10-Q 1 d351112d10q.htm FORM 10-Q FORM 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

 

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from         to         

Commission File No. 1-6571

Merck & Co., Inc.

One Merck Drive

Whitehouse Station, N.J. 08889-0100

(908) 423-1000

 

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 July 31, 2012:    3,045,632,274

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 þ    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 þ    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):

 

Large accelerated filer þ

  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 þ


Part I - Financial Information

Item 1.  Financial Statements

MERCK & CO., INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENT OF INCOME

(Unaudited, $ in millions except per share amounts)

 

         Three Months Ended     
June  30,
              Six Months Ended      
June  30,
 
          2012            2011                2012          2011  

Sales

      $     12,311          $     12,151              $     24,041          $     23,732   

Costs, Expenses and Other

         

Materials and production

    4,112        4,284          8,150        8,343   

Marketing and administrative

    3,249        3,525          6,322        6,689   

Research and development

    2,165        1,936          4,026        4,094   

Restructuring costs

    144        668          363        654   

Equity income from affiliates

    (142     (55       (253     (193

Other (income) expense, net

    103        121            247        744   
      9,631        10,479            18,855        20,331   

Income Before Taxes

    2,680        1,672          5,186        3,401   

Taxes on Income

    860        (382         1,599        276   

Net Income

    $       1,820        $       2,054          $       3,587        $       3,125   

Less: Net Income Attributable to Noncontrolling Interests

    27        30            56        58   

Net Income Attributable to Merck & Co., Inc.

    $       1,793        $       2,024            $       3,531        $       3,067   

Basic Earnings per Common Share Attributable to

         

Merck & Co., Inc. Common Shareholders

    $         0.59        $         0.65            $         1.16        $         0.99   

Earnings per Common Share Assuming Dilution Attributable

         

to Merck & Co., Inc. Common Shareholders

    $         0.58        $         0.65            $         1.15        $         0.98   

Dividends Declared per Common Share

    $         0.42        $         0.38            $         0.84        $         0.76   

The accompanying notes are an integral part of this consolidated financial statement.

 

- 2 -


MERCK & CO., INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Unaudited, $ in millions)

 

    Three Months Ended
June 30,
        

Six Months Ended

June 30,

 
          2012                2011                     2012               2011      

Net Income Attributable to Merck & Co., Inc.

    $ 1,793          $ 2,024               $ 3,531          $ 3,067    

Other Comprehensive Income Net of Taxes:

            

Net unrealized gain (loss) on derivatives, net of reclassifications

    102          (30)            44          (137)   

Net unrealized gain (loss) on investments, net of reclassifications

            (4)            30          (5)   

Benefit plan net gain (loss) and prior service cost (credit), net of amortization

    18          10             18          28    

Cumulative translation adjustment

    (30)         418               (86)         554    
      91          394                       440    

Comprehensive Income Attributable to Merck & Co., Inc.

    $       1,884          $        2,418               $       3,537          $       3,507    

The accompanying notes are an integral part of this consolidated financial statement.

 

- 3 -


MERCK & CO., INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

(Unaudited, $ in millions except per share amounts)

 

      June 30,  
2012  
    December 31,
2011
 

Assets

    

Current Assets

    

Cash and cash equivalents

   $ 16,752      $ 13,531   

Short-term investments

     698        1,441   

Accounts receivable (net of allowance for doubtful accounts of $144 in 2012 and $131 in 2011)

     8,152        8,261   

Inventories (excludes inventories of $1,490 in 2012 and $1,379 in 2011 classified in Other assets - see Note 6)

     6,249        6,254   

Deferred income taxes and other current assets

     3,788        3,694   

Total current assets

     35,639        33,181   

Investments

     4,085        3,458   

Property, Plant and Equipment, at cost, net of accumulated depreciation of $17,049 in 2012 and $16,176 in 2011

     15,867        16,297   

Goodwill

     12,158        12,155   

Other Intangibles, Net

     31,620        34,302   

Other Assets

     6,156        5,735   
     $         105,525      $ 105,128   

Liabilities and Equity

    

Current Liabilities

    

Loans payable and current portion of long-term debt

   $ 3,922      $ 1,990   

Trade accounts payable

     1,674        2,023   

Accrued and other current liabilities

     8,917        10,170   

Income taxes payable

     1,091        781   

Dividends payable

     1,308        1,281   

Total current liabilities

     16,912        16,245   

Long-Term Debt

     15,057        15,525   

Deferred Income Taxes and Noncurrent Liabilities

     15,883        16,415   

Merck & Co., Inc. Stockholders’ Equity

    

Common stock, $0.50 par value

    

Authorized - 6,500,000,000 shares

    

Issued - 3,577,103,522 shares in 2012 and 2011

     1,788        1,788   

Other paid-in capital

     40,550        40,663   

Retained earnings

     39,950        38,990   

Accumulated other comprehensive loss

     (3,126     (3,132
     79,162        78,309   

Less treasury stock, at cost:

    

538,194,526 shares in 2012 and 536,109,713 shares in 2011

     23,968        23,792   

Total Merck & Co., Inc. stockholders’ equity

     55,194        54,517   

Noncontrolling Interests

     2,479        2,426   

Total equity

     57,673        56,943   
     $ 105,525      $ 105,128   

The accompanying notes are an integral part of this consolidated financial statement.

 

- 4 -


MERCK & CO., INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited, $ in millions)

 

          Six Months Ended      
June 30,
 
          2012              2011      

Cash Flows from Operating Activities

   

Net income

      $       3,587          $       3,125   

Adjustments to reconcile net income to net cash provided by operating activities:

   

Depreciation and amortization

    3,594        3,663   

Intangible asset impairment charges

    136        439   

Equity income from affiliates

    (253     (193

Dividends and distributions from equity affiliates

    122        121   

Deferred income taxes

    (365     (841

Share-based compensation

    169        200   

Other

    143        (456

Net changes in assets and liabilities

    (2,059     (1,485

Net Cash Provided by Operating Activities

    5,074        4,573   

Cash Flows from Investing Activities

   

Capital expenditures

    (762     (689

Purchases of securities and other investments

    (4,001     (3,066

Proceeds from sales of securities and other investments

    4,174        2,890   

Dispositions of businesses, net of cash divested

    -        323   

Acquisitions of businesses, net of cash acquired

    -        (373

Other

    21        (28

Net Cash Used in Investing Activities

    (568     (943

Cash Flows from Financing Activities

   

Net change in short-term borrowings

    1,637        1,396   

Payments on debt

    (2     (1,265

Purchases of treasury stock

    (985     (314

Dividends paid to stockholders

    (2,559     (2,351

Proceeds from exercise of stock options

    601        162   

Other

    (3     (57

Net Cash Used in Financing Activities

    (1,311     (2,429

Effect of Exchange Rate Changes on Cash and Cash Equivalents

    26        241   

Net Increase in Cash and Cash Equivalents

    3,221        1,442   

Cash and Cash Equivalents at Beginning of Year

    13,531        10,900   

Cash and Cash Equivalents at End of Period

    $     16,752        $     12,342   

The accompanying notes are an integral part of this consolidated financial statement.

 

- 5 -


Notes to Consolidated Financial Statements (unaudited)

1.   Basis of Presentation

The accompanying unaudited interim 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 28, 2012.

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 presentation 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 year presentation.

Recently Adopted Accounting Standards

In the first quarter of 2012, the Company retrospectively adopted amended guidance issued by the Financial Accounting Standards Board (the “FASB”) on the presentation of comprehensive income in financial statements. As a result of adopting this standard, the Company has presented a separate Statement of Comprehensive Income. The adoption of this new guidance did not impact the Company’s financial position, results of operations or cash flows.

Recently Issued Accounting Standards

In July 2012, the FASB issued amended guidance that simplifies how an entity tests indefinite-lived intangibles for impairment. The amended guidance will allow companies to first assess qualitative factors to determine whether it is more-likely-than-not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. The updated guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company is currently evaluating the impact of adoption on its financial position and results of operations.

2.   Restructuring

Merger Restructuring Program

In February 2010, subsequent to the Merck and Schering-Plough Corporation (“Schering-Plough”) merger (the “Merger”), the Company commenced actions under a global restructuring program (the “Merger Restructuring Program”) in conjunction with the integration of the legacy Merck and legacy Schering-Plough businesses. This Merger Restructuring Program is intended to optimize the cost structure of the combined company. In July 2011, the Company announced the latest phase of the Merger Restructuring Program during which the Company expects to reduce its workforce measured at the time of the Merger by an additional 12% to 13% across the Company worldwide. A majority of the workforce reductions in this phase of the Merger Restructuring Program relate to manufacturing (including Animal Health), administrative and headquarters organizations. Previously announced workforce reductions of approximately 17% in earlier phases of the program primarily reflect the elimination of positions in sales, administrative and headquarters organizations, as well as from the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company will continue to hire employees in strategic growth areas of the business as necessary. The Company will continue to pursue productivity efficiencies and evaluate its manufacturing supply chain capabilities on an ongoing basis which may result in future restructuring actions.

The Company recorded total pretax restructuring costs of $291 million and $808 million in the second quarter of 2012 and 2011, respectively, and $568 million and $921 million in the first six months of 2012 and 2011, respectively, related to this program. Since inception of the Merger Restructuring Program through June 30, 2012, Merck has recorded total pretax accumulated costs of approximately $5.7 billion and eliminated approximately 20,230 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The restructuring actions under the Merger Restructuring Program are expected to be substantially completed by the end of 2013, with the exception of certain actions, principally manufacturing-related, which are expected to be substantially completed by 2015. The Company originally estimated the total cumulative pretax costs for this program to be approximately $5.8 billion to $6.6 billion and the Company now expects the cumulative costs to be near the upper end of this range. The Company estimates that approximately two-thirds of the cumulative pretax costs relate to cash outlays, primarily related to employee separation expense. Approximately one-third of the

 

- 6 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.

2008 Global Restructuring Program

In October 2008, Merck announced a global restructuring program (the “2008 Restructuring Program”) to reduce its cost structure, increase efficiency, and enhance competitiveness. As part of the 2008 Restructuring Program, the Company expects to eliminate approximately 7,200 positions — 6,800 active employees and 400 vacancies — across the Company worldwide. Pretax restructuring costs of $(4) million and $1 million were recorded in the second quarter of 2012 and 2011, respectively, and $10 million and $5 million were recorded in the first six months of 2012 and 2011, respectively, related to the 2008 Restructuring Program. Since inception of the 2008 Restructuring Program through June 30, 2012, Merck has recorded total pretax accumulated costs of $1.6 billion and eliminated approximately 6,390 positions comprised of employee separations and the elimination of contractors and vacant positions. The 2008 Restructuring Program was substantially completed in 2011, with the exception of certain manufacturing-related actions, which are expected to be completed by 2015, with the total cumulative pretax costs estimated to be up to $2.0 billion. The Company estimates that two-thirds of the cumulative pretax costs relate to cash outlays, primarily from 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 Merger Restructuring Program and 2008 Restructuring Program activities by type of cost:

 

    Three Months Ended June 30, 2012          Six Months Ended June 30, 2012  
($ in millions)   Separation
Costs
    Accelerated
Depreciation
     Other     Total           Separation
Costs
    Accelerated
Depreciation
           Other     Total  

Merger Restructuring Program

                                                                           

Materials and production

  $ -      $ 56       $         20      $ 76         $ -      $ 33          $ 37      $ 70   

Marketing and administrative

    -        20         1        21           -        43            2        45   

Research and development

    -        41         -        41           -        82            4        86   

Restructuring costs

    124        -         29        153             304        -              63        367   
      124        117         50        291             304        158              106        568   

2008 Restructuring Program

                                                                           

Materials and production

    -        1         4        5           -        3            11        14   

Restructuring costs

    (13     -         4        (9          (11     -              7        (4
      (13     1         8        (4          (11     3              18        10   
    $         111      $         118       $ 58      $        287           $        293      $        161            $        124      $         578   
   

 

Three Months Ended June 30, 2011

         Six Months Ended June 30, 2011  
($ in millions)   Separation
Costs
    Accelerated
Depreciation
     Other     Total           Separation
Costs
    Accelerated
Depreciation
           Other     Total  

Merger Restructuring Program

                                                                           

Materials and production

  $ -      $ 91       $ 5      $ 96         $ -      $ 152          $ 5      $ 157   

Marketing and administrative

    -        22         1        23           -        45            1        46   

Research and development

    -        38         (22     16           -        80            (19     61   

Restructuring costs

    646        -         27        673             607        -              50        657   
      646        151         11        808             607        277              37        921   

2008 Restructuring Program

                                                                           

Materials and production

    -        4         2        6           -        6            2        8   

Restructuring costs

    (7     -         2        (5          (8     -              5        (3
      (7     4         4        1             (8     6              7        5   
    $ 639      $ 155       $ 15      $ 809           $ 599      $ 283            $ 44      $ 926   

Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. In the second quarter of 2012 and 2011, approximately 780 positions and 585 positions, respectively, were eliminated under the Merger Restructuring Program. In addition, approximately 60 positions were eliminated in the second quarter of 2011 under the 2008 Restructuring Program. In the first six months of 2012 and 2011, approximately 1,800 positions and 1,335 positions, respectively, were eliminated under the Merger Restructuring Program and approximately 140 positions and 180 positions,

 

- 7 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

respectively, were eliminated under the 2008 Restructuring Program. 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 cash flows were sufficient to recover the respective book values, Merck was required to accelerate depreciation of the site assets rather than write them off immediately. 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 2012 and 2011 includes asset abandonment, shut-down and other related costs. Additionally, other activity includes employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans (see Note 12) and share-based compensation costs.

The following table summarizes the charges and spending relating to Merger Restructuring Program and 2008 Restructuring Program activities for the six months ended June 30, 2012:

 

($ in millions)    Separation
Costs
    Accelerated
Depreciation
      Other           Total        

Merger Restructuring Program

                                

Restructuring reserves January 1, 2012

   $ 1,144      $ -      $ 51      $ 1,195   

Expense

     304        158        106        568   

(Payments) receipts, net

     (634     -        (66     (700

Non-cash activity

     -        (158     (51     (209

Restructuring reserves June 30, 2012 (1)

   $      814      $             -      $           40      $          854   

2008 Restructuring Program

                                

Restructuring reserves January 1, 2012

   $ 126      $ -      $ -      $ 126   

Expense

     (11     3        18        10   

(Payments) receipts, net

     (15     -        (8     (23

Non-cash activity

     -        (3     (10     (13

Restructuring reserves June 30, 2012 (1)

   $ 100      $ -      $ -      $ 100   

 

(1) 

The cash outlays associated with the Merger Restructuring Program are expected to be substantially completed by the end of 2013 with the exception of certain actions, principally manufacturing-related, which are expected to be substantially completed by 2015. The cash outlays associated with the remaining restructuring reserves for the 2008 Restructuring Program are primarily manufacturing-related and are expected to be completed by the end of 2015.

Legacy Schering-Plough Program

Prior to the Merger, Schering-Plough commenced a Productivity Transformation Program which was designed to reduce and avoid costs and increase productivity. The Company recorded accelerated depreciation costs included in Materials and production costs of $2 million and $7 million for the second quarter of 2012 and 2011, respectively, and $4 million and $16 million for the first six months of 2012 and 2011, respectively. The remaining reserve associated with this program, which is substantially complete, was $18 million at June 30, 2012.

3.   Acquisitions, Divestitures, Research Collaborations and License Agreements

In April 2012, the Company entered into an agreement with Endocyte, Inc. (“Endocyte”) to develop and commercialize Endocyte’s novel investigational therapeutic candidate vintafolide (MK-8109). Vintafolide is currently being evaluated in a Phase III clinical trial for platinum-resistant ovarian cancer (PROCEED) and a Phase II trial for non-small cell lung cancer. Under the agreement, Merck gained worldwide rights to develop and commercialize vintafolide. Endocyte received a $120 million upfront payment, which the Company recorded in Research and development expenses in the second quarter of 2012, and is eligible for milestone payments of up to $880 million based on the successful achievement of development, regulatory and commercialization goals for vintafolide for a total of six cancer indications. In addition, if vintafolide receives regulatory approval, Endocyte will receive an equal share of the profit in the United States as well as a royalty on sales of

 

- 8 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

the product in the rest of the world. Endocyte has retained the right to co-promote vintafolide with Merck in the United States and Merck has the exclusive right to promote vintafolide in the rest of world. Endocyte will be responsible for the majority of funding and completion of the PROCEED trial. Merck will be responsible for most other development activities, all other costs and will have most decision rights for vintafolide. Merck has the right to terminate the agreement on 90 days notice. Merck and Endocyte both have the right to terminate the agreement due to the material breach or insolvency of the other party. Endocyte has the right to terminate the agreement in the event that Merck challenges an Endocyte patent right relating to vintafolide. Upon termination of the agreement, depending upon the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of vintafolide and, in the case of termination for cause by Merck, certain royalty obligations and U.S. profit and loss sharing.

In May 2011, Merck completed the acquisition of Inspire Pharmaceuticals, Inc. (“Inspire”), a specialty pharmaceutical company focused on developing and commercializing ophthalmic products. Under the terms of the merger agreement, Merck acquired all outstanding shares of common stock of Inspire at a price of $5.00 per share in cash for a total of approximately $420 million. 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. The determination of fair value requires management to make significant estimates and assumptions. In connection with the acquisition, substantially all of the purchase price was allocated to Inspire’s product and product right intangible assets and related deferred tax liabilities, a deferred tax asset relating to Inspire’s net operating loss carryforwards, and goodwill. This transaction closed on May 16, 2011, and accordingly, the results of operations of the acquired business have been included in the Company’s results of operations since the acquisition date. Pro forma financial information has not been included because Inspire’s historical financial results are not significant when compared with the Company’s financial results.

In March 2011, the Company sold the Merck BioManufacturing Network, a provider of contract manufacturing and development services for the biopharmaceutical industry and wholly owned by Merck, to Fujifilm Corporation (“Fujifilm”). Under the terms of the agreement, Fujifilm purchased all of the equity interests in two Merck subsidiaries which together owned all of the assets of the Merck BioManufacturing Network comprising facilities located in Research Triangle Park, North Carolina and Billingham, United Kingdom. As part of the agreement with Fujifilm, Merck has committed to purchase certain development and manufacturing services at fair value from Fujifilm over a three-year period following the closing of the transaction. The transaction resulted in a gain of $127 million in the first six months of 2011 reflected in Other (income) expense, net.

4.   Collaborative Arrangements

The Company continues its strategy of establishing external alliances to complement its substantial internal research capabilities, including research collaborations, licensing preclinical and clinical compounds and technology platforms 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 new technologies across a broad range of therapeutic areas. These arrangements often include upfront payments and royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development, as well as expense reimbursements or payments to the third party.

Cozaar/Hyzaar

In 1989, Merck and E.I. duPont de Nemours and Company (“DuPont”) agreed to form a long-term research and marketing collaboration to develop a class of therapeutic agents for high blood pressure and heart disease, discovered by DuPont, called angiotensin II receptor antagonists, which include Cozaar and Hyzaar. In return, Merck provided DuPont marketing rights in the United States and Canada to its prescription medicines, Sinemet and Sinemet CR (the Company has since regained global marketing rights to Sinemet and Sinemet CR). Pursuant to a 1994 agreement with DuPont, the Company has an exclusive licensing agreement to market Cozaar and Hyzaar in return for royalties and profit share payments to DuPont. The patents that provided market exclusivity in the United States and in a number of major European markets for Cozaar and Hyzaar expired in 2010.

Remicade/Simponi

In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (“Centocor”), a Johnson & Johnson (“J&J”) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Plough’s subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi, a fully human monoclonal antibody. The Company had exclusive marketing rights to both products outside the United States, Japan and

 

- 9 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

certain other Asian markets. In December 2007, Schering-Plough and Centocor revised their distribution agreement regarding the development, commercialization and distribution of both Remicade and Simponi, extending the Company’s rights to exclusively market Remicade to match the duration of the Company’s exclusive marketing rights for Simponi. In addition, Schering-Plough and Centocor agreed to share certain development costs relating to Simponi’s auto-injector delivery system. On October 6, 2009, the European Commission approved Simponi as a treatment for rheumatoid arthritis and other immune system disorders in two presentations – a novel auto-injector and a prefilled syringe. As a result, the Company’s marketing rights for both products extend for 15 years from the first commercial sale of Simponi in the European Union (the “EU”) following the receipt of pricing and reimbursement approval within the EU. In April 2011, Merck and J&J reached an agreement to amend the agreement governing the distribution rights to Remicade and Simponi. Under the terms of the amended distribution agreement, Merck relinquished marketing rights for Remicade and Simponi to J&J in territories including Canada, Central and South America, the Middle East, Africa and Asia Pacific effective July 1, 2011. Merck retained exclusive marketing rights throughout Europe, Russia and Turkey (the “Retained Territories”). In addition, beginning July 1, 2011, all profits derived from Merck’s exclusive distribution of the two products in the Retained Territories are being equally divided between Merck and J&J. J&J also received a one-time payment from Merck of $500 million in April 2011, which the Company recorded as a charge to Other (income) expense, net in the first quarter of 2011.

5.   Financial Instruments

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 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 sales, such that it is probable the hedged transaction will occur. 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 premium 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.

 

- 10 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

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 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, unrealized gains or losses are recorded in Sales each period. The cash flows from these contracts are reported as operating activities in the 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 foreign currency denominated net monetary assets of foreign subsidiaries where the U.S. dollar is the 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.

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 the subsidiary. The cash flows from these contracts are reported as investing activities in the 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 gains (losses) of $92 million and $(178) million for the first six months of 2012 and 2011, respectively, from the euro-denominated notes.

 

- 11 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

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.

In June 2011, the Company terminated nine interest rate swap contracts with a total notional amount of $3.5 billion. These swaps effectively converted $3.5 billion of its fixed-rate notes, with maturity dates varying from March 2015 to June 2019, to floating rate instruments. As a result of the swap terminations, the Company received $175 million in cash, which included $36 million in accrued interest. The corresponding $139 million basis adjustment of the debt associated with the terminated swap contracts was deferred and is being amortized as a reduction of interest expense over the respective term of the notes. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.

At June 30, 2011, the Company was a party to 13 pay-floating, receive-fixed interest rate swap contracts with notional amounts of $1.9 billion in the aggregate designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes. The interest rate swap contracts were 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 benchmark interest rate were recorded in interest expense and offset by the fair value changes in the swap contracts. The Company terminated certain of these interest rate swap contracts in the third quarter of 2011 and the remaining interest rate swap contracts matured in the fourth quarter of 2011. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.

Presented in the table below is the fair value of derivatives segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments:

 

         June 30,2012      December 31, 2011  
         Fair Value of Derivative      U.S. Dollar      Fair Value of Derivative      U.S. Dollar  

($ in millions)

  Balance Sheet Caption      Asset         Liability         Notional         Asset         Liability         Notional   

Derivatives Designated as Hedging Instruments

  

Foreign exchange contracts (current)

 

Deferred income taxes and other current assets

     $ 279       $ -       $ 5,005         $ 196       $ -       $ 3,727   

Foreign exchange contracts (non-current)

 

Other assets

     470         -         5,177         420         -         4,956   

Foreign exchange contracts (current)

 

Accrued and other current liabilities

     -         13         411         -         53         1,718   

Foreign exchange contracts (non-current)

 

Deferred income taxes and noncurrent liabilities

     -         7         436         -         1         104   
           $ 749       $ 20       $ 11,029         $ 616       $ 54       $ 10,505   

Derivatives Not Designated as Hedging Instruments

  

Foreign exchange contracts (current)

 

Deferred income taxes and other current assets

     $ 100       $ -       $ 4,511         $ 139       $ -       $ 5,306   

Foreign exchange contracts (non-current)

 

Other assets

     35         -         339         -         -         -   

Foreign exchange contracts (current)

 

Accrued and other current liabilities

     -         28         3,740         -         54         5,013   
           $ 135       $ 28       $ 8,590         $ 139       $ 54       $ 10,319   
           $ 884       $ 48       $ 19,619         $ 755       $ 108       $ 20,824   

 

- 12 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

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 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      
June 30,
                Six Months Ended      
June 30,
 
($ in millions)          2012                 2011                       2012                 2011        

 

 

Derivatives designated in fair value hedging relationships

            

 

Interest rate swap contracts

            

Amount of gain recognized in Other (income) expense, net on derivatives

     $       -      $       (126)            $       -      $       (163)   

Amount of loss recognized in Other (income) expense, net on hedged item

     -        126             -        163    

Derivatives designated in foreign currency cash flow hedging relationships

            

 

Foreign exchange contracts

            

Amount of loss reclassified from AOCI to Sales

     26        20             53        27    

Amount of (gain) loss recognized in OCI on derivatives

     (154     69             (34     252    

Derivatives designated in foreign currency net investment hedging relationships

            

 

Foreign exchange contracts

            

Amount of gain recognized in Other (income) expense, net on derivatives (1)

     (2     (2)            (11     (8)   

Amount of loss (gain) recognized in OCI on derivatives

     86        33             (56     34    

Derivatives not designated in a hedging relationship

            

 

Foreign exchange contracts

            

Amount of (gain) loss recognized in Other (income) expense, net on derivatives (2)

     (279     33             (26     349    

 

 

 

(1) 

There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing.

(2) 

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 June 30, 2012, the Company estimates $2 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.

Investments in Debt and Equity Securities

Information on available-for-sale investments is as follows:

 

    June 30, 2012         December 31, 2011  
    Fair     Amortized     Gross Unrealized         Fair     Amortized     Gross Unrealized  
($ in millions)   Value     Cost     Gains     Losses         Value     Cost     Gains     Losses  

 

     

 

 

 

 

Corporate notes and bonds

  $ 2,787      $ 2,759      $ 30      $ (2)        $ 2,032      $ 2,024      $ 16      $ (8)   

U.S. government and agency securities

    773        772        1                 1,021        1,018        3          

Asset-backed securities

    441        439        2                 292        292        1        (1)   

Mortgage-backed securities

    271        270        2        (1)          223        223        1        (1)   

Commercial paper

    220        220        -                 1,029        1,029        -          

Foreign government bonds

    76        75        1                 72        72        -          

Other debt securities

    3        1        2                 3        1        2          

Equity securities

    383        354        29                 397        383        14          

 

 
  $ 4,954      $ 4,890      $ 67      $ (3)        $ 5,069      $ 5,042      $ 37      $ (10)   

 

 

Available-for-sale debt securities included in Short-term investments totaled $698 million at June 30, 2012. Of the remaining debt securities, $3.4 billion mature within five years. At June 30, 2012, there were no debt securities pledged as collateral.

 

- 13 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

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 are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. The Company had no Level 3 assets at June 30, 2012 or December 31, 2011.

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.

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)    June 30, 2012            December 31, 2011  

Assets

                          

Investments

                          

Corporate notes and bonds

   $ -       $ 2,787       $ -       $ 2,787          $ -       $ 2,032       $ -       $ 2,032   

U.S. government and agency securities

     -         773         -         773            -         1,021         -         1,021   

Asset-backed securities (1)

     -         441         -         441            -         292         -         292   

Mortgage-backed securities (1)

     -         271         -         271            -         223         -         223   

Commercial paper

     -         220         -         220            -         1,029         -         1,029   

Foreign government bonds

     -         76         -         76            -         72         -         72   

Equity securities

     203         9         -         212            205         22         -         227   

Other debt securities

     -         3         -         3            -         3         -         3   
       203         4,580         -         4,783              205         4,694         -         4,899   

Other assets

                          

Securities held for employee compensation

     171         -         -         171            170         -         -         170   
                          

Derivative assets (2)

                          

Purchased currency options

     -         763         -         763            -         613         -         613   

Forward exchange contracts

     -         121         -         121            -         142         -         142   
       -         884         -         884              -         755         -         755   

Total assets

   $           374       $      5,464       $             -       $      5,838            $           375       $      5,449       $             -       $      5,824   

Liabilities

                          

Derivative liabilities (2)

                          

Forward exchange contracts

   $ -       $ 48       $ -       $ 48          $ -       $ 107       $ -       $ 107   

Written currency options

     -         -         -         -            -         1         -         1   

Total liabilities

   $ -       $ 48       $ -       $ 48            $ -       $ 108       $ -       $ 108   

 

(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.

 

- 14 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

There were no transfers between Level 1 and Level 2 during the first six months of 2012. As of June 30, 2012, Cash and cash equivalents of $16.8 billion included $15.9 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy).

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 June 30, 2012 was $21.2 billion compared with a carrying value of $19.0 billion and at December 31, 2011 was $19.5 billion compared with a carrying value of $17.5 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. Approximately 40% of the Company’s cash and cash equivalents are invested in five highly rated money market funds.

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 credit worthiness 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 the global economic downturn and the sovereign debt issues in certain European countries. The Company continues to monitor the credit and economic conditions within Greece, Spain, Italy and Portugal, among other members of the EU. These economic conditions, as well as inherent variability of timing of cash receipts, have resulted in, and may continue to result in, an increase in the average length of time that it takes to collect accounts receivable outstanding. As such, time value of money discounts have been recorded for those customers for which collection of accounts receivable is expected to be in excess of one year. 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.

At June 30, 2012, the Company’s accounts receivable in Greece, Italy, Spain and Portugal totaled approximately $1.0 billion. Of this amount, hospital and public sector receivables were approximately $700 million in the aggregate, of which approximately 16%, 38%, 28% and 18% related to Greece, Italy, Spain and Portugal, respectively. As of June 30, 2012, the Company’s total accounts receivable outstanding for more than one year were approximately $200 million, of which approximately 70% related to accounts receivable in Greece, Italy, Spain and Portugal, mostly comprised of hospital and public sector receivables.

During the second quarter of 2012, the Company collected approximately $500 million of accounts receivable in connection with the Spanish government’s debt stabilization/stimulus plan. In addition, in the second and first quarters of 2012, the Company completed non-recourse factorings of approximately $120 million and $110 million, respectively, of hospital and public sector accounts receivable in Italy.

As previously disclosed, the Company received zero coupon bonds from the Greek government in settlement of 2007-2009 receivables related to certain government sponsored institutions. The Company had recorded impairment charges to reduce the bonds to fair value. During 2011, the Company sold a portion of these bonds and the remainder was sold during the first quarter of 2012.

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

 

- 15 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

counterparty. As of June 30, 2012 and December 31, 2011, the Company had received cash collateral of $539 million and $327 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 June 30, 2012 or December 31, 2011.

6.    Inventories

Inventories consisted of:

 

($ in millions)          June 30,       
2012
      December 31,  
2011
 

Finished goods

  $ 1,808      $ 1,983   

Raw materials and work in process

    5,705        5,396   

Supplies

    265        297   

Total (approximates current cost)

    7,778        7,676   

Reduction to LIFO costs

    (39     (43
    $ 7,739      $ 7,633   

Recognized as:

   

Inventories

  $ 6,249      $ 6,254   

Other assets

    1,490        1,379   

Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At both June 30, 2012 and December 31, 2011, these amounts included $1.3 billion of inventories not expected to be sold within one year. In addition, these amounts included $169 million and $127 million at June 30, 2012 and December 31, 2011, respectively, of inventories produced in preparation for product launches.

7.    Other Intangibles

In connection with mergers and acquisitions, the Company measures the fair value of marketed products and research and development pipeline programs and capitalizes these amounts. During the second quarter of 2012 and 2011, the Company recorded $127 million and $19 million, respectively, and during the first six months of 2012 and 2011, recorded $136 million and $321 million, respectively, of in-process research and development (“IPR&D”) impairment charges within Research and development expenses primarily for pipeline programs that had previously been deprioritized and were deemed to have no alternative use in the period. Also, during the second quarter of 2011, the Company recorded an intangible asset impairment charge of $118 million within Materials and production costs related to a marketed product. The Company may recognize additional non-cash impairment charges in the future related to other pipeline programs or marketed products and such charges could be material.

8.    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 and was comprised of the following:

 

   

    Three Months Ended    

June 30,

       

    Six Months Ended    

June 30,

 
($ in millions)   2012      2011          2012      2011  

AstraZeneca LP

  $ 140         $ 44        $ 253       $ 177   

Other (1)

    2           11            -         16   
    $ 142         $ 55          $ 253       $ 193   

 

(1) 

Includes results from Sanofi Pasteur MSD.

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”), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in

 

- 16 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

exchange for a 99% general partner interest. 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 June 2012, Merck and AstraZeneca amended the 1998 option agreement which gave AstraZeneca the option to buy Merck’s common stock interest in KBI and, through it, Merck’s interest in Nexium and Prilosec as well as AZLP. The updated agreement eliminates AstraZeneca’s option to acquire Merck’s interest in KBI in 2012 and provides AstraZeneca a new option to acquire Merck’s interest in KBI in June 2014. As a result of the amended agreement, Merck will continue to record supply sales and equity income from the partnership for the remainder of 2012 and 2013. In 2014, AstraZeneca has the option to purchase Merck’s interest in KBI based in part on the value of Merck’s interest in Prilosec and Nexium. AstraZeneca’s option is exercisable between March 1, 2014 and April 30, 2014. If AstraZeneca chooses to exercise this option, the closing date is expected to be June 30, 2014. Under the amended agreement, AstraZeneca will make a payment to Merck upon closing of $327 million, reflecting an estimate of the fair value of Merck’s interest in Nexium and Prilosec. This portion of the exercise price is subject to a true-up in 2018 based on actual sales from closing in 2014 to June 2018. The exercise price will also include an additional amount equal to a multiple of ten times Merck’s average 1% annual profit allocation in the partnership for the three-years prior to exercise. The Company believes that it is likely that AstraZeneca will exercise its option in 2014.

Summarized financial information for AZLP is as follows:

 

     Three Months Ended          Six Months Ended  
     June 30,          June 30,  
($ in millions)    2012      2011           2012      2011  

Sales

   $ 1,150       $           1,181         $ 2,192       $           2,336   

Materials and production costs

     520         516           959         1,061   

Other expense, net

     350         345             732         646   

Income before taxes (1)

   $ 280       $ 320           $ 501       $ 629   

 

(1) 

Merck’s partnership returns from AZLP are generally contractually determined and are not based on a percentage of income from AZLP, other than with respect to Merck’s 1% limited partnership interest.

9.    Contingencies and Environmental Liabilities

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 additional matters such as antitrust actions and environmental matters. Except for the Vioxx Litigation and the ENHANCE Litigation (each as defined below) for which separate assessments are provided in this Note, 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.

Given the preliminary nature of the litigation discussed below, including the Vioxx Litigation and the ENHANCE Litigation, 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

 

- 17 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

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 certain product liabilities effective August 1, 2004.

Vioxx Litigation

Product Liability Lawsuits

As previously disclosed, Merck is a defendant in approximately 100 federal and state lawsuits (the “Vioxx Product Liability Lawsuits”) alleging personal injury or economic loss as a result of the purchase or use of Vioxx. Most of the remaining 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.

There is one U.S. Vioxx Product Liability Lawsuit currently scheduled for trial in 2012. Merck has previously disclosed the outcomes of several Vioxx Product Liability Lawsuits that were tried prior to 2012. All post-trial appeals have been resolved.

There are pending in various U.S. courts putative class actions purportedly brought on behalf of individual purchasers or users of Vioxx seeking reimbursement for alleged economic loss. In the Vioxx MDL proceeding, approximately 30 such class actions remain. In June 2010, Merck moved to strike the class claims or for judgment on the pleadings regarding the master complaint, which includes the above-referenced cases, and briefing on that motion was completed in September 2010. The Vioxx MDL court heard oral argument on Merck’s motion in October 2010 and took it under advisement.

In 2008, a Missouri state court certified a class of Missouri plaintiffs seeking reimbursement for out-of-pocket costs relating to Vioxx. The Vioxx MDL court issued an order in April 2012 enjoining the Missouri plaintiffs from offering any evidence that does not sufficiently exclude damages attributable to claims already settled through the prior personal injury and third-party payor settlements and from executing any judgment obtained through admission of such evidence. The Missouri plaintiffs have appealed that decision to the U.S. Court of Appeals for the Fifth Circuit, which has set an expedited briefing schedule on plaintiffs’ appeal. Trial has been rescheduled for November 1, 2012, in light of the appeal. In Indiana, plaintiffs filed a motion to certify a class of Indiana Vioxx purchasers in a case pending before the Circuit Court of Marion County, Indiana. That case has been dormant for several years. In April 2010, a Kentucky state court denied Merck’s motion for summary judgment and certified a class of Kentucky plaintiffs seeking reimbursement for out-of-pocket costs relating to Vioxx. The trial court subsequently entered an amended class certification order in January 2011. Merck appealed that order to the Kentucky Court of Appeals and, on February 10, 2012, the Kentucky Court of Appeals reversed the trial court’s amended class certification order and denied certification. The plaintiff has petitioned the Kentucky Supreme Court to review the Court of Appeals’ order. Merck opposed the petition, and the Kentucky Supreme Court has not yet ruled.

Merck has also been named as a defendant in several lawsuits brought by, or on behalf of, government entities. Six of these suits are being brought by state Attorneys General and one has been brought on behalf of a county. All of these actions except for an action brought by the Kentucky Attorney General are in the Vioxx MDL proceeding. These actions allege that Merck misrepresented the safety of Vioxx. These suits seek recovery for expenditures on Vioxx by government-funded health care programs, such as Medicaid, and/or penalties for alleged Consumer Fraud Act violations. Judge Fallon remanded the Kentucky case to state court on January 3, 2012. Merck’s petition to appeal that decision to the U.S. Court of Appeals for the Fifth Circuit was denied. The lawsuit brought by the county is a putative class action filed by Santa Clara County, California on behalf of all similarly situated California counties. Merck moved for judgment on the pleadings in the case brought by Santa Clara County in September 2011. The court granted Merck’s motion on March 20, 2012, but gave the county leave to file an amended complaint.

Shareholder Lawsuits

As previously disclosed, in addition to the Vioxx Product Liability Lawsuits, various putative class actions and individual lawsuits under federal securities laws and state laws have been filed against Merck and various current and former officers and directors (the “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 Merck’s motion to dismiss the Fifth Amended Class Action Complaint in the consolidated securities action. Among other things, the claims based on statements made on or after the voluntary withdrawal of Vioxx on September 30, 2004 have been dismissed. In October 2011, defendants answered the Fifth Amended Class Action Complaint. Discovery is currently proceeding in accordance with the court’s scheduling order.

 

- 18 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

As previously disclosed, several individual securities lawsuits filed by foreign institutional investors also are consolidated with the Vioxx Securities Lawsuits. In October 2011, plaintiffs filed amended complaints in each of the pending individual securities lawsuits. Also in October 2011, a new individual securities lawsuit was filed in the District of New Jersey by several foreign institutional investors; that case is also consolidated with the Vioxx Securities Lawsuits. On January 20, 2012, defendants filed motions to dismiss in one of the individual lawsuits (the “ABP Lawsuit”). Briefing on the motions to dismiss was completed on March 26, 2012. On August 1, 2012, Judge Chesler granted in part and denied in part the motions to dismiss the ABP Lawsuit. Among other things, certain alleged misstatements and omissions were dismissed as inactionable and all state law claims were dismissed in full. By stipulation and order, defendants are not required to respond to the complaints in the remaining individual securities lawsuits until on or about September 15, 2012.

Insurance

The Company has Directors and Officers insurance coverage applicable to the Vioxx Securities Lawsuits with remaining stated upper limits of approximately $175 million. As a result of the previously disclosed insurance arbitration, additional insurance coverage for these claims should also be available, if needed, under upper-level excess policies that provide coverage for a variety of risks. There are disputes with the insurers about the availability of some or all of the Company’s insurance coverage for these claims and there are likely to be additional disputes. The amounts actually recovered under the policies discussed in this paragraph may be less than the stated upper limits.

Investigations

As previously disclosed, Merck received subpoenas from the Department of Justice (the “DOJ”) requesting information related to Merck’s research, marketing and selling activities with respect to Vioxx in a federal health care investigation under criminal statutes. As previously disclosed, in March 2009, Merck received a letter from the U.S. Attorney’s Office for the District of Massachusetts identifying it as a target of the grand jury investigation regarding Vioxx. In 2010, the Company established a $950 million reserve (the “Vioxx Liability Reserve”) in connection with the anticipated resolution of the DOJ’s investigation.

In November 2011, the Company announced that it had reached a resolution with federal and state authorities regarding this matter, pending court approval. Under civil settlement agreements signed with the United States and individually with 44 states and the District of Columbia, Merck paid approximately two-thirds of the Vioxx Liability Reserve to resolve civil allegations related to Vioxx. As a result, the United States and the participating states have released Merck from civil liability related to the government’s allegations regarding the sale and promotion of Vioxx. The Company also has agreed to plead guilty to one count of misdemeanor misbranding of Vioxx under the Federal Food, Drug, and Cosmetic Act by promoting the drug for the treatment of rheumatoid arthritis prior to the approval of that indication by the U.S. Food and Drug Administration (the “FDA”) in April 2002. The Company paid a fine of approximately one-third of the Vioxx Liability Reserve to the federal government as part of the plea agreement.

In December 2011, the U.S. District Court for the District of Massachusetts conducted a hearing with regard to the resolution. During that hearing, the parties advised the court as to the nature of the resolution and the core documents comprising the resolution. On April 19, 2012, the court accepted the resolution and thereafter the Company made the payments noted above.

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 Australia, Brazil, Canada, Europe and Israel (collectively, the “Vioxx Foreign Lawsuits”). As previously disclosed, the Company has entered into an agreement to resolve all claims related to Vioxx in Canada. The agreement is pending approval by courts in Canada’s provinces.

Reserves

The Company believes that it has meritorious defenses to the remaining Vioxx Product Liability Lawsuits, Vioxx Securities Lawsuits and Vioxx Foreign Lawsuits (collectively, the “Vioxx Lawsuits”) 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 Lawsuits. As previously disclosed, the Company has a reserve with respect to the Canada Settlement Agreement. The Company also has an immaterial remaining reserve relating to the Vioxx investigation discussed above for the non-participating states with which litigation is continuing. The Company has established no other liability reserves with respect to the Vioxx Litigation. Unfavorable outcomes in the Vioxx Litigation could have a material adverse effect on the Company’s financial position, liquidity and results of operations.

 

- 19 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

Other Product Liability Litigation

Fosamax

As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax (the “Fosamax Litigation”). As of June 30, 2012, approximately 3,615 cases, which include approximately 4,175 plaintiff groups, 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 1,200 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 2,415 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 (the “JPML”) ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation (the “Fosamax ONJ MDL”) for coordinated pre-trial proceedings. The Fosamax ONJ MDL has been transferred to Judge John Keenan in the U.S. District Court for the Southern District of New York. As a result of the JPML order, approximately 950 of the cases are before Judge Keenan. In the first Fosamax ONJ MDL trial, Boles v. Merck, the Fosamax ONJ MDL court declared a mistrial because the eight person jury could not reach a unanimous verdict. The Boles case was retried in June 2010 and resulted in a verdict in favor of the plaintiff in the amount of $8 million. Merck filed post-trial motions seeking judgment as a matter of law or, in the alternative, a new trial. In October 2010, the court denied Merck’s post-trial motions but sua sponte ordered a remittitur reducing the verdict to $1.5 million. Plaintiff rejected the remittitur ordered by the court and requested a new trial on damages, which is scheduled to take place on September 18, 2012. Merck intends to appeal the verdict in Boles after the new trial on damages has concluded. Three other cases have been tried to verdict in the Fosamax ONJ MDL. Defense verdicts in favor of Merck were returned in each of those three cases.

In February 2011, Judge Keenan ordered that there will be two further bellwether trials conducted in the Fosamax ONJ MDL. Spano v. Merck and Jellema v. Merck were selected by the court to be tried in 2012, but each case was dismissed by the plaintiffs. On March 28, 2012, the court selected Scheinberg v. Merck as the next case to be tried and set the trial date for January 14, 2013.

Outside the Fosamax ONJ MDL, in Florida, Carballo v. Merck has been set for trial on October 15, 2012 and Anderson v. Merck has been set for trial on January 14, 2013.

In addition, in July 2008, an application was made by the Atlantic County Superior Court of New Jersey requesting that all of the Fosamax cases pending in New Jersey be considered for mass tort designation and centralized management before one judge in New Jersey. In October 2008, the New Jersey Supreme Court ordered that all pending and future actions filed in New Jersey arising out of the use of Fosamax and seeking damages for existing dental and jaw-related injuries, including ONJ, but not solely seeking medical monitoring, be designated as a mass tort for centralized management purposes before Judge Carol E. Higbee in Atlantic County Superior Court. As of June 30, 2012, approximately 240 ONJ cases were pending against Merck in Atlantic County, New Jersey. In July 2009, Judge Higbee entered a Case Management Order (and various amendments thereto) setting forth a schedule that contemplates completing fact and expert discovery in an initial group of cases to be reviewed for trial. In February 2011, the jury in Rosenberg v. Merck, the first trial in the New Jersey coordinated proceeding, returned a verdict in Merck’s favor. In April 2012, the jury in Sessner v. Merck, the second case tried in New Jersey, also returned a verdict in Merck’s favor.

In California, the parties are reviewing the claims of two plaintiffs in the Carrie Smith, et al. v. Merck case and the claims in Pedrojetti v. Merck. The cases of one or more of these plaintiffs are expected to be tried in 2013.

Discovery is ongoing in the Fosamax ONJ MDL litigation, the New Jersey coordinated proceeding, and the remaining jurisdictions where Fosamax cases are pending. The Company intends to defend against these lawsuits.

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 “Fosamax Femur Fracture MDL”). As a result of the JPML order, approximately 510 cases were pending in the Fosamax Femur Fracture MDL as of June 30, 2012. A Case Management Order has been entered that requires the parties to review

 

- 20 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

40 cases (later reduced to 33 cases) with a fact discovery deadline of July 31, 2012 and an expert discovery deadline of November 28, 2012. Judge Joel Pisano has selected four cases to be tried as the initial bellwether cases in the Fosamax Femur Fracture MDL and has set an April 8, 2013 trial date for the first bellwether case.

As of June 30, 2012, approximately 1,535 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge Higbee in Atlantic County Superior Court. The parties have selected an initial group of 30 cases to be reviewed through fact discovery. Plaintiffs subsequently dismissed or advised that they will dismiss seven of the cases that were selected and discovery in the remaining cases is continuing. Judge Higbee has set March 4, 2013 as the date for the first trial of the New Jersey state Femur Fracture cases.

As of June 30, 2012, approximately 350 cases alleging Femur Fractures have been filed 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 Steven Perk is now presiding over the coordinated proceedings. No scheduling order has yet been entered.

Additionally, there are nine Femur Fracture cases pending in other state courts. A trial date has been set for August 12, 2013 for the Barnes case pending in Alabama state court.

Discovery is ongoing in the Fosamax Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits.

NuvaRing

As previously disclosed, beginning in May 2007, a number of complaints were filed in various jurisdictions asserting claims against the Company’s subsidiaries Organon USA, Inc., Organon Pharmaceuticals USA, Inc., Organon International (collectively, “Organon”), and the Company arising from Organon’s marketing and sale of NuvaRing, a combined hormonal contraceptive vaginal ring. The plaintiffs contend that Organon and Schering-Plough, among other things, failed to adequately design and manufacture NuvaRing and failed to adequately warn of the alleged increased risk of venous thromboembolism (“VTE”) posed by NuvaRing, and/or downplayed the risk of VTE. The plaintiffs seek damages for injuries allegedly sustained from their product use, including some alleged deaths, heart attacks and strokes. The majority of the cases are currently pending in a federal multidistrict litigation (the “NuvaRing MDL”) venued in Missouri and in a coordinated proceeding in New Jersey state court.

As of June 30, 2012, there were approximately 1,100 NuvaRing cases. Of these cases, approximately 950 are or will be pending in the NuvaRing MDL in the U.S. District Court for the Eastern District of Missouri before Judge Rodney Sippel, and approximately 135 are pending in coordinated discovery proceedings in the Bergen County Superior Court of New Jersey before Judge Brian R. Martinotti. Six additional cases are pending in various other state courts.

Pursuant to orders of Judge Sippel in the NuvaRing MDL, the parties originally selected a pool of more than 20 cases to prepare for trial and that pool has since been narrowed to eight cases from which the first trials in the NuvaRing MDL will be selected. Pursuant to Judge Martinotti’s order in the New Jersey proceeding, the parties selected 10 trial pool cases to be prepared for trial and the first trial is expected to commence in February 2013. The parties have completed fact discovery in the originally selected trial pool cases in each jurisdiction and the Company anticipates expert discovery to be completed in those first trial pool cases by the summer of 2012. Certain replacement trial pool cases remain in fact discovery. Moreover, on January 31, 2012, the parties in the New Jersey coordinated proceeding selected an additional 10 trial pool cases for completion of fact discovery.

The Company anticipates filing motions related to the admissibility of expert testimony beginning in the summer of 2012 and continuing through the fall with status conferences to be held in each coordinated proceeding following the completion of briefing to discuss the timing of hearings related to the motions. The Company expects substantive hearings on those motions to take place in late 2012. The Company anticipates that status conferences will be held in each coordinated proceeding following rulings on the substantive evidentiary motions to determine a methodology for selecting the first cases to be tried. The Company intends to defend 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 June 30, 2012, approximately 200 lawsuits involving a total of approximately 325 plaintiffs (in a few instances spouses are joined in the suits) who allege that they have experienced persistent sexual side effects following cessation of treatment with Propecia and/or Proscar have been filed against Merck. The lawsuits, which are in their early stages, are pending in federal courts in New Jersey, Washington, Washington D.C., Florida, Illinois, Colorado, Missouri and Ohio, and in state court in New Jersey.

 

- 21 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

The federal lawsuits have been consolidated for pretrial purposes in a federal MDL before Judge John Gleeson of the Eastern District of New York. The matters pending in state court in New Jersey have been consolidated before Judge Jessica Mayer in Middlesex County. The Company intends to defend against these lawsuits.

Governmental Proceedings

As publicly disclosed, on June 21, 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Company’s M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit, but has advised the Company that it will decline to exercise that right. Thus, the two former employees are pursuing the lawsuit without the involvement of the U.S. government. The Company intends to defend against this lawsuit.

Vytorin/Zetia Litigation

As previously disclosed, in April 2008, a Merck shareholder filed a putative class action lawsuit in federal court which has been consolidated in the District of New Jersey with another federal securities lawsuit under the caption In re Merck & Co., Inc. Vytorin Securities Litigation. An amended consolidated complaint was filed in October 2008 and named as defendants Merck; Merck/Schering-Plough Pharmaceuticals, LLC; and certain of the Company’s current and former officers and directors. The complaint alleges that Merck delayed releasing unfavorable results of the ENHANCE clinical trial regarding the efficacy of Vytorin and that Merck made false and misleading statements about expected earnings, knowing that once the results of the ENHANCE study were released, sales of Vytorin would decline and Merck’s earnings would suffer. In December 2008, Merck and the other defendants moved to dismiss this lawsuit on the grounds that the plaintiffs failed to state a claim for which relief can be granted. In September 2009, the court denied defendants’ motion to dismiss. In June 2011, lead plaintiffs filed a motion for leave to further amend the consolidated complaint, which was granted on February 7, 2012. On February 9, 2012, plaintiffs filed a second amended consolidated complaint, which defendants answered on February 23, 2012. In February 2012, the parties completed briefing on lead plaintiffs’ motion for class certification. That motion is now pending before the court. On March 1, 2012, defendants filed a motion for summary judgment. That motion is now fully briefed and pending before the court.

There is a similar consolidated, putative class action securities lawsuit pending in the District of New Jersey, filed by a Schering-Plough shareholder against Schering-Plough and its former Chairman, President and Chief Executive Officer, Fred Hassan, under the caption In re Schering-Plough Corporation/ENHANCE Securities Litigation. The amended consolidated complaint was filed in September 2008 and names as defendants Schering-Plough; Merck/Schering-Plough Pharmaceuticals; certain of the Company’s current and former officers and directors; and underwriters who participated in an August 2007 public offering of Schering-Plough’s common and preferred stock. In December 2008, Schering-Plough and the other defendants filed motions to dismiss this lawsuit on the grounds that the plaintiffs failed to state a claim for which relief can be granted. In September 2009, the court denied defendants’ motions to dismiss. In February 2012, the parties completed briefing on lead plaintiffs’ motion for class certification. That motion is now pending before the court. On March 1, 2012, the Schering-Plough defendants filed a motion for partial summary judgment and the underwriter defendants filed a motion for summary judgment. Those motions are now fully briefed and pending before the court.

As previously disclosed, in April 2008, a member of a Merck ERISA plan filed a putative class action lawsuit against Merck and certain of the Company’s current and former officers and directors alleging they breached their fiduciary duties under ERISA. Since that time, there have been other similar ERISA lawsuits filed against Merck in the District of New Jersey, and all of those lawsuits have been consolidated under the caption In re Merck & Co., Inc. Vytorin ERISA Litigation. A consolidated amended complaint was filed in February 2009, and names as defendants Merck and various current and former members of the Company’s Board of Directors. The plaintiffs allege that the ERISA plans’ investment in Merck stock was imprudent because Merck’s earnings were dependent on the commercial success of its cholesterol drug Vytorin, and defendants knew or should have known that the results of a scientific study would cause the medical community to turn to less expensive drugs for cholesterol management. On May 24, 2012, the plaintiffs filed an unopposed motion for preliminary approval of settlement, conditional certification of a settlement class, approval of the class notice, and scheduling of a final fairness hearing. The court granted that motion on June 22, 2012 and scheduled a hearing on final approval of the settlement for September 25, 2012. Pursuant to the settlement agreement, Merck’s insurers have paid $10.4 million into a settlement fund which (after enumerated costs, fees, and awards are withdrawn) will be allocated to members of the settlement class according to a plan of allocation to be approved by the court. The settlement agreement provides that, in exchange for such consideration, the plaintiffs and settlement class members will issue broad releases with prejudice.

There was a similar consolidated, putative class action ERISA lawsuit pending in the District of New Jersey, filed by a member of a Schering-Plough ERISA plan against Schering-Plough and certain of its then-current and former officers and directors, alleging they breached their fiduciary duties under ERISA, bearing the caption In re Schering-Plough Corp. ENHANCE ERISA

 

- 22 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

Litigation. The consolidated amended complaint was filed in October 2009 and named as defendants Schering-Plough, various then-current and former members of Schering-Plough’s Board of Directors and then-current and former members of committees of Schering-Plough’s Board of Directors. On February 10, 2012, the plaintiffs filed an executed class action settlement agreement and preliminary approval order. The court signed the preliminary approval order on February 16, 2012, and held a final fairness hearing on May 30, 2012. On May 31, 2012, the court issued an opinion, order, and final judgment. Among other things, the final judgment dismissed this action with prejudice, provided releases to the defendants, and approved the settlement agreement pursuant to which Merck’s insurers have paid $12.25 million into a settlement fund.

Discovery in the lawsuits referred to in this section (collectively, the “ENHANCE Litigation”) has concluded. The Company believes that it has meritorious defenses to the ENHANCE Litigation and intends to vigorously defend against these lawsuits. 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 ENHANCE Litigation. Unfavorable outcomes resulting from the ENHANCE Litigation could have a material adverse effect on the Company’s financial position, liquidity and results of operations.

Insurance

The Company has Directors and Officers insurance coverage applicable to the Vytorin shareholder lawsuits brought by legacy Schering-Plough shareholders with stated upper limits of approximately $250 million, which is currently being used to partially fund the Company’s legal fees. There are disputes with the insurers about the availability of some or all of the Company’s insurance coverage for these claims and there are likely to be additional disputes. The amounts actually recovered under the policies discussed in this paragraph may be less than the stated limits. The Company also has Fiduciary and other insurance for the Vytorin ERISA lawsuits which funded the costs of the two ERISA settlements discussed above.

Commercial Litigation

AWP Litigation

As previously disclosed, the Company and/or certain of its subsidiaries remain defendants in cases brought by various states alleging manipulation by pharmaceutical manufacturers of Average Wholesale Prices (“AWP”), which are sometimes used by public and private payors in calculating provider reimbursement levels. The outcome of these lawsuits could include substantial damages, the imposition of substantial fines and penalties and injunctive or administrative remedies.

Since the start of 2012, the Company has settled certain AWP cases brought by the states of Alabama, Alaska, Kansas, Kentucky, Louisiana, and Mississippi. The Company and/or certain of its subsidiaries continue to be defendants in cases brought by six states.

A motion has also been filed to reinstate the Company as a defendant in a putative class action in New Jersey State court which alleges on behalf of third-party payers and individuals that manufacturers inflated drug prices by manipulation of AWPs and other means. This case was dismissed against the Company without prejudice in 2007.

K-DUR Antitrust Litigation

As previously disclosed, in June 1997 and January 1998, Schering-Plough settled patent litigation with Upsher-Smith, Inc. (“Upsher-Smith”) and ESI Lederle, Inc. (“Lederle”), respectively, relating to generic versions of K-DUR, Schering-Plough’s long-acting potassium chloride product supplement used by cardiac patients, for which Lederle and Upsher-Smith had filed Abbreviated New Drug Applications (“ANDAs”). Following the commencement of an administrative proceeding by the U.S. Federal Trade Commission (the “FTC”) in 2001 alleging anti-competitive effects from those settlements (which has been resolved in Schering-Plough’s favor), putative class and non-class action suits were filed on behalf of direct and indirect purchasers of K-DUR against Schering-Plough, Upsher-Smith and Lederle and were consolidated in a multi-district litigation in the U.S. District Court for the District of New Jersey. These suits claimed violations of federal and state antitrust laws, as well as other state statutory and common law causes of action, and sought unspecified damages. In April 2008, the indirect purchasers voluntarily dismissed their case. In March 2010, the District Court granted summary judgment to the defendants on the remaining lawsuits and dismissed the matter in its entirety. However, in July 2012, the Third Circuit Court of Appeals reversed the District Court’s judgment and remanded the case for further proceedings. At the same time, the Third Circuit upheld a December 2008 decision by the District Court to certify certain direct purchaser plaintiffs’ claims as a class action. The Company intends to seek further judicial review.

Coupon Litigation

Since March 2012, a number of private health plans have filed separate putative class action lawsuits against the Company alleging that Merck’s coupon programs injured health insurers by reducing beneficiary co-payment amounts, thereby allegedly causing beneficiaries to purchase higher-priced drugs than they otherwise would have purchased and increasing the insurers’ reimbursement costs. The actions, which were filed in U.S. District Court for the District of New Jersey and the Southern District of Illinois, seek damages and injunctive relief barring the Company from issuing coupons that would reduce beneficiary co-pays on

 

- 23 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

behalf of putative nationwide classes of health insurers. Similar actions relating to manufacturer coupon programs have been filed against several other pharmaceutical manufacturers in a variety of federal courts. The Company intends to defend against these lawsuits.

Patent Litigation

From time to time, generic manufacturers of pharmaceutical products file ANDAs with the 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 marketed via agreements with other companies) currently involved in such patent infringement litigation in the United States include: AzaSite, Cancidas, Emend for Injection, Nasonex, Nexium, Noxafil, Vytorin and Zetia. 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 legacy Schering-Plough products, potentially significant intangible asset impairment charges.

AzaSite — In May 2011, a patent infringement suit was filed in the United States against Sandoz Inc. (“Sandoz”) in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to market a generic version of AzaSite. The lawsuit automatically stays FDA approval of Sandoz’s ANDA until October 2013 or until an adverse court decision, if any, whichever may occur earlier.

Cancidas — In November 2009, a patent infringement lawsuit was filed in the United States against Teva Parenteral Medicines, Inc. (“TPM”) in respect of TPM’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Cancidas. That lawsuit has been dismissed with no rights granted to TPM. Also, in March 2010, a patent infringement lawsuit was filed in the United States against Sandoz in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Cancidas. In April 2012, the parties entered into a settlement agreement allowing Sandoz to sell a generic version of Cancidas commencing on August 28, 2017.

Emend for Injection — In May 2012, a patent infringement lawsuit was filed in the United States against Sandoz in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to market a generic version of Emend for Injection. The lawsuit automatically stays FDA approval of Sandoz’s ANDA until July 2015 or until an adverse court decision, if any, whichever may occur earlier. In June 2012, a patent infringement lawsuit was filed in the United States against Accord Healthcare, Inc. US, Accord Healthcare, Inc. and Intas Pharmaceuticals Ltd (collectively, “Intas”) in respect of Intas’ application to the FDA seeking pre-patent expiry approval to market a generic version of Emend for Injection. The lawsuit automatically stays FDA approval of Intas’ ANDA until July 2015 or until an adverse court decision, if any, whichever may occur earlier.

Integrilin — In February 2009, a patent infringement lawsuit was filed (jointly with Millennium Pharmaceuticals, Inc.) in the United States against TPM in respect of TPM’s application to the FDA seeking approval to sell a generic version of Integrilin prior to the expiry of the last to expire listed patent. In October 2011, the parties entered a settlement agreement allowing TPM to sell a generic version of Integrilin beginning June 2, 2015.

Nasonex — In December 2009, a patent infringement suit was filed in the United States against Apotex Corp. (“Apotex”) in respect of Apotex’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. A trial in this matter was held in April 2012. A decision was issued on June 15, 2012, holding that the Merck patent covering mometasone furoate monohydrate was valid, but that it was not infringed by Apotex’s proposed product. The finding of non-infringement is under appeal.

Nexium — Patent infringement lawsuits were brought (jointly with AstraZeneca) in the United States against the following generic companies: Ranbaxy Laboratories Ltd., IVAX Pharmaceuticals, Inc. (later acquired by Teva Pharmaceuticals, Inc. (“Teva”)), Dr. Reddy’s Laboratories, Sandoz, Lupin Ltd., Hetero Drugs Limited Unit III (“Hetero”) and Torrent Pharmaceuticals Ltd. in response to each generic company’s application seeking pre-patent expiry approval to sell a generic version of Nexium. Settlements have been reached in each of these lawsuits, the terms of which provide that the respective generic company may bring a generic version of esomeprazole product to market on May 27, 2014. In addition, a patent infringement lawsuit was also filed (jointly with AstraZeneca) in February 2010 in the United States against Sun Pharma Global Fze (“Sun Pharma”) in respect of its application to the FDA seeking pre-patent expiry approval to sell a generic version of Nexium IV, which lawsuit was settled with an agreement which provides that Sun Pharma will be entitled to bring its generic esomeprazole IV product to market in the United States on January 1, 2014. Finally, additional patent infringement lawsuits have been filed (jointly with AstraZeneca) in the United States against Hamni USA, Inc. (“Hamni”) and Mylan Laboratories Limited (“Mylan Labs”) related to their applications to the FDA seeking pre-patent expiry approval to sell generic versions of Nexium. The Hamni and Mylan Labs applications to the FDA remain stayed until May 2013 and August 2014, respectively, or until earlier adverse court decisions, if any.

 

- 24 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

Noxafil — In May 2011, a patent infringement suit was filed in the United States against Sandoz in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to market a generic version of Noxafil. In May 2012, Sandoz withdrew its challenge to Merck’s Noxafil patents and the lawsuit has been dismissed.

NuvaRing — In February 2011, a patent infringement suit was brought against Merck in the International Trade Commission (the “ITC”) by Femina Pharma Incorporated (“Femina”) in respect of the product NuvaRing. The complaint alleged that NuvaRing infringes a patent owned by Femina. Femina’s ITC complaint sought an exclusion order against the importation of NuvaRing into the United States. A hearing began in the ITC proceeding on January 17, 2012 and on January 18, 2012 Femina withdrew its complaint and terminated the action. In addition, in November 2011, Femina brought a patent infringement lawsuit against Merck in the Eastern District of Virginia asserting that NuvaRing infringes the same patent. That case was stayed pending the outcome of the ITC proceeding. In April 2012, Femina voluntarily withdrew its lawsuit.

Propecia — In December 2010, a patent infringement lawsuit was filed in the United States against Hetero in respect of Hetero’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Propecia. In March 2011, the Company settled this lawsuit with Hetero by agreeing to allow Hetero to sell a generic 1 mg finasteride product beginning on July 1, 2013. By virtue of a previous litigation settlement agreement, another generic manufacturer has been given the right to enter the U.S. market in January 2013.

Temodar — In July 2007, a patent infringement action was filed (jointly with Cancer Research Technologies, Limited (“CRT”)) in the United States against Barr Laboratories (“Barr”) (later acquired by Teva) in respect of Barr’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Temodar. In January 2010, the court issued a decision finding the CRT patent unenforceable on grounds of prosecution laches and inequitable conduct. In November 2010, the appeals court issued a decision reversing the trial court’s finding. In December 2010, Barr filed a petition seeking a rehearing en banc of the appeal, which petition was denied. In June 2011, Barr filed a petition for review by the U.S. Supreme Court, which was denied. By virtue of an agreement that Barr not launch a product during the appeal process, the Company has agreed that Barr can launch a product in August 2013.

In September 2010, a patent infringement lawsuit was filed (jointly with CRT) in the United States against Sun Pharmaceutical Industries Inc. (“Sun”) in respect of Sun’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Temodar. The lawsuit automatically stayed FDA approval of Sun’s ANDA until February 2013 or until an adverse court decision, if any, whichever may occur earlier. In November 2010, a patent infringement lawsuit was filed (jointly with CRT) in the United States against Accord HealthCare Inc. (“Accord”) in respect of its application to the FDA seeking pre-patent expiry approval to sell a generic version of Temodar. The lawsuit automatically stayed FDA approval of Accord’s application until April 13, 2013 or until an adverse court decision, if any, whichever may occur earlier. The Company and CRT entered into agreements with Sun and Accord to stay the respective lawsuits pending the outcome of the U.S. Supreme Court appeal process in the Barr lawsuit. In light of the U.S. Supreme Court’s denial of Barr’s petition, Sun and Accord withdrew their challenges to the Temodar patent and the respective lawsuits have been withdrawn.

Vytorin — In December 2009, a patent infringement lawsuit was filed in the United States against Mylan Pharmaceuticals, Inc. (“Mylan”) in respect of Mylan’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Vytorin. A trial against Mylan jointly in respect of Zetia and Vytorin was conducted in December 2011. In April 2012, the court issued a decision finding the patent valid and enforceable. Accordingly, Mylan’s ANDA will not be approvable until April 25, 2017. Mylan has appealed that decision. In February 2010, a patent infringement lawsuit was filed in the United States against Teva in respect of Teva’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Vytorin. In July 2011, the patent infringement lawsuit was dismissed and Teva agreed not to sell generic versions of Zetia or Vytorin until the Company’s exclusivity rights expire on April 25, 2017, except in certain circumstances. In August 2010, a patent infringement lawsuit was filed in the United States against Impax Laboratories Inc. (“Impax”) in respect of Impax’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Vytorin. An agreement was reached with Impax to stay the lawsuit pending the outcome of the lawsuit with Mylan. In October 2011, a patent infringement lawsuit was filed in the United States against Actavis Inc. (“Actavis”) in respect to Actavis’ application to the FDA seeking pre-patent expiry approval to sell a generic version of Vytorin.

 

- 25 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

An agreement was reached with Actavis to stay the lawsuit pending the outcome of the lawsuit with Mylan.

Zetia — In March 2007, a patent infringement lawsuit was filed in the United States against Glenmark Pharmaceuticals Inc., USA and its parent corporation (collectively, “Glenmark”) in respect of Glenmark’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Zetia. In May 2010, Glenmark agreed to a settlement by virtue of which Glenmark will be permitted to launch its generic product in the United States on December 12, 2016, subject to receiving final FDA approval. In June 2010, a patent infringement lawsuit was filed in the United States against Mylan in respect of Mylan’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Zetia. A trial against Mylan jointly in respect of Zetia and Vytorin was conducted in December 2011. In April 2012, the court issued a decision finding the patent valid and enforceable. Accordingly, Mylan’s ANDA will not be approvable until April 25, 2017. Mylan has appealed that decision. In September 2010, a patent infringement lawsuit was filed in the United States against Teva in respect of Teva’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Zetia. In July 2011, the patent infringement lawsuit was dismissed without any rights granted to Teva.

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 June 30, 2012 and December 31, 2011 of approximately $250 million and $240 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.

Environmental Matters

The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Company’s potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial position, results of operations, liquidity or capital resources of the Company. The Company has taken an active role in identifying and providing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties.

As previously disclosed, approximately 2,200 plaintiffs have filed an amended complaint against Merck and 12 other defendants in U.S. District Court, Eastern District of California asserting claims under the Clean Water Act, the Resource Conservation and Recovery Act, as well as negligence and nuisance. The suit seeks damages for personal injury, diminution of property value, medical monitoring and other alleged real and personal property damage associated with groundwater, surface water and soil contamination found at the site of a former Merck

 

- 26 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

subsidiary in Merced, California. Certain of the other defendants in this suit have settled with plaintiffs regarding some or all aspects of plaintiffs’ claims. This lawsuit is proceeding in a phased manner. A jury trial commenced in February 2011 during which a jury was asked to make certain factual findings regarding whether contamination moved off-site to any areas where plaintiffs could have been exposed to such contamination and, if so, when, where and in what amounts. Defendants in this “Phase 1” trial included Merck and three of the other original 12 defendants. In March 2011, the Phase 1 jury returned a mixed verdict, finding in favor of Merck and the other defendants as to some, but not all, of plaintiffs’ claims. Specifically, the jury found that contamination from the site did not enter or affect plaintiffs’ municipal water supply wells or any private domestic wells. The jury found, however, that plaintiffs could have been exposed to contamination via air emissions prior to 1994, as well as via surface water in the form of storm drainage channeled into an adjacent irrigation canal, including during a flood in April 2006. In response to post-trial motions by Merck and other defendants, on September 7, 2011, the court entered an order setting aside a part of the Phase 1 jury’s findings that had been in favor of plaintiffs. Specifically, the court held that plaintiffs could not have been exposed to any contamination in surface or flood water during the April 2006 flood or, in fact, at any time later than 1991. Merck’s motion for reconsideration of the remainder of the jury’s Phase I verdict that was adverse to Merck was denied. Following the retirement of the judge handling this case, on September 21, 2011, the case was assigned to Judge David O. Carter of the U.S. District Court for the Central District of California. Judge Carter selected 10 plaintiffs whose claims would be reviewed and, depending on the outcome of Merck’s anticipated summary judgment motions, possibly tried in early 2013. Plaintiffs subsequently withdrew the claim of one of those 10 plaintiffs, leaving nine whose claims may proceed to trial. The court has dismissed the claims of 1,083 of the plaintiffs in this action whose claims were precluded by aspects of the Phase I jury findings and the court’s subsequent orders.

10.  Equity

 

                                                                                                                                      
                                Accumulated                              
                   Other            Other                    Non-         
     Common Stock           Paid-In             Retained       Comprehensive      Treasury Stock      Controlling         
($ and shares in millions)    Shares       Par Value        Capital      Earnings     Loss      Shares      Cost        Interests      Total  

 

Balance January 1, 2011

     3,577       $ 1,788         $ 40,701         $ 37,536      $ (3,216)         495         $     (22,433)        $ 2,429         $       56,805     

Net income attributable to
Merck & Co., Inc.

     -         -           -           3,067        -           -           -            -           3,067     

Cash dividends declared on common stock

     -         -           -           (2,360     -           -           -            -           (2,360)    

Treasury stock shares purchased

     -         -           -           -        -           9           (314)          -           (314)    

Share-based compensation plans and other

     -         -           (44)         -        -           (10)         331            -           287     

Other comprehensive income

     -         -           -           -        440           -           -            -           440     

Net income attributable to noncontrolling interests

     -         -           -           -        -           -           -            58           58     

Distributions attributable to noncontrolling interests

     -         -           -           -        -           -           -            (61)          (61)    

 

 

Balance June 30, 2011

     3,577       $ 1,788         $ 40,657         $ 38,243      $ (2,776)         494       $ (22,416)        $ 2,426         $ 57,922     

 

 

 

Balance January 1, 2012

     3,577       $ 1,788         $ 40,663         $ 38,990      $ (3,132)         536         $ (23,792)        $ 2,426         $ 56,943     

Net income attributable to
Merck & Co., Inc.

     -         -           -           3,531        -           -           -            -           3,531     

Cash dividends declared on common stock

     -         -           -           (2,571     -           -           -            -           (2,571)    

Treasury stock shares purchased

     -         -           -           -        -           26           (985)          -           (985)    

Share-based compensation plans and other

     -         -           (113)         -        -           (24)         809            -           696     

Other comprehensive income

     -         -           -           -        6           -           -            -           6     

Net income attributable to noncontrolling interests

     -         -           -           -        -           -           -            56           56     

Distributions attributable to noncontrolling interests

     -         -           -           -        -           -           -            (3)          (3)    

 

 

Balance June 30, 2012

     3,577       $ 1,788         $ 40,550         $ 39,950      $ (3,126)         538         $ (23,968)        $ 2,479         $ 57,673     

 

 

In connection with the 1998 restructuring of Astra Merck Inc., the Company assumed $2.4 billion par value preferred stock with a dividend rate of 5% per annum, which is carried by KBI and included in Noncontrolling interests on the Consolidated Balance Sheet. If AstraZeneca exercises its option to acquire Merck’s interest in AZLP (see Note 8), this preferred stock obligation will be retired.

 

- 27 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

The accumulated balances related to each component of other comprehensive income (loss), net of taxes, were as follows:

 

($ in millions)        Derivatives          Investments            Employee
Benefit 
Plans
         Cumulative
    Translation
    Adjustment
     Accumulated 
Other 
Comprehensive 
Loss 
 

 

 

 

Balance January 1, 2011

   $ 41        $ 31        $ (2,043)       $ (1,245)           $     (3,216)    

Other comprehensive (loss) income

     (137)         (5)         28          554          440     

 

 

Balance at June 30, 2011

   $ (96)       $ 26        $ (2,015)       $ (691)           $ (2,776)    

 

 

 

Balance January 1, 2012

   $       $ 21        $ (2,346)       $ (811)           $ (3,132)    

Other comprehensive income (loss)

     44          30          18          (86)         6     

 

 

Balance at June 30, 2012

   $ 48        $ 51        $ (2,328)       $ (897)           $ (3,126)    

 

 

Included in cumulative translation adjustment are pretax gains of approximately $340 million for the first six months of 2011 relating to translation impacts of intangible assets recorded in conjunction with the Merger.

11.  Share-Based Compensation Plans

The Company has share-based compensation plans under which employees and non-employee directors may be granted restricted stock units (“RSUs”). In addition, the Company grants options to purchase shares of Company common stock at the fair market value at the time of grant and performance share units (“PSUs”) to certain management-level employees. The Company recognizes the fair value of share-based compensation in net income on a straight-line basis over the requisite service period.

The following table provides amounts of share-based compensation cost recorded in the Consolidated Statement of Income:

 

       Three Months Ended    
June 30,
         Six Months Ended      
June 30,
 
  

 

 

    

 

 

 

($ in millions)

     2012            2011             2012            2011       

 

 

 

Pretax share-based compensation expense

       $ 93      $ 107             $ 169      $ 200    

Income tax benefit

     (29     (37)          (53     (69)    

 

 

Total share-based compensation expense, net of taxes

       $ 64      $ 70             $ 116      $ 131    

 

 

During the first six months of 2012 and 2011, the Company granted 7 million RSUs with a weighted-average grant date fair value of $39.29 per RSU and 8 million RSUs with a weighted-average grant date fair value of $36.47 per RSU, respectively.

During the first six months of 2012 and 2011, the Company granted 7 million options with a weighted-average exercise price of $39.26 per option and 8 million options with a weighted-average exercise price of $36.55 per option, respectively. The weighted-average fair value of options granted for the first six months of 2012 and 2011 was $5.46 and $5.37 per option, respectively, and was determined using the following assumptions:

 

               Six Months Ended           
June 30,
 
     2012         2011   

 

 

 

Expected dividend yield

     4.4%         4.3%   

Risk-free interest rate

     1.3%         2.6%   

Expected volatility

     25.3%         23.2%   

Expected life (years)

     7.0          7.0    

 

 

At June 30, 2012, there was $555 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 2.0 years. For segment reporting, share-based compensation costs are unallocated expenses.

 

- 28 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

12.  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 cost of such plans consisted of the following components:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
($ in millions)          2012                  2011                  2012                  2011        

 

 

 

Service cost

     $ 141        $ 151          $ 283        $ 303    

Interest cost

     166          180          332          359    

Expected return on plan assets

     (244)         (242)         (488)         (485)   

Net amortization

     48          46          96          91    

Termination benefits

                             17    

Curtailments

     (1)         (6)         (1)         (10)   

Settlements

                             (1)   

 

 
     $ 114        $ 136          $ 231        $ 274    

 

 

The Company provides medical, dental and life insurance benefits, principally to its eligible U.S. retirees and similar benefits to their dependents, through its other postretirement benefit plans. The net cost of such plans consisted of the following components:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
($ in millions)          2012                  2011                  2012                  2011        

 

 

 

Service cost

     $ 21        $ 28          $ 42        $ 56    

Interest cost

     31          35          62          71    

Expected return on plan assets

     (34)         (36)         (68)         (71)   

Net amortization

     (8)         (6)         (16)         (9)   

Termination benefits

                               

Curtailments

     (2)                 (4)           

 

 
     $ 11        $ 25          $ 21        $ 54    

 

 

In connection with restructuring actions (see Note 2), termination charges for the three and six months ended June 30, 2012 and 2011 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 were recorded on pension and other postretirement benefit plans and settlements were recorded on pension plans as reflected in the tables above.

13.  Other (Income) Expense, Net

Other (income) expense, net, consisted of:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
($ in millions)          2012                  2011                  2012                  2011        

 

 

 

Interest income

     $ (76)       $ (39)         $ (129)       $ (69)   

Interest expense

     172          170          346          345    

Exchange losses

     13                  80          43    

Other, net

     (6)         (11)         (50)         425    

 

 
     $ 103        $ 121          $ 247        $ 744    

 

 

 

- 29 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

As a result of significant collections of accounts receivable in Spain during the second quarter (see Note 5), the Company recognized incremental interest income of approximately $35 million in the second quarter and first six months of 2012 for accelerated accretion of time value of money discounts related to these receivables. Other, net (as presented in the table above) for the first six months of 2011 reflects a $500 million charge related to the resolution of the arbitration proceeding involving the Company’s rights to market Remicade and Simponi (see Note 4), as well as a $127 million gain on the sale of certain manufacturing facilities and related assets. Interest paid for the six months ended June 30, 2012 and 2011 was $324 million and $194 million, respectively, which excludes commitment fees. Interest paid for the six months ended June 30, 2011 is net of $175 million received by the Company from the termination of certain interest rate swap contracts during the period (see Note 5).

14.  Taxes on Income

The effective tax rates of 32.1% and 30.8% for the second quarter and first six months of 2012 and (22.8)% and 8.1% for the second quarter and first six months of 2011 reflect the impacts of acquisition-related costs and restructuring costs, partially offset by the beneficial impact of foreign earnings. In addition, the effective tax rates for the second quarter and first six months of 2011 also reflect a net favorable impact relating to the settlement of Merck’s 2002-2005 federal income tax audit as discussed below, as well as the net favorable impact of certain foreign and state tax rate changes that resulted in a net $230 million reduction of deferred tax liabilities on intangibles established in purchase accounting. In addition, the effective tax rate for the first six months of 2011 also reflects the impact of the $500 million charge related to the resolution of the arbitration proceeding with J&J.

In April 2011, the Internal Revenue Service (the “IRS”) concluded its examination of Merck’s 2002-2005 federal income tax returns and as a result the Company was required to make net payments of approximately $465 million. The Company’s unrecognized tax benefits for the years under examination exceeded the adjustments related to this examination period and therefore the Company recorded a net $700 million tax provision benefit in the second quarter of 2011. This net benefit reflects the decrease of unrecognized tax benefits for the years under examination partially offset by increases to the unrecognized tax benefits for years subsequent to the examination period as a result of this settlement. The Company disagrees with the IRS treatment of one issue raised during this examination and is appealing the matter through the IRS administrative process.

As previously disclosed, the Canada Revenue Agency (the “CRA”) has proposed adjustments for 1999 and 2000 relating to intercompany pricing matters and, in July 2011, the CRA issued assessments for other miscellaneous audit issues for tax years 2001-2004. These adjustments would increase Canadian tax due by approximately $330 million plus approximately $390 million of interest through June 30, 2012. The Company disagrees with the positions taken by the CRA and believes they are without merit. The Company continues to contest the assessments through the CRA appeals process. The CRA is expected to prepare similar adjustments for later years. Management believes that resolution of these matters will not have a material effect on the Company’s financial position or liquidity.

15.  Earnings Per Share

The Company calculates earnings per share pursuant to the two-class method, which is an earnings allocation formula that determines earnings per share for common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. RSUs and certain PSUs granted before December 31, 2009 to certain management level employees participate in dividends on the same basis as common shares and such dividends are nonforfeitable by the holder. As a result, these RSUs and PSUs meet the definition of a participating security. For RSUs and PSUs issued on or after January 1, 2010, dividends declared during the vesting period are payable to the employees only upon vesting and therefore such RSUs and PSUs do not meet the definition of a participating security.

 

- 30 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

The calculations of earnings per share under the two-class method are as follows:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
($ and shares in millions except per share amounts)          2012                  2011                  2012                  2011        

 

 

 

Basic Earnings per Common Share

           

Net income attributable to Merck & Co., Inc.

     $ 1,793       $     2,024           $ 3,531       $         3,067     

Less: Income allocated to participating securities

     1         4           3         8     

 

 

Net income allocated to common shareholders

     $ 1,792       $ 2,020           $ 3,528       $ 3,059     

 

 

 

Average common shares outstanding

     3,041         3,086           3,042         3,085     

 

 
     $ 0.59       $ 0.65           $ 1.16       $ 0.99     

 

 

 

Earnings per Common Share Assuming Dilution

           

Net income attributable to Merck & Co., Inc.

     $ 1,793       $ 2,024           $ 3,531       $ 3,067     

Less: Income allocated to participating securities

     1         4           3         8     

 

 

Net income allocated to common shareholders

     $ 1,792       $ 2,020           $ 3,528       $ 3,059     

 

 

 

Average common shares outstanding

     3,041         3,086           3,042         3,085     

Common shares issuable (1)

     31         24           32         21     

 

 

Average common shares outstanding assuming dilution

     3,072         3,110           3,074         3,106     

 

 
     $ 0.58       $ 0.65           $ 1.15       $ 0.98     

 

 

 

(1)

Issuable primarily under share-based compensation plans.

For the three months ended June 30, 2012 and 2011, 107 million and 138 million, respectively, and for the first six months of 2012 and 2011, 112 million and 173 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.

16.        Segment Reporting

The Company’s operations are principally managed on a products basis and are comprised of four operating segments – Pharmaceutical, Animal Health, Consumer Care and Alliances (which includes revenue and equity income from the Company’s relationship with AZLP). The Animal Health, Consumer Care and Alliances segments are not material for separate reporting and are included in all other in the table below. The Pharmaceutical segment includes human health pharmaceutical and vaccine products marketed either directly by the Company or through joint ventures. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccines is sold to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. The Company also has animal health operations that discover, develop, manufacture and market animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. Additionally, the Company has consumer care operations that develop, manufacture and market over-the-counter, foot care and sun care products, which are sold through wholesale and retail drug, food chain and mass merchandiser outlets.

 

- 31 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

Sales of the Company’s products were as follows:

 

                          Three Months Ended                    
June 30,
                          Six Months Ended                    
June 30,
 
($ in millions)    2012      2011      2012      2011  

 

 

Primary Care and Women’s Health

           

Cardiovascular

           

Zetia

     $ 632         $ 592           $ 1,246         $ 1,174     

Vytorin

     445         459           889         939     

Diabetes and Obesity

           

Januvia

     1,058         779           1,977         1,518     

Janumet

     411         321           802         626     

Respiratory

           

Singulair

     1,431         1,354           2,771         2,682     

Nasonex

     293         323           668         696     

Clarinex

     140         209           273         364     

Asmanex

     51         47           99         107     

Dulera

     50         25           89         37     

Women’s Health and Endocrine

           

Fosamax

     186         221           370         429     

NuvaRing

     157         154           303         297     

Follistim AQ

     125         143           241         276     

Implanon

     85         81           161         141     

Cerazette

     72         66           139         125     

Other

           

Maxalt

     154         131           310         304     

Arcoxia

     117         100           229         214     

Avelox

     44         61           117         167     

Hospital and Specialty

           

Immunology

           

Remicade

     518         842           1,037         1,595     

Simponi

     76         75           150         129     

Infectious Disease

           

Isentress

     398         337           735         629     

PegIntron

     183         154           345         319     

Cancidas

     166         168           311         326     

Victrelis

     126         21           238         22     

Invanz

     110         103           211         189     

Primaxin

     104         136           192         272     

Noxafil

     66         56           125         110     

Oncology

           

Temodar

     225         234           461         481     

Emend

     145         120           247         207     

Other

           

Cosopt/Trusopt

     105         122           229         236     

Bridion

     60         47           118         89     

Integrilin

     60         56           113         120     

Diversified Brands

           

Cozaar/Hyzaar

     337         406           674         832     

Propecia

     100         112           208         218     

Zocor

     96         107           199         234     

Claritin Rx

     48         65           134         186     

Remeron

     66         57           123         117     

Proscar

     55         53           106         113     

Vasotec/Vaseretic

     49         59           102         116     

Vaccines (1)

           

Gardasil

     324         277           608         490     

ProQuad/M-M-R II/Varivax

     316         291           571         535     

RotaTeq

     142         148           284         272     

Zostavax

     148         122           224         146     

Pneumovax

     101         64           213         143     

Other pharmaceutical (2) 

     985         1,062           2,000         1,957     

 

 

Total Pharmaceutical segment sales

     10,560         10,360           20,642         20,179     

 

 

Other segment sales (3) 

     1,680         1,690           3,273         3,323     

 

 

Total segment sales

     12,240         12,050           23,915         23,502     

 

 

Other (4)

     71         101           126         230     

 

 
     $ 12,311         $ 12,151           $ 24,041         $ 23,732     

 

 

 

(1) 

These amounts do not reflect sales of vaccines sold in most major European markets through the Company’s joint venture, Sanofi Pasteur MSD, the results of which are reflected in Equity income from affiliates. These amounts do, however, reflect supply sales to Sanofi Pasteur MSD.

(2) 

Other pharmaceutical primarily includes sales of other human health pharmaceutical products not listed separately.

(3) 

Reflects other non-reportable segments, including Animal Health and Consumer Care, and revenue from the Company’s relationship with AZLP primarily relating to sales of Nexium. Revenue from AZLP was $223 million and $306 million for the second quarter of 2012 and 2011, respectively, and $409 million and $628 million for the first six months of 2012 and 2011, respectively.

(4) 

Other revenues are primarily comprised of miscellaneous corporate revenues, third-party manufacturing sales, sales related to divested products or businesses and supply sales not included in segment results. The declines in other revenues in the second quarter and first six months of 2012 as compared with the same periods of 2011 reflect lower third-party manufacturing sales, which for the year-to-date period were attributable in part to the divestiture of certain manufacturing facilities in the first quarter of 2011.

 

- 32 -


Notes to Consolidated Financial Statements (unaudited) (continued)

 

A reconciliation of segment profits to Income before taxes is as follows:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
($ in millions)          2012                  2011                  2012                  2011        

 

 

 

Segment profits:

           

Pharmaceutical segment

     $       6,906        $ 6,443          $ 13,502        $ 12,659    

Other segments

     774          726          1,578          1,517    
  

 

 

 

Total segment profits

     7,680          7,169          15,080          14,176    

Other profits (losses)

     45          34          (28)         (15)   

Unallocated:

           

Interest income

     76          39          129          69    

Interest expense

     (172)         (170)         (346)         (345)   

Equity income from affiliates

     11          (87)         (9)         (81)   

Depreciation and amortization

     (574)         (623)         (1,135)         (1,194)   

Research and development

     (1,930)         (1,679)         (3,573)         (3,618)   

Amortization of purchase accounting adjustments

     (1,226)         (1,225)         (2,455)         (2,504)   

Restructuring costs

     (144)         (668)         (363)         (654)   

Arbitration settlement charge

                             (500)   

Other unallocated, net

     (1,086)         (1,118)         (2,114)         (1,933)   

 

 
     $ 2,680        $ 1,672          $ 5,186        $ 3,401    

 

 

Segment profits are comprised of segment sales less standard costs and certain operating expenses directly incurred by the segments. For internal management reporting presented to the chief operating decision maker, Merck does not allocate materials and production costs, other than standard costs, the majority of research and development expenses or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase adjustments are not allocated to segments.

Other profits (losses) are primarily comprised of miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales, divested products or businesses and other supply sales.

Other unallocated, net includes expenses from corporate and manufacturing cost centers, product intangible asset impairment charges, gains or losses on sales of businesses and assets and other miscellaneous income or expense items.

 

- 33 -


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

U.S. Health Care Reform Legislation

In 2010, the United States enacted major health care reform legislation. Various market reforms advanced in 2011 and will continue through full implementation in 2014.

Effective in 2011, the law requires pharmaceutical manufacturers to pay a 50% discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called “donut hole”). Approximately $38 million and $36 million was recorded as a reduction to revenue in the second quarter of 2012 and 2011, respectively, and $76 million and $70 million for the first six months of 2012 and 2011, respectively, related to the estimated impact of this provision of health care reform.

Also, beginning in 2011, pharmaceutical manufacturers are required to pay an annual health care reform fee. The total annual industry fee, which was $2.5 billion in 2011 and will be $2.8 billion in 2012, is assessed on each company in proportion to its share of sales to certain government programs, such as Medicare and Medicaid. The Company’s portion of the annual fee is payable no later than September 30 of the applicable calendar year and is not tax deductible. Each year, the liability related to the annual fee is estimated by the Company and recorded in full during the first quarter with a corresponding offset to a deferred asset. The deferred asset is amortized to Marketing and administrative expenses on a straight-line basis (net of any revisions) during the year. The liability related to the annual fee recognized in 2012 was $190 million and for 2011 was $162 million. The Company recognized expenses of $48 million and $43 million for the second quarter of 2012 and 2011, respectively, and $95 million and $85 million for the first six months of 2012 and 2011, respectively, related to this fee.

Arbitration Settlement

In April 2011, Merck and Johnson & Johnson (“J&J”) reached an agreement to amend the agreement governing the distribution rights to Remicade (infliximab) and Simponi (golimumab). This agreement concluded the arbitration proceeding J&J initiated in May 2009. Under the terms of the amended distribution agreement, Merck relinquished marketing rights for Remicade and Simponi to J&J in territories including Canada, Central and South America, the Middle East, Africa and Asia Pacific effective July 1, 2011. Merck retained exclusive marketing rights throughout Europe, Russia and Turkey (the “Retained Territories”). In addition, beginning July 1, 2011, all profits derived from Merck’s exclusive distribution of the two products in the Retained Territories are being equally divided between Merck and J&J. J&J also received a one-time payment from Merck of $500 million in April 2011.

Singulair Patent Expiries

The patent that provided U.S. market exclusivity for Singulair expired in August 2012. In addition, the patent that provides market exclusivity for Singulair will expire in a number of major European markets in February 2013. The Company expects a significant and rapid reduction in sales thereafter in those markets. The patent that provides market exclusivity for Singulair in Japan will expire in 2016. For the full year of 2011, sales of Singulair were $3.5 billion in the United States, $724 million in Europe and $641 million in Japan.

Operating Results

Sales

Worldwide sales were $12.3 billion for the second quarter of 2012, an increase of 1% compared with the second quarter of 2011. Global sales for the first six months of 2012 were $24.0 billion, an increase of 1% compared with the same period in 2011. Foreign exchange unfavorably affected global sales performance by 4% and 2% for the second quarter and first six months of 2012, respectively. The revenue increases largely reflect higher sales of Januvia (sitagliptin), Victrelis (boceprevir), Janumet (sitagliptin/metformin hydrochloride HCI), Gardasil [human papillomavirus quadrivalent (types 6, 11, 16 and 18) vaccine, recombinant], Isentress (raltegravir), Singulair (montelukast sodium) and Zostavax [Zoster Vaccine Live]. Also contributing to revenue growth in both periods were higher sales of the Company’s animal health products. These increases were partially offset by lower sales of Remicade due to the relinquishment of marketing rights in certain territories as a result of the arbitration settlement discussed above. Sales growth was also negatively affected by lower revenue from the Company’s relationship with AstraZeneca LP (“AZLP”), as well as by lower sales of Cozaar (losartan potassium), Hyzaar (losartan potassium hydrochlorothiazide), Clarinex (desloratadine) and Primaxin (imipenem and cilastatin sodium).

While several of the Company’s brands experienced positive volume growth trends in the European Union (the “EU”) in the first half of 2012, the environment in the EU continues to be challenging. Many countries have announced austerity measures, which include the implementation of pricing actions to reduce prices of generic and patented drugs. While the Company is taking steps to mitigate the impact in the EU, the austerity measures continued to negatively affect the Company’s revenue performance in the first six months of 2012 and the Company anticipates high mid-single digit pricing pressures for the full year of 2012 across Europe as well as from the biennial price reductions in Japan.

 

- 34 -


Sales of the Company’s products were as follows:

 

                          Three Months Ended                    
June 30,
                          Six Months Ended                    
June 30,
 
($ in millions)    2012      2011      2012      2011  

 

 

Primary Care and Women’s Health

           

Cardiovascular

           

Zetia

     $ 632       $ 592           $ 1,246       $ 1,174     

Vytorin

     445         459           889         939     

Diabetes and Obesity

           

Januvia

     1,058         779           1,977         1,518     

Janumet

     411         321           802         626     

Respiratory

           

Singulair

     1,431         1,354           2,771         2,682     

Nasonex

     293         323           668         696     

Clarinex

     140         209           273         364     

Asmanex

     51         47           99         107     

Dulera

     50         25           89         37     

Women’s Health and Endocrine

           

Fosamax

     186         221           370         429     

NuvaRing

     157         154           303         297     

Follistim AQ

     125         143           241         276     

Implanon

     85         81           161         141     

Cerazette

     72         66           139         125     

Other

           

Maxalt

     154         131           310         304     

Arcoxia

     117         100           229         214     

Avelox

     44         61           117         167     

Hospital and Specialty

           

Immunology

           

Remicade

     518         842           1,037         1,595     

Simponi

     76         75           150         129     

Infectious Disease

           

Isentress

     398         337           735         629     

PegIntron

     183         154           345         319     

Cancidas

     166         168           311         326     

Victrelis

     126         21           238         22     

Invanz

     110         103           211         189     

Primaxin

     104         136           192         272     

Noxafil

     66         56           125         110     

Oncology

           

Temodar

     225         234           461         481     

Emend

     145         120           247         207     

Other

           

Cosopt/Trusopt

     105         122           229         236     

Bridion

     60         47           118         89     

Integrilin

     60         56           113         120     

Diversified Brands

           

Cozaar/Hyzaar

     337         406           674         832     

Propecia

     100         112           208         218     

Zocor

     96         107           199         234     

Claritin Rx

     48         65           134         186     

Remeron

     66         57           123         117     

Proscar

     55         53           106         113     

Vasotec/Vaseretic

     49         59           102         116     

Vaccines (1)

           

Gardasil

     324         277           608         490     

ProQuad/M-M-R II/Varivax

     316         291           571         535     

RotaTeq

     142         148           284         272     

Zostavax

     148         122           224         146     

Pneumovax

     101         64           213         143     

Other pharmaceutical (2) 

     985         1,062           2,000         1,957     

 

 

Total Pharmaceutical segment sales

     10,560         10,360           20,642         20,179     

 

 

Other segment sales (3) 

     1,680         1,690           3,273         3,323     

 

 

Total segment sales

     12,240         12,050           23,915         23,502     

 

 

Other (4)

     71         101           126         230     

 

 
     $ 12,311       $ 12,151           $ 24,041       $ 23,732     

 

 
(1) 

These amounts do not reflect sales of vaccines sold in most major European markets through the Company’s joint venture, Sanofi Pasteur MSD, the results of which are reflected in Equity income from affiliates. These amounts do, however, reflect supply sales to Sanofi Pasteur MSD.

(2) 

Other pharmaceutical primarily includes sales of other human health pharmaceutical products not listed separately.

(3) 

Reflects other non-reportable segments, including Animal Health and Consumer Care, and revenue from the Company’s relationship with AZLP primarily relating to sales of Nexium. Revenue from AZLP was $223 million and $306 million for the second quarter of 2012 and 2011, respectively, and $409 million and $628 million for the first six months of 2012 and 2011, respectively.

(4) 

Other revenues are primarily comprised of miscellaneous corporate revenues, third-party manufacturing sales, sales related to divested products or businesses and supply sales not included in segment results. The declines in other revenues in the second quarter and first six months of 2012 as compared with the same periods of 2011 reflect lower third-party manufacturing sales, which for the year-to-date period were attributable in part to the divestiture of certain manufacturing facilities in the first quarter of 2011.

 

- 35 -


The provision for discounts includes indirect customer discounts that occur when a contracted customer purchases directly through an intermediary wholesale purchaser, known as chargebacks, as well as indirectly in the form of rebates owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. These discounts, in the aggregate, reduced revenues by $1.5 billion and $1.3 billion for the three months ended June 30, 2012 and 2011, respectively, and $3.0 billion and $2.5 billion for the six months ended June 30, 2012 and 2011, respectively. Inventory levels at key U.S. wholesalers for each of the Company’s major pharmaceutical products are generally less than one month.

Pharmaceutical Segment

Primary Care and Women’s Health

Cardiovascular

Sales of Zetia (ezetimibe) (also marketed as Ezetrol outside the United States), a cholesterol-absorption inhibitor, were $632 million in the second quarter of 2012, an increase of 7% compared with the second quarter of 2011, and were $1.2 billion for the first six months of 2012, an increase of 6% compared with the same period in 2011. Foreign exchange unfavorably affected global sales performance by 2% and 1% in the second quarter and first six months of 2012, respectively. The sales increases reflect positive performance in the United States due to pricing, partially offset by volume declines. Sales growth in the first six months of 2012 also reflects volume growth in Japan and the emerging markets. Sales of Vytorin (ezetimibe/simvastatin) (marketed outside the United States as Inegy), a combination product containing the active ingredients of both Zetia and Zocor (simvastatin), were $445 million and $889 million in the second quarter and first six months of 2012, respectively, representing declines of 3% and 5%, respectively, compared with the same periods in 2011. Foreign exchange unfavorably affected global sales performance by 4% and 2% in the second quarter and first six months of 2012, respectively. The sales declines reflect volume declines in the United States, partially offset by pricing in the United States and volume growth in international markets.

In March 2012, the Data Safety Monitoring Board (the “DSMB”) of the IMPROVE-IT trial, a large cardiovascular outcomes study evaluating ezetimibe/simvastatin against simvastatin alone in patients presenting with acute coronary syndrome, completed the second pre-specified interim efficacy analysis of the study. The DSMB conducted the planned interim efficacy analysis after the trial had reached approximately 75% of the targeted 5,250 clinical endpoints called for in the study design. The DSMB recommended that the study continue without change in design and stated it planned to review the data again in approximately nine months. That review has been scheduled for March 2013, at which point nine months of additional data will have been adjudicated. Merck remains blinded to IMPROVE-IT safety and efficacy data. IMPROVE-IT is an 18,000 patient event-driven trial and, based on the current rate at which events are being reported, the Company now anticipates the targeted 5,250 clinical endpoints for study completion will be reached in 2014.

Diabetes and Obesity

Global sales of Januvia, Merck’s dipeptidyl peptidase-4 (“DPP-4”) inhibitor for the treatment of type 2 diabetes, were $1.1 billion in the second quarter of 2012 and $2.0 billion for the first six months of 2012, representing increases of 36% and 30%, respectively, compared with the same periods of 2011, reflecting volume growth in international markets, including in Japan, and in the United States. DPP-4 inhibitors represent a class of prescription medications that improve blood sugar control in patients with type 2 diabetes by enhancing a natural body system called the incretin system, which helps to regulate glucose by affecting the beta cells and alpha cells in the pancreas.

Worldwide sales of Janumet, Merck’s oral antihyperglycemic agent that combines sitagliptin (Januvia) with metformin in a single tablet to target all three key defects of type 2 diabetes, were $411 million for the second quarter of 2012 and $802 million for the first six months of 2012, representing increases of 28% in each of those periods compared with the same periods of 2011, reflecting growth in the United States, Europe and the emerging markets.

In February 2012, the U.S. Food and Drug Administration (the “FDA”) approved Janumet XR, a treatment for type 2 diabetes that combines sitagliptin with extended-release metformin. Janumet XR provides a convenient once-daily treatment option for health care providers and patients who need help to control their blood sugar.

 

- 36 -


As previously disclosed, on February 17, 2012, the FDA sent a Warning Letter to the Company relating to Januvia and Janumet stating that the Company did not fulfill a post-marketing requirement for a 3-month pancreatic safety study in a diabetic rodent model treated with sitagliptin. Merck has been in communication with the FDA regarding this study and Merck’s efforts to complete it in a timely and satisfactory manner. Under the terms of the Warning Letter, within 30 days from the date of the letter, the Company must submit to the FDA a final study protocol for a new 3-month rodent study that will satisfy the FDA’s requirements and a proposed revised timetable for completion of the study. Within 6 months from the date of the letter, the FDA expects that the Company will have obtained agreement with the FDA on an adequate study protocol and will have initiated the study. The letter states that failure to correct the violation may result in regulatory actions by the FDA, including, but not limited to, civil money penalties. The Company has reached an agreement with the FDA on a study protocol and is proceeding with the study. Merck remains fully committed to fulfilling the FDA’s requirements.

Respiratory

Worldwide sales for Singulair, a once-a-day oral medicine for the chronic treatment of asthma and for the relief of symptoms of allergic rhinitis, were $1.4 billion for the second quarter of 2012 and $2.8 billion for the first six months of 2012, increases of 6% and 3%, respectively, compared with the same periods in 2011. The patent that provided U.S. market exclusivity for Singulair expired in August 2012. In addition, the patent that provides market exclusivity for Singulair will expire in a number of major European markets in February 2013. The Company expects a significant and rapid reduction in sales thereafter in those markets. The patent that provides market exclusivity for Singulair in Japan will expire in 2016. For the full year of 2011, sales of Singulair were $3.5 billion in the United States, $724 million in Europe and $641 million in Japan.

Global sales of Nasonex (mometasone furoate monohydrate), an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms, were $293 million for the second quarter of 2012 and $668 million for the first six months of 2012, representing declines of 9% and 4%, respectively, compared with the same periods of 2011. Foreign exchange unfavorably affected global sales performance by 3% and 1% for the second quarter and first six months of 2012, respectively. The sales declines were driven by unfavorable pricing in Europe, as well as lower volumes in the United States and the emerging markets. In addition, for the year-to-date period in 2012, lower volumes in Japan also contributed to the sales decline. In June 2012, the U.S. District Court for the District of New Jersey ruled against the company in a patent infringement suit against Apotex Inc. and Apotex Corp. (collectively “Apotex”) holding that Apotex’s generic version of Nasonex does not infringe on the Company’s patent (see Note 9 to the interim consolidated financial statements). Apotex is seeking FDA approval to sell its generic version of Nasonex. If generic versions become available, significant losses of Nasonex sales in the U.S. market are anticipated and could result in a material non-cash impairment charge related to the Nasonex intangible asset. U.S. sales of Nasonex were $604 million for the full year of 2011. As a result of the unfavorable U.S. District Court decision, the Company evaluated the Nasonex intangible asset for impairment and concluded that it was not impaired. The Company has appealed the U.S. District Court decision.

Global sales of Clarinex (marketed as Aerius in many countries outside the United States), a non-sedating antihistamine, were $140 million for the second quarter of 2012 and $273 million for the first six months of 2012, decreases of 33% and 25%, respectively, compared with the same periods of 2011, reflecting volume declines in Europe as a result of generic competition. As previously disclosed, by virtue of litigation settlements, certain generic manufacturers have been given the right to enter the U.S. market in 2012. The U.S. patent and exclusivity periods otherwise expire in 2020. In July 2012, a generic manufacturer launched a generic version of Clarinex in the United States. Accordingly, the Company anticipates that U.S. sales of Clarinex will be negatively impacted in the third and fourth quarters of 2012 and beyond. U.S. sales of Clarinex were $197 million for the full year of 2011.

Women’s Health and Endocrine

Worldwide sales for Fosamax (alendronate sodium) and Fosamax Plus D (alendronate sodium/cholecalciferol) (marketed as Fosavance throughout the EU and as Fosamac in Japan) for the treatment and, in the case of Fosamax, prevention of osteoporosis were $186 million for the second quarter of 2012 and $370 million for the first six months of 2012, representing declines of 16% and 14%, respectively, over the comparable periods of 2011. These medicines have lost market exclusivity in the United States and have also lost market exclusivity in most major European markets. Accordingly, the Company is experiencing sales declines within the Fosamax product franchise and the Company expects the declines to continue.

Worldwide sales of NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product, were $157 million for the second quarter of 2012 and $303 million for the first six months of 2012, increases of 2% in each of these periods compared with the same periods of 2011, largely reflecting volume growth in the emerging markets. Foreign exchange negatively affected sales performance by 4% and 3% for the second quarter and first six months of 2012, respectively.

 

- 37 -


Global sales of Follistim AQ (follitropin beta injection) (marketed in most countries outside the United States as Puregon), a biological fertility treatment, were $125 million for the second quarter of 2012 and $241 million for the first six months of 2012, declines of 12% and 13%, respectively, compared with the same periods of 2011, largely driven by volume declines in Europe. Puregon lost market exclusivity in the EU in August 2009. Foreign exchange unfavorably affected global sales performance by 3% and 2% for the second quarter and first six months of 2012, respectively.