterinarians, which increased demand for vaccines, parasiticides and anti-infectives. Revenues were unfavorably impacted by weakness in pain and sedation medicines due to a one-time supply disruption.

Segment revenues were also favorably impacted by the inclusion of an incremental $147 million, or 13%, from the acquisition of FDAH and were negatively impacted by government-mandated divestitures in 2010 related to the acquisition of FDAH, which decreased revenues by 1%.

EuAfME operating segment

EuAfME segment revenues increased by $140 million, or 16%, in 2010 compared to 2009. Base revenue decline was $9 million, or (1%), of which approximately $10 million of the decline came from livestock products partially offset by a growth of approximately $1 million in companion animal products.

 

 

Livestock product revenues were unfavorably impacted by weak economic conditions in Western Europe and declining cattle and sheep populations. This was partially offset by growth in emerging markets including Russia, Turkey and North Africa.

 

 

Companion animal product revenues were favorably impacted by growth in Convenia/Cefovecin primarily in Germany and the U.K. Segment performance also benefited from growth in Mavacoxib, a pain medicine, in Germany, Italy and emerging markets. This was partially offset by macro-economic conditions in Western Europe, which resulted in the contraction of the overall market.

Segment revenues were also favorably impacted by the inclusion of an incremental $229 million, or 26%, from the acquisition of FDAH and were negatively impacted by government-mandated divestitures in 2010 related to the FDAH acquisition, which decreased revenues by 8%. Additionally, revenues were unfavorably impacted by 1% due to foreign exchange.

 

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CLAR operating segment

CLAR segment revenues increased by $213 million, or 47%, in 2010 compared to 2009. Base revenue growth was $23 million, or 5%, of which approximately $8 million in growth came from livestock products and approximately $15 million in growth came from companion animal products.

 

 

Livestock product revenue growth was driven by the continued expansion of the domestic and export-oriented cattle market in Brazil.

 

 

Companion animal product revenue growth was driven by increased sales of canine vaccines and parasiticides, resulting from promotional efforts in Brazil focused on the rapidly growing petcare market. Revenue growth was also driven by increased sales of canine parasiticides in Canada due to an extended flea and tick season.

Segment revenues were also favorably impacted by the inclusion of an incremental $146 million, or 32%, from the acquisition of FDAH. Additionally, revenues were favorably impacted by 10% due to foreign exchange.

APAC operating segment

APAC segment revenues increased by $190 million, or 59%, in 2010 compared to 2009. Base revenue growth in the APAC operating segment was $49 million, or 15%, of which approximately $45 million in growth came from livestock products and approximately $4 million in growth came from companion animal products.

 

 

Livestock product revenue growth was particularly strong in Australia across all species and product categories. Additionally, emerging market investments in our sales organization and marketing initiatives drove growth in anti-infectives for swine, poultry and cattle. China continued to contribute to segment growth as a result of the continued progression of industrialization of livestock production.

 

 

Companion animal product revenue growth was primarily driven by increased sales of anti-infectives in Japan and Australia, as well as increased sales of parasiticides in Japan and emerging markets in Asia.

Segment revenues were also favorably impacted by the inclusion of an incremental $118 million, or 36% from the acquisition of FDAH and were negatively impacted by government-mandated divestitures in 2010 related to the acquisition of FDAH, which decreased revenues by 2%. Additionally, revenues were favorably impacted by 10% due to foreign exchange.

Costs and expenses

Cost of sales

 

     Nine Months
Ended
    % Change     Year Ended
December 31,
    % Change  
(MILLIONS OF DOLLARS)    September 30,
2012
    October 2,
2011
    12/11     2011     2010     2009     11/10      10/09  

Cost of sales(a)

   $ 1,130      $ 1,233        (8   $ 1,652      $ 1,444      $ 1,078        14         34   

% of revenues

     36     40       39     40     39     

 

Certain amounts and percentages may reflect rounding adjustments.

(a) Allocation of corporate enabling functions was: $1 million and $2 million in the first nine months of 2012 and 2011, respectively, and $3 million in 2011, $6 million in 2010 and $0 million in 2009.

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

Cost of sales decreased $103 million, or (8%), in the first nine months of 2012 compared to the first nine months of 2011, primarily as a result of:

 

 

the non-recurrence of approximately $24 million of incremental purchase accounting charges in 2011 reflecting the fair value adjustments to inventory acquired from KAH that was subsequently sold in 2011;

 

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the non-recurrence of a $12 million inventory write-off in 2011 related to suspended sales of 3-Nitro;

 

 

favorable product mix;

 

 

increased operational efficiencies and savings associated with margin improvement initiatives, including plant network optimization, yield improvements and overall cost reductions; and

 

 

favorable foreign exchange.

2011 vs. 2010

Cost of sales increased $208 million, or 14%, in 2011 compared to 2010, primarily as a result of:

 

 

the addition of approximately $200 million in costs associated with KAH products inclusive of incremental purchase accounting charges of $24 million reflecting the fair value adjustments to inventory acquired from KAH that was subsequently sold;

 

 

base revenue growth; and

 

 

unfavorable product mix between our legacy portfolio and KAH portfolio;

partially offset by:

 

 

increased operational efficiencies and savings associated with margin improvement initiatives, including plant network optimization, yield improvements and overall cost reductions.

2010 vs. 2009

Cost of sales increased $366 million, or 34%, in 2010 compared to 2009, primarily as a result of:

 

 

the addition of approximately $300 million in costs associated with the inclusion of FDAH products, for a full year in 2010 compared to a partial year in 2009 inclusive of purchase accounting charges of $66 million reflecting the fair value adjustments to inventory acquired from FDAH that was subsequently sold; and

 

 

unfavorable product mix between our legacy portfolio and FDAH portfolio;

partially offset by:

 

 

increased operational efficiencies and savings associated with margin improvement initiatives, including plant network optimization, yield improvements and overall cost reductions.

Selling, general and administrative expenses

 

     Nine Months
Ended
    % Change     Year Ended
December 31,
    % Change  
(MILLIONS OF DOLLARS)    September 30,
2012
    October 2,
2011
    12/11     2011     2010     2009     11/10      10/09  

Selling, general and administrative expenses(a)

   $ 1,017      $ 1,026        (1   $ 1,453      $ 1,382      $ 1,066        5         30   

% of revenues

     32     33       34     39     39     

 

Certain amounts and percentages may reflect rounding adjustments.

 

(a) Allocation of corporate enabling functions was: $185 million and $199 million in the first nine months of 2012 and 2011, respectively, and $268 million in 2011, $260 million in 2010 and $219 million in 2009.

 

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Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

SG&A expenses decreased by $9 million, or (1%), in the first nine months of 2012 compared to the first nine months of 2011, primarily as a result of:

 

 

reductions in costs due to both acquisition-related synergies and cost reduction initiatives, which are also reflected in the decreased allocation of corporate enabling functions; and

 

 

favorable foreign exchange;

partially offset by:

 

 

the inclusion of an incremental one month of U.S. and two months of international KAH operations; and

 

 

initiatives to increase our direct sales and marketing presence in certain emerging markets.

2011 vs. 2010

SG&A expenses increased $71 million, or 5%, in 2011 compared to 2010, primarily as a result of:

 

 

the addition of KAH operations, eleven months in the U.S. and ten months internationally; and

 

 

initiatives to increase our direct sales and marketing presence in certain emerging markets;

partially offset by:

 

 

reductions in costs due to both acquisition-related synergies and cost reduction initiatives.

2010 vs. 2009

SG&A expenses increased $316 million, or 30%, in 2010 compared to 2009, primarily as a result of:

 

 

the addition of a full year of FDAH operations; and

 

 

promotional efforts to increase awareness of recently acquired FDAH products;

partially offset by:

 

 

reductions in costs due to cost reduction initiatives.

Research and development expenses

 

     Nine Months Ended     % Change     Year Ended
December 31,
    % Change  
(MILLIONS OF DOLLARS)    September 30,
2012
    October 2,
2011
    12/11     2011     2010     2009     11/10      10/09  

Research and development expenses(a)

   $ 288      $ 308        (6   $ 427      $ 411      $ 368        4         12   

% of revenues

     9     10       10     11     13     

 

Certain amounts and percentages may reflect rounding adjustments.

 

(a) Allocation of corporate enabling functions was: $43 million and $48 million in the first nine months of 2012 and 2011, respectively, and $64 million in 2011, $79 million in 2010 and $72 million in 2009.

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

R&D expenses decreased $20 million, or (6%), in the first nine months of 2012 compared to the first nine months of 2011, primarily as a result of:

 

   

cost reduction initiatives including a decreased allocation of enabling functions; and

 

   

favorable foreign exchange.

 

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2011 vs. 2010

R&D expenses increased $16 million, or 4% in 2011 compared to 2010, primarily as a result of $19 million in accelerated depreciation related to the closing of an R&D facility in the U.K. Also, the incremental $10 million of R&D expenses from the acquisition of KAH and the acquisition of a diagnostics business (in December 2010) contributed to the increase in R&D expenses. These expenses were partially offset by reductions in costs due to acquisition related synergies and cost reduction initiatives.

2010 vs. 2009

R&D expenses increased $43 million, or 12%, in 2010 compared to 2009, primarily as a result of the inclusion of a full year of FDAH R&D costs.

Amortization of intangible assets

 

     Nine Months
Ended
     % Change      Year Ended
December 31,
     % Change  
(MILLIONS OF DOLLARS)    September 30,
2012
     October 2,
2011
     12/11      2011      2010      2009      11/10      10/09  

Amortization of intangible assets

   $ 48       $ 51         (6)       $ 69       $ 58       $ 33         19         76   

 

Certain amounts and percentages may reflect rounding adjustments.

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

Amortization of intangible assets decreased $3 million, or (6%), in the first nine months of 2012 compared to the first nine months of 2011, which includes the impact of impairments taken at the end of 2011.

2011 vs. 2010

Amortization of intangible assets increased $11 million, or 19%, in 2011 compared to 2010, primarily as a result of the addition of finite-lived intangible assets acquired as part of our acquisition of KAH.

2010 vs. 2009

Amortization of intangible assets increased $25 million, or 76%, in 2010 compared to 2009, primarily as a result of a full year of amortization related to the finite-lived intangible assets acquired as part of our acquisition of FDAH.

Restructuring charges and certain acquisition-related costs

 

     Nine Months Ended      % Change      Year Ended
December 31,
     % Change  
(MILLIONS OF DOLLARS)    September 30,
2012
     October 2,
2011
     12/11      2011      2010      2009      11/10     10/09  

Restructuring charges and certain acquisition-related costs(a)

   $ 55       $ 108         (49)       $ 154       $ 202       $ 340         (24     (41

 

Certain amounts and percentages may reflect rounding adjustments.

 

(a) Allocation of Restructuring charges and certain acquisition-related costs was: $47 million and $51 million in the first nine months of 2012 and 2011, respectively, and $70 million in 2011, $104 million in 2010 and $121 million in 2009.

We have incurred significant direct costs for restructuring and integrating acquired businesses, such as KAH on January 31, 2011 and FDAH on October 15, 2009, among others, and, to a lesser extent, in connection with our ongoing cost reduction/productivity initiatives.

 

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Our acquisition-related costs primarily relate to restructuring charges for employees, assets and activities that will not continue in the combined company. The majority of these charges are termination costs, but we also exited a number of distributor and other contracts and performed some facility rationalization efforts. Our integration costs are generally comprised of consulting costs related to the integration of systems and processes. As our acquired businesses are substantively integrated, we are no longer incurring significant acquisition-related costs.

The costs associated with our cost reduction/productivity initiatives are predominately termination costs associated with plant closings initiated by Pfizer’s manufacturing division. These cost reduction/productivity initiatives are ongoing.

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

Restructuring charges and certain acquisition-related costs decreased $53 million, or (49%), primarily as a result of:

 

 

a net $49 million decrease in employee termination expenses which results from terminations related to acquisitions; and

 

 

a $17 million decrease in integration costs primarily related to the KAH acquisition;

partially offset by:

 

 

a $9 million increase in asset impairment charges primarily from the allocation of the impairment of a Pfizer facility.

2011 vs. 2010

Restructuring charges and certain acquisition-related costs decreased $48 million, or (24)%, in 2011 compared to 2010, primarily as a result of lower integration and restructuring costs related to the KAH acquisition in 2011 and the integration and restructuring costs related to FDAH in 2010 as the FDAH acquisition was significantly larger and more complex than the KAH acquisition.

2010 vs. 2009

Restructuring charges and certain acquisition-related costs decreased $138 million, or (41)%, in 2010, compared to 2009, primarily as a result of:

 

 

a $167 million decrease in restructuring costs related to employee termination costs in 2010 compared to 2009, primarily due to the higher level of restructuring costs associated with the FDAH acquisition that occurred in 2009; and

 

 

the non-recurrence of $23 million in allocated FDAH transaction costs recorded in 2009;

partially offset by:

 

 

a $65 million increase in 2010 integration and exit costs related to the FDAH acquisition.

Other (income)/deductions—net

 

     Nine Months Ended      % Change      Year Ended
December 31,
     % Change  
(MILLIONS OF DOLLARS)    September 30,
2012
     October 2,
2011
     12/11      2011      2010     2009      11/10      10/09  

Other (income)/deductions—net

   $ (14)       $ 16         *       $ 84       ($ 93   $ 23         *         *   

 

Certain amounts may reflect rounding adjustments.

* Calculation not meaningful.

 

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Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

The change in other (income)/deductions—net had a favorable impact of $30 million on net income attributable to Zoetis in the first nine months of 2012 compared to the first nine months of 2011, primarily as a result of:

 

 

a favorable $14 million settlement in the first nine months of 2012 regarding an intellectual property matter, as well as a $7 million change in an estimate for an environmental-related reserve; and

 

 

lower asset impairment charges of identifiable intangible assets of approximately $4 million. See Notes to Unaudited Condensed Combined Financial Statements—Note 4. Other (Income)/Deductions—Net.

2011 vs. 2010

The change in other (income)/deductions—net had an unfavorable impact of $177 million on net income attributable to Zoetis in 2011 compared to 2010, primarily as a result of:

 

 

the non-recurrence of net gains of $104 million on asset disposals included in 2010 on government-mandated divestitures in connection with the acquisition of FDAH; and

 

 

asset impairment charges of identifiable intangible assets of $69 million. See Notes to Combined Financial Statements—Note 6. Other (Income)/Deductions—Net.

2010 vs. 2009

The change in other (income)/deductions—net had a favorable impact of $116 million on net income attributable to Zoetis in 2010 compared to 2009, primarily as a result of:

 

 

net gains of $104 million on sales of government-mandated divestitures in connection with the acquisition of FDAH. See Notes to Combined Financial Statements—Note 4D. Acquisitions, Divestitures and Certain Investments: Divestitures; and

 

 

the incremental impact of royalty related income of $25 million resulting from agreements from FDAH;

partially offset by:

 

 

the full-year impact of interest expense on allocated long-term debt of Pfizer of $11 million. See Notes to Combined Financial Statements—Note 6. Other (Income)/Deductions—Net.

Provision for taxes on income

 

     Nine Months Ended     % Change      Year Ended
December 31,
    % Change  
(MILLIONS OF DOLLARS)    September 30,
2012
    October 2,
2011
    12/11      2011     2010     2009     11/10      10/09  

Provision/(benefit) for taxes on income

   $ 190      $ 126        51       $ 146      $ 67        ($47     118         *   

Effective tax rate

     29.9     34.6        37.1     37.6     (31.8 %)      

 

Certain amounts and percentages may reflect rounding adjustments.

 

* Calculation not meaningful.

During the third quarter of 2012, Pfizer reached a settlement with the U.S. Internal Revenue Service (IRS) with respect to the audits of the Pfizer Inc. tax returns for the years 2006 through 2008. The settlement resulted in an income tax benefit to Zoetis of approximately $29.3 million, representing tax and interest.

During the first quarter of 2011, Pfizer reached a settlement with the IRS with respect to the audits of the Wyeth tax returns for the years 2002 through 2005. The settlement resulted in an income tax benefit to Zoetis of approximately $9.5 million, representing tax and interest.

 

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During the fourth quarter of 2010, Pfizer reached a settlement with the IRS related to issues Pfizer had appealed with respect to the audits of the Pfizer Inc. tax returns for the years 2002 through 2005, as well as the Pharmacia audit for the year 2003 through the date of merger with Pfizer (April 16, 2003). As a result of settling these audit years, in the fourth quarter of 2010, we reduced our unrecognized tax benefits by approximately $25.5 million and recorded a corresponding tax benefit for Zoetis. The full year 2010 effective tax rate of Zoetis was also favorably impacted by the reversal of $7.9 million of accruals related to interest on these unrecognized tax benefits.

For the nine months ended September 30, 2012 and October 2, 2011, see Notes to Unaudited Condensed Combined Financial Statements—Note 5A. Tax Matters: Taxes on Income. For the years ended December 31, 2011, 2010 and 2009, see Notes to Combined Financial Statements—Note 7A. Tax Matters: Taxes on Income.

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

The lower effective tax rate in the first nine months of 2012 compared to the first nine months of 2011 is primarily due to:

 

   

the tax benefit resulting from the aforementioned $29.3 million settlement in 2012; and

 

   

the change in the jurisdictional mix of earnings, which includes the impact of the location of earnings as well as repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and as a result of operating fluctuations in the normal course of business, the impact of non-deductible items and the extent and location of other income and expense items, such as restructuring charges, asset impairments and gains and losses on asset divestitures;

partially offset by:

 

   

the non-recurrence of the aforementioned $9.5 million settlement in 2011; and

 

   

the expiration of the U.S. research and development credit.

2011 vs. 2010

The lower effective tax rate in 2011 compared to 2010 is primarily due to:

 

   

the change in the jurisdictional mix of earnings, which includes the impact of the location of earnings as well as repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and as a result of operating fluctuations in the normal course of business, the impact of non-deductible items and the extent and location of other income and expense items, such as restructuring charges, asset impairments and gains and losses on asset divestitures;

 

   

the aforementioned $9.5 million reduction in unrecognized tax benefits in 2011, which were recorded as a result of the favorable tax audit settlement pertaining to prior years; and

 

   

the non-recurrence of the write-off of a deferred tax asset of approximately $21.3 million in 2010 to record the impact of the U.S. healthcare legislation concerning the tax treatment of the Medicare Part D subsidy for retiree prescription drug coverage;

partially offset by:

 

   

the non-recurrence of the aforementioned $25.5 million reduction in our unrecognized tax benefits and $7.9 million in interest on those unrecognized tax benefits in 2010 resulting from the resolution of certain tax positions which were recorded as a result of the favorable tax audit settlement pertaining to prior years.

 

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2010 vs. 2009

The higher effective tax rate in 2010 compared to 2009 is primarily due to:

 

   

the write-off of a deferred tax asset of approximately $21.3 million to record the impact of the U.S. healthcare legislation concerning the tax treatment of the Medicare Part D subsidy for retiree prescription drug coverage; and

 

   

the change in the jurisdictional mix of earnings, which includes the impact of the location of earnings as well as repatriation costs. The jurisdictional mix of earnings can vary as a result of repatriation decisions and as a result of operating fluctuations in the normal course of business, the impact of non-deductible items and the extent and location of other income and expense items, such as restructuring charges, asset impairments and gains and losses on asset divestitures;

partially offset by:

 

   

the aforementioned $25.5 million reduction in our unrecognized tax benefits and $7.9 million in interest on those unrecognized tax benefits in 2010 resulting from the resolution of certain tax positions which were recorded as a result of the favorable tax audit settlement pertaining to prior years.

Adjusted net income

General description of Adjusted net income (a non-GAAP financial measure)

Adjusted net income is an alternative view of performance used by management, and we believe that investors’ understanding of our performance is enhanced by disclosing this performance measure. We report Adjusted net income to portray the results of our major operations, the discovery, development, manufacture and commercialization of animal health medicine and vaccine products, prior to considering certain income statement elements. We have defined Adjusted net income as net income attributable to Zoetis before the impact of purchase accounting adjustments, acquisition-related costs and certain significant items. The Adjusted net income measure is not, and should not be viewed as, a substitute for U.S. GAAP reported net income attributable to Zoetis.

The Adjusted net income measure is an important internal measurement for us. We measure our overall performance on this basis in conjunction with other performance metrics. The following are examples of how the Adjusted net income measure is utilized:

 

 

senior management receives a monthly analysis of our operating results that is prepared on an Adjusted net income basis;

 

 

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

 

 

other goal setting and performance measurements.

Despite the importance of this measure to management in goal setting and performance measurement, Adjusted net income is a non-GAAP financial measure that has no standardized meaning prescribed by U.S. GAAP and, therefore, has limits in its usefulness to investors. Because of its non-standardized definition, Adjusted net income, unlike U.S. GAAP net income, may not be comparable to the calculation of similar measures of other companies. Adjusted net income is presented to permit investors to more fully understand how management assesses performance.

We also recognize that, as an internal measure of performance, the Adjusted net income measure has limitations, and we do not restrict our performance-management process solely to this metric. A limitation of the Adjusted net income measure is that it provides a view of our operations without including all events during a period, such as the effects of an acquisition or amortization of purchased intangibles, and does not provide a comparable view of our performance to other companies. We also use other specifically tailored tools designed to achieve the highest levels of performance.

 

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Purchase accounting adjustments

Adjusted net income is calculated prior to considering certain significant purchase accounting impacts that result from business combinations and net asset acquisitions. These impacts, primarily associated with the Pharmacia Animal Health business (acquired in 2003), FDAH (acquired in 2009) and KAH (acquired in 2011), include the incremental charge to cost of sales from the sale of acquired inventory that was written up to fair value, amortization related to the increase in fair value of the acquired finite-lived intangible assets and depreciation related to the increase/decrease in fair value of the acquired fixed assets. Therefore, the Adjusted net income measure includes the revenues earned upon the sale of the acquired products without considering the aforementioned significant charges.

While certain purchase accounting adjustments can occur through 20 or more years, this presentation provides an alternative view of our performance that is used by management to internally assess business performance. We believe the elimination of amortization attributable to acquired intangible assets provides management and investors an alternative view of our business results by providing a degree of parity to internally developed intangible assets for which R&D costs previously have been expensed.

A completely accurate comparison of internally developed intangible assets and acquired intangible assets cannot be achieved through Adjusted net income. These components of Adjusted net income are derived solely from the impact of the items listed above. We have not factored in the impact of any other differences in experience that might have occurred if we had discovered and developed those intangible assets on our own, and this approach does not intend to be representative of the results that would have occurred in those circumstances. For example, our R&D costs in total, and in the periods presented, may have been different; our speed to commercialization and resulting revenues, if any, may have been different; or our costs to manufacture may have been different. In addition, our marketing efforts may have been received differently by our customers. As such, in total, there can be no assurance that our Adjusted net income amounts would have been the same as presented had we discovered and developed the acquired intangible assets.

Acquisition-related costs

Adjusted net income is calculated prior to considering transaction, integration, restructuring and additional depreciation costs associated with significant business combinations or net-asset acquisitions because these costs are unique to each transaction and represent costs that were incurred to restructure and integrate certain businesses as a result of the acquisition decision. We have made no adjustments for the resulting synergies.

We believe that viewing income prior to considering these charges provides investors with a useful additional perspective because the significant costs incurred in a business combination result primarily from the need to eliminate duplicate assets, activities or employees––a natural result of acquiring a fully integrated set of activities. For this reason, we believe that the costs incurred to convert disparate systems, to close duplicative facilities or to eliminate duplicate positions (for example, in the context of a business combination) can be viewed differently from those costs incurred in the ordinary course of business.

The integration and restructuring costs associated with a business combination may occur over several years, with the more significant impacts ending within three years of the transaction. Because of the need for certain external approvals for some actions, the span of time needed to achieve certain restructuring and integration activities can be lengthy. For example, due to the regulated nature of the animal health medicines and vaccines business, the closure of excess facilities can take several years, as all manufacturing changes are subject to extensive validation and testing and must be approved by the FDA and/or other regulatory authorities.

Certain significant items

Adjusted net income is calculated prior to considering certain significant items. Certain significant items represent substantive, unusual items that are evaluated on an individual basis. Such evaluation considers both the quantitative and the qualitative aspect of their unusual nature. Unusual, in this context, may represent items that are not part of our ongoing business; items that, either as a result of their nature or size, we would not expect to

 

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occur as part of our normal business on a regular basis; items that would be non-recurring; or items that relate to products that we no longer sell. While not all-inclusive, examples of items that could be included as certain significant items would be a major non-acquisition-related restructuring charge and associated implementation costs for a program that is specific in nature with a defined term, such as those related to our non-acquisition-related cost-reduction and productivity initiatives; amounts related to disposals of products or facilities that do not qualify as discontinued operations as defined by U.S. GAAP; certain intangible asset impairments; adjustments related to the resolution of certain tax positions; the impact of adopting certain significant, event-driven tax legislation; or charges related to legal matters. For the nine months ended September 30, 2012 and October 2, 2011, see Notes to Unaudited Condensed Combined Financial Statements—Note 10. Segment, Geographic and Revenue Information. For the years ended December 31, 2011, 2010 and 2009, see Notes to Combined Financial Statements—Note 16. Segment, Geographic and Revenue Information. Our normal, ongoing defense costs or settlements of and accruals on legal matters made in the normal course of our business would not be considered certain significant items.

Reconciliation and detailed descriptions

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

 

     Nine Months Ended      Year Ended December 31,  
(MILLIONS OF DOLLARS)    September 30,
2012
    October 2,
2011
     2011      2010     2009  

Reported net income attributable to Zoetis

   $ 446      $ 236       $ 245       $ 110      $ (100

Purchase accounting adjustments—net of tax

     26        46         55         103        27   

Acquisition-related costs—net of tax

     23        57         78         145        168   

Certain significant items—net of tax

     (13     42         125         (83     94   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Adjusted net income

   $ 482      $ 381       $ 503       $ 275      $ 189   

The effective tax rate on Adjusted pre-tax income is 34.6% and 33.7% in the first nine months of 2012 and 2011, respectively. The higher effective tax rate in the first nine months of 2012 is due to the non-recurrence of approximately $9.5 million reduction in unrecognized tax benefits in 2011, which were recorded as a result of a favorable tax audit settlement pertaining to prior years, and the expiration of the U.S. research and development credit; partially offset by the change in the jurisdictional mix of earnings, which includes the impact of the location of earnings as well as repatriation costs.

The effective tax rate on Adjusted pre-tax income is 34.3%, 39.9% and 36.5% for full year 2011, 2010 and 2009, respectively. The lower effective tax rate for the full year 2011 is primarily due to a reduction in unrecognized tax benefits in 2011, which were recorded as a result of a favorable tax audit settlement pertaining to prior years, the non-recurrence of the write-off in 2010 of a deferred tax asset to record the impact of the U.S. healthcare legislation concerning the tax treatment of the Medicare Part D subsidy for retiree prescription drug coverage, as well as the change in the jurisdictional mix of earnings.

Throughout 2012, we have undertaken a number of internal reorganization steps designed to improve our operational efficiency and reduce costs. As a result of these actions, which will change our jurisdictional mix of earnings, among other impacts, we expect that our future effective tax rate on Adjusted pre-tax income will be lower than historical levels.

Adjusted net income includes the following charges for each of the periods presented:

 

     Nine Months Ended      Year Ended December 31,  
(MILLIONS OF DOLLARS)    September 30,

2012

     October 2,

2011

     2011      2010      2009  

Interest

   $ 23       $ 27       $ 36       $ 37       $ 26   

Taxes

     255         195         264         183         108   

Depreciation

     93         85         117         103         86   

Amortization

     14         15         20         19         17   

 

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

 

    Nine Months Ended     Year Ended
December 31,
 
(MILLIONS OF DOLLARS)   September 30,
2012
    October 2,
2011
    2011     2010     2009  

Purchase accounting adjustments:

         

Amortization and depreciation(a)

  $ 36      $ 36      $ 48      $ 41      $ 16   

Cost of sales, primarily related to fair value adjustments of acquired inventory(b)

    3        33        34        107        24   

 

 

Total purchase accounting adjustments, pre-tax

    39        69        82        148        40   

Income taxes(k)

    13        23        27        45        13   

 

 

Total purchase accounting adjustments—net of tax

    26        46        55        103        27   

 

 

Acquisition-related costs(c):

         

Transaction costs(d)

    —          1        2        1        23   

Integration costs(d)

    31        47        71        92        46   

Restructuring charges(d)

    (8     35        41        107        178   

Additional depreciation—asset restructuring(g)

    11        4        8        17        —     

 

 

Total acquisition-related costs, pre-tax

    34        87        122        217        247   

Income taxes(k)

    11        30        44        72        79   

 

 

Total acquisition-related costs—net of tax

    23        57        78        145        168   

 

 

Certain significant items(e):

         

Restructuring charges(f)

    32        24        40        2        93   

Implementation costs and additional depreciation—asset restructuring(g)

    14        13        22        —          66   

Certain asset impairment charges(h)

    —          9        69        —          —     

Inventory write-off (in Cost of sales)

    —          12        12        13        —     

Net gains on sale of assets(i)

    —          —          —          (104     (2

Other(j)

    (18     —          29        5        —     

 

 

Total certain significant items, pre-tax

    28        58        172        (84     157   

Income taxes(k)

    41        16        47        (1     63   

 

 

Total certain significant items—net of tax

    (13     42        125        (83     94   

 

 

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

  $ 36      $ 145      $ 258      $ 165      $ 289   

 

Certain amounts and percentages may reflect rounding adjustments.

(a) Amortization and depreciation expense related to purchase accounting adjustments with respect to identifiable intangible assets and property, plant and equipment were distributed as follows in the first nine months of 2012, in the first nine months of 2011, and in 2011, 2010 and 2009, respectively: $37 million, $37 million, $49 million, $41 million and $17 million in Amortization of intangible assets; $0 million, $0 million, $1 million, $0 million and $0 million in Research and development expenses; $1 million income, $1 million income, $2 million income, $0 million and $1 million income in Selling, general and administrative expenses.
(b) Also includes depreciation expense in Cost of Sales of $3 million, $9 million, $10 million, $22 million and $5 million in the first nine months of 2012, in the first nine months of 2011 and in 2011, 2010 and 2009 respectively.
(c) Acquisition-related costs were distributed as follows in the first nine months of 2012, in the first nine months of 2011, and in 2011, 2010 and 2009, respectively: $9 million, $3 million, $6 million, $0 million and $0 million in Cost of sales; $2 million, $2 million, $3 million, $17 million and $0 million in Selling, general and administrative expenses; $0 million, $1 million income, $1 million income, $0 million and $0 million in Other (income)/deductions—net; $23 million, $83 million, $114 million, $200 million and $247 million in Restructuring charges and certain acquisition related costs.
(d) Included in Restructuring charges and certain acquisition-related costs. For the nine months ended September 30, 2012 and October 2, 2011, see Notes to Unaudited Condensed Combined Financial Statements—Note 3. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives. For the years ended December 31, 2011, 2010 and 2009, see Notes to Combined Financial Statements—Note 5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives.
(e)

Certain significant items were distributed as follows in the first nine months of 2012, in the first nine months of 2011, and in 2011, 2010 and 2009, respectively: $4 million income, $12 million, $31 million, $19 million and $53 million in Cost of sales; $4 million, $2 million,

 

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  $5 million, $0 million and $10 million in Selling, general and administrative expenses; $10 million, $11 million, $19 million, $0 million and $3 million in Research and development expenses; $14 million income, $9 million, $77 million, $105 million income and $2 million income in Other (income)/deductions—net; $32 million, $24 million, $40 million, $2 million and $93 million in Restructuring charges and certain acquisition-related costs.
(f) Represents restructuring charges incurred for our cost-reduction/productivity initiatives. Included in Restructuring charges and certain acquisition-related costs. For the nine months ended September 30, 2012 and October 2, 2011, see Notes to Unaudited Condensed Combined Financial Statements—Note 3. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives. For the years ended December 31, 2011, 2010 and 2009, see Notes to Combined Financial Statements—Note 5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives.
(g) Amounts in certain significant items relate to our cost-reduction/productivity initiatives and amounts in acquisition-related costs relate to our acquisition activity. For the nine months ended September 30, 2012 and October 2, 2011, see Notes to Unaudited Condensed Combined Financial Statements—Note 3. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives. For the years ended December 31, 2011, 2010 and 2009, see Notes to Combined Financial Statements—Note 5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives.
(h) Included in Other (income)/deductions—net. For the nine months ended September 30, 2012 and October 2, 2011, see Notes to Unaudited Condensed Combined Financial Statements—Note 4. Other (Income)/Deductions—Net. For the years ended December 31, 2011, 2010 and 2009, see Notes to Combined Financial Statements—Note 6. Other (Income)/Deductions—Net.
(i) Included in Other (income)/deductions—net. See Notes to Combined Financial Statements—Note 6. Other (Income)/Deductions—Net for more information.
(j) In the nine months ended September 30, 2012, certain significant items included income related to a favorable legal settlement for an intellectual property matter of $14 million and $4 million income related to a change in estimate with respect to transitional manufacturing agreements associated with divestitures. See Notes to Unaudited Condensed Combined Financial Statements—Note 4. Other (Income)/Deductions—Net. For the years ended December 31, 2011 and 2010, significantly all reflected charges are related to transitional manufacturing purchase agreements associated with divestitures. See Notes to Combined Financial Statements—Note 4D. Acquisitions, Divestitures and Certain Investments: Divestitures.
(k) Included in Provision/(benefit) for taxes on income/(loss). Income taxes includes the tax effect of the associated pre-tax amounts, calculated by determining the jurisdictional location of the pre-tax amounts and applying that jurisdiction’s applicable tax rate. In addition, income taxes for Certain significant items in the nine months ended September 30, 2012 includes a $29.3 million tax benefit and for the year ended December 31, 2010 includes a $33 million tax benefit recorded in the fourth quarter, both as a result of settlements of certain audits. For the nine months ended September 30, 2012 and the nine months ended October 2, 2011, see Notes to Unaudited Condensed Combined Financial Statements—Note 5A. Tax Matters: Taxes on Income. For the years ended December 31, 2011, 2010 and 2009, see Notes to Combined Financial Statements—Note 7A. Tax Matters: Taxes on Income.

Analysis of the combined statements of comprehensive income/(loss)

Discussion of changes

Virtually all changes in other comprehensive income for all periods presented are related to foreign currency translation adjustments. These changes result from the strengthening or weakening of the U.S. dollar as compared to the currencies in the countries in which we do business. The gains and losses associated with these changes are deferred on the balance sheet in Accumulated other comprehensive loss until realized. Specifically, the changes to Accumulated other comprehensive loss for the first nine months of 2012 reflect the strengthening of the U.S. dollar against the euro and the Brazilian real. The changes for the first nine months of 2011 reflect the weakening of the U.S. dollar against the Australian dollar and the Brazilian real partially offset by the strengthening of the U.S. dollar against the euro.

Analysis of the combined balance sheets

Discussion of changes

September 30, 2012 vs. December 31, 2011

Virtually all changes in our assets and liabilities as of September 30, 2012 compared to December 31, 2011, reflect, among other things, decreases due to the impact of foreign exchange.

For information about certain of our financial assets and liabilities, including Cash and cash equivalents, Accounts receivable, less allowance for doubtful accounts and Allocated long-term debt, see “—Analysis of financial condition, liquidity and capital resources” below.

For Inventories, the change also reflects the annual inventory build of cattle products in advance of seasonal movements and the establishment of higher targeted inventory levels for certain products.

 

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For Other current liabilities, the change also reflects a decrease in restructuring liabilities.

For Other non-current liabilities, the change also reflects the movement of certain balances to Other current liabilities and certain changes to estimates related to contingency reserves.

December 31, 2011 vs. December 31, 2010

Virtually all changes in our assets and liabilities as of December 31, 2011 compared to December 31, 2010 reflect, among other things, increases associated with our acquisition of KAH. See Notes to Combined Financial Statements—Note 4A. Acquisitions, Divestitures and Certain Investments: Acquisition of King Animal Health.

For information about certain of our financial assets and liabilities, including Cash and cash equivalents, Accounts receivable, less allowance for doubtful accounts, Current portion of allocated long-term debt and Allocated long-term debt, see “—Analysis of financial condition, liquidity and capital resources” below. In addition, changes in Current portion of allocated long-term debt, and Allocated long-term debt reflects scheduled principal payments as well as the call on December 31, 2011 of a senior unsecured note due in March 2012.

For Accounts receivable, less allowance for doubtful accounts, the change also reflects an increase due to increased sales at the end of 2011, as compared to the end of 2010.

For Goodwill, the change also reflects the goodwill recorded as a result of the formation of the Jilin Pfizer Guoyuan joint venture. See Notes to Combined Financial Statements—Note 4E. Acquisitions, Divestitures and Certain Investments: Certain Investments.

For Identifiable intangible assets, less accumulated amortization, the change also includes the impact of impairments of certain assets. See Notes to Combined Financial Statements—Note 6. Other (Income)/Deductions—Net.

Analysis of the combined statements of cash flows

 

     Nine Months Ended     % Change     Year Ended December 31,     % Change  
(MILLIONS OF DOLLARS)    September 30,
2012
    October 2,
2011
    12/11     2011     2010     2009     11/10      10/09  

Cash provided by/(used in):

                 

Operating activities

   $ 144      $ 383        (62   $ 497      $ 254      $ 98        96         159   

Investing activities

     (89     (423     (79     (449     (9     (1,821     *         *   

Financing activities

            122        *        (30     (277     1,823        *         *   

Effect of exchange-rate changes on cash and cash equivalents

     (1     (1     *        (2     (4     (7     *         *   
  

 

 

     

 

 

      

Net increase/(decrease) in cash and cash equivalents

   $ 54      $ 81        (33   $ 16      $ (36   $ 93        *         *   
  

 

 

     

 

 

      

 

Certain amounts and percentages may reflect rounding adjustments.

* Calculation not meaningful.

Operating activities

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

Our net cash provided by operating activities was $144 million in the first nine months of 2012 compared to $383 million in the first nine months of 2011. This decrease in operating cash flows was primarily attributable to:

 

 

increased pre-tax earnings;

 

 

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more than offset by:

 

 

the annual inventory build of cattle products in advance of seasonal movements and the establishment of higher targeted inventory levels for certain products; and

 

 

higher net payments for income taxes.

The change in the line item called Other changes in assets and liabilities, net of acquisitions and divestitures reflects the change in inventory described above.

2011 vs. 2010

Our net cash provided by operating activities was $497 million in 2011 compared to $254 million in 2010. The increase in operating cash flows was primarily attributable to:

 

 

the inclusion of operating cash flows from KAH acquired on January 31, 2011; and

 

 

the timing of receipts and payments in the ordinary course of business.

2010 vs. 2009

Our net cash provided in operating activities was $254 million in 2010 compared to $98 million in 2009. The increase in operating cash flows was primarily attributable to:

 

 

the inclusion of a full year of operating cash flows from FDAH acquired on October 15, 2009; and

 

 

the timing of receipts and payments in the ordinary course of business.

Investing activities

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

Our net cash used in investing activities was $89 million in the first nine months of 2012 compared to $423 million in the first nine months of 2011. In the first nine months of 2011, Pfizer acquired KAH for $345 million in cash. See Notes to Combined Financial Statements—Note 4A. Acquisitions, Divestitures and Certain Investments: Acquisition of King Animal Health.

2011 vs. 2010

Our net cash used in investing activities was $449 million in 2011 compared to $9 million in 2010. The increase in net cash used by investing activities was primarily attributable to:

 

 

net cash of $345 million paid for the acquisition of KAH; and

 

 

higher 2010 proceeds of $169 million from sales of assets.

See Notes to Combined Financial Statements—Note 4. Acquisitions, Divestitures and Certain Investments.

2010 vs. 2009

Our net cash used in investing activities was $9 million in 2010 compared to $1.8 billion in 2009. The decrease in net cash used by investing activities was primarily attributable to:

 

 

net cash of $2.3 billion paid in 2009 for the acquisition of FDAH;

partially offset by:

 

 

lower cash proceeds of $369 million from the sale of assets.

See Notes to Combined Financial Statements—Note 4B. Acquisitions, Divestitures and Certain Investments: Acquisition of Fort Dodge Animal Health.

 

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Financing activities

Nine months ended September 30, 2012 vs. nine months ended October 2, 2011

Our net cash provided by financing activities was less than $1 million in the first nine months 2012 compared to $122 million in the first nine months of 2011. The decrease in net cash provided by financing activities was attributable to a decrease in net financing from Pfizer.

2011 vs. 2010

Our net cash used in financing activities was $30 million in 2011 compared to $277 million in 2010. The decrease in net cash used in 2011 was primarily attributable to:

 

 

an increase in our financing activities with Pfizer of $596 million primarily related to the acquisition of KAH in 2011;

partially offset by:

 

 

an allocation of principal payments of long-term debt of $143 million; and

 

 

an increase in dividends paid of $209 million.

2010 vs. 2009

Our net cash used in financing activities was $277 million in 2010 compared to cash provided by financing activities of $1.8 billion in 2009. The decrease in net cash provided by financing activities was primarily attributable to:

 

 

proceeds of $719 million in 2009 from allocated long-term debt from Pfizer;

 

 

a decrease of $1.3 billion in our financing activities with Pfizer related to the acquisition of FDAH in 2009; and

 

 

an increase in dividends paid of $106 million.

Analysis of financial condition, liquidity and capital resources

We and Pfizer have agreed that our cash balance on the date of the completion of this offering will be at least $300 million. To the extent that our cash balance on the date of the completion of this offering is less than $300 million, Pfizer will pay us an amount in cash equal to the shortfall. While we believe our cash on hand, our operating cash flows and our anticipated financing arrangements will be sufficient to support our future cash needs, we can provide no assurance that our liquidity and capital resources will meet future funding requirements. Risks to our meeting future funding requirements include global economic conditions described in the following paragraph.

The global financial markets recently have undergone and may continue to experience significant volatility and disruption. The timing and sustainability of an economic recovery is uncertain and additional macroeconomic, business and financial disruptions may arise. As markets change, we will continue to monitor our liquidity position, and there can be no assurance that the challenging economic environment or a further economic downturn would not impact our liquidity or our ability to obtain future financing.

 

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Selected measures of liquidity and capital resources

Certain relevant measures of our liquidity and capital resources follow:

 

     Nine Months
Ended
     As of
December 31,
 
(MILLIONS OF DOLLARS)    September 30,
2012
     2011      2010  

Cash and debt

        

Cash and cash equivalents

   $ 133       $ 79       $ 63   

Current portion of allocated long-term debt

     —           —           38   

Allocated long-term debt

     580         575         673   

Accounts receivable, less allowance for doubtful accounts: 2011—$29 and 2010—$26

     848         871         773   

Working capital

     1,818         1,468         1,308   

Ratio of current assets to current liabilities

     3.47:1         2.74:1         2.62:1   

 

Certain amounts may reflect rounding adjustments.

We participate in Pfizer’s centralized cash management system, and generally all of our excess cash is transferred to Pfizer on a daily basis. Cash disbursements for operations and/or investing activities are funded as needed by Pfizer. The cash and cash equivalents presented here are amounts recorded on legal entities that are dedicated to Zoetis.

The combined financial statements include an allocation of long-term debt from Pfizer that was issued to partially finance the acquisition of Wyeth (including FDAH). The debt has been allocated on a pro-rata basis using the deemed acquisition cost of FDAH as a percentage of the total acquisition cost of Wyeth. No other allocations of debt have been made as none are specifically related to our operations.

For additional information about the sources and uses of our funds, see “—Analysis of the combined balance sheets” and “—Analysis of the combined statements of cash flows.”

In December 2012, we entered into a revolving credit agreement with a syndicate of banks providing for a five-year $1.0 billion senior unsecured revolving credit facility. The credit facility will not be available for borrowings until the date on which certain conditions, including the completion of this offering and the receipt of certain investment grade ratings, are satisfied. We expect that these conditions will be met concurrently with the completion of this offering. The credit facility contains a financial covenant requiring us to not exceed a maximum total leverage ratio and, unless on the effective date of the credit facility certain investment grade ratings specified in the revolving credit agreement are received, to maintain a minimum interest coverage ratio. In addition, the credit facility contains other customary covenants. Subject to certain conditions, we will have the right to increase the credit facility to up to $1.5 billion. See “Description of certain indebtedness—Credit facility.”

In connection with the senior notes offering, we incurred approximately $3.65 billion aggregate principal amount of senior indebtedness, including the $1.0 billion of our senior notes that was transferred to Pfizer and subsequently disposed of by Pfizer. Immediately prior to the completion of this offering, we will transfer an amount of cash equal to substantially all of the net proceeds we received in the senior notes offering to Pfizer. These transactions will result in a change to our balance sheet as it will replace the Current portion of allocated long-term debt and Allocated long-term debt presented in the table above. Upon the completion of the senior notes offering, we anticipate the Current portion of long-term debt to be $0 million and the Long-term debt to be $3.64 billion (net of original issue debt discount of $10 million).

Accounts receivable are usually collected over a period of 60 to 90 days. For the nine months ended September 30, 2012 and for the years ended December 31, 2011 and 2010, we have achieved an overall reduction

 

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in the number of days that accounts receivables are outstanding. We regularly monitor our accounts receivable for collectability, particularly in markets where economic conditions remain uncertain. We believe that our allowance for doubtful accounts is appropriate. Our assessment is based on such factors as past due history, historical and expected collection patterns, the financial condition of our customers, the robust nature of our credit and collection practices and the economic environment.

Contractual obligations

Payments due under contractual obligations as of December 31, 2011 are set forth below:

 

       Total        Years  
(MILLIONS OF DOLLARS)         2012        2013-
  2014  
     2015-
  2016  
       Thereafter    

Allocated long-term debt, including allocated interest obligations(a)

   $ 1,040       $ 31       $ 135       $ 312       $ 562   

Other long-term liabilities reflected on our combined balance sheet under U.S. GAAP(b)

     10         2         2         2         4   

Operating lease commitments

     62         16         21         11         14   

Purchase obligations and other(c)

     202         68         65         21         48   

Uncertain tax positions(d)

                                       

 

Certain amounts may reflect rounding adjustments.

(a) Allocated long-term debt obligations include both expected principal and interest obligations of Pfizer that have been allocated to Zoetis in the combined financial statements. The allocated debt is comprised of U.S. dollar and foreign currency denominated senior unsecured notes issued by Pfizer to partially finance the acquisition of FDAH. Our calculations of expected interest payments incorporate only current period assumptions for interest rates, foreign currency translation rates and Pfizer hedging strategies, see Notes to Combined Financial Statements—Note 9D. Financial Instruments: Allocated Long-Term Debt.
(b) Includes expected payments relating to our future benefit payments net of plan assets (included in determination of the projected benefit obligation) for pension plans that are dedicated to Zoetis employees in the Netherlands, Germany, India, the Philippines and Korea. Excludes approximately $120 million of liabilities related to employee terminations, legal and environmental contingencies and other matters, most of which do not represent contractual obligations. See Notes to Combined Financial Statements—Note 5. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives and Note 15. Commitments and Contingencies.
(c) Includes agreements to purchase goods and services that are enforceable and legally binding and includes amounts relating to advertising, information technology services, employee benefit administration services, and potential milestone payments deemed reasonably likely to occur.
(d) Except for amounts reflected in Income taxes payable, we are unable to predict the timing of tax settlements, as tax audits can involve complex issues and the resolution of those issues may span multiple years, particularly if subject to negotiation or litigation.

The table above excludes amounts for potential milestone payments unless the payments are deemed reasonably likely to occur. Payments under these agreements generally become due and payable only upon the achievement of certain development, regulatory and/or commercialization milestones, which may span several years and/or which may never occur. Our historical contractual obligations in the table above are not necessarily indicative of our contractual obligations in the future as a standalone public company.

Following the completion of the Transactions, as defined in “Unaudited pro forma condensed combined financial statements,” the allocated long-term debt presented in the table above will be retained by Pfizer and it will be replaced by payments due under contractual obligations associated with the $3,650 million aggregate principal amount of notes issued in connection with the senior notes offering. Immediately after the senior notes offering, in the table above our total payments due under contractual obligations associated with the senior notes was $5,794 million, representing expected principal and interest obligations of $233 million in 2013 through 2014, $629 million in 2015 through 2016 and $4,932 million thereafter.

Off-balance sheet arrangements

We do not currently use off-balance sheet arrangements for the purpose of credit enhancement, hedging transactions, investment or other financial purposes.

 

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In the ordinary course of business and in connection with the sale of assets and businesses, we may indemnify our counterparties against certain liabilities that may arise in connection with a transaction or that are related to activities prior to a transaction. These indemnifications typically pertain to environmental, tax, employee and/or product-related matters, and patent-infringement claims. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we would be required to reimburse the loss. These indemnifications generally are 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, 2012 or December 31, 2011, recorded amounts for the estimated fair value of these indemnifications are not significant.

New accounting standards

For discussion of our new accounting standards, see Notes to Combined Financial Statements—Note 3A. Significant Accounting Policies: New Accounting Standards.

Significant accounting policies and application of critical accounting estimates

In presenting our financial statements in conformity with U.S. GAAP, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures.

We believe that the following accounting policies are critical to an understanding of our combined financial statements as they require the application of the most difficult, subjective and complex judgments and, therefore, could have the greatest impact on our financial statements: (i) acquisitions and fair value; (ii) revenues; and (iii) impairment reviews—long-lived assets, including goodwill and other intangible assets.

Below are some of our more critical accounting estimates.

For more information regarding our significant accounting policies, estimates and assumptions, see Notes to Combined Financial Statements—Note 3. Significant Accounting Policies.

Acquisitions and fair value

For a discussion about the application of fair value to our recent acquisitions, see Notes to Combined Financial Statements—Note 4. Acquisitions, Divestitures and Certain Investments.

For a discussion about the application of fair value to our allocated long-term debt, see Notes to Combined Financial Statements—Note 9D. Financial Instruments: Allocated Long-Term Debt.

For a discussion about the application of fair value to our asset impairment reviews, see Notes to Combined Financial Statements—Note 6. Other (Income)/Deductions—Net and Unaudited Condensed Combined Financial Statements—Note 4. Other (Income)/Deductions—Net.

Revenues

Our gross product revenues are subject to deductions that are generally estimated and recorded in the same period that the revenues are recognized and primarily represent sales returns and revenue incentives. For example:

 

 

for sales returns, we perform calculations in each market that incorporate the following, as appropriate: local returns policies and practices; returns as a percentage of revenues; an understanding of the reasons for past returns; estimated shelf life by product; an estimate of the amount of time between shipment and return or lag time; and any other factors that could impact the estimate of future returns, product recalls, discontinuation of products or a changing competitive environment; and

 

 

for revenue incentives, we use our historical experience with similar incentives programs to estimate the impact of such programs on revenues.

 

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If any of our ratios, factors, assessments, experiences or judgments are not indicative or accurate predictors of our future experience, our results could be materially affected. Although the amounts recorded for these revenue deductions are heavily dependent on estimates and assumptions, historically our adjustments to actual results have not been material. The sensitivity of our estimates can vary by program, type of customer and geographic location.

Amounts recorded for revenue deductions can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. For further information about the risks associated with estimates and assumptions, see Notes to Combined Financial Statements—Note 3B. Significant Accounting Policies: Estimates and Assumptions.

Impairment reviews––long-lived assets

We review all of our long-lived assets for impairment indicators throughout the year and we perform detailed testing whenever impairment indicators are present. In addition, we perform detailed impairment testing for goodwill and indefinite-lived assets at least annually. When necessary, we record charges for impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets.

Our impairment review processes are described in Notes to Combined Financial Statements—Note 3J. Significant Accounting Policies: Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets and, for deferred tax assets, in Note 3M. Significant Accounting Policies: Deferred Tax Assets and Liabilities and Income Tax Contingencies.

Examples of events or circumstances that may be indicative of impairment include:

 

 

a significant adverse change in the extent or manner in which an asset is used. For example, restrictions imposed by the regulatory authorities could affect our ability to manufacture or sell a product.

 

 

a projection or forecast that demonstrates losses or reduced profits associated with an asset. This could result, for example, from the introduction of a competitor’s product that results in a significant loss of market share or the inability to achieve the previously projected revenue growth, or from the lack of acceptance of a product by customers.

Our impairment reviews of most of our long-lived assets depend heavily on the determination of fair value, as defined by U.S. GAAP, and these judgments can materially impact our results of operations. A single estimate of fair value can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. For information about the risks associated with estimates and assumptions, see Notes to Combined Financial Statements—Note 3B. Significant Accounting Policies: Estimates and Assumptions.

Intangible assets other than goodwill—impairment discussion

As a result of our intangible asset impairment review work, described in detail below, we recognized a number of impairments of identifiable intangible assets other than goodwill.

We recorded the following identifiable intangible asset impairment charges in Other (income)/deductions—net:

 

 

In the first nine months of 2012, the asset impairment charges include (i) approximately $2 million of finite-lived companion animal developed technology rights; (ii) approximately $1 million of finite-lived trademarks related to genetic testing services; and (iii) approximately $2 million of finite-lived patents related to poultry technology. The intangible asset impairment charges for 2012 reflect, among other things, the loss of revenues as a result of negative market conditions and, with respect to the poultry technology, a re-assessment of economic viability.

 

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In 2011, the asset impairment charges include: (i) approximately $30 million of finite-lived intangible assets related to parasiticides technology as a result of declining gross margins and increased competition; (ii) approximately $12 million of finite-lived intangible assets related to equine influenza and tetanus technology due to third-party supply issues; (iii) approximately $10 million of finite-lived intangible assets related to genetic testing services that did not find consumer acceptance; and (iv) approximately $17 million related to IPR&D projects (acquired from Vetnex in 2010 and from FDAH in 2009), as a result of the termination of the development programs due to a re-assessment of their economic viability.

 

 

In 2009, the asset impairment charges include: (i) approximately $3 million write-off related to an equine licensing arrangement, which was required to be surrendered in connection with Pfizer’s acquisition of Wyeth; and (ii) approximately $2 million write-off of finite-lived intangible assets related to a canine product that could not find consumer acceptance.

For a description of our accounting policy, see Notes to Combined Financial Statements—Note 3J. Significant Accounting Policies: Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets.

When we are required to determine the fair value of intangible assets other than goodwill, we use an income approach, specifically the multi-period excess earnings method, also known as the discounted cash flow method. We start with a forecast of all the expected net cash flows associated with the asset, which includes the application of a terminal value for indefinite-lived assets, and then we apply an asset-specific discount rate to arrive at a net present value. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which includes the expected impact of competitive, legal and/or regulatory forces on the projections, the impact of technological risk associated with IPR&D assets, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows.

While all identifiable intangible assets can be impacted by events and thus lead to impairment, in general, identifiable intangible assets that are at the highest risk of impairment include IPR&D assets and newly acquired or recently impaired indefinite-lived brand assets. IPR&D assets are higher-risk assets, because R&D is an inherently risky activity. Newly acquired and recently impaired indefinite-lived assets are more vulnerable to impairment because the assets are recorded at fair value and are then subsequently measured at the lower of fair value or carrying value at the end of each reporting period. As such, immediately after acquisition or impairment, even small declines in the outlook for these assets can negatively impact our ability to recover the carrying value and can result in an impairment charge.

Goodwill—impairment discussion

As a result of our goodwill impairment review work, described in detail below, we concluded that none of our goodwill is impaired as of September 30, 2012 and December 31, 2011, and we do not believe the risk of impairment is significant at this time.

For a description of our accounting policy, see Notes to Combined Financial Statements—Note 3J. Significant Accounting Policies: Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets.

In determining the fair value of each reporting unit, the income approach was used. The income approach is a forward-looking approach to estimating fair value and relies primarily on internal forecasts. Within the income approach, the method that we use is the discounted cash flow method. We start with a forecast of all the expected net cash flows associated with the reporting unit, which includes the application of a terminal value, and then we apply a reporting unit-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which includes the expected impact of technological risk and competitive, legal and/or regulatory forces on the projections, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows.

 

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While all reporting units can confront events and circumstances that can lead to impairment, we do not believe that the risk of goodwill impairment for any of our reporting units is significant at this time.

For all of our reporting units, there are a number of future events and factors that may impact future results and that could potentially have an impact on the outcome of subsequent goodwill impairment testing. For a list of these factors, see “—Factors affecting our performance.”

Contingencies

Legal matters

We are subject to numerous contingencies arising in the ordinary course of business, such as product liability and other product-related litigation, commercial litigation, environmental claims and proceedings, patent litigation and government investigations. See Notes to Combined Financial Statements—Note 15A. Commitments and Contingencies: Legal Proceedings and see Unaudited Condensed Combined Financial Statements—Note 9A. Commitments and Contingencies: Legal Proceedings.

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 and/or accrued.

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 heavily 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.

Tax matters

We account for income tax contingencies using a benefit recognition model. See Notes to Combined Financial Statements—Note 3M. Significant Accounting Policies: Deferred Tax Assets and Liabilities and Income Tax Contingencies. If our initial assessment fails to result in the recognition of a tax benefit, we regularly monitor our position and subsequently recognize the tax benefit if: (i) there are changes in tax law, analogous case law or there is new information that sufficiently raise the likelihood of prevailing on the technical merits of the position to more likely than not; (ii) the statute of limitations expires; or (iii) there is a completion of an audit resulting in a favorable settlement of that tax year with the appropriate agency. We regularly re-evaluate our tax positions based on the results of audits of federal, state and foreign income tax filings, statute of limitations expirations, and changes in tax law or receipt of new information that would either increase or decrease the technical merits of a position relative to the “more-likely-than-not” standard.

Our assessments concerning uncertain tax positions are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and 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

 

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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. See Notes to Unaudited Condensed Combined Financial Statements—Note 5B. Tax Matters: Tax Contingencies and Notes to Combined Statements—Note 7C. Tax Matters: Tax Contingencies.

Qualitative and quantitative disclosures about market risk

Foreign exchange risk

A significant portion of our revenues and costs are exposed to changes in foreign exchange rates. Our primary net foreign currency translation exposures are the euro, the Brazilian real and the Australian dollar. As a business unit of Pfizer and under Pfizer’s risk management umbrella, we seek to manage our foreign exchange risk in part through operational means, including managing same-currency revenues in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Additionally, as a standalone public company, we may implement a foreign currency hedging strategy to limit our foreign exchange risk.

 

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Industry

Overview

The animal health industry, which focuses on both livestock and companion animals, is a growing industry that impacts billions of people worldwide. The demand for animal protein to feed the world continues to increase, even as arable land, fresh water and other natural resources important to global animal protein production become more scarce. In addition, threats to human health associated with livestock are of growing concern to consumers, livestock producers and regulators. Therefore, increasing the efficiency of livestock production and keeping herds and flocks free from disease, including through the use of medicines and vaccines, is a key market need. Growth in the companion animal products category is driven by economic development and related increases in disposable income, increasing pet ownership and companion animals living longer. Therefore, increasing medical treatment of companion animals and advances in animal health medicines and vaccines, is a key market need. Pet ownership continues to be popular, with approximately 62% of households in the United States having at least one pet, according to the American Pet Products Association, or APPA.

Broadly defined, as measured by revenues, the approximately $100 billion animal health industry includes all products and services, other than livestock feed and pet food, that promote livestock productivity and health and companion animal health, such as medicines and vaccines, diagnostics, medical devices, pet supplies, nutritional supplements, veterinary services and other related services. Within this broad market, medicines and vaccines, our core area of operation, represented a global market of $22 billion, as measured by 2011 revenues, grew at a CAGR of 6% between 2006 and 2011 and, excluding the impact of foreign exchange, is projected to grow at a CAGR of 6% per year between 2011 and 2016, according to Vetnosis.

Zoetis is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. According to Vetnosis, as measured by revenues in 2011, we are the largest business in the animal health medicines and vaccines business, and we are the market leader in all of the major regions in which we operate, with the exception of Western Europe, where we hold the number two position. Following this offering, we expect that we will be the largest standalone company exclusively focused on animal health medicines and vaccines.

Our business is diversified across many regions, species and product categories. Our products are sold in more than 120 countries, including developed markets and emerging markets, and our products are primarily used in eight different types of animals, which we refer to as species.

We believe we have the largest and most customer-focused sales organization in the industry and a reputation for providing value-added products, high-quality manufacturing and reliability of supply, with high brand recognition and strong brand loyalty. We have a track record of developing products that meet the needs of our customers, and we believe we are a leader in animal health R&D. From 2004 to 2011, we obtained approximately one-fourth of all animal health medicine approvals granted by the FDA, and approximately one-fifth of all animal health vaccine approvals granted by the USDA. We believe these strengths are important drivers of our leadership in the animal health industry.

 

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2011 revenues for top animal health businesses, in millions

 

LOGO

 

Sources: Zoetis combined financial statements for Zoetis revenues and Vetnosis for other animal health businesses’ revenues.

Livestock

The primary livestock species for the production of animal protein are cattle (both beef and dairy), swine, poultry, sheep and fish. Livestock health and production are essential to meeting the growing demand for animal protein of a global population that is increasing in size and standard of living, particularly in many emerging markets. As part of the global ecosystem, livestock health is critical to assuring a safe, sustainable global food supply and reducing the outbreak of infectious disease in both humans and animals. The livestock medicines and vaccines sector represented $13.1 billion of sales in 2011, or 60% of the total animal health medicines and vaccines market. This sector grew at a CAGR of 7% between 2006 and 2011 and, excluding the impact of foreign exchange, is projected to grow at a CAGR of 6% per year between 2011 and 2016, according to Vetnosis.

Factors influencing growth in demand for livestock medicines and vaccines include:

 

 

human population growth and increasing standards of living, particularly in many emerging markets;

 

 

consequently increasing demand for improved nutrition, particularly animal protein;

 

 

natural resource constraints, such as scarcity of arable land, fresh water and increased competition for cultivated land, resulting in fewer resources that will be available to meet this increased demand for animal protein; and

 

 

increased focus on food safety.

These and other factors have increased the demand for animal protein and the need for greater livestock production efficiency. The global population continues to grow in both size and standard of living, with people consuming an increasing amount of animal protein and dairy per capita. Recent projections by the United Nations suggest that the world will add over two billion people by 2050, mostly in developing countries.

Since the early 1960s, per capita consumption of milk in certain developed markets has almost doubled, meat consumption has more than tripled, and egg consumption has increased fivefold, according to the Food and

 

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Agriculture Organization of the United Nations, or the FAO. Current per capita consumption of animal protein and dairy products in emerging markets, including China, are a fraction of the consumption levels in developed markets. When coupled with increasing pressures on natural resources, this rising animal protein demand must be met more efficiently, using fewer production resources.

Animal health medicines and vaccines have contributed to improvements in production efficiency over the last 50 years by improving feed conversion ratios, production yields and cycle times and by reducing disease in animals. We believe that improvements in production efficiency will continue to depend on effective animal health products, such as vaccines to protect herds from disease, medicines to treat diseases and limit their spread and automated high-throughput devices, such as those used to vaccinate poultry eggs. Because of this dependence, we believe that animal health medicines and vaccines will continue to be among the most important tools used by livestock producers to meet their productivity imperative.

Livestock producers are exposed to (a) commodity price fluctuations, such as livestock feed prices, (b) the market price for animal protein products and (c) changes in the regulatory environment. Additionally, diseases in herds and flocks are a significant threat to livestock producer economics. The cost to livestock producers of animal health medicines and vaccines is small relative to other livestock production costs, including feed, and animal health medicines and vaccines help protect producers’ investments by treating and preventing diseases in herds and flocks before they become widespread, thus improving economic outcomes for producers. As a result, demand for animal health medicines and vaccines has typically been more stable than demand for other production inputs.

Threats to human health associated with the livestock industry are of growing concern to consumers, livestock producers and regulators and are another key area of concern that animal health medicines and vaccines help to address. These threats come in two basic forms—zoonotic diseases and foodborne illnesses.

Zoonotic diseases are diseases that can be transmitted between animals and humans, including potentially pandemic viruses, such as influenza, as well as infectious diseases, such as rabies, brucellosis and anthrax. Approximately 75% of the new diseases that have affected humans over the past ten years have been caused by zoonotic pathogens originating from animals or from products of animal origin, according to the FAO. Products that address the risk of zoonotic diseases include vaccines that protect animals against Lyme disease or rabies and parasiticides that kill intestinal parasites in animals, such as roundworms or hookworms.

Foodborne illness can arise from disease agents or contaminants that enter the food chain during the production and processing of animal-based foods. The Centers for Disease Control and Prevention estimates that approximately one in six Americans suffers from foodborne diseases each year. Products that help address the risk of foodborne illnesses include anti-infectives, such as those used to treat salmonella or E. coli infections in animals, and vaccines, such as those used to prevent salmonella in poultry. In the United States, outbreaks of foodborne illnesses linked to animal sources are estimated to create a loss of more than $8 billion per year due to illness, deaths and lost productivity, according to the FAO.

Companion animals

The primary companion animal species are dogs, cats and horses. Industry sources indicate that companion animals improve the physical and emotional well-being of pet owners. Pet ownership and spending per pet are increasing globally, and industry sources report that pet owners indicate a preference for reducing spending on other aspects of their lifestyle, including entertainment, clothing and household goods, before reducing spending on petcare. The companion animal medicines and vaccines sector represented $8.9 billion of sales in 2011, or 40% of the total animal health medicines and vaccines market. This sector grew at a CAGR of 6% between 2006 and 2011 and, excluding the impact of foreign exchange, is projected to grow at a CAGR of 5% per year between 2011 and 2016, according to Vetnosis.

 

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Factors influencing growth in demand for companion animal medicines and vaccines include:

 

 

economic development and related increases in disposable income, particularly in many emerging markets;

 

 

increasing pet ownership; and

 

 

companion animals living longer, increasing medical treatment of companion animals and advances in companion animal medicines and vaccines.

Approximately 78% of dog owners in the United States gave their dog(s) medications in 2010 as compared to 50% in 1998, and approximately 47% of cat owners in the United States treated their cat(s) with medications in 2010 as compared to 31% in 1998, according to the APPA. Further, economic development in many emerging markets is driving significant growth in pet ownership and spending in many of those markets. For example, pet ownership in Latin America (including Argentina, Brazil, Chile, Colombia, Mexico, and Venezuela) grew at a CAGR of 3% between 2007 and 2012, according to Euromonitor International data as of June 2012. Pet spending, which includes spending on pet food and non-prescription pet products, grew at a CAGR of 3% in the United States and a CAGR of 14% in Latin America between 2007 and 2012, according to Euromonitor International data as of June 2012.

The companion animal sector has been experiencing the use of more aggressive and expensive medical interventions, including an increase in the use of medicines and vaccines. Companion animal medicines and vaccines improve the quality of and extend the life of pets and help veterinarians achieve better medical outcomes. Advances in medicines and vaccines have created new opportunities for chronic care in pets for diseases associated with old age, such as dermatological infections, cardiovascular diseases, osteoarthritis and cancer. In addition, animal health medicines and vaccines businesses can increase convenience and compliance for pet owners by introducing medicines and vaccines with simplified dosage forms and delivery mechanisms.

Animal health industry distinctions from human health industry

The business of developing and marketing animal health medicines and vaccines shares a number of characteristics with the business of developing medicines and vaccines for human health. These similarities include complex and regulated product manufacturing, products that must be proven efficacious and safe in clinical trials to be approved by regulators, a reliance on new product development through R&D and products that are marketed based on labeled claims regarding impacts on health. However, there are also significant differences between the animal health medicines and vaccines and human health businesses, including:

 

 

animal health generally has faster, less expensive and more predictable R&D processes as well as more sustainable R&D pipelines;

 

 

animal health businesses often have more diversified product portfolios;

 

 

animal health sales representatives have better access to customer decision makers and generally spend more time with a customer on a sales visit;

 

 

animal health primarily has a self-pay nature; and

 

 

animal health products have less generic competition and higher brand loyalty.

R&D is faster, less expensive and more predictable and sustainable

R&D for animal health is generally faster and less expensive than for human health because it requires fewer clinical studies, involves fewer subjects and is conducted directly in the target species. Because there is no need to bridge from pre-clinical investigations in one species to the final target species, decisions on the potential efficacy and safety of products often can be made more quickly, and the likelihood of success often can be established earlier in development than in human health R&D.

 

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There are also differences in the composition of animal health R&D pipelines. While the development of new chemical and biological entities through new product R&D continues to play an important role, the majority of animal health R&D investment is focused on brand lifecycle development. New product R&D leverages discoveries of agribusiness, pharmaceutical and biotechnology R&D. Brand lifecycle development leverages existing animal health products by adding new species or claims, achieving approvals in new markets and creating new combinations and reformulations. The ability to leverage both the prior discoveries of other industries and of existing animal health R&D generally yields faster, less expensive and more predictable R&D processes and more sustainable R&D pipelines as compared to human health.

More diverse product portfolios

Animal health medicines and vaccines businesses have generally diversified product portfolios across many products and, in general, animal health medicines and vaccines businesses are less reliant on a small number of top selling key products than human health businesses. This contrasts with many large human health businesses that have significant product sales concentration. Animal health products are developed for multiple species, leading to greater product diversification than in human health. In addition, products are sold across different regions, which may have environmental, cultural, epidemiological and other differences that contribute to distinct product requirements in each region. As a result, animal health products often have a smaller market size, and the performance of any single product typically has less impact on an animal health medicines and vaccines business as compared to human health businesses. For example, in 2011, our top selling product line contributed less than 8% of our revenues, and our top ten best selling product lines contributed less than 38% of our revenues.

Partnership relationships with customers

The animal health medicines and vaccines industry typically uses a combination of sales representatives to inform customers about the attributes of animal health products and technical and veterinary operations specialists to provide advice regarding local, regional and global trends in animal health. These direct relationships allow animal health medicines and vaccines businesses to understand the needs of their customers and develop products to better meet those needs. Additionally, sales representatives focus on partnering with their customers to educate and support them on topics such as local disease awareness and to help them adopt new and more sophisticated animal health medicines and vaccines solutions, including the use of medicines and vaccines. As a result of these relationships, sales and consulting visits are typically longer and more meaningful, and sales representatives have better access to customer decision makers as compared to human health. However, some industry participants do continue to rely on distributors to market and sell their products, particularly in certain emerging markets.

Primarily self-pay

Livestock producers and pet owners generally pay for animal healthcare out-of-pocket. Purchasers make decisions without the influence of insurance companies or government payors that are often involved in product and pricing decisions in human healthcare. We believe that this dynamic results in less pricing pressure than in human health.

Livestock producers and veterinarians make the product and therapy decisions for livestock. Livestock producers more readily adopt new technologies and products that improve their profitability. Livestock producers are able to see measurable economic outcomes related to the use of animal health medicines and vaccines, as compared to human health in which outcomes can be less certain and more difficult to demonstrate. Therefore, we believe that animal health medicines and vaccines businesses can market new technologies and products at attractive price points.

Companion animal veterinarians continue to be key decision-makers and dispensers of medicines and vaccines for companion animals. Pet owners often purchase medicines and vaccines directly from veterinarians. As a result, the sale of animal health products directly to pet owners is a meaningful contributor to veterinary practice economics.

 

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Strong brand loyalty and less generic competition

There is no large, well-capitalized company principally focused on generic animal health products that exists as a global competitor in the industry. The reasons for this include the smaller average market size of each product opportunity, the importance of direct distribution and education to veterinarians and livestock producers and the primarily self-pay nature of the business. In addition, companion animal health products are often directly prescribed and dispensed by veterinarians. We believe that this dynamic results in less pricing pressure than in human health. For example, although Rimadyl lost patent exclusivity in the United States in 2001, our revenues from Rimadyl have increased 35% since 2001 despite generic competition.

The importance of quality and safety concerns to pet owners, veterinarians and livestock producers also contributes to animal health brand loyalty. As a result, we believe that significant brand loyalty to products often continues after the loss of patent-based and regulatory exclusivity.

Regional differences in animal health markets

The animal health medicines and vaccines market is characterized by meaningful differences in customer needs across different regions. This variability of needs means that the breadth of a business’s product portfolio and a real-time understanding of regional and local trends are key success factors for animal health medicines and vaccines businesses. Variability is due to a number of factors, including:

 

 

Economic differences. In developed markets, there are generally higher standards of living and a greater degree of disposable income. Emerging markets are generally characterized by a higher level of economic growth leading to a rapidly growing middle class with increasing disposable income. Higher levels of economic development are generally correlated with higher levels of consumption of animal protein as well as increased pet ownership and spending per pet.

 

 

Cultural differences. Dietary preferences and restrictions based on cultural traditions and trends shape livestock production and animal protein choices. The human-pet relationship also varies according to differing social norms and traditions, leading to differences in pet ownership and petcare standards.

 

 

Epidemiological differences. Degree of urbanization, endemic diseases, animal housing practices and veterinary public health standards can vary across regions. These factors can result in differences in the prevalence of certain bacterial and viral strains and disease dynamics.

 

 

Treatment differences. Utilization of different types of medicines and vaccines, in particular high technology products, differs across markets. In many emerging markets, as compared to developed markets, the level of sophistication in livestock production is lower but is becoming more industrialized and the medical treatment for companion animals is less established but is advancing. We have observed that the use of medicines and vaccines, including more sophisticated products, is increasing in many emerging markets, in both the livestock and companion animal sectors, to more closely resemble activity in developed markets.

 

 

Environmental differences. Differences in climate, in particular rainfall and temperature, and the availability of arable land and fresh water, can have meaningful impacts on livestock productivity. Climate conditions and seasonal weather patterns also influence infectious disease and parasite prevalence.

 

 

Regulatory differences. Regulatory standards differ across markets and impact the ability to introduce, market, manufacture and distribute certain types of animal health products.

We believe these regional differences are reflected in differing growth rates of sales of animal health medicines and vaccines in various markets.

 

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Business

Overview

Zoetis is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals. For more than 60 years, as a business unit of Pfizer, we have been committed to enhancing the health of animals and bringing solutions to our customers who raise and care for them. Measured by our revenues of $4.2 billion for the year ended December 31, 2011, we are the largest animal health medicines and vaccines business. We market a diverse range of products across four regions: the United States, Europe/Africa/Middle East, Canada/Latin America and Asia/Pacific; eight core species: the livestock species of cattle, swine, poultry, sheep, and fish, and the companion animal species of dogs, cats and horses; and five major product categories: vaccines, parasiticides, anti-infectives, medicinal feed additives and other pharmaceutical.

With our sales organization of approximately 3,400 employees, we directly market our portfolio of more than 300 product lines to livestock producers and veterinarians located in approximately 70 countries across North America, Europe, Africa, Asia, Australia and Latin America, and are a market leader in nearly all of the major regions in which we operate. Through our efforts to establish an early and direct presence in many emerging markets, such as Brazil, China and India, emerging markets contributed 27% of our revenues for the year ended December 31, 2011, which we believe makes us the largest animal health medicines and vaccines business as measured by revenues 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 the industry’s largest sales organization, which includes an 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, lead to enduring and valued relationships with our customers. From 2004 to 2011, we obtained approximately one-fourth of all animal health medicine approvals granted by the FDA, and approximately one-fifth of all animal health vaccine approvals granted by the USDA. The majority of our R&D programs focus on brand lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations.

We believe our ability to successfully position our diverse portfolio of products with high brand recognition in attractive markets and execute our operating plan has contributed to our financial performance over the last several years. For the nine months ended September 30, 2012, our revenues were $3.2 billion, reflecting growth of 2% compared to the nine months ended October 2, 2011. In 2011 and 2010, our revenues were $4.2 billion and $3.6 billion, reflecting growth of 18% and 30% compared to the prior year periods.

As a result of the impact of recent significant acquisitions and related government-mandated divestitures on the revenue numbers in our statement of operations, during the nine months ended September 30, 2012 and October 2, 2011 and the years ended December 31, 2011, 2010 and 2009, the growth trend on our existing portfolio from year to year is not readily apparent. We believe that it is not only important to understand overall revenue growth, but also existing portfolio growth year over year. As such, we utilize “base revenue growth.” Base revenue growth is defined as revenue growth excluding the impact of incremental revenues from recent significant acquisitions, government-mandated divestitures and foreign exchange. Our base revenue growth was 5% in the nine months ended September 30, 2012, 7% in 2011 and 7% in 2010 compared to the prior year periods. For a more complete description of base revenue growth, see “Management’s discussion and analysis of financial condition and results of operations—Analysis of the combined statements of operations.”

For the nine months ended September 30, 2012, our Adjusted net income (a non-GAAP financial measure) was $482 million, reflecting growth of 27% compared to the nine months ended October 2, 2011. In 2011 and 2010, our

 

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Adjusted net income was $503 million and $275 million, reflecting growth of 83% and 46% compared to the prior year periods. For the nine months ended September 30, 2012, our net income attributable to Zoetis was $446 million, reflecting growth of 89% compared to the nine months ended October 2, 2011. In 2011 and 2010, our net income attributable to Zoetis was $245 million and $110 million, reflecting growth of 123% and 210% compared to the prior year periods. For a reconciliation of Adjusted net income to net income attributable to Zoetis, see “Management’s discussion and analysis of financial condition and results of operations—Adjusted net income.”

We organize and operate our business in four regions, and our products are sold in more than 120 countries. Within each of these regional segments we offer a diversified product portfolio for both livestock and companion animal customers in order to capitalize on regional and local trends and customer needs.

Our livestock products primarily prevent or treat conditions, enabling the cost-effective production of safe, high-quality animal protein. Growth in the livestock medicines and vaccines sector is driven by human population growth and increasing standards of living, consequently increasing demand for improved nutrition, particularly animal protein, increasing natural resource constraints driving a need for enhanced productivity, and increased focus on food safety. Livestock products represented approximately 66% of our revenues for the year ended December 31, 2011.

Our companion animal products improve the quality of and extend the life of pets, increase convenience and compliance for pet owners and help veterinarians improve the quality of care they provide. Growth in the companion animal medicines and vaccines sector is driven by economic development and related increases in disposable income, increasing pet ownership, companion animals living longer, increasing medical treatment of companion animals and advances in animal health medicines and vaccines. Companion animal products represented approximately 34% of our revenues for the year ended December 31, 2011.

We have a diversified product portfolio with revenues generated in different regions for different species by different product categories. We refer to a single product brand in all of its dosage forms for all species as a product line. Our global product portfolio is diversified across more than 300 product lines. In 2011, our top selling product line, the ceftiofur line, contributed less than 8% of our revenues, and our top ten product lines contributed less than 38% of our revenues.

Our vaccine products prevent diseases of the respiratory, gastrointestinal and reproductive tracts or induce an immune response. Our parasiticide products prevent or eliminate external and internal parasites such as fleas, ticks and worms. Our anti-infective products prevent, kill or slow the growth of bacteria, fungi or protozoa. We also provide medicines, nutrients and probiotics to livestock through our medicinal feed additive products. Our other pharmaceutical products include pain and sedation, oncology and antiemetic products. Our product portfolio is enhanced by complementary businesses, including diagnostics, genetics, devices and services such as dairy data management, e-learning and professional consulting.

 

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LOGO

Following this offering, we expect that we will be the largest standalone company exclusively focused on animal health medicines and vaccines. Our largest competitors are all captive divisions of large pharmaceutical companies in which animal health sales comprise a relatively small portion of the overall business. By becoming a separate public company, we will be able to focus exclusively on our animal health business with increased strategic and operational flexibility.

While the development of new chemical and biological entities through new product R&D continues to play an important role in our growth strategies, the majority of our R&D investment is focused on brand lifecycle development. New product R&D leverages discoveries of agribusiness, pharmaceutical and biotechnology R&D. Our brand lifecycle development leverages our existing product portfolio to expand our product lines by adding new species or claims, achieving approvals in new countries and creating new combinations and reformulations. Our ability to leverage both the discoveries of other industries and of our existing R&D generally yields a faster, less expensive and more predictable R&D process and a more sustainable R&D pipeline as compared to human health.

 

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We believe we are the industry leader in animal health R&D. From 2004 to 2011, we obtained approximately one-fourth of all animal health medicine approvals granted by the FDA, and approximately one-fifth of all animal health vaccine approvals granted by the USDA. The majority of our R&D programs focus on brand lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations.

Our business segments

The animal health medicines and vaccines market is characterized by meaningful differences in customer needs across different regions. This is due to a variety of factors, including:

 

 

economic differences, such as standards of living in developed markets as compared to emerging markets;

 

 

cultural differences, such as dietary preferences for different animal proteins, pet ownership preferences and petcare standards;

 

 

epidemiological differences, such as the prevalence of certain bacterial and viral strains and disease dynamics;

 

 

treatment differences, such as utilization of different types of medicines and vaccines, in particular high technology products;

 

 

environmental differences, such as seasonality, climate and the availability of arable land and fresh water; and

 

 

regulatory differences, such as standards for product approval and manufacturing.

As a result of these differences, among other things, we organize and operate our business in four regions: the United States, Europe/Africa/Middle East, Canada/Latin America and Asia/Pacific. Within each of these regional segments, we offer a diversified product portfolio for both livestock and companion animal customers so that we can capitalize on local trends and customer needs. Our business segments are:

 

 

United States with revenues of $1,294 million and $1,659 million that represented 41% and 39% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively.

 

 

Europe/Africa/Middle East with revenues of $799 million and $1,144 million that represented 25% and 27% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively. Key developed markets in this segment include the United Kingdom, Germany and France. Key emerging markets in this segment include Russia, Turkey and South Africa.

 

 

Canada/Latin America with revenues of $549 million and $788 million that represented 18% and 19% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively. The developed market in this segment is Canada. Key emerging markets in this segment include Brazil and Mexico.

 

 

Asia/Pacific with revenues of $518 million and $642 million that represented 16% and 15% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively. Key developed markets in this segment include Australia, Japan, New Zealand and South Korea. Key emerging markets in this segment include India and China.

For additional information regarding our performance in each of these regional segments and the impact of foreign exchange rates as well as significant acquisitions that Pfizer completed in recent years, see “Management’s discussion and analysis of financial condition and results of operations.”

Our global scale and scope enable us to leverage our diversified product portfolio as well as our understanding of animal health industry trends across different regions and customer types. Our global product portfolio is

 

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diversified across more than 300 product lines, and our products are sold in more than 120 countries, with operations in developed markets and emerging markets. The markets we consider to be emerging markets contributed approximately 27% of our revenues for the year ended December 31, 2011. Continuing to expand in emerging markets is a core element of our growth strategy, which we believe will continue to make us the largest animal health medicines and vaccines business as measured by revenues across emerging markets as a whole.

Our history

As a business unit of Pfizer, our business has been built over the course of more than 60 years, with key developments including the following:

 

Year

  

Event(s)

1952    Pfizer established the Agricultural Division to promote Terramycin
1988   

Agricultural Division renamed Pfizer Animal Health

1995    Pfizer acquired SmithKline Beecham Animal Health, expanding our business into vaccines and companion animal markets
1997   

Launched Rimadyl, the first approved non-steroidal anti-inflammatory for dogs; although Rimadyl lost patent exclusivity in the United States in 2001, our revenues from Rimadyl have increased 35% since 2001 despite generic competition

2003   

Pfizer acquired Pharmacia Corporation, which added a variety of animal health assets, most notably strengthening our cattle portfolio

 

Established dedicated R&D headquarters in Kalamazoo, Michigan

 

Pfizer acquired CSL Animal Health, strengthening our global pipeline and portfolio of vaccines in Australia and New Zealand

2004    Launched Draxxin, a premium anti-infective for livestock delivering a full course of therapy in one dose
2006    Launched Convenia, the first antibiotic for skin infections in dogs and cats that provides an entire course of therapy in one injection
2007   

Pfizer acquired Embrex, Inc., expanding our business into poultry devices and vaccines

 

Launched Cerenia, the first antiemetic therapy developed specifically for dogs

2008    Pfizer acquired Catapult Pty Ltd. and Bovigen LLC, expanding our business into animal genetics
2009   

Pfizer acquired Wyeth, and with it Fort Dodge Animal Health, providing key brands such as ProHeart for dogs, Synovex for cattle and Innovator/Duvaxyn West Nile Virus vaccine for horses, as well as a complementary poultry vaccines business

 

Pfizer acquired Vetnex Animal Health Ltd. in India, further expanding in a key emerging market

2010   

Pfizer acquired Microtek International, Inc., expanding our business into aquaculture vaccines

 

Pfizer acquired Synbiotics Corporation, strengthening our position in veterinary diagnostics

2011   

Pfizer acquired King Pharmaceuticals, Inc. and with it Alpharma, strengthening our position in the poultry business with a medicinal feed additives business and further strengthening our position in the cattle and swine businesses

 

Established vaccine manufacturing capabilities in China through formation of the Jilin Pfizer Guoyuan joint venture

 

Launched Improvest in the United States, the first product to reduce boar taint without the need for surgical castration

 

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Our competitive strengths

We believe that the following strengths create sustainable competitive advantages that will enable us to continue our growth as a leader in the animal health medicines and vaccines industry:

Global leader with scale and scope

Zoetis is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines. Measured by revenues, we were the largest animal health medicines and vaccines business in the world in 2011. We had approximately $3.2 billion and $4.2 billion in revenues and $446 million and $245 million of net income attributable to Zoetis for the nine months ended September 30, 2012 and the year ended December 31, 2011, respectively.

According to Vetnosis, as measured by revenues in 2011, we were the market leader in all of the major regions in which we operate, with the exception of Western Europe, where we held the number two position. We believe we have an industry-leading global footprint, with products sold in more than 120 countries and direct operations in approximately 70 countries, which provides us with direct access to our customer base through customer relationships and with early knowledge of local emerging trends and customer needs.

Following this offering, we expect that we will be the largest standalone company exclusively focused on animal health medicines and vaccines. By becoming a separate public company, we will be able to focus exclusively on our animal health business with increased strategic and operational flexibility.

Established direct presence in emerging markets

We have an established direct presence in many important emerging markets, and we are a leader in many of the emerging markets in which we operate. We believe this direct presence has enabled us to become the largest animal health medicines and vaccines business as measured by revenues across emerging markets as a whole. Emerging markets contributed approximately 27% of our revenues for the year ended December 31, 2011. In 2011, we experienced 12% base revenue growth in our Asia/Pacific segment and 9% base revenue growth in our Canada/Latin America segment.

For example, we have a strong direct presence in Brazil where we have manufacturing sites in Guarulhos and Campinas and an R&D site in São Paulo. We believe this direct presence has contributed to our role as a market leader in Latin America and allows us to meet the needs of our customers in Brazil and in other emerging markets in this region.

In addition, we have more than thirty years of direct presence in India and currently maintain a strong commercial and manufacturing presence in India with specialized livestock and companion animal operations. We have a manufacturing site in Haridwar, India and an R&D site in Thane, India, where we are developing products specifically for the Indian market, as well as products for other regions. Through the acquisition of Vetnex Animal Health Ltd. in 2009, we further expanded our presence in India.

We also have a strong direct presence in China. We have three manufacturing sites in China and we believe that we have the largest sales organization of any multinational animal health medicines and vaccines business in China. In 2011, we established the Jilin Pfizer Guoyuan joint venture in China, which will provide us with biological manufacturing capabilities and access to local swine vaccine candidates.

Diversified product portfolio

We market products across eight core species and five major product categories. Livestock products represented approximately 66% of our revenues and companion animals products represented approximately 34% of our revenues for the year ended December 31, 2011.

 

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Generally, because we have lower product sales concentration than many of our competitors, the performance of any single product has less impact on our company as compared to other, less-diversified animal health businesses. In 2011, our top selling product line contributed less than 8% of our revenues, and our top ten best selling product lines contributed less than 38% of our revenues.

According to Vetnosis, as measured by revenues in 2011 on a global basis, our product portfolio ranked number one in anti-infectives, which represented approximately 31% of our revenues, number two in medicinal feed additives, which represented approximately 8% of our revenues, number two in vaccines, which represented approximately 26% of our revenues, and number three in parasiticides, which represented approximately 15% of our revenues.

The depth of our product portfolio enables us to address the varying needs of different customers with a high degree of expertise. Our medicines and vaccines portfolio is enhanced by complementary businesses, including diagnostics, genetics, devices and services such as dairy data management, e-learning and professional consulting.

Leader in direct sales and marketing with strong customer relationships

We believe our sales organization, consisting of approximately 3,400 employees, is the largest in our industry, with direct operations in approximately 70 countries. Our sales organization is supported by our technical and veterinary operations specialists, who advise our customers with in-depth technical and medical expertise and disease education. This allows us to offer animal healthcare solutions for both livestock producers and veterinarians and simultaneously strengthen our partnership relationships with these customers. In addition, our direct global presence supports specialized local R&D initiatives, allows us to rapidly capitalize on market-specific situations and provides a global platform for R&D and business expansion.

Our commercial model emphasizes direct selling, and we believe we are less reliant on distributors than our competitors. We believe we achieve both stronger customer relationships and better economic returns on our products by emphasizing these direct relationships with veterinarians and livestock producers. Our direct relationships create a high level of regional and local specialization and allow us to focus on partnering with our customers to educate and support them on topics such as disease awareness and to help them adopt new and more sophisticated animal health solutions, including the use of medicines and vaccines. As a result, we believe veterinarians and livestock producers increasingly view us as advisors.

Leader in product development—new product R&D and brand lifecycle development

We believe that we are a leader in animal health R&D, both through our own product development capabilities as well as through our leverage of external product development partnerships. We have a track record of developing products that meet the needs of our customers. For example, for the convenience of livestock producers and veterinarians, we have introduced Draxxin, which delivers a full course of antibiotics in one injection. Similarly, we have introduced injectable products that we believe to be more convenient for veterinarians and pet owners, including Convenia, which provides a full course of antibiotics in one injection, and ProHeart 6, which provides six months of heartworm prevention in one injection.

From 2004 to 2011, we obtained approximately one-fourth of all animal health medicine approvals granted by the FDA, and approximately one-fifth of all animal health vaccine approvals granted by the USDA. While the development of new chemical and biological entities through new product R&D continues to play an important role in our growth strategies, the majority of our R&D investment is focused on brand lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations. New product R&D leverages discoveries of agribusiness, pharmaceutical and biotechnology R&D. Our ability to leverage both the discoveries of other industries and of our existing R&D generally yields a faster, less expensive and more predictable R&D process and a more sustainable R&D pipeline as compared to human health.

 

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High-quality products delivered reliably by our world-class manufacturing operations

We believe that we are a leader in manufacturing quality and in supply reliability. We have strong globally managed and coordinated quality control and quality assurance programs in place at our manufacturing sites, and conduct internal and external inspections and audits at these sites. Our manufacturing sites experienced approximately 170 regulatory inspections globally between 2007 and 2011, with no findings that required material remediation or other penalties. In addition, our regional and global manufacturing teams seek to ensure that all of our CMOs adhere to our standards of manufacturing quality, and they are regularly audited.

We utilize a diversified network of proprietary manufacturing sites and CMOs to maximize operational efficiencies and to help meet demand for our products. Our proprietary manufacturing network is based on centralized oversight of a system of “anchor” and “satellite” sites to maximize cost efficiencies. Additionally, we co-locate R&D centers at many of our manufacturing sites in order to embed production design into the R&D process and to facilitate the efficient transfer of R&D projects to commercial-scale manufacturing.

The breadth and reliability of our manufacturing and supply chain enable us to produce medicines and vaccines for distribution in all major regions globally. Our manufacturing and supply chain provide us with a global platform for continued expansion. Due to the geographic breadth of our manufacturing operations, we believe that we are able to introduce products quickly and efficiently.

Dedicated employees and experienced management team

Our employees include skilled animal healthcare professionals helping to sustain and grow our business. Our research team has an average tenure of more than ten years, and our sales organization employees have, on average, been with us for more than five years. Additionally, with our veterinarians and veterinary researchers, we believe that we have more professionally educated animal health experts on our team than any of our competitors.

Several members of our executive team lead and have led important and influential animal health industry organizations, such as the International Federation for Animal Health and the Animal Health Institute, helping to ensure that we are a leader in identifying and addressing key market trends and challenges.

Track record of top-line revenue growth and significant cash flow generation

We have generated revenue growth at a CAGR of 24% over the three years ended December 31, 2011, and base revenue growth of 7% and 7% for the years ended December 31, 2011 and December 31, 2010, respectively. For the nine months ended September 30, 2012, we generated revenue growth of 2% and base revenue growth of 5% as compared to the nine months ended October 2, 2011. Our revenue growth has been driven by increased demand across our diversified product portfolio and acquisitions. For a description of base revenue growth, see “Management’s discussion and analysis of financial condition and results of operations—Analysis of the combined statements of operations.”

Our business is diversified across many regions, species and product categories. In 2011, our top selling product line contributed less than 8% of our revenues, and our top ten best selling product lines contributed less than 38% of our revenues. Our revenue growth, driven by a diverse product portfolio and acquisitions, has generated significant cash flow.

Our growth strategies

We are committed to enhancing the health of animals and bringing solutions to our customers who raise and care for them. We intend to continue to grow our business by pursuing the following core strategies:

Leverage our direct local presence and strong customer relationships

With our sales organization of approximately 3,400 employees, we directly market our portfolio of more than 300 product lines to livestock producers and veterinarians located in approximately 70 countries and provide

 

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additional support through our technical and veterinary operations specialists. We believe this model and the brand loyalty enjoyed by our existing products provide us with operational efficiencies and access to an array of new growth opportunities, including a platform to encourage the adoption by our customers of more sophisticated animal health products. We believe our close contact with customers provides us with an in-depth understanding of their businesses, which allows us to develop products that address unmet customer needs.

We also believe that we have a high degree of specialized knowledge of our markets and that our local sales organization, regional R&D presence, global supply chain infrastructure and reliable delivery of high-quality products that are relevant for local diseases and challenges will continue to differentiate us from our competitors. Our brand lifecycle development R&D projects are a result of, among other things, our ability to leverage our global platform of direct selling and strong customer relationships.

Further penetrate emerging markets

Human population and economic development are also driving increased demand for animal protein in many emerging markets. In addition, rising standards of living in many emerging markets are associated with an increase in pet ownership and spending per pet.

We believe we are well-positioned in many emerging markets, based on our diverse product portfolio and our regional and local focus, and that we have further opportunities to expand in emerging markets by reaching new customers, by introducing more of our products and by supporting the adoption by our customers of more sophisticated animal health products, such as new vaccines and single-injection anti-infectives, including Draxxin for livestock and Convenia for companion animals. Furthermore, we believe that consolidation of livestock producers in certain emerging markets will drive adoption of our products, as they seek to achieve greater benefits of scale.

We believe we will be able to efficiently develop and market new products that respond to the needs of our emerging market customers and provide strong customer service and technical support in these markets.

Pursue new product development and value-added brand lifecycle development to extend our product portfolio

We intend to continue to develop and grow our product portfolio by developing new chemical and biological entities through new product R&D as well as by expanding our product lines by adding new species or claims, achieving approvals in new countries and creating new combinations and reformulations. For example, the periodic emergence of novel bacterial and viral strains provides opportunities for new product R&D and brand lifecycle development of our existing product lines. Our 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. We leverage our strong direct presence in many regions, which we believe allows us to cost-effectively develop and introduce new products, including brand lifecycle development products.

The majority of our R&D programs focus on brand lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations. Subject to certain restrictions, we also expect to maintain access to Pfizer’s proprietary compound library and database to develop new products pursuant to the R&D collaboration and license agreement.

Remain the partner of choice for access to new products and technologies

We intend to continue to expand our extensive network of research partnerships around the globe in order to gain access to new technologies, pharmaceutical targets and vaccine antigens. Through participation in over 100 research alliances with leading universities and research institutes, we support cutting-edge research and secure the right to develop and commercialize new products and technologies. We participate as the sole industry partner in a number of multi-institution research alliances that are supported by an investment of over $100

 

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million from local or regional government funds. Examples of these key research alliances include our partnership with several European universities in a research consortium that was awarded approximately $11 million from the European Union to progress research into a number of economically important parasite vaccines, as well as our 2010 partnership with the Easter Bush Research Consortium, an alliance of four top research centers in the U.K. focused on progressing research for the prevention and treatment of livestock diseases. In addition, once we become a standalone public company, we intend to explore opportunities to enter into collaboration agreements and external alliances with other parties, including parties that may have chosen not to collaborate with us while we were a business unit of Pfizer.

In the past we have benefited from Pfizer’s acquisitions of large pharmaceutical companies with animal health operations. In the future, we intend to continue to grow our business through smaller scale acquisitions, asset purchases, in-licensing transactions, supply and distribution agreements and other strategic partnerships. We have completed numerous business development transactions in the last five years to support our growth. In 2007, we entered into the poultry segment through the acquisition of Embrex, Inc., a biotechnology company with a focus on in ovo delivery of poultry vaccines. In 2009, we licensed novel food safety vaccines for livestock from Epitopix LLC. Through the acquisition of Vetnex Animal Health Ltd. in 2009, we expanded our presence in India and gained access to branded generics manufacturing and development. In 2011, we established the Jilin Pfizer Guoyuan joint venture in China, which will provide us with biological manufacturing capabilities and access to local swine vaccine candidates.

Continue to provide high-quality products and improve manufacturing production margins

Our global commercial and manufacturing teams collaborate on various operational efficiency initiatives, including yield improvements, procurement, site and area synergies and manufacturing support rationalization, intended to improve our manufacturing production margins. These operational efficiency initiatives have delivered consistent gross margin improvements for our legacy products, and as we have integrated acquisitions we have also applied these operational efficiency initiatives to improve production margins. Following this offering, we intend to continue our efficiency improvement programs, including Six Sigma and Lean capabilities.

We believe that we are a leader in manufacturing quality and in supply reliability. Our manufacturing and supply chain provide us with a global platform for continued expansion, including in emerging markets, and we believe that we will continue to increase our production efficiencies and expand production margins as our business grows.

Expand into complementary businesses to become a more complete, trusted partner in providing solutions

We intend to continue to expand our presence in complementary businesses, including diagnostics, genetics, devices and services. As part of our 2007 acquisition of Embrex, Inc., we entered into the business of poultry devices, which facilitate in ovo vaccine delivery. In 2008, we entered the livestock genetics business through the acquisition of Bovigen LLC and Catapult Pty Ltd. In 2010, we entered the complementary business of animal diagnostics through the acquisition of Synbiotics Corporation.

We also intend to expand our complementary services, including dairy data management, e-learning and professional consulting, to help our customers improve their practice management capabilities and production efficiencies. We believe that these expanded offerings, supported by our technical expertise, will drive an outcomes-based approach to animal healthcare that has the potential to generate incremental revenues, as well as increase customer loyalty and sales of our products.

Our products

Since the inception of our business, we have focused on developing a broad portfolio of animal health products. Our product portfolio has grown to a total of more than 300 product lines. We have comprehensive product lines for both livestock and companion animals across each of our major product categories.

 

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Our major product categories are:

 

 

vaccines: biological preparations that 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;

 

 

medicinal feed additives: products that provide medicines, nutrients and probiotics to livestock; and

 

 

other pharmaceutical: complementary products, such as pain and sedation, oncology and antiemetic products.

Our remaining revenues are derived from other product categories, such as nutritionals and agribusiness, as well as products in complementary areas, including diagnostics, genetics, devices and services. We believe many of these complementary areas represent potential growth opportunities for our business to expand in the future.

Historically, a substantial portion of our products and revenues have been the result of brand lifecycle development. For example, the first product in our ceftiofur line was an anti-infective approved for treating Bovine Respiratory Disease in cattle that was administered via intramuscular injection. Through follow-on studies and reformulations, we have expanded the product line into additional cattle claims and administration routes as well as other species and regions. Several products in the line provide a full course of therapy in one injection. The ceftiofur product line currently includes the brands Excede, Excenel and Naxcel.

In addition to brand lifecycle development, we also pursue the development of new chemical and biological entities through new product R&D as part of our growth strategies. Examples of our first-in-class or best-in-class products that we have launched in the past ten years and products that we believe may represent platforms for future brand lifecycle development include:

 

 

Draxxin, a novel antibiotic for livestock that delivers a full course of therapy in one dose, launched in 2003;

 

 

Inforce, the first and only respiratory vaccine for cattle that prevents respiratory disease caused by bovine respiratory syncytial virus (BRSV) while also aiding in the prevention of infectious bovine rhinotracheitis (IBR) and parainfluenza3 (PI3), launched in 2010;

 

 

Improvac/Improvest, the only product that reduces boar taint in male swine without surgical castration, launched in 2004 in Australia and New Zealand and in 2011 in the United States;

 

 

Convenia, the first single-injection anti-infective for common bacterial skin infections in cats and dogs, launched in 2006; and

 

 

Palladia, the first drug to be approved by the FDA for treating cancer in dogs, launched in 2009.

We pursue the development of new vaccines for emerging infectious diseases, with an operating philosophy of “first to know and fast to market.” Examples of the successful execution of this strategy include the first equine vaccine for West Nile Virus in the United States and European Union and the first swine vaccine for Pandemic H1N1 Influenza Virus in the United States.

 

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Our product lines and products that represented approximately 1% or more of our revenues in 2011 include:

Livestock products

 

Product line / product

  

Description

  

Primary species

Vaccines

     
Bovishield line    Aid in preventing diseases, including infectious bovine rhinotracheitis (IBR), bovine viral diarrhea (BVD, Types 1 and 2), parainfluenza3 (PI3) virus and bovine respiratory syncytial virus (BRSV), Leptospira borgpetersenii, L. pomona, L. grippotyphosa, L. canicola and L. icterohaemorrhagiae, depending on formulation    Cattle
Improvac / Improvest    Vaccination to reduce boar taint, as an alternative to surgical castration    Swine
RespiSure line    Aid in preventing chronic pneumonia caused by Mycoplasma hyopneumoniae    Swine
Rispoval line    Aid in preventing three key viruses involved in cattle pneumonia—BRSV, PI3 and BVD—as well as other respiratory diseases, depending on formulation    Cattle

Parasiticides

     
Cydectin    Injectable or pour-on endectocide to treat and control internal and external cattle parasites, including gastrointestinal roundworms, lungworms, cattle grubs, mites and lice    Cattle, sheep
Dectomax    Injectable or pour-on endectocide, characterized by extended duration of activity, for the treatment and control of internal and external parasite infections    Cattle, swine

Anti-infectives

     
Aureomycin    Provides livestock producers treatment and convenience against a wide range of respiratory, enteric and reproductive diseases    Cattle, poultry, sheep, swine
BMD    Aid in preventing and controlling enteritis, thereby increasing rate of weight gain and improving feed efficiency    Cattle, poultry, swine
Ceftiofur line    Broad-spectrum cephalosporin antibiotic active against Gram-positive and Gram-negative bacteria, including ß-lactamase-producing strains, with some formulations producing a single course of therapy in one injection    Cattle, horses, sheep, swine
Draxxin    Single-dose low-volume antibiotic for the treatment and prevention of bovine and swine respiratory disease, infectious bovine kerato conjunctivitis and bovine foot rot    Cattle, swine
Lincomycin line    Aid in preventing and treating Chronic Respiratory Disease associated with Mycoplasma and coliform infections in growing chickens and for the treatment of swine dysentery (bloody scours) associated with Brachyspira (Serpulina) hyodysenteriae    Swine, poultry
Spectramast    Aid in preventing and treating mastitis, delivered via intramammary administration. Same active ingredient as the ceftiofur line    Cattle
Terramycin    Antibiotic for the treatment of susceptible infections    Cattle, poultry, sheep, swine

Other

     
Eazi-Breed CIDR    Progesterone-releasing device for the control of the estrus cycle    Cattle, sheep
Embrex devices    Devices for enhancing hatchery operations efficiency through in ovo detection and vaccination    Poultry
Lutalyse    For estrus control or in the induction of parturition or abortion    Cattle, swine

 

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Companion animal products

 

Product line / product

  

Description

  

Primary species

Vaccines

     
Vanguard 4-way Lepto    Compatible with Vanguard High Titer and protects against leptospirosis caused by Leptospira canicola, L. grippotyphosa, L. icterohaemorrhagiae and L. pomona    Dogs