10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| For the quarterly period ended March 31, 2016 |
OR
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¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| For the transition period from ______ to ______ |
Commission File No. 1-6571
Merck & Co., Inc.
2000 Galloping Hill Road
Kenilworth, N.J. 07033
(908) 740-4000
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Incorporated in New Jersey | | I.R.S. Employer |
| | Identification No. 22-1918501 |
The number of shares of common stock outstanding as of the close of business on April 30, 2016: 2,768,025,348
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer x | | Accelerated filer ¨ | | Non-accelerated filer ¨ | | Smaller reporting company ¨ |
| | (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Part I - Financial Information
Item 1. Financial Statements
MERCK & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(Unaudited, $ in millions except per share amounts)
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| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Sales | $ | 9,312 |
| | $ | 9,425 |
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Costs, Expenses and Other | | | |
Materials and production | 3,572 |
| | 3,569 |
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Marketing and administrative | 2,318 |
| | 2,601 |
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Research and development | 1,659 |
| | 1,737 |
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Restructuring costs | 91 |
| | 82 |
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Other (income) expense, net | 48 |
| | 55 |
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| 7,688 |
| | 8,044 |
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Income Before Taxes | 1,624 |
| | 1,381 |
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Taxes on Income | 494 |
| | 423 |
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Net Income | 1,130 |
| | 958 |
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Less: Net Income Attributable to Noncontrolling Interests | 5 |
| | 5 |
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Net Income Attributable to Merck & Co., Inc. | $ | 1,125 |
| | $ | 953 |
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Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders | $ | 0.41 |
| | $ | 0.34 |
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Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders | $ | 0.40 |
| | $ | 0.33 |
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Dividends Declared per Common Share | $ | 0.46 |
| | $ | 0.45 |
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MERCK & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited, $ in millions)
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| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Net Income Attributable to Merck & Co., Inc. | $ | 1,125 |
| | $ | 953 |
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Other Comprehensive Income (Loss) Net of Taxes: | | | |
Net unrealized (loss) gain on derivatives, net of reclassifications | (202 | ) | | 252 |
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Net unrealized gain on investments, net of reclassifications | 63 |
| | 46 |
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Benefit plan net (loss) gain and prior service (credit) cost, net of amortization | (28 | ) | | 35 |
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Cumulative translation adjustment | 121 |
| | (177 | ) |
| (46 | ) | | 156 |
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Comprehensive Income Attributable to Merck & Co., Inc. | $ | 1,079 |
| | $ | 1,109 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
MERCK & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited, $ in millions except per share amounts)
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| March 31, 2016 | | December 31, 2015 |
Assets | | | |
Current Assets | | | |
Cash and cash equivalents | $ | 9,716 |
| | $ | 8,524 |
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Short-term investments | 3,227 |
| | 4,903 |
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Accounts receivable (net of allowance for doubtful accounts of $186 in 2016 and $165 in 2015) (excludes accounts receivable of $10 in 2016 and 2015 classified in Other assets - see Note 4) | 6,850 |
| | 6,484 |
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Inventories (excludes inventories of $1,258 in 2016 and $1,569 in 2015 classified in Other assets - see Note 5) | 5,102 |
| | 4,700 |
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Other current assets | 3,877 |
| | 5,140 |
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Total current assets | 28,772 |
| | 29,751 |
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Investments | 12,554 |
| | 13,039 |
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Property, Plant and Equipment, at cost, net of accumulated depreciation of $16,052 in 2016 and $15,923 in 2015 | 12,360 |
| | 12,507 |
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Goodwill | 17,784 |
| | 17,723 |
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Other Intangibles, Net | 21,364 |
| | 22,602 |
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Other Assets | 5,921 |
| | 6,055 |
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| $ | 98,755 |
| | $ | 101,677 |
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Liabilities and Equity | | | |
Current Liabilities | | | |
Loans payable and current portion of long-term debt | $ | 2,113 |
| | $ | 2,583 |
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Trade accounts payable | 2,241 |
| | 2,533 |
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Accrued and other current liabilities | 10,043 |
| | 11,216 |
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Income taxes payable | 1,864 |
| | 1,560 |
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Dividends payable | 1,307 |
| | 1,309 |
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Total current liabilities | 17,568 |
| | 19,201 |
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Long-Term Debt | 23,656 |
| | 23,829 |
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Deferred Income Taxes | 6,256 |
| | 6,535 |
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Other Noncurrent Liabilities | 7,374 |
| | 7,345 |
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Merck & Co., Inc. Stockholders’ Equity | | | |
Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2016 and 2015 | 1,788 |
| | 1,788 |
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Other paid-in capital | 40,145 |
| | 40,222 |
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Retained earnings | 45,192 |
| | 45,348 |
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Accumulated other comprehensive loss | (4,194 | ) | | (4,148 | ) |
| 82,931 |
| | 83,210 |
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Less treasury stock, at cost: 807,550,812 shares in 2016 and 795,975,449 shares in 2015 | 39,125 |
| | 38,534 |
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Total Merck & Co., Inc. stockholders’ equity | 43,806 |
| | 44,676 |
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Noncontrolling Interests | 95 |
| | 91 |
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Total equity | 43,901 |
| | 44,767 |
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| $ | 98,755 |
| | $ | 101,677 |
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The accompanying notes are an integral part of this condensed consolidated financial statement.
MERCK & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited, $ in millions)
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| Three Months Ended March 31, |
| 2016 | | 2015 |
Cash Flows from Operating Activities | | | |
Net income | $ | 1,130 |
| | $ | 958 |
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Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 1,561 |
| | 1,637 |
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Intangible asset impairment charges | 277 |
| | 14 |
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Equity income from affiliates | (34 | ) | | (145 | ) |
Dividends and distributions from equity affiliates | 4 |
| | 3 |
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Deferred income taxes | (70 | ) | | (179 | ) |
Share-based compensation | 68 |
| | 63 |
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Other | 97 |
| | 551 |
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Net changes in assets and liabilities | (875 | ) | | (618 | ) |
Net Cash Provided by Operating Activities | 2,158 |
| | 2,284 |
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Cash Flows from Investing Activities | | | |
Capital expenditures | (279 | ) | | (203 | ) |
Purchases of securities and other investments | (2,367 | ) | | (5,039 | ) |
Proceeds from sales of securities and other investments | 4,620 |
| | 6,287 |
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Acquisition of Cubist Pharmaceuticals, Inc., net of cash acquired | — |
| | (7,598 | ) |
Acquisitions of other businesses, net of cash acquired | (147 | ) | | — |
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Other | (86 | ) | | (52 | ) |
Net Cash Provided by (Used in) Investing Activities | 1,741 |
| | (6,605 | ) |
Cash Flows from Financing Activities | | | |
Net change in short-term borrowings | — |
| | 2,177 |
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Proceeds from issuance of debt | — |
| | 7,941 |
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Payments on debt | (851 | ) | | (2,902 | ) |
Purchases of treasury stock | (913 | ) | | (1,015 | ) |
Dividends paid to stockholders | (1,279 | ) | | (1,280 | ) |
Proceeds from exercise of stock options | 202 |
| | 242 |
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Other | (10 | ) | | (8 | ) |
Net Cash (Used in) Provided by Financing Activities | (2,851 | ) | | 5,155 |
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Effect of Exchange Rate Changes on Cash and Cash Equivalents | 144 |
| | (295 | ) |
Net Increase in Cash and Cash Equivalents | 1,192 |
| | 539 |
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Cash and Cash Equivalents at Beginning of Year | 8,524 |
| | 7,441 |
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Cash and Cash Equivalents at End of Period | $ | 9,716 |
| | $ | 7,980 |
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The accompanying notes are an integral part of this condensed consolidated financial statement.
Notes to Condensed Consolidated Financial Statements (unaudited)
The accompanying unaudited condensed consolidated financial statements of Merck & Co., Inc. (Merck or the Company) have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States for complete consolidated financial statements are not included herein. These interim statements should be read in conjunction with the audited financial statements and notes thereto included in Merck’s Form 10-K filed on February 26, 2016.
The results of operations of any interim period are not necessarily indicative of the results of operations for the full year. In the Company’s opinion, all adjustments necessary for a fair statement of these interim statements have been included and are of a normal and recurring nature. Certain reclassifications have been made to prior year amounts to conform to the current presentation.
Recently Adopted Accounting Standards
In the first quarter of 2016, the Company adopted accounting guidance issued by the Financial Accounting Standards Board (FASB) in April 2015, which requires debt issuance costs to be presented as a direct deduction from the carrying amount of that debt on the balance sheet as opposed to being presented as a deferred charge. Approximately $100 million of debt issuance costs were reclassified in the first quarter of 2016 as a result of the adoption of the new standard. Prior period amounts have been recast to conform to the new presentation.
Recently Issued Accounting Standards
In May 2014, the FASB issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. In August 2015, the FASB approved a one-year deferral of the effective date making this guidance effective for interim and annual periods beginning in 2018. Reporting entities may choose to adopt the standard as of the original effective date. The Company is currently assessing the impact of adoption on its consolidated financial statements.
In January 2016, the FASB issued revised guidance for the accounting and reporting of financial instruments. The new guidance requires that equity investments with readily determinable fair values currently classified as available-for-sale be measured at fair value with changes in fair value recognized in net income. The new guidance also simplifies the impairment testing of equity investments without readily determinable fair values and changes certain disclosure requirements. This guidance is effective for interim and annual periods beginning in 2018. Early adoption is not permitted. The Company is currently assessing the impact of adoption on its consolidated financial statements.
In February 2016, the FASB issued new accounting guidance for the accounting and reporting of leases. The new guidance requires that lessees recognize a right-of-use asset and a lease liability recorded on the balance sheet for each of its leases (other than leases that meet the definition of a short-term lease). Leases will be classified as either operating or finance. Operating leases will result in straight-line expense in the income statement (similar to current operating leases) while finance leases will result in more expense being recognized in the earlier years of the lease term (similar to current capital leases). The new guidance will be effective for interim and annual periods beginning in 2019. Early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
In March 2016, the FASB issued new guidance intended to simplify the accounting and reporting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification of taxes paid in the statement of cash flows. Among other provisions, the new guidance will require all income tax effects of awards to be recognized in the income statement when the awards vest or are settled (as opposed to existing guidance under which tax effects are recorded to other paid-in-capital in certain instances). The guidance is effective for interim and annual periods beginning in 2018. Early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
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2. | Acquisitions, Divestitures, Research Collaborations and License Agreements |
The Company continues its strategy of establishing external alliances to complement its internal research capabilities, including research collaborations, licensing preclinical and clinical compounds to drive both near- and long-term growth. The Company supplements its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain products.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
In January 2016, Merck acquired IOmet Pharma Ltd (IOmet), a privately held UK-based drug discovery company focused on the development of innovative medicines for the treatment of cancer, with a particular emphasis on the fields of cancer immunotherapy and cancer metabolism. The acquisition provides Merck with IOmet’s preclinical pipeline of IDO (indoleamine-2,3-dioxygenase 1), TDO (tryptophan-2,3-dioxygenase), and dual-acting IDO/TDO inhibitors. Total purchase consideration in the transaction of $227 million included an upfront cash payment of $150 million and future additional milestone payments of up to $250 million that are contingent upon certain clinical and regulatory milestones being achieved, which the Company determined had a fair value of $77 million at the acquisition date. The transaction was accounted for as an acquisition of a business; accordingly, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date. Merck recognized intangible assets for in-process research and development (IPR&D) of $155 million and net deferred tax assets of $26 million. The excess of the consideration transferred over the fair value of net assets acquired of $46 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible assets related to IPR&D was determined using an income approach, through which fair value is estimated based upon the asset’s probability-adjusted future net cash flows, which reflects the stage of development of the project and the associated probability of successful completion. The net cash flows were then discounted to present value using a discount rate of 10.5%. The fair value of the contingent consideration was determined utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment also utilizing a discount rate of 10.5%. Actual cash flows are likely to be different than those assumed. This transaction closed on January 11, 2016; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. Pro forma financial information has not been included because IOmet’s historical financial results are not significant when compared with the Company’s financial results.
Also in January 2016, Merck sold the U.S. marketing rights to Cortrophin and Corticotropin Zinc Hydroxide to ANI Pharmaceuticals, Inc. (ANI). Under the terms of the agreement, ANI made an upfront payment of $75 million, which was recorded in Sales in the first quarter of 2016, and may make additional payments to the Company based on future sales. Merck does not have any ongoing supply or other performance obligations after the closing date.
In February 2015, Merck and NGM Biopharmaceuticals, Inc. (NGM), a privately held biotechnology company, entered into a multi-year collaboration to research, discover, develop and commercialize novel biologic therapies across a wide range of therapeutic areas. The collaboration includes multiple drug candidates currently in preclinical development at NGM, including NP201, which is being evaluated for the treatment of diabetes, obesity and nonalcoholic steatohepatitis. NGM will lead the research and development of the existing preclinical candidates and have the autonomy to identify and pursue other discovery stage programs at its discretion. Merck will have the option to license all resulting NGM programs following human proof-of-concept trials. If Merck exercises this option, Merck will lead global product development and commercialization for the resulting products, if approved. Under the terms of the agreement, Merck made an upfront payment to NGM of $94 million, which is included in Research and development expenses, and purchased a 15% equity stake in NGM for $106 million. Merck committed up to $250 million to fund all of NGM’s efforts under the initial five-year term of the collaboration, with the potential for additional funding if certain conditions are met. Prior to Merck initiating a Phase 3 study for a licensed program, NGM may elect to either receive milestone and royalty payments or, in certain cases, to co-fund development and participate in a global cost and revenue share arrangement of up to 50%. The agreement also provides NGM with the option to participate in the co-promotion of any co-funded program in the United States. Merck will have the option to extend the research agreement for two additional two-year terms. Each party has certain termination rights under the agreement in the event of an uncured material breach by the other party. Additionally, Merck has certain termination rights in the event of the occurrence of certain defined conditions. Upon a termination event, depending on the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of compounds discovered under the agreement and certain related payment obligations.
Acquisition of Cubist Pharmaceuticals, Inc.
In January 2015, Merck acquired Cubist Pharmaceuticals, Inc. (Cubist), a leader in the development of therapies to treat serious infections caused by a broad range of bacteria. The acquisition complements Merck’s existing hospital acute care business. This transaction closed on January 21, 2015; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. During the first six months of 2015, the Company incurred $324 million of transaction costs directly related to the acquisition of Cubist including share-based compensation costs, severance costs and legal and advisory fees which are reflected in Marketing and administrative expenses. Of this amount, $226 million was recorded in the first quarter of 2015 and $98 million was recorded in the second quarter of 2015, but should have been recorded in the first quarter of 2015 which was the period the acquisition closed.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
The following unaudited supplemental pro forma data presents consolidated information as if the acquisition of Cubist had been completed on January 1, 2014:
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| Three Months Ended March 31, |
($ in millions, except per share amounts) | 2015 |
Sales | $ | 9,511 |
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Net income attributable to Merck & Co., Inc. | 1,035 |
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Basic earnings per common share attributable to Merck & Co., Inc. common shareholders | 0.37 |
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Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders | 0.36 |
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The unaudited supplemental pro forma data reflects the historical information of Merck and Cubist adjusted to include additional amortization expense based on the fair value of assets acquired, additional interest expense that would have been incurred on borrowings used to fund the acquisition, transaction costs associated with the acquisition, and the related tax effects of these adjustments. The pro forma data should not be considered indicative of the results that would have occurred if the acquisition had been consummated on January 1, 2014, nor are they indicative of future results.
The Company incurs substantial costs for restructuring program activities related to Merck’s productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010, subsequent to the Merck and Schering-Plough Corporation (Schering-Plough) merger, the Company commenced actions under a global restructuring program (the Merger Restructuring Program) designed to streamline the cost structure of the combined company. In 2013, the Company initiated actions under a global restructuring program (the 2013 Restructuring Program) as part of a global initiative to sharpen its commercial and research and development focus. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company is also reducing its global real estate footprint and continues to improve the efficiency of its manufacturing and supply network. The non-facility related restructuring actions under the Merger Restructuring Program are substantially complete. The actions under the 2013 Restructuring Program were substantially completed by the end of 2015. Accordingly, as of January 1, 2016, the remaining accrued liability for future separations under these programs were combined and remaining activities, which primarily relate to ongoing facility rationalizations, are being accounted for in the aggregate.
The Company recorded total pretax costs of $196 million and $225 million in the first quarter of 2016 and 2015, respectively, related to restructuring program activities. Since inception of the programs through March 31, 2016, Merck has recorded total pretax accumulated costs of approximately $11.7 billion and eliminated approximately 38,745 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company expects to substantially complete the remaining actions under these programs by the end of 2017 and incur approximately $1.3 billion of additional pretax costs. The Company estimates that approximately two-thirds of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.
For segment reporting, restructuring charges are unallocated expenses.
The following tables summarize the charges related to restructuring program activities by type of cost:
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| Three Months Ended March 31, 2016 |
($ in millions) | Separation Costs | | Accelerated Depreciation | | Other | | Total |
Materials and production | $ | — |
| | $ | 22 |
| | $ | 25 |
| | $ | 47 |
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Marketing and administrative | — |
| | 3 |
| | — |
| | 3 |
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Research and development | — |
| | 55 |
| | — |
| | 55 |
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Restructuring costs | 26 |
| | — |
| | 65 |
| | 91 |
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| $ | 26 |
| | $ | 80 |
| | $ | 90 |
| | $ | 196 |
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Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
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| | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2015 |
($ in millions) | Separation Costs | | Accelerated Depreciation | | Other | | Total |
Materials and production | $ | — |
| | $ | 13 |
| | $ | 92 |
| | $ | 105 |
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Marketing and administrative | — |
| | 34 |
| | 2 |
| | 36 |
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Research and development | — |
| | — |
| | 2 |
| | 2 |
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Restructuring costs | 29 |
| | — |
| | 53 |
| | 82 |
|
| $ | 29 |
| | $ | 47 |
| | $ | 149 |
| | $ | 225 |
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Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. In the first quarter of 2016 and 2015, approximately 470 positions and 1,085 positions, respectively, were eliminated under the restructuring program activities. These position eliminations were comprised of actual headcount reductions and the elimination of contractors and vacant positions.
Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the site, based upon the anticipated date the site will be closed or divested, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All of the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck recorded accelerated depreciation of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors.
Other activity in 2016 and 2015 includes asset abandonment, shut-down and other related costs, as well as pretax gains and losses resulting from sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 11) and share-based compensation.
The following table summarizes the charges and spending relating to restructuring program activities for the three months ended March 31, 2016:
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($ in millions) | Separation Costs | | Accelerated Depreciation | | Other | | Total |
Restructuring reserves January 1, 2016 | $ | 592 |
| | $ | — |
| | $ | 53 |
| | $ | 645 |
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Expense | 26 |
| | 80 |
| | 90 |
| | 196 |
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(Payments) receipts, net | (108 | ) | | — |
| | (66 | ) | | (174 | ) |
Non-cash activity | — |
| | (80 | ) | | (26 | ) | | (106 | ) |
Restructuring reserves March 31, 2016 (1) | $ | 510 |
| | $ | — |
| | $ | 51 |
| | $ | 561 |
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(1) | The remaining cash outlays are expected to be substantially completed by the end of 2017. |
Derivative Instruments and Hedging Activities
The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments.
A significant portion of the Company’s revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Company’s foreign currency risk management program, as well as its interest rate risk management activities are discussed below.
Foreign Currency Risk Management
The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates.
The primary objective of the revenue hedging program is to reduce the potential for longer-term unfavorable changes in foreign exchange rates to decrease the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales that are expected to occur over its planning cycle, typically no more than three years into the future. The Company will layer in hedges over time, increasing the portion of third-party and intercompany distributor entity sales hedged as it gets closer to the expected date of the forecasted foreign currency denominated
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
sales. The portion of sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The hedged anticipated sales are a specified component of a portfolio of similarly denominated foreign currency-based sales transactions, each of which responds to the hedged currency risk in the same manner. The Company manages its anticipated transaction exposure principally with purchased local currency put options, which provide the Company with a right, but not an obligation, to sell foreign currencies in the future at a predetermined price. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, total changes in the options’ cash flows offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the options’ value reduces to zero, but the Company benefits from the increase in the U.S. dollar equivalent value of the anticipated foreign currency cash flows.
In connection with the Company’s revenue hedging program, a purchased collar option strategy may be utilized. With a purchased collar option strategy, the Company writes a local currency call option and purchases a local currency put option. As compared to a purchased put option strategy alone, a purchased collar strategy reduces the upfront costs associated with purchasing puts through the collection of premiums by writing call options. If the U.S. dollar weakens relative to the currency of the hedged anticipated sales, the purchased put option value of the collar strategy reduces to zero and the Company benefits from the increase in the U.S. dollar equivalent value of its anticipated foreign currency cash flows; however, this benefit would be capped at the strike level of the written call. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the written call option value of the collar strategy reduces to zero and the changes in the purchased put cash flows of the collar strategy would offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales.
The Company may also utilize forward contracts in its revenue hedging program. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the increase in the fair value of the forward contracts offsets the decrease in the expected future U.S. dollar cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the decrease in the fair value of the forward contracts offsets the increase in the value of the anticipated foreign currency cash flows.
The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Condensed Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other comprehensive income (OCI), depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the effective portion of the unrealized gains or losses on these contracts is recorded in Accumulated other comprehensive income (AOCI) and reclassified into Sales when the hedged anticipated revenue is recognized. The hedge relationship is highly effective and hedge ineffectiveness has been de minimis. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes.
The primary objective of the balance sheet risk management program is to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiary’s functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts, which enable the Company to buy and sell foreign currencies in the future at fixed exchange rates and economically offset the consequences of changes in foreign exchange from the monetary assets. Merck routinely enters into contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The Company will also minimize the effect of exchange on monetary assets and liabilities by managing operating activities and net asset positions at the local level. The cash flows from these contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows.
Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net. The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net. Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year.
The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates. The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within OCI, and remains in AOCI until either the sale or complete or substantially complete liquidation of
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
the subsidiary. The cash flows from these contracts are reported as investing activities in the Condensed Consolidated Statement of Cash Flows.
Foreign exchange risk is also managed through the use of foreign currency debt. The Company’s senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI. Included in the cumulative translation adjustment are pretax losses of $58 million and pretax gains $334 million for the first three months of 2016 and 2015, respectively, from the euro-denominated notes.
Interest Rate Risk Management
The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk.
At March 31, 2016, the Company was a party to 30 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below.
|
| | | | | | | | | | |
($ in millions) | March 31, 2016 |
Debt Instrument | Par Value of Debt | | Number of Interest Rate Swaps Held | | Total Swap Notional Amount |
0.70% notes due 2016 | $ | 1,000 |
| | 4 |
| | $ | 1,000 |
|
1.30% notes due 2018 | 1,000 |
| | 4 |
| | 1,000 |
|
5.00% notes due 2019 | 1,250 |
| | 3 |
| | 550 |
|
1.85% notes due 2020 | 1,250 |
| | 5 |
| | 1,250 |
|
3.875% notes due 2021 | 1,150 |
| | 5 |
| | 1,150 |
|
2.40% notes due 2022 | 1,000 |
| | 4 |
| | 1,000 |
|
2.35% notes due 2022 | 1,250 |
| | 5 |
| | 1,250 |
|
The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows.
Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2016 | | December 31, 2015 |
| | Fair Value of Derivative | | U.S. Dollar Notional | | Fair Value of Derivative | | U.S. Dollar Notional |
($ in millions) | Balance Sheet Caption | Asset | | Liability | | Asset | | Liability | |
Derivatives Designated as Hedging Instruments | | | | | | | | | | | | |
Interest rate swap contracts (noncurrent) | Other assets | $ | 169 |
| | $ | — |
| | $ | 6,200 |
| | $ | 42 |
| | $ | — |
| | $ | 2,700 |
|
Interest rate swap contracts (current) | Accrued and other current liabilities | — |
| | 1 |
| | 1,000 |
| | — |
| | 1 |
| | 1,000 |
|
Interest rate swap contracts (noncurrent) | Other noncurrent liabilities | — |
| | — |
| | — |
| | — |
| | 23 |
| | 3,500 |
|
Foreign exchange contracts (current) | Other current assets | 436 |
| | — |
| | 4,871 |
| | 579 |
| | — |
| | 4,171 |
|
Foreign exchange contracts (noncurrent) | Other assets | 252 |
| | — |
| | 3,552 |
| | 386 |
| | — |
| | 4,136 |
|
Foreign exchange contracts (current) | Accrued and other current liabilities | — |
| | 11 |
| | 236 |
| | — |
| | 1 |
| | 77 |
|
| | $ | 857 |
|
| $ | 12 |
|
| $ | 15,859 |
|
| $ | 1,007 |
|
| $ | 25 |
|
| $ | 15,584 |
|
Derivatives Not Designated as Hedging Instruments | | | | | | | | | | | | |
Foreign exchange contracts (current) | Other current assets | $ | 104 |
| | $ | — |
| | $ | 2,829 |
| | $ | 212 |
| | $ | — |
| | $ | 8,783 |
|
Foreign exchange contracts (noncurrent) | Other assets | 18 |
| | — |
| | 260 |
| | 18 |
| | — |
| | 179 |
|
Foreign exchange contracts (current) | Accrued and other current liabilities | — |
| | 151 |
| | 7,178 |
| | — |
| | 37 |
| | 2,508 |
|
Foreign exchange contracts (noncurrent) | Other noncurrent liabilities | — |
| | 1 |
| | 6 |
| | — |
| | 1 |
| | 6 |
|
| | $ | 122 |
| | $ | 152 |
| | $ | 10,273 |
| | $ | 230 |
| | $ | 38 |
| | $ | 11,476 |
|
| | $ | 979 |
|
| $ | 164 |
|
| $ | 26,132 |
|
| $ | 1,237 |
|
| $ | 63 |
|
| $ | 27,060 |
|
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
As noted above, the Company records its derivatives on a gross basis in the Condensed Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Company’s derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes:
|
| | | | | | | | | | | | | | | |
| March 31, 2016 | | December 31, 2015 |
($ in millions) | Asset | | Liability | | Asset | | Liability |
Gross amounts recognized in the consolidated balance sheet | $ | 979 |
| | $ | 164 |
| | $ | 1,237 |
| | $ | 63 |
|
Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet | (112 | ) | | (113 | ) | | (59 | ) | | (59 | ) |
Cash collateral (received) posted | (495 | ) | | — |
| | (862 | ) | | — |
|
Net amounts | $ | 372 |
| | $ | 51 |
| | $ | 316 |
| | $ | 4 |
|
The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a foreign currency cash flow hedging relationship, (iii) designated in a foreign currency net investment hedging relationship and (iv) not designated in a hedging relationship:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2016 | | 2015 |
Derivatives designated in a fair value hedging relationship | | | |
Interest rate swap contracts | | | |
Amount of gain recognized in Other (income) expense, net on derivatives (1) | $ | (150 | ) | | $ | (25 | ) |
Amount of loss recognized in Other (income) expense, net on hedged item (1) | 147 |
| | 22 |
|
Derivatives designated in foreign currency cash flow hedging relationships | | | |
Foreign exchange contracts | | | |
Amount of gain reclassified from AOCI to Sales | (143 | ) | | (167 | ) |
Amount of loss (gain) recognized in OCI on derivatives | 167 |
| | (565 | ) |
Derivatives designated in foreign currency net investment hedging relationships | | | |
Foreign exchange contracts | | | |
Amount of gain recognized in Other (income) expense, net on derivatives (2) | — |
| | (1 | ) |
Amount of loss recognized in OCI on derivatives | — |
| | 8 |
|
Derivatives not designated in a hedging relationship | | | |
Foreign exchange contracts | | | |
Amount of loss (gain) recognized in Other (income) expense, net on derivatives (3) | 24 |
| | (248 | ) |
Amount of gain recognized in Sales | — |
| | (1 | ) |
(1) There was $3 million of ineffectiveness on the hedge during both the first quarter of 2016 and 2015.
(2) There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing.
(3) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates.
At March 31, 2016, the Company estimates $221 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales. The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
Investments in Debt and Equity Securities
Information on available-for-sale investments is as follows:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2016 | | December 31, 2015 |
| Fair Value | | Amortized Cost | | Gross Unrealized | | Fair Value | | Amortized Cost | | Gross Unrealized |
($ in millions) | Gains | | Losses | | Gains | | Losses |
Corporate notes and bonds | $ | 10,419 |
| | $ | 10,377 |
| | $ | 55 |
| | $ | (13 | ) | | $ | 10,259 |
| | $ | 10,299 |
| | $ | 7 |
| | $ | (47 | ) |
U.S. government and agency securities | 1,813 |
| | 1,806 |
| | 7 |
| | — |
| | 1,761 |
| | 1,767 |
| | — |
| | (6 | ) |
Asset-backed securities | 1,292 |
| | 1,292 |
| | 2 |
| | (2 | ) | | 1,284 |
| | 1,290 |
| | — |
| | (6 | ) |
Commercial paper | 798 |
| | 798 |
| | — |
| | — |
| | 2,977 |
| | 2,977 |
| | — |
| | — |
|
Mortgage-backed securities | 684 |
| | 681 |
| | 4 |
| | (1 | ) | | 694 |
| | 697 |
| | 1 |
| | (4 | ) |
Foreign government bonds | 468 |
| | 467 |
| | 1 |
| | — |
| | 607 |
| | 586 |
| | 22 |
| | (1 | ) |
Equity securities | 475 |
| | 395 |
| | 83 |
| | (3 | ) | | 534 |
| | 409 |
| | 125 |
| | — |
|
| $ | 15,949 |
| | $ | 15,816 |
| | $ | 152 |
| | $ | (19 | ) | | $ | 18,116 |
| | $ | 18,025 |
| | $ | 155 |
| | $ | (64 | ) |
Available-for-sale debt securities included in Short-term investments totaled $3.2 billion at March 31, 2016. Of the remaining debt securities, $11.3 billion mature within five years. At March 31, 2016 and December 31, 2015, there were no debt securities pledged as collateral.
Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest:
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation.
If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities measured at fair value on a recurring basis are summarized below:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Fair Value Measurements Using | | Fair Value Measurements Using |
| Quoted Prices In Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total | | Quoted Prices In Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total |
($ in millions) | March 31, 2016 | | December 31, 2015 |
Assets | | | | | | | | | | | | | | | |
Investments | | | | | | | | | | | | | | | |
Corporate notes and bonds | $ | — |
| | $ | 10,419 |
| | $ | — |
| | $ | 10,419 |
| | $ | — |
| | $ | 10,259 |
| | $ | — |
| | $ | 10,259 |
|
U.S. government and agency securities | — |
| | 1,813 |
| | — |
| | 1,813 |
| | — |
| | 1,761 |
| | — |
| | 1,761 |
|
Asset-backed securities (1) | — |
| | 1,292 |
| | — |
| | 1,292 |
| | — |
| | 1,284 |
| | — |
| | 1,284 |
|
Commercial paper | — |
| | 798 |
| | — |
| | 798 |
| | — |
| | 2,977 |
| | — |
| | 2,977 |
|
Mortgage-backed securities (1) | — |
| | 684 |
| | — |
| | 684 |
| | — |
| | 694 |
| | — |
| | 694 |
|
Foreign government bonds | — |
| | 468 |
| | — |
| | 468 |
| | — |
| | 607 |
| | — |
| | 607 |
|
Equity securities | 307 |
| | — |
| | — |
| | 307 |
| | 360 |
| | — |
| | — |
| | 360 |
|
| 307 |
| | 15,474 |
| | — |
| | 15,781 |
| | 360 |
| | 17,582 |
| | — |
| | 17,942 |
|
Other assets | | | | | | | | | | | | | | | |
Securities held for employee compensation | 154 |
| | 14 |
| | — |
| | 168 |
| | 155 |
| | 19 |
| | — |
| | 174 |
|
Derivative assets (2) | | | | | | | | | | | | | | | |
Purchased currency options | — |
| | 735 |
| | — |
| | 735 |
| | — |
| | 1,041 |
| | — |
| | 1,041 |
|
Interest rate swaps | — |
| | 169 |
| | — |
| | 169 |
| | — |
| | 42 |
| | — |
| | 42 |
|
Forward exchange contracts | — |
| | 75 |
| | — |
| | 75 |
| | — |
| | 154 |
| | — |
| | 154 |
|
| — |
| | 979 |
| | — |
| | 979 |
| | — |
| | 1,237 |
| | — |
| | 1,237 |
|
Total assets | $ | 461 |
| | $ | 16,467 |
| | $ | — |
| | $ | 16,928 |
| | $ | 515 |
| | $ | 18,838 |
| | $ | — |
| | $ | 19,353 |
|
Liabilities | | | | | | | | | | | | | | | |
Other liabilities | | | | | | | | | | | | | | | |
Contingent consideration | $ | — |
| | $ | — |
| | $ | 652 |
| | $ | 652 |
| | $ | — |
| | $ | — |
| | $ | 590 |
| | $ | 590 |
|
Derivative liabilities (2) | | | | | | | | | | | | | | | |
Forward exchange contracts | — |
| | 162 |
| | — |
| | 162 |
| | — |
| | 38 |
| | — |
| | 38 |
|
Written currency options | — |
| | 1 |
| | — |
| | 1 |
| | — |
| | 1 |
| | — |
| | 1 |
|
Interest rate swaps | — |
| | 1 |
| | — |
| | 1 |
| | — |
| | 24 |
| | — |
| | 24 |
|
| — |
| | 164 |
| | — |
| | 164 |
| | — |
| | 63 |
| | — |
| | 63 |
|
Total liabilities | $ | — |
|
| $ | 164 |
|
| $ | 652 |
|
| $ | 816 |
|
| $ | — |
|
| $ | 63 |
|
| $ | 590 |
|
| $ | 653 |
|
| |
(1) | Primarily all of the asset-backed securities are highly-rated (Standard & Poor’s rating of AAA and Moody’s Investors Service rating of Aaa), secured primarily by credit card, auto loan, and home equity receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies. |
| |
(2) | The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Company’s own credit risk, the effects of which were not significant. |
There were no transfers between Level 1 and Level 2 during the first three months of 2016. As of March 31, 2016, Cash and cash equivalents of $9.7 billion included $8.9 billion of cash equivalents (considered Level 2 in the fair value hierarchy).
Contingent Consideration
Summarized information about the changes in liabilities for contingent consideration is as follows:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2016 | | 2015 |
Fair value January 1 | $ | 590 |
| | $ | 428 |
|
Changes in fair value (1) | 10 |
| | 61 |
|
Additions | 77 |
| | 123 |
|
Payments | (25 | ) | | (50 | ) |
Fair value March 31 | $ | 652 |
| | $ | 562 |
|
(1) Recorded in Research and development expenses and Materials and production costs.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
In the first quarter of 2016 and 2015, the Company recognized liabilities for contingent consideration related to the acquisitions of IOmet and Cubist, respectively, reflected as “Additions” in the table above (see Note 2). The payments of contingent consideration reflected in the table above for 2016 relate to the first commercial sale of Zerbaxa in the European Union and for 2015 relate to the first commercial sale of Zerbaxa in the United States.
Other Fair Value Measurements
Some of the Company’s financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature.
The estimated fair value of loans payable and long-term debt (including current portion) at March 31, 2016, was $27.2 billion compared with a carrying value of $25.8 billion and at December 31, 2015, was $27.0 billion compared with a carrying value of $26.4 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy.
Concentrations of Credit Risk
On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards as specified in the Company’s investment policy guidelines.
The majority of the Company’s accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business, taking into consideration global economic conditions and the ongoing sovereign debt issues in certain European countries. At March 31, 2016 and December 31, 2015, Other assets included $10 million of accounts receivable not expected to be collected within one year. At March 31, 2016, the Company’s total net accounts receivable outstanding for more than one year were approximately $130 million. The Company does not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on its financial position, liquidity or results of operations.
Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Company’s financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Company’s credit rating, and the credit rating of the counterparty. As of March 31, 2016 and December 31, 2015, the Company had received cash collateral of $495 million and $862 million, respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities. The Company had not advanced any cash collateral to counterparties as of March 31, 2016 or December 31, 2015.
Inventories consisted of:
|
| | | | | | | |
($ in millions) | March 31, 2016 | | December 31, 2015 |
Finished goods | $ | 1,417 |
| | $ | 1,343 |
|
Raw materials and work in process | 4,399 |
| | 4,374 |
|
Supplies | 169 |
| | 168 |
|
Total (approximates current cost) | 5,985 |
| | 5,885 |
|
Increase to LIFO costs | 375 |
| | 384 |
|
| $ | 6,360 |
| | $ | 6,269 |
|
Recognized as: | | | |
Inventories | $ | 5,102 |
| | $ | 4,700 |
|
Other assets | 1,258 |
| | 1,569 |
|
Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At March 31, 2016 and December 31, 2015, these amounts included $1.2 billion and $1.5 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $100 million and $63 million at March 31, 2016 and December 31, 2015, respectively, of inventories produced in preparation for product launches.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
In connection with acquisitions, the Company measures the fair value of marketed products and research and development pipeline programs and capitalizes these amounts.
During the first quarter of 2016, the Company recorded an intangible asset impairment charge of $252 million within Materials and production costs related to Zontivity, a product marketed by the Company for the reduction of thrombotic cardiovascular events in patients with a history of myocardial infarction or with peripheral arterial disease. In March 2016, following several business decisions that reduced sales expectations for Zontivity in the United States and Europe, the Company lowered its cash flow projections for Zontivity. The Company utilized market participant assumptions and considered several different scenarios to determine the fair value of the intangible asset related to Zontivity that, when compared with its related carrying value, resulted in the impairment charge noted above. During the first quarter of 2015, the Company recorded an intangible asset impairment charge of $12 million related to Rebetol, a product marketed by the Company for the treatment of chronic hepatitis C virus infection. Sales of Rebetol were adversely affected by loss of market share as a result of the availability of newer therapeutic options, which led to changes in the cash flow assumptions for Rebetol that indicated that the Rebetol intangible asset value was not recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine the fair value of the intangible asset related to Rebetol that, when compared with its related carrying value, resulted in the impairment charge noted above.
Also during the first quarter of 2016, the Company recorded $25 million of IPR&D impairment charges within Research and development expenses primarily related to deprioritized pipeline programs that were deemed to have no alternative use during the period.
The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material.
| |
7. | Joint Ventures and Other Equity Method Affiliates |
Equity income from affiliates reflects the performance of the Company’s joint ventures and other equity method affiliates including Sanofi Pasteur MSD (SPMSD) and certain investment funds. Equity income from affiliates was $34 million and $145 million for the first quarter of 2016 and 2015, respectively, and is included in Other (income) expense, net (see Note 12).
Sanofi Pasteur MSD
In March 2016, Merck and Sanofi Pasteur announced their intention to end their joint vaccines operations in Europe. The joint venture SPMSD, owned equally by Sanofi Pasteur and Merck, was created in 1994 to develop and commercialize vaccines originating from both companies’ pipelines to improve and promote public health in 19 European countries. Sanofi Pasteur and Merck expect the project to be completed by the end of 2016, subject to local labor laws and regulations and regulatory approvals. Upon concluding the joint venture, Merck plans to integrate its European vaccine business into its operations, manage its product portfolio and pursue its growth strategy in Europe. Joint venture vaccine sales were $182 million and $162 million for the first quarter of 2016 and 2015, respectively.
AstraZeneca LP
In 1998, Merck and Astra completed the restructuring of the ownership and operations of their existing joint venture whereby Merck acquired Astra’s interest in KBI Inc. (KBI) and contributed KBI’s operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the Partnership). Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership. The Partnership, renamed AstraZeneca LP (AZLP) upon Astra’s 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights. In connection with AstraZeneca’s 2014 exercise of its option to purchase Merck’s interest in KBI, the Company deferred $327 million of the exercise price, which reflected an estimate of the fair value of Merck’s interest in Nexium and Prilosec. This amount, which is subject to a true-up in 2018 based on actual sales from closing in 2014 to June 2018, was deferred and recognized over time in Other (income) expense, net as the contingency was eliminated as sales occurred. The deferred income amount has been fully amortized based on the sales performance of Nexium and Prilosec subsequent to the 2014 option exercise. Beginning in the first quarter of 2016, the Company is recognizing income and a corresponding receivable for amounts that will be due to Merck from AstraZeneca based on the sales performance of Nexium and Prilosec subject to the true-up in June 2018. The Company recognized $21 million of such income in the first quarter of 2016.
The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Company’s financial position, results of operations or cash flows.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation.
The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable.
The Company’s decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities effective August 1, 2004.
Vioxx Litigation
Product Liability Lawsuits
As previously disclosed, Merck is a defendant in approximately five active federal and state lawsuits (Vioxx Product Liability Lawsuits) alleging personal injury as a result of the use of Vioxx. Most of these cases are coordinated in a multidistrict litigation in the U.S. District Court for the Eastern District of Louisiana (the Vioxx MDL) before Judge Eldon E. Fallon.
As previously disclosed, Merck is also a defendant in approximately 30 putative class action lawsuits alleging economic injury as a result of the purchase of Vioxx. All but one of those cases are in the Vioxx MDL. Merck has reached a resolution, approved by Judge Fallon, of these class actions in the Vioxx MDL. Under the settlement, Merck will pay up to $23 million to resolve all properly documented claims submitted by class members, approved attorneys’ fees and expenses, and approved settlement notice costs and certain other administrative expenses. The court entered an order approving the settlement in January 2014 and the claims review process was recently completed.
Merck is also a defendant in lawsuits brought by state Attorneys General of three states — Alaska, Montana and Utah. The lawsuits are pending in state courts. These actions allege that Merck misrepresented the safety of Vioxx and seek recovery for expenditures on Vioxx by government-funded health care programs, such as Medicaid, and/or penalties for alleged Consumer Fraud Act violations. Trial has been scheduled in the Montana case for September 12, 2016, and trial has been set in the Alaska case for January 9, 2017. A motion for judgment on the pleadings in the Montana case is currently pending. Merck’s motion to dismiss in Utah and motion for judgment on the pleadings in Alaska were both recently denied.
Shareholder Lawsuits
As previously disclosed, in addition to the Vioxx Product Liability Lawsuits, various putative class actions and individual lawsuits have been filed against Merck and certain former employees alleging that the defendants violated federal securities laws by making alleged material misstatements and omissions with respect to the cardiovascular safety of Vioxx (Vioxx Securities Lawsuits). The Vioxx Securities Lawsuits are coordinated in a multidistrict litigation in the U.S. District Court for the District of New Jersey before Judge Stanley R. Chesler, and have been consolidated for all purposes. In August 2011, Judge Chesler granted in part and denied in part defendants’ motions to dismiss in the consolidated securities class action (the Class Action). In June 2013, plaintiffs filed their Sixth Amended Class Action Complaint, which defendants answered in July 2013. Following the completion of discovery, defendants moved for summary judgment, which the court granted in part and denied in part in May 2015. On January 15, 2016, the Company announced that it had reached an agreement with plaintiffs to settle the Class Action for $830 million, plus an additional amount for attorneys’ fees and expenses, in exchange for, among other things, a dismissal with prejudice of the Class Action and full releases of all claims against defendants. The Company paid the total settlement amount into escrow in April 2016. After available funds under certain insurance policies, Merck’s net cash payment for the settlement and fees was approximately $680 million. The proposed settlement covers all claims relating to Vioxx by settlement class members who purchased Merck securities between May 21, 1999, and October 29, 2004. The settlement is not an admission of wrongdoing and, as part of the settlement agreement, defendants continue to deny the allegations. The proposed settlement, including any award of attorneys’ fees and expenses, is subject to final court approval. On February 8, 2016, the parties filed the stipulation of settlement, which the court preliminarily approved on February 11, 2016. The court has set a final approval hearing for June 28, 2016. The proposed settlement does not resolve the individual securities lawsuits discussed below.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
As previously disclosed, 13 individual securities lawsuits filed by foreign and domestic institutional investors also are consolidated with the Vioxx Securities Lawsuits. The allegations in the individual securities lawsuits are substantially similar to the allegations in the Vioxx Securities Lawsuits. Discovery has been completed in those actions and the court has issued a final pre-trial schedule; no trial date has been set. The proposed settlement in the Class Action, discussed above, does not resolve the individual securities lawsuits, although each individual plaintiff has the right, at its option, to join the settlement class at no additional cost to Merck on or before June 23, 2016.
Insurance
As a result of the previously disclosed insurance arbitration, the Company’s insurers paid insurance proceeds of approximately $380 million in connection with the settlement of the Class Action. The Company also has Directors and Officers insurance coverage applicable to the Vioxx Securities Lawsuits with remaining stated upper limits of approximately $145 million. There are disputes with the insurers about the availability of some or all of the Company’s Directors and Officers insurance coverage for these claims. The amounts actually recovered under the Directors and Officers policies discussed in this paragraph may be less than the stated upper limits.
International Lawsuits
As previously disclosed, in addition to the lawsuits discussed above, Merck has been named as a defendant in litigation relating to Vioxx in Brazil and Europe (collectively, the Vioxx International Lawsuits). The litigation in these jurisdictions is generally in procedural stages and Merck expects that the litigation may continue for a number of years.
Reserves
In connection with the settlement of the Class Action, which remains subject to final court approval, the Company established a net reserve of $680 million in the fourth quarter of 2015. The Company also has a reserve with respect to certain Vioxx Product Liability Lawsuits and an immaterial remaining reserve relating to the previously disclosed Vioxx investigation for the non-participating states with which litigation is continuing. The Company has established no other liability reserves for, and believes that it has meritorious defenses to, the remaining Vioxx Product Liability Lawsuits, Vioxx Securities Lawsuits and Vioxx International Lawsuits (collectively, the Remaining Vioxx Litigation) and will vigorously defend against them. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek indeterminate damages, the Company is unable to predict the outcome of these matters and, at this time, cannot reasonably estimate the possible loss or range of loss with respect to the Remaining Vioxx Litigation.
Other Product Liability Litigation
Fosamax
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax (Fosamax Litigation). As of March 31, 2016, approximately 4,435 cases had been filed and were pending against Merck in either federal or state court, including one case which seeks class action certification, as well as damages and/or medical monitoring. In approximately 30 of these actions, plaintiffs allege, among other things, that they have suffered osteonecrosis of the jaw (ONJ), generally subsequent to invasive dental procedures, such as tooth extraction or dental implants and/or delayed healing, in association with the use of Fosamax. In addition, plaintiffs in approximately 4,405 of these actions generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax.
Cases Alleging ONJ and/or Other Jaw Related Injuries
In August 2006, the Judicial Panel on Multidistrict Litigation (JPML) ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation (Fosamax ONJ MDL) for coordinated pre-trial proceedings.
In December 2013, Merck reached an agreement in principle with the Plaintiffs’ Steering Committee (PSC) in the Fosamax ONJ MDL to resolve pending ONJ cases not on appeal in the Fosamax ONJ MDL and in the state courts for an aggregate amount of $27.7 million. Merck and the PSC subsequently formalized the terms of this agreement in a Master Settlement Agreement (ONJ Master Settlement Agreement) that was executed in April 2014 and included over 1,200 plaintiffs. As a condition to the settlement, 100% of the state and federal ONJ plaintiffs had to agree to participate in the settlement plan or Merck could either terminate the ONJ Master Settlement Agreement, or waive the 100% participation requirement and agree to a lesser funding amount for the settlement fund. On July 14, 2014, Merck elected to proceed with the ONJ Master Settlement Agreement at a reduced funding level since the participation level was approximately 95%. Merck has fully funded the ONJ Master Settlement Agreement and the escrow agent under the agreement has been making settlement payments to qualifying plaintiffs. The claims of approximately 35 non-participants’ will remain once the settlement is complete. The ONJ Master Settlement Agreement has no effect on the cases alleging Femur Fractures discussed below.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
Cases Alleging Femur Fractures
In March 2011, Merck submitted a Motion to Transfer to the JPML seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. The Motion to Transfer was granted in May 2011, and all federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (the Femur Fracture MDL). Judge Pisano presided over the Femur Fracture MDL until March 10, 2015, at which time the Femur Fracture MDL was reassigned from Judge Pisano to Judge Freda L. Wolfson following Judge Pisano’s retirement. In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck, the jury returned a verdict in Merck’s favor. In addition, on June 27, 2013, the Femur Fracture MDL court granted Merck’s motion for judgment as a matter of law in the Glynn case and held that the plaintiff’s failure to warn claim was preempted by federal law.
In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the court’s preemption decision in the Glynn case. Pursuant to the show cause order, on March 26, 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases are appealing that decision to the U.S. Court of Appeals for the Third Circuit. In June 2015, the Femur Fracture MDL court dismissed without prejudice another approximately 520 cases pending plaintiffs’ appeal of the preemption ruling to the Third Circuit.
On June 17, 2014, Judge Pisano granted Merck summary judgment in the Gaynor v. Merck case and found that Merck’s updates in January 2011 to the Fosamax label regarding atypical femur fractures were adequate as a matter of law and that Merck adequately communicated those changes. The plaintiffs in Gaynor have appealed Judge Pisano’s decision to the Third Circuit. In August 2014, Merck filed a motion requesting that Judge Pisano enter a further order requiring all plaintiffs in the Femur Fracture MDL who claim that the 2011 Fosamax label is inadequate and the proximate cause of their alleged injuries to show cause why their cases should not be dismissed based on the court’s preemption decision and its ruling in the Gaynor case. In November 2014, the court granted Merck’s motion and entered the requested show cause order.
As of March 31, 2016, approximately 20 cases were pending in the Femur Fracture MDL, excluding the 515 cases dismissed with prejudice on preemption grounds that are pending appeal and the 520 cases dismissed without prejudice that are also pending the aforementioned appeal.
As of March 31, 2016, approximately 3,040 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge Jessica Mayer in Middlesex County. The parties selected an initial group of 30 cases to be reviewed through fact discovery. Two additional groups of 50 cases each to be reviewed through fact discovery were selected in November 2013 and March 2014, respectively. A further group of 25 cases to be reviewed through fact discovery was selected by Merck in July 2015.
As of March 31, 2016, approximately 300 cases alleging Femur Fractures have been filed and are pending in California state court. A petition was filed seeking to coordinate all Femur Fracture cases filed in California state court before a single judge in Orange County, California. The petition was granted and Judge Thierry Colaw is currently presiding over the coordinated proceedings. In March 2014, the court directed that a group of 10 discovery pool cases be reviewed through fact discovery and subsequently scheduled the Galper v. Merck case, which plaintiffs’ selected, as the first trial. The Galper trial began on February 17, 2015 and the jury returned a verdict in Merck’s favor on April 3, 2015, and plaintiff has appealed that verdict to the California appellate court. The next Femur Fracture trial in California that was scheduled to begin on April 25, 2016, was stayed at plaintiffs’ request and a new trial date has not been set.
Additionally, there are six Femur Fracture cases pending in other state courts.
Discovery is ongoing in the Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits.
Januvia/Janumet
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet. As of March 31, 2016, approximately 1,140 product user claims have been served on Merck alleging generally that use of Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. These complaints were filed in several different state and federal courts.
Most of the claims were filed in a consolidated multidistrict litigation proceeding in the U.S. District Court for the Southern District of California called “In re Incretin-Based Therapies Products Liability Litigation” (MDL). The MDL includes federal lawsuits alleging pancreatic cancer due to use of the following medicines: Januvia, Janumet, Byetta and Victoza, the latter two of which are products manufactured by other pharmaceutical companies. The majority of claims not filed in the MDL were filed in the Superior Court of California, County of Los Angeles (California State Court). There are 12 cases pending against Merck in state courts other than the California State Court.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
On November 9, 2015, the MDL granted summary judgment on the grounds of preemption as to all claims alleging injury due to pancreatic cancer. Based on that ruling, on November 30, 2015, the MDL entered final judgment resulting in the dismissal of the pancreatic cancer claims against Merck relating to approximately 715 product users.
On November 16, 2015, the California State Court likewise granted summary judgment on preemption grounds as to claims alleging injury due to pancreatic cancer. Based on that ruling, on April 5, 2016, the California State Court entered final judgment resulting in the dismissal of the pancreatic cancer claims against Merck relating to approximately 350 product users.
Plaintiffs are appealing the MDL preemption ruling, and are expected to do likewise with respect to the California State Court ruling.
In addition to the claims noted above, the Company has agreed, as of December 31, 2015, to toll the statute of limitations for approximately 20 additional claims. The Company intends to continue defending against these lawsuits.
Propecia/Proscar
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar. As of March 31, 2016, approximately 1,385 lawsuits have been filed by plaintiffs who allege that they have experienced persistent sexual side effects following cessation of treatment with Propecia and/or Proscar. Approximately 55 of the plaintiffs also allege that Propecia or Proscar has caused or can cause prostate cancer, testicular cancer or male breast cancer. The lawsuits have been filed in various federal courts and in state court in New Jersey. The federal lawsuits have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Brian Cogan of the Eastern District of New York. The matters pending in state court in New Jersey have been consolidated before Judge Mayer in Middlesex County. In addition, there is one matter pending in state court in Massachusetts and one matter pending in state court in New York. The Company intends to defend against these lawsuits.
Governmental Proceedings
The Company has received a civil investigative demand from the U.S. Attorney’s Office for the Southern District of New York that requests information relating to the Company’s contracts with, services from and payments to pharmacy benefit managers with respect to Maxalt and Levitra from January 1, 2006 to the present. The Company is cooperating with the investigation.
As previously disclosed, the Company’s subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Company’s policy is to cooperate with these authorities and to provide responses as appropriate.
Commercial and Other Litigation
Sales Force Litigation
As previously disclosed, in May 2013, Ms. Kelli Smith filed a complaint against the Company in the United States District Court for the District of New Jersey on behalf of herself and a putative class of female sales representatives and a putative sub-class of female sales representatives with children, claiming (a) discriminatory policies and practices in selection, promotion and advancement, (b) disparate pay, (c) differential treatment, (d) hostile work environment and (e) retaliation under federal and state discrimination laws. In January 2014, plaintiffs filed an amended complaint adding four additional named plaintiffs. On October 8, 2014, the court denied the Company’s motion to dismiss or strike the class claims as premature. In September 2015, plaintiffs filed additional motions, including a motion for conditional certification under the Equal Pay Act; a motion to amend the pleadings seeking to add ERISA and constructive discharge claims and a Company subsidiary as a named defendant; and a motion for equitable relief. Merck filed papers in opposition to the motions. On April 27, 2016, the court granted plaintiff’s motion for conditional certification but denied plaintiffs’ motions to extend the liability period for their Equal Pay Act claims back to June 2009. As a result, the liability period will date back to April 2012, at the earliest. On April 29, 2016, the Magistrate Judge granted plaintiffs’ request to amend the complaint to add the following: (i) a Company subsidiary as a corporate defendant; (ii) an ERISA claim and (iii) an individual constructive discharge claim for one of the named plaintiffs.
Merck KGaA Litigation
In January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), operating as the EMD Group in the United States, alleging it improperly uses the name “Merck” in the United States. KGaA has filed suit against the Company in France, the United Kingdom (UK), Germany, Switzerland and Mexico alleging breach of the parties’ co-existence agreement, unfair competition and/or trademark infringement. In December 2015, the Paris Court of First Instance issued a judgment finding that certain activities by the Company directed towards France did not constitute trademark infringement and unfair competition while other activities were found to infringe. The Company and KGaA have both appealed the decision. In January 2016, the UK High Court issued a judgment finding that the Company had breached the co-existence agreement and infringed KGaA’s trademark rights as a result of certain activities
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
directed towards the UK based on use of the word MERCK on promotional and information activity. As noted in the UK decision, this finding was not based on the Company’s use of the sign MERCK in connection with the sale of products or any material pharmaceutical business transacted in the UK. The Company and KGaA have both appealed this decision.
Patent Litigation
From time to time, generic manufacturers of pharmaceutical products file Abbreviated New Drug Applications with the U.S. Food and Drug Administration (FDA) seeking to market generic forms of the Company’s products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Certain products of the Company (or products marketed via agreements with other companies) currently involved in such patent infringement litigation in the United States include: Cancidas, Cubicin, Invanz, Nasonex, Noxafil, and NuvaRing. Similar lawsuits defending the Company’s patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by generic companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges.
Cancidas — In February 2014, a patent infringement lawsuit was filed in the United States against Xellia Pharmaceuticals ApS (Xellia) with respect to Xellia’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cancidas. In June 2015, the district court found that Xellia infringed the Company’s patent and ordered that Xellia’s application not be approved until the patent expires in September 2017 (including pediatric exclusivity). Xellia has appealed this decision, and the appeal was heard in March 2016. In August 2014, a patent infringement lawsuit was filed in the United States against Fresenius Kabi USA, LLC (Fresenius) in respect of Fresenius’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cancidas. The lawsuit automatically stays FDA approval of Fresenius’s application until December 2016 or until an adverse court decision, if any, whichever may occur earlier.
Cubicin — In March 2012, a patent infringement lawsuit was filed in the United States against Hospira, Inc. (Hospira), with respect to Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. A trial was held in February 2014, and in December 2014 the district court found the composition patent, which expires in June 2016, to be valid and infringed. Later patents, expiring in September 2019 and November 2020, were found to be invalid. Hospira appealed the finding that the composition patent is not invalid and the Company cross-appealed the finding that the later patents are invalid. In November 2015, the U.S. Court of Appeals for the Federal Circuit affirmed the lower court decision. The Company has asked the United States Supreme Court to review this decision. Hospira’s application will not be approved until at least June 2016.
In October 2013, a patent infringement lawsuit was filed in the United States against Strides, Inc. and Agila Specialties Private Limited (Strides/Agila), with respect to Strides/Agila’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. As a result of the Hospira decision, Strides/Agila’s application will not be approved until at least June 2016.
In July 2014, a patent infringement lawsuit was filed in the United States against Fresenius, with respect to Fresenius’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. As a result of the Hospira decision, Fresenius’s application will not be approved until at least June 2016.
In December 2015, a patent infringement lawsuit was filed in the United States against Sagent Pharmaceuticals, Inc. (Sagent), with respect to Sagent’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. As a result of the Hospira decision, Sagent’s application will not be approved until at least June 2016.
In December 2015, a patent infringement lawsuit was filed in the United States against Actavis LLC (Actavis), with respect to Actavis’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. As a result of the Hospira decision, Actavis’s application will not be approved until at least June 2016.
In January 2016, a patent infringement lawsuit was filed in the United States against Dr. Reddy’s Laboratories Ltd. and Dr. Reddy’s Laboratories, Inc. (Dr. Reddy’s), with respect to Dr. Reddy’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. As a result of the Hospira decision, Dr. Reddy’s application will not be approved until at least June 2016.
In February 2016, a patent infringement lawsuit was filed in the United States against Crane Pharmaceuticals LLC (Crane), with respect to Crane’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. As a result of the Hospira decision, Crane’s application will not be approved until at least June 2016.
An earlier district court action against Teva Parenteral Medicines Inc., Teva Pharmaceuticals USA, Inc. and Teva Pharmaceutical Industries Ltd. (collectively, Teva) resulted in a settlement whereby Teva can launch a generic version of Cubicin at the latest in December 2017, or earlier under certain conditions, but in no event before June 2016.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
In October 2014, Agila Specialties Inc. and Mylan Pharmaceuticals Inc. (Agila/Mylan) filed petitions for Inter Partes Review (IPR) at the United States Patent and Trademark Office (USPTO) seeking the invalidity of the September 2019 and November 2020 patents. In April 2015, Agila/Mylan withdrew its petitions for IPR in exchange for the Company agreeing to narrow the issues in the Strides/Agila lawsuit referenced above. In November 2014, Fresenius filed petitions for IPR at the USPTO seeking the invalidity of the September 2019 patents. In May 2015, the USPTO granted Fresenius’s petition for an IPR on the September 2019 patents. The IPR hearing was held in February 2016. In July 2015, Fresenius filed petitions for IPR seeking invalidity of the November 2020 patents. In January 2016, the USPTO granted Fresenius’s petition for an IPR on the November 2020 patents.
Invanz — In July 2014, a patent infringement lawsuit was filed in the United States against Hospira in respect of Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The lawsuit automatically stays FDA approval of Hospira’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. The trial in this matter was held in April 2016 and the Company is awaiting the court’s decision. In August 2015, a patent infringement lawsuit was filed in the United States against Savior Lifetec Corporation (Savior) in respect of Savior’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The lawsuit automatically stays FDA approval of Savior’s application until November 2017 or until an adverse court decision, if any, whichever may occur earlier.
Nasonex — In July 2014, a patent infringement lawsuit was filed in the United States against Teva Pharmaceuticals USA, Inc. (Teva Pharma) in respect of Teva Pharma’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Teva Pharma’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. The trial in this matter is scheduled to begin in May 2016. In March 2015, a patent infringement lawsuit was filed in the United States against Amneal Pharmaceuticals LLC (Amneal), in respect of Amneal’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Amneal’s application until August 2017 or until an adverse court decision, if any, whichever may occur earlier. The trial in this matter is scheduled to begin in June 2016.
A previous decision, issued in June 2013, held that the Merck patent in the Teva Pharma and Amneal lawsuits covering mometasone furoate monohydrate was valid, but that it was not infringed by Apotex Corp.’s proposed product. In April 2015, a patent infringement lawsuit was filed against Apotex Inc. and Apotex Corp. (Apotex) in respect of Apotex’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex that the Company believes differs from the generic version in the previous lawsuit.
Noxafil — In August 2015, the Company filed a lawsuit against Actavis Laboratories Fl, Inc. (Actavis) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. The lawsuit automatically stays FDA approval of Actavis’s application until December 2017 or until an adverse court decision, if any, whichever may occur earlier.
In March 2016, the Company filed a lawsuit against Roxane Laboratories, Inc. (Roxane) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. The lawsuit automatically stays FDA approval of Roxane’s application until August 2018 or until an adverse court decision, if any, whichever may occur earlier.
In February 2016, the Company filed a lawsuit against Par Sterile Products LLC, Par Pharmaceutical, Inc., Par Pharmaceutical Companies, Inc. and Par Pharmaceutical Holdings, Inc. (collectively, Par) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. Since Par did not challenge an earlier expiring patent at issue in the Actavis and Crane litigation, if that patent is upheld, Par’s application to the FDA will not be approved until at least that patent expires in July 2019. If that patent is not upheld, the lawsuit automatically stays FDA approval of Roxane’s application until August 2018 or until an adverse court decision in this litigation, if any, whichever may occur earlier.
NuvaRing — In December 2013, the Company filed a lawsuit against a subsidiary of Allergan plc in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing. The trial in this matter was held in January 2016 and the Company is awaiting the court’s decision. In September 2015, the Company filed a lawsuit against Teva Pharma in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing.
The Company has been involved in ongoing litigation in Canada with Apotex concerning the Company’s patents related to lovastatin, alendronate, and norfloxacin. All of the litigation has now been either settled or concluded, subject, in one case involving lovastatin, to Apotex’s right to file a motion for reconsideration to the Supreme Court of Canada. As a consequence of the conclusion of all of this litigation, in the second quarter of 2016, if Apotex does not move for reconsideration or such motion is denied, the Company will record a net gain of approximately $100 million.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
Anti-PD-1 Antibody Patent Oppositions and Litigation
As previously disclosed, Ono Pharmaceutical Co. (Ono) has a European patent (EP 1 537 878) (’878) that broadly claims the use of an anti-PD-1 antibody, such as the Company’s immunotherapy, Keytruda, for the treatment of cancer. Ono has previously licensed its commercial rights to an anti-PD-1 antibody to Bristol-Myers Squibb (BMS) in certain markets. The Company believes that the ’878 patent is invalid and filed an opposition in the European Patent Office (EPO) seeking its revocation. In June 2014, the Opposition Division of the EPO found the claims in the ’878 patent are valid. The Company received the Opposition Division’s written opinion in September 2014 and the Company submitted its substantive appeal in February 2015. In April 2014, the Company, and three other companies, opposed another European patent (EP 2 161 336) (’336) owned by BMS and Ono that it believes is invalid. The ’336 patent, if valid, broadly claims anti-PD-1 antibodies that could include Keytruda. BMS and Ono recently submitted a request to amend the claims of the ’336 patent. If the EPO allows this amendment, the claims of the ’336 patent would no longer broadly claim anti-PD-1 antibodies such as Keytruda.
In May 2014, the Company filed a lawsuit in the UK seeking revocation of the UK national versions of both the ’878 and ’336 patents. In July 2014, Ono and BMS sued the Company seeking a declaration that the ’878 patent would be infringed in the UK by the marketing of Keytruda. The Company has sought a declaration from the UK court that Keytruda will not infringe the ’336 patent in the UK. BMS and Ono notified the Company of their request to amend the claims of the EPO ’336 patent and of their intention to seek permission from the court to similarly amend the UK national version so that the claims of the ’336 patent would no longer broadly claim anti-PD-1 antibodies such as Keytruda. A trial was held in the UK in July 2015. At that trial, the issues of validity and infringement of the ’878 patent were heard at the same time by the court. In October 2015, the court issued its judgment, finding the ’878 patent valid and infringed. Merck appealed this judgment. The appeal is scheduled to be heard in March 2017.
In February 2015, the Company filed lawsuits in the Netherlands seeking revocation of the Dutch national versions of both the ’878 and ’336 patents. BMS and Ono amended the claims of the ’336 patent so that the claims of the ’336 patent no longer broadly claim anti-PD-1 antibodies such as Keytruda. Trial regarding the validity and infringement of the ’878 patent was held in January 2016 and the Company is anticipating a decision in May 2016.
In December 2015, BMS and Ono filed lawsuits against the Company in France, Ireland, Switzerland and Germany alleging infringement of the ’878 patent. In January 2016, BMS and Ono filed a lawsuit against the Company in Spain alleging infringement of the ’878 patent. In France, BMS and Ono have filed for preliminary relief seeking payment of damages while the case is pending. A hearing on this preliminary relief was held in February 2016 and BMS’s and Ono’s request for preliminary relief was denied. Dates for trials regarding the validity and infringement of the Irish, French, Swiss and Spanish national versions of the ’878 patent have not yet been scheduled. A trial concerning the infringement of the German version of the ’878 patent is currently scheduled to begin in March 2017.
The Company continues to believe the ’878 patent is invalid.
The Company can file lawsuits seeking revocation of the ’336 and ’878 patents in other national courts in Europe at any time, and Ono and BMS can file patent infringement actions against the Company in other national courts in Europe at or around the time the Company launches Keytruda. If a national court determines that the Company infringed a valid claim in the ’878 or ’336 patent, Ono and BMS may be entitled to monetary damages, including royalties on future sales of Keytruda, and potentially could seek an injunction to prevent the Company from marketing Keytruda in that country.
The USPTO granted US Patent Nos. 8,728,474 to Ono and 8,779,105 to Ono and BMS. These patents are equivalent to the ’878 and ’336 patents, respectively. In September 2014, BMS and Ono filed a lawsuit in the United States alleging that, by marketing Keytruda, the Company will infringe US Patent No. 8,728,474. BMS and Ono are not seeking to prevent or stop the marketing of Keytruda in the United States. The trial in this matter is currently scheduled to begin in April 2017. The Company believes that the 8,728,474 patent and the 8,779,105 patent are both invalid. Recently, Ono filed lawsuits in the United States alleging that, by marketing Keytruda, the Company will infringe US Patent Nos. 9,067,999 and 9,073,994, which are patents related to the 8,728,474 patent. The Company believes the 9,067,999 and 9,073,994 patents are also invalid.
On April 15, 2016, the Company filed a declaratory judgment action in the United States against BMS and Ono seeking a ruling that US Patent Nos. 8,779,105 and 9,084,776 are invalid and/or not infringed by the sale of Keytruda. These patents are equivalents of the ’336 patent.
In September 2014, the Company filed a lawsuit in Australia seeking the revocation of Australian Patent No. 2011203119, which is equivalent to the ’336 patent. In March 2015, BMS and Ono counterclaimed in this matter alleging that the Company’s manufacture and supply of Keytruda to the Australian market will infringe Australian Patent No. 2011203119. A trial on this patent is scheduled for September 2017.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
Ono and BMS have similar and other patents and applications, which the Company is closely monitoring, pending in the United States, Japan and other countries.
The Company is confident that it will be able to market Keytruda in any country in which it is approved and that it will not be prevented from doing so by the Ono or BMS patents or any pending applications.
Gilead Patent Litigation and Opposition
In August 2013, Gilead Sciences, Inc. (Gilead) filed a lawsuit in the United States District Court for the Northern District of California seeking a declaration that two Company patents were invalid and not infringed by the sale of their two sofosbuvir containing products, Solvadi and Harvoni. The Company filed a counterclaim that the sale of these products did infringe these two patents and sought a reasonable royalty for the past, present and future sales of these products. In March 2016, at the conclusion of a jury trial, the patents were found to be not invalid and infringed. The jury awarded the Company $200 million as a royalty for sales of these products up to December 2015. After the conclusion of the jury trial, the judge held a bench trial on the equitable defenses raised by Gilead. The parties have completed their briefing and argument on these defenses and are awaiting the judge’s decision. The parties have agreed to sever the issue of a reasonable royalty for sales after March 2016. The Company will pay 20%, net of legal fees, of any damages or royalties that it is awarded to Ionis Pharmaceuticals, Inc.
The Company, through its Idenix Pharmaceuticals, Inc. subsidiary, has pending litigations against Gilead in the United States, the UK, Norway, Canada, Germany, France, and Australia based on different patent estates that would also be infringed by Gilead’s sales of these two products. Gilead has opposed the European patent at the EPO. Trial in the United States is currently scheduled for October and December 2016. In the UK, Norway, and Canada, the Company was initially unsuccessful and those cases are currently under appeal. The EPO opposition division revoked the European patent, and the Company is currently analyzing the decision and considering its options. The cases in France and Germany have been stayed pending the final decision of the EPO. The Australian patent was recently found to be invalid. The Company is currently analyzing the decision and considering its options.
Other Litigation
There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Company’s financial position, results of operations or cash flows either individually or in the aggregate.
Legal Defense Reserves
Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Company’s legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of March 31, 2016 and December 31, 2015 of approximately $250 million and $245 million, respectively, represents the Company’s best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Common Stock | Other Paid-In Capital | Retained Earnings | Accumulated Other Comprehensive Loss | Treasury Stock | Non- Controlling Interests | Total |
($ and shares in millions) | Shares | Par Value | Shares | Cost |
Balance at January 1, 2015 | 3,577 |
| $ | 1,788 |
| $ | 40,423 |
| $ | 46,021 |
| $ | (4,323 | ) | 739 |
| $ | (35,262 | ) | $ | 144 |
| $ | 48,791 |
|
Net income attributable to Merck & Co., Inc. | — |
| — |
| — |
| 953 |
| — |
| — |
| — |
| — |
| 953 |
|
Cash dividends declared on common stock | — |
| — |
| — |
| (1,282 | ) | — |
| — |
| — |
| — |
| (1,282 | ) |
Treasury stock shares purchased | — |
| — |
| — |
| — |
| — |
| 17 |
| (1,015 | ) | — |
| (1,015 | ) |
Share-based compensation plans and other | — |
| — |
| (68 | ) | — |
| — |
| (7 | ) | 374 |
| — |
| 306 |
|
Other comprehensive income | — |
| — |
| — |
| — |
| 156 |
| — |
| — |
| — |
| 156 |
|
Changes in noncontrolling ownership interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| 5 |
| 5 |
|
Net income attributable to noncontrolling interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| 5 |
| 5 |
|
Distributions attributable to noncontrolling interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| (2 | ) | (2 | ) |
Balance at March 31, 2015 | 3,577 |
| $ | 1,788 |
| $ | 40,355 |
| $ | 45,692 |
| $ | (4,167 | ) | 749 |
| $ | (35,903 | ) | $ | 152 |
| $ | 47,917 |
|
Balance at January 1, 2016 | 3,577 |
| $ | 1,788 |
| $ | 40,222 |
| $ | 45,348 |
| $ | (4,148 | ) | 796 |
| $ | (38,534 | ) | $ | 91 |
| $ | 44,767 |
|
Net income attributable to Merck & Co., Inc. | — |
| — |
| — |
| 1,125 |
| — |
| — |
| — |
| — |
| 1,125 |
|
Cash dividends declared on common stock | — |
| — |
| — |
| (1,281 | ) | — |
| — |
| — |
| — |
| (1,281 | ) |
Treasury stock shares purchased | — |
| — |
| — |
| — |
| — |
| 18 |
| (913 | ) | — |
| (913 | ) |
Share-based compensation plans and other | — |
| — |
| (77 | ) | — |
| — |
| (6 | ) | 322 |
| — |
| 245 |
|
Other comprehensive loss | — |
| — |
| — |
| — |
| (46 | ) | — |
| — |
| — |
| (46 | ) |
Net income attributable to noncontrolling interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| 5 |
| 5 |
|
Distributions attributable to noncontrolling interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| (1 | ) | (1 | ) |
Balance at March 31, 2016 | 3,577 |
| $ | 1,788 |
| $ | 40,145 |
| $ | 45,192 |
| $ | (4,194 | ) | 808 |
| $ | (39,125 | ) | $ | 95 |
| $ | 43,901 |
|
| |
10. | Share-Based Compensation Plans |
The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. The Company also issues RSUs to employees of certain of the Company’s equity method investees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant.
The following table provides the amounts of share-based compensation cost recorded in the Condensed Consolidated Statement of Income:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2016 | | 2015 |
Pretax share-based compensation expense | $ | 68 |
| | $ | 63 |
|
Income tax benefit | (20 | ) | | (19 | ) |
Total share-based compensation expense, net of taxes | $ | 48 |
| | $ | 44 |
|
Amounts in the table above do not reflect share-based compensation costs to settle non-vested Cubist equity awards attributable to postcombination service that were recognized as transaction expense in 2015 (see Note 2).
During the first three months of 2016 and 2015, the Company granted 133 thousand RSUs with a weighted-average grant date fair value of $48.83 per RSU and 87 thousand RSUs with a weighted-average grant date fair value of $58.33 per RSU, respectively. During the first three months of 2016 and 2015, the Company granted 74 thousand stock options with a weighted-average exercise price of $48.83 per option and 95 thousand stock options with a weighted-average exercise price of $58.33 per option, respectively. The weighted-average fair value of options granted for the first three months of 2016 and 2015 was $5.76 and $6.98 per option, respectively, and was determined using the following assumptions:
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
|
| | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Expected dividend yield | 3.8 | % | | 4.2 | % |
Risk-free interest rate | 1.3 | % | | 1.7 | % |
Expected volatility | 21.0 | % | | 21.7 | % |
Expected life (years) | 6.2 |
| | 6.3 |
|
At March 31, 2016, there was $689 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted-average period of 2.4 years.
The Company typically communicates the value of annual share-based compensation awards to employees during the first quarter, but the related share amounts are not established and communicated until early May. Therefore, while the number of RSU and stock option grants disclosed above do not reflect any amounts relating to the annual grants, share-based compensation costs for the first quarter of 2016 and 2015 and unrecognized compensation expense at March 31, 2016 reflect an impact relating to the awards communicated to employees. For segment reporting, share-based compensation costs are unallocated expenses.
| |
11. | Pension and Other Postretirement Benefit Plans |
The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. The net periodic benefit cost (credit) of such plans consisted of the following components:
|
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
($ in millions) | U.S. | | International | | U.S. | | International |
Service cost | $ | 73 |
| | $ | 58 |
| | $ | 83 |
| | $ | 66 |
|
Interest cost | 113 |
| | 52 |
| | 109 |
| | 53 |
|
Expected return on plan assets | (210 | ) | | (95 | ) | | (206 | ) | | (97 | ) |
Net amortization | 15 |
| | 19 |
| | 43 |
| | 27 |
|
Termination benefits | 4 |
| | — |
| | 16 |
| | 1 |
|
Curtailments | — |
| | 1 |
| | (7 | ) | | — |
|
Settlements | — |
| | — |
| | — |
| | 2 |
|
| $ | (5 | ) | | $ | 35 |
| | $ | 38 |
| | $ | 52 |
|
The Company provides medical benefits, principally to its eligible U.S. retirees and similar benefits to their dependents, through its other postretirement benefit plans. The net cost (credit) of such plans consisted of the following components:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2016 | | 2015 |
Service cost | $ | 13 |
| | $ | 20 |
|
Interest cost | 21 |
| | 27 |
|
Expected return on plan assets | (35 | ) | | (36 | ) |
Net amortization | (26 | ) | | (15 | ) |
Termination benefits | 1 |
| | 4 |
|
Curtailments | (1 | ) | | (6 | ) |
| $ | (27 | ) | | $ | (6 | ) |
In connection with restructuring actions (see Note 3), termination charges were recorded on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring actions, curtailments and settlements were recorded on pension and other postretirement benefit plans as reflected in the tables above.
The Company currently expects that, following certain allowable administrative actions expected to occur later in 2016, approximately $1.0 billion of other postretirement benefit plan assets will no longer be restricted for retiree benefits and will be available to fund certain other health and welfare benefits.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
| |
12. | Other (Income) Expense, Net |
Other (income) expense, net, consisted of:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2016 | | 2015 |
Interest income | $ | (79 | ) | | $ | (74 | ) |
Interest expense | 172 |
| | 164 |
|
Exchange losses | 38 |
| | 95 |
|
Equity income from affiliates | (34 | ) | | (145 | ) |
Other, net | (49 | ) | | 15 |
|
| $ | 48 |
| | $ | 55 |
|
The decrease in equity income from affiliates in the first quarter of 2016 as compared with the first quarter of 2015 was driven primarily by lower equity income from certain research investment funds.
Other, net (as reflected in the table above) in the first quarter of 2015 includes an expense of $78 million for a contribution of investments in equity securities to the Merck Foundation.
Interest paid for the three months ended March 31, 2016 and 2015 was $160 million and $138 million, respectively.
The effective income tax rates of 30.4% and 30.6% for the first quarter of 2016 and 2015, respectively, reflect the impacts of acquisition and divestiture-related costs and restructuring costs, partially offset by the beneficial impact of foreign earnings.
The Company is under examination by numerous tax authorities in various jurisdictions globally. The ultimate finalization of the Company’s examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. However, there is one item that is currently under discussion with the Internal Revenue Service relating to the 2006 through 2008 examination. The Company has concluded that its position should be sustained upon audit. However, if this item were to result in an unfavorable outcome or settlement, it could have a material adverse impact on the Company’s financial position, liquidity and results of operations.
The calculations of earnings per share are as follows:
|
| | | | | | | |
| Three Months Ended March 31, |
($ and shares in millions except per share amounts) | 2016 | | 2015 |
Net income attributable to Merck & Co., Inc. | $ | 1,125 |
| | $ | 953 |
|
Average common shares outstanding | 2,774 |
| | 2,835 |
|
Common shares issuable (1) | 21 |
| | 30 |
|
Average common shares outstanding assuming dilution | 2,795 |
| | 2,865 |
|
Basic earnings per common share attributable to Merck & Co., Inc. common shareholders | $ | 0.41 |
| | $ | 0.34 |
|
Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders | $ | 0.40 |
| | $ | 0.33 |
|
| |
(1) | Issuable primarily under share-based compensation plans. |
For the three months ended March 31, 2016 and 2015, 10 million and 3 million, respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
| |
15. | Other Comprehensive Income (Loss) |
Changes in AOCI by component are as follows:
|
| | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, |
($ in millions) | Derivatives | | Investments | | Employee Benefit Plans | | Cumulative Translation Adjustment | | Accumulated Other Comprehensive Income (Loss) |
Balance January 1, 2015, net of taxes | $ | 530 |
| | $ | 111 |
| | $ | (2,986 | ) | | $ | (1,978 | ) | | $ | (4,323 | ) |
Other comprehensive income (loss) before reclassification adjustments, pretax | 565 |
| | 93 |
| | 6 |
| | (53 | ) | | 611 |
|
Tax | (198 | ) | | (10 | ) | | (3 | ) | | (124 | ) | | (335 | ) |
Other comprehensive income (loss) before reclassification adjustments, net of taxes | 367 |
| | 83 |
| | 3 |
| | (177 | ) | | 276 |
|
Reclassification adjustments, pretax | (171 | ) | (1) | (56 | ) | (2) | 54 |
| (3) | — |
| | (173 | ) |
Tax | 56 |
| | 19 |
| | (22 | ) | | — |
| | 53 |
|
Reclassification adjustments, net of taxes | (115 | ) |
| (37 | ) |
| 32 |
|
| — |
| | (120 | ) |
Other comprehensive income (loss), net of taxes | 252 |
| | 46 |
| | 35 |
| | (177 | ) | | 156 |
|
Balance March 31, 2015, net of taxes | $ | 782 |
| | $ | 157 |
| | $ | (2,951 | ) | | $ | (2,155 | ) | | $ | (4,167 | ) |
| | | | | | | | | |
Balance January 1, 2016, net of taxes | $ | 404 |
| | $ | 41 |
| | $ | (2,407 | ) | | $ | (2,186 | ) | | $ | (4,148 | ) |
Other comprehensive income (loss) before reclassification adjustments, pretax | (167 | ) | | 54 |
| | (35 | ) | | 99 |
| | (49 | ) |
Tax | 58 |
| | 16 |
| | (1 | ) | | 22 |
| | 95 |
|
Other comprehensive income (loss) before reclassification adjustments, net of taxes | (109 | ) | | 70 |
| | (36 | ) | | 121 |
| | 46 |
|
Reclassification adjustments, pretax | (143 | ) | (1) | (11 | ) | (2) | 7 |
| (3) | — |
| | (147 | ) |
Tax | 50 |
| | 4 |
| | 1 |
| | — |
| | 55 |
|
Reclassification adjustments, net of taxes | (93 | ) |
| (7 | ) |
| 8 |
|
| — |
| | (92 | ) |
Other comprehensive income (loss), net of taxes | (202 | ) | | 63 |
| | (28 | ) | | 121 |
| | (46 | ) |
Balance March 31, 2016, net of taxes | $ | 202 |
| | $ | 104 |
| | $ | (2,435 | ) | | $ | (2,065 | ) | | $ | (4,194 | ) |
| |
(1) | Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales. |
| |
(2) | Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI |