10-Q 1 mrk0331201410q.htm 10-Q MRK 03.31.2014 10Q




 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the quarterly period ended March 31, 2014
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 April 30, 2014: 2,922,376,244
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
        Accelerated filer ¨
 
Non-accelerated filer ¨
 
Smaller reporting company ¨
 
 
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
 





Part I - Financial Information
Item 1. Financial Statements
MERCK & CO., INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF INCOME
(Unaudited, $ in millions except per share amounts)
 
 
Three Months Ended 
 March 31,
 
2014
 
2013
Sales
$
10,264

 
$
10,671

Costs, Expenses and Other
 
 
 
Materials and production
3,903

 
3,959

Marketing and administrative
2,734

 
2,987

Research and development
1,574

 
1,907

Restructuring costs
125

 
119

Equity income from affiliates
(124
)
 
(133
)
Other (income) expense, net
(39
)
 
282

 
8,173

 
9,121

Income Before Taxes
2,091

 
1,550

Taxes on Income
360

 
(66
)
Net Income
1,731

 
1,616

Less: Net Income Attributable to Noncontrolling Interests
26

 
23

Net Income Attributable to Merck & Co., Inc.
$
1,705

 
$
1,593

Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders
$
0.58

 
$
0.53

Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders
$
0.57

 
$
0.52

Dividends Declared per Common Share
$
0.44

 
$
0.43

 
MERCK & CO., INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited, $ in millions)
 
 
Three Months Ended 
 March 31,
 
2014
 
2013
Net Income Attributable to Merck & Co., Inc.
$
1,705

 
$
1,593

Other Comprehensive Income (Loss) Net of Taxes:
 
 
 
Net unrealized (loss) gain on derivatives, net of reclassifications
(66
)
 
236

Net unrealized (loss) gain on investments, net of reclassifications
(2
)
 
1

Benefit plan net (loss) gain and prior service (credit) cost, net of amortization
(1
)
 
161

Cumulative translation adjustment
87

 
(345
)
 
18

 
53

Comprehensive Income Attributable to Merck & Co., Inc.
$
1,723

 
$
1,646

 The accompanying notes are an integral part of these consolidated financial statements.

- 2 -




MERCK & CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Unaudited, $ in millions except per share amounts)
 
 
March 31, 2014
 
December 31, 2013
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
15,828

 
$
15,621

Short-term investments
4,685

 
1,865

Accounts receivable (net of allowance for doubtful accounts of $171 in 2014
and $146 in 2013) (excludes accounts receivable of $275 in 2014 and 2013
classified in Other assets - see Note 4)
7,188

 
7,184

Inventories (excludes inventories of $1,493 in 2014 and $1,704 in 2013
classified in Other assets - see Note 5)
6,376

 
6,226

Deferred income taxes and other current assets
3,939

 
4,763

    Assets held for sale
3,224

 
26

Total current assets
41,240

 
35,685

Investments
11,456

 
9,770

Property, Plant and Equipment, at cost, net of accumulated depreciation of $18,622
in 2014 and $18,121 in 2013
14,296

 
14,973

Goodwill
12,120

 
12,301

Other Intangibles, Net
20,517

 
23,801

Other Assets
8,831

 
9,115

 
$
108,460

 
$
105,645

Liabilities and Equity
 
 
 
Current Liabilities
 
 
 
Loans payable and current portion of long-term debt
$
8,559

 
$
4,521

Trade accounts payable
2,434

 
2,274

Accrued and other current liabilities
8,707

 
9,501

Income taxes payable
595

 
251

Dividends payable
1,327

 
1,321

    Liabilities held for sale
848

 

Total current liabilities
22,470

 
17,868

Long-Term Debt
19,589

 
20,539

Deferred Income Taxes
5,881

 
6,776

Other Noncurrent Liabilities
7,956

 
8,136

Merck & Co., Inc. Stockholders’ Equity
 
 
 
Common stock, $0.50 par value
Authorized - 6,500,000,000 shares
Issued - 3,577,103,522 shares in 2014 and 2013
1,788

 
1,788

Other paid-in capital
40,450

 
40,508

Retained earnings
39,661

 
39,257

Accumulated other comprehensive loss
(2,179
)
 
(2,197
)
 
79,720

 
79,356

Less treasury stock, at cost:
647,565,088 shares in 2014 and 649,576,808 shares in 2013
29,745

 
29,591

Total Merck & Co., Inc. stockholders’ equity
49,975

 
49,765

Noncontrolling Interests
2,589

 
2,561

Total equity
52,564

 
52,326

 
$
108,460

 
$
105,645

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

- 3 -




MERCK & CO., INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited, $ in millions)
 
 
Three Months Ended 
 March 31,
 
2014
 
2013
Cash Flows from Operating Activities
 
 
 
Net income
$
1,731

 
$
1,616

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
1,754

 
1,674

Intangible asset impairment charges

 
30

Equity income from affiliates
(124
)
 
(133
)
Dividends and distributions from equity affiliates
66

 
5

Deferred income taxes
(304
)
 
(71
)
Share-based compensation
56

 
67

Other
(115
)
 
326

Net changes in assets and liabilities
(703
)
 
(1,173
)
Net Cash Provided by Operating Activities
2,361

 
2,341

Cash Flows from Investing Activities
 
 
 
Capital expenditures
(205
)
 
(351
)
Purchases of securities and other investments
(6,825
)
 
(4,010
)
Proceeds from sales of securities and other investments
2,632

 
3,161

Dispositions of businesses, net of cash divested
533

 

Other
58

 
47

Net Cash Used in Investing Activities
(3,807
)
 
(1,153
)
Cash Flows from Financing Activities
 
 
 
Net change in short-term borrowings
3,149

 
880

Payments on debt
(3
)
 
(506
)
Purchases of treasury stock
(1,167
)
 
(580
)
Dividends paid to stockholders
(1,290
)
 
(1,306
)
Proceeds from exercise of stock options
931

 
92

Other

 
(1
)
Net Cash Provided by (Used in) Financing Activities
1,620

 
(1,421
)
Effect of Exchange Rate Changes on Cash and Cash Equivalents
33

 
(194
)
Net Increase (Decrease) in Cash and Cash Equivalents
207

 
(427
)
Cash and Cash Equivalents at Beginning of Year
15,621

 
13,451

Cash and Cash Equivalents at End of Period
$
15,828

 
$
13,024

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

- 4 -

Notes to Interim 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 27, 2014.
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 presentation.
2.
Restructuring
2013 Restructuring Program
In October 2013, the Company announced a global restructuring program (the “2013 Restructuring Program”) as part of a global initiative to sharpen its commercial and research and development focus. As part of the program, the Company expects to reduce its total workforce by approximately 8,500 positions. These workforce reductions will primarily come from the elimination of positions in sales, administrative and headquarters organizations, as well as research and development. The Company will also reduce its global real estate footprint and continue to improve the efficiency of its manufacturing and supply network. The Company will continue to hire employees in strategic growth areas of the business as necessary.
The Company recorded total pretax costs of $160 million in the first quarter of 2014 related to this restructuring program. Since inception of the 2013 Restructuring Program through March 31, 2014, Merck has recorded total pretax accumulated costs of approximately $1.4 billion and eliminated approximately 2,760 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The actions under the 2013 Restructuring Program are expected to be substantially completed by the end of 2015 with the cumulative pretax costs estimated to be approximately $2.5 billion to $3.0 billion. The Company estimates that approximately two-thirds of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.
Merger Restructuring Program
In 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”) designed to streamline the cost structure of the combined company. Further actions under this program were initiated in 2011. The actions under this 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.
On October 1, 2013, the Company sold its active pharmaceutical ingredient (“API”) manufacturing business, including the related manufacturing facility, in the Netherlands to Aspen Holdings (“Aspen”) as part of planned manufacturing facility rationalizations under the Merger Restructuring Program. Also in connection with the sale, Aspen acquired certain branded products from Merck, which transferred to Aspen effective December 31, 2013. Consideration for the transaction included cash of $705 million and notes receivable with a present value of $198 million at the time of disposition. The Company received $172 million of the cash portion of the consideration in the fourth quarter of 2013 and the remaining $533 million was received by the Company in January 2014.
The Company recorded total pretax costs of $166 million and $153 million in the first quarter of 2014 and 2013, respectively, related to this restructuring program. Since inception of the Merger Restructuring Program through March 31, 2014, Merck has recorded total pretax accumulated costs of approximately $7.3 billion and eliminated approximately 27,240 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. Approximately 5,600 position eliminations remain pending under this program as of March 31, 2014, which include the remaining actions under the 2008 Restructuring Program that are being reported as part of the Merger Restructuring Program as discussed below. The non-manufacturing related restructuring actions under the Merger Restructuring Program were substantially completed by the end of 2013. The remaining actions under this program relate to ongoing manufacturing facility rationalizations, which are expected to be substantially completed by 2016. The Company expects the estimated total cumulative pretax costs for this program to be approximately $7.4 billion to $7.7 billion. 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 cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.

- 5 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

2008 Restructuring Program
In 2008, Merck announced a global restructuring program (the “2008 Restructuring Program”) to reduce its cost structure, increase efficiency, and enhance competitiveness. Pretax costs of $41 million were recorded in the first quarter of 2013 related to the 2008 Restructuring Program. Any remaining activities under the 2008 Restructuring Program are being accounted for as part of the Merger Restructuring Program effective July 1, 2013.
For segment reporting, restructuring charges are unallocated expenses.
The following tables summarize the charges related to restructuring program activities by type of cost:
 
Three Months Ended March 31, 2014
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
2013 Restructuring Program
 
 
 
 
 
 
 
Materials and production
$

 
$
81

 
$
6

 
$
87

Marketing and administrative

 
19

 

 
19

Research and development

 
41

 
7

 
48

Restructuring costs
25

 

 
(19
)
 
6

 
25

 
141

 
(6
)
 
160

Merger Restructuring Program
 
 
 
 
 
 
 
Materials and production

 
68

 
(36
)
 
32

Marketing and administrative

 
12

 

 
12

Research and development

 
2

 
1

 
3

Restructuring costs
29

 

 
90

 
119

 
29

 
82

 
55

 
166

 
$
54

 
$
223

 
$
49

 
$
326


 
Three Months Ended March 31, 2013
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Merger Restructuring Program
 
 
 
 
 
 
 
Materials and production
$

 
$
31

 
$
9

 
$
40

Marketing and administrative

 
15

 

 
15

Research and development

 
15

 

 
15

Restructuring costs
65

 

 
18

 
83

 
65

 
61

 
27

 
153

2008 Restructuring Program
 
 
 
 
 
 
 
Materials and production

 

 
3

 
3

Marketing and administrative

 
2

 

 
2

Restructuring costs
32

 

 
4

 
36

 
32

 
2

 
7

 
41

 
$
97

 
$
63

 
$
34

 
$
194

Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. In the first quarter of 2014, approximately 1,220 positions were eliminated under the 2013 Restructuring Program. In the first quarter of 2014 and 2013, approximately 360 positions and 740 positions, respectively, were eliminated under the Merger Restructuring Program. In addition, approximately 50 positions were eliminated in the first quarter of 2013 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 undiscounted cash flows were sufficient to recover the respective book values, Merck was required to accelerate depreciation of the site assets rather than record an impairment charge. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors.

- 6 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

Other activity in 2014 and 2013 includes pretax gains and losses resulting from sales of facilities and related assets, as well as asset abandonment, shut-down and other related costs. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 11) and share-based compensation.
Adjustments to previously recorded amounts were not material in any period.
The following table summarizes the charges and spending relating to restructuring activities by program for the three months ended March 31, 2014:
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
2013 Restructuring Program
 
 
 
 
 
 
 
Restructuring reserves January 1, 2014
$
745

 
$

 
$
23

 
$
768

Expense
25

 
141

 
(6
)
 
160

(Payments) receipts, net
(235
)
 

 
(19
)
 
(254
)
Non-cash activity

 
(141
)
 
19

 
(122
)
Restructuring reserves March 31, 2014 (1)
$
535

 
$

 
$
17

 
$
552

Merger Restructuring Program
 
 
 
 
 
 
 
Restructuring reserves January 1, 2014
$
725

 
$

 
$
12

 
$
737

Expense
29

 
82

 
55

 
166

(Payments) receipts, net
(77
)
 

 
(35
)
 
(112
)
Non-cash activity

 
(82
)
 
(21
)
 
(103
)
Restructuring reserves March 31, 2014 (1)
$
677

 
$

 
$
11

 
$
688

(1) 
The cash outlays associated with the 2013 Restructuring Program are expected to be substantially completed by the end of 2015. The cash outlays associated with the Merger Restructuring Program were substantially completed by the end of 2013 with the exception of certain actions, principally manufacturing-related, which are expected to be substantially completed by 2016.
3.
Acquisitions, Divestitures, Research Collaborations and License Agreements
The Company continues its strategy of establishing external alliances to complement its substantial internal research capabilities, including research collaborations, licensing preclinical and clinical compounds to drive both near- and long-term growth. The Company supplements its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its pipeline to examine candidates which may provide more value through out-licensing and as part of its portfolio assessment process may also divest certain products.
In January 2014, Merck sold the U.S. marketing rights to Saphris (asenapine), an antipsychotic indicated for the treatment of schizophrenia and bipolar I disorder in adults to Forest Laboratories, Inc. (“Forest”). Under the terms of the agreement, Forest made upfront payments of $232 million, which were recorded in Sales in the first quarter of 2014, and will make additional payments to Merck based on defined sales milestones. In addition, as part of this transaction, Merck has agreed to supply product to Forest until patent expiry.
In March 2014, Merck divested its Sirna Therapeutics, Inc. (“Sirna”) subsidiary to Alnylam Pharmaceuticals, Inc. (“Alnylam”) for consideration of $25 million and 2,520,044 shares of Alnylam common stock. Under the terms of the agreement, Merck received 85% of the Alnylam shares in the first quarter of 2014 (valued at $172 million at the time of closing) and the remaining 15% of the shares will be received by Merck later in 2014. Merck recorded a gain of $182 million included in Other (income) expense, net in the first quarter of 2014 related to this transaction. Upon receipt of the remaining shares of Alnylam, the Company will recognize an additional gain based on the market value of the Alnylam shares when received. Merck is eligible to receive future payments associated with the achievement of certain regulatory and commercial milestones, as well as royalties on future sales. The excess of Merck’s tax basis in its investment in Sirna over the value received resulted in an approximate $300 million tax benefit recorded in the first quarter of 2014.
In April 2013, Merck and Pfizer Inc. (“Pfizer”) announced that they had entered into a worldwide (except Japan) collaboration agreement for the development and commercialization of Pfizer’s ertugliflozin, an investigational oral sodium glucose cotransporter (“SGLT2”) inhibitor being evaluated for the treatment of type 2 diabetes. The Company has initiated Phase 3 clinical trials for ertugliflozin with Pfizer. Under the terms of the agreement, Merck and Pfizer will collaborate on the clinical development and commercialization of ertugliflozin and ertugliflozin-containing fixed-dose combinations with metformin and with Januvia (sitagliptin) tablets. Merck will continue to retain the rights to its existing portfolio of sitagliptin-containing products. Through

- 7 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

the first quarter of 2013, Merck recorded research and development expenses of $60 million for upfront and milestone payments made to Pfizer. Pfizer will be eligible for additional payments associated with the achievement of pre-specified future clinical, regulatory and commercial milestones. The companies will share potential revenues and certain costs 60% to Merck and 40% to Pfizer. Each party will have certain manufacturing and supply obligations. The Company and Pfizer each have the right to terminate the agreement due to a material, uncured breach by, or insolvency of, the other party, or in the event of a safety issue. Pfizer has the right to terminate the agreement upon 12 months notice at any time following the first anniversary of the first commercial sale of a collaboration product, but must assign all rights to ertugliflozin to Merck. 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 ertugliflozin and certain payment obligations.
In February 2013, Merck and Supera Farma Laboratorios S.A. (“Supera”), a Brazilian pharmaceutical company co-owned by Cristália and Eurofarma, established the previously announced joint venture that markets, distributes and sells a portfolio of pharmaceutical and branded generic products from Merck, Cristália and Eurofarma in Brazil. Merck owns 51% of the joint venture, and Cristália and Eurofarma collectively own 49%. 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. This resulted in Merck recognizing intangible assets for currently marketed products of $89 million, in-process research and development (“IPR&D”) of $100 million, goodwill of $103 million, and deferred tax liabilities of $64 million. The Company also recorded increases to Noncontrolling interests and Other paid-in capital in the amounts of $112 million and $116 million, respectively. This transaction closed on February 1, 2013, and accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. During the fourth quarter of 2013, as a result of changes in cash flow assumptions for certain compounds, the Company recorded $15 million of impairment charges related to the IPR&D recorded in the Supera transaction.
Merck Consumer Care
In May 2014, the Company announced that it had entered into a definitive agreement to sell its Merck Consumer Care (“MCC”) business to Bayer AG (“Bayer”) for $14.2 billion. Under the terms of the agreement, Bayer will acquire Merck’s existing over-the-counter (“OTC”) business, including the global trademark and prescription rights for Claritin and Afrin.
The Company also announced a worldwide clinical development collaboration with Bayer to market and develop its portfolio of soluble guanylate cyclase (“sGC”) modulators. This includes Bayer’s Adempas (riociguat), the first member of this novel class of compounds. Adempas is approved to treat pulmonary arterial hypertension (“PAH”) and is the first and only drug treatment approved for patients with chronic thromboembolic pulmonary hypertension (“CTEPH”). Adempas is currently marketed in the United States and Europe for both PAH and CTEPH and in Japan for CTEPH. The two companies will equally share costs and profits from the collaboration and implement a joint development and commercialization strategy. The collaboration also includes clinical development of Bayer’s vericiguat, which is currently in Phase 2 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development at Bayer. Merck will in turn make available its early-stage sGC compounds under similar terms.
    In return for these broad collaboration rights, Merck will make an upfront payment to Bayer of $1 billion with the potential for additional milestone payments upon the achievement of agreed-upon sales goals. For Adempas, Bayer will continue to lead commercialization in the Americas, while Merck will lead commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead.
The Company expects after-tax proceeds from the sale of MCC to be between $8 billion and $9 billion. Merck expects to close the sale of MCC in second half of 2014, subject to customary closing conditions, including regulatory approvals.

- 8 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

At March 31, 2014, the Company determined it was appropriate to reflect the assets and liabilities of Merck Consumer Care as held for sale in the Consolidated Balance Sheet. Information with respect to Consumer Care assets and liabilities held for sale is as follows:
($ millions)
March 31, 2014
Assets
 
Accounts receivable, net
$
207

Inventories
316

Deferred income taxes and other current assets
48

Property, plant and equipment, net
221

Goodwill
137

Other intangibles, net
2,194

  Other assets
66

 
$
3,189

Liabilities
 
Trade accounts payable
$
101

Accrued and other current liabilities
193

Deferred income taxes
543

Other noncurrent liabilities
11

 
$
848

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 has exclusive marketing rights to both products throughout Europe, Russia and Turkey. 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. All profits derived from Merck’s exclusive distribution of the two products in these countries are equally divided between Merck and J&J.
4.
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

- 9 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

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. 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. 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, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the 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. The cash flows from these contracts are reported as operating activities in the Consolidated Statements of Cash Flows.
Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net. The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net. Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year.
The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates. The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency

- 10 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

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 of $12 million and $78 million for the first three months of 2014 and 2013, respectively, from the euro-denominated notes.
Interest Rate Risk Management
The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk.
At March 31, 2014, the Company was party to a total of 15 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes. There are four swaps maturing in 2016 with notional amounts of $250 million each that effectively convert the Company’s 0.70% fixed-rate notes due in 2016 to floating-rate instruments; four swaps maturing in 2018 with notional amounts of $250 million each that effectively convert the Company’s 1.30% fixed-rate notes due in 2018 to floating-rate instruments; four swaps maturing in 2017, one with a notional amount of $200 million, two with notional amounts of $250 million each, and one with a notional amount of $300 million, that effectively convert the Company’s 6.00% fixed-rate notes due in 2017 to floating-rate instruments; and three swaps maturing in 2019, two with notional amounts of $200 million each, and one with a notional amount of $150 million, that effectively convert a portion of the Company’s 5.00% notes due in 2019 to floating rate instruments. The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (“LIBOR”) swap rate. The fair value changes in the notes attributable to changes in the LIBOR are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.
Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments:
 
 
March 31, 2014
 
December 31, 2013
 
 
Fair Value of Derivative
 
U.S. Dollar
Notional
 
Fair Value of Derivative
 
U.S. Dollar
Notional
($ in millions)
Balance Sheet Caption
Asset
 
Liability
 
Asset
 
Liability
 
Derivatives Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts (non-current)
Other assets
$
14

 
$

 
$
1,550

 
$
13

 
$

 
$
1,550

Interest rate swap contracts (non-current)
Other noncurrent liabilities

 
22

 
2,000

 

 
25

 
2,000

Foreign exchange contracts (current)
Deferred income taxes and other current assets
402

 

 
5,541

 
493

 

 
4,427

Foreign exchange contracts (non-current)
Other assets
387

 

 
6,158

 
515

 

 
6,676

Foreign exchange contracts (current)
Accrued and other current liabilities

 
10

 
1,245

 

 
19

 
1,659

Foreign exchange contracts (non-current)
Other noncurrent liabilities

 
3

 
475

 

 

 

 
 
$
803


$
35


$
16,969


$
1,021


$
44


$
16,312

Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts (current)
Deferred income taxes and other current assets
$
74

 
$

 
$
7,161

 
$
69

 
$

 
$
5,705

Foreign exchange contracts (current)
Accrued and other current liabilities

 
71

 
6,441

 

 
140

 
7,892

 
 
$
74

 
$
71

 
$
13,602

 
$
69

 
$
140

 
$
13,597

 
 
$
877


$
106


$
30,571


$
1,090


$
184


$
29,909


- 11 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Company’s derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes:
 
March 31, 2014
 
December 31, 2013
 
($ in millions)
Asset
 
Liability
 
Asset
 
Liability
 
Gross amounts recognized in the consolidated balance sheet
$
877

 
$
106

 
$
1,090

 
$
184

 
Gross amount subject to offset in master netting arrangements
not offset in the consolidated balance sheet
(102
)
 
(102
)
 
(147
)
 
(147
)
 
Cash collateral (received) posted
(478
)
 

 
(652
)
 

 
Net amounts
$
297

 
$
4

 
$
291

 
$
37

 
The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a foreign currency cash flow hedging relationship, (iii) designated in a foreign currency net investment hedging relationship and (iv) not designated in a hedging relationship:
 
Three Months Ended 
 March 31,
($ in millions)
2014
 
2013
Derivatives designated in a fair value hedging relationship
 
 
 
Interest rate swap contracts
 
 
 
Amount of gain recognized in Other (income) expense, net on derivatives
$
(4
)
 
$

Amount of loss recognized in Other (income) expense, net on hedged item
4

 

Derivatives designated in foreign currency cash flow hedging relationships
 
 
 
Foreign exchange contracts
 
 
 
Amount of loss reclassified from AOCI to Sales
2

 
32

Amount of loss (gain) recognized in OCI on derivatives
102

 
(349
)
 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
)
Amount of loss (gain) recognized in OCI on derivatives
42

 
(180
)
Derivatives not designated in a hedging relationship
 
 
 
Foreign exchange contracts
 
 
 
Amount of (gain) loss recognized in Other (income) expense, net on derivatives (2)
(82
)
 
24

Amount of gain recognized in Sales 
(1
)
 
(10
)
(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 March 31, 2014, the Company estimates $62 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.


- 12 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

Investments in Debt and Equity Securities
Information on available-for-sale investments is as follows:
 
March 31, 2014
 
December 31, 2013
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
($ in millions)
Gains
 
Losses
 
Gains
 
Losses
Corporate notes and bonds
$
7,883

 
$
7,854

 
$
38

 
$
(9
)
 
$
7,054

 
$
7,037

 
$
32

 
$
(15
)
Commercial paper
3,622

 
3,622

 

 

 
1,206

 
1,206

 

 

U.S. government and agency securities
1,882

 
1,885

 
1

 
(4
)
 
1,236

 
1,239

 
1

 
(4
)
Asset-backed securities
1,230

 
1,232

 
2

 
(4
)
 
1,300

 
1,303

 
1

 
(4
)
Foreign government bonds
641

 
641

 
1

 
(1
)
 
125

 
126

 

 
(1
)
Mortgage-backed securities
497

 
499

 
2

 
(4
)
 
476

 
479

 
2

 
(5
)
Equity securities
637

 
587

 
78

 
(28
)
 
471

 
397

 
74

 

 
$
16,392

 
$
16,320

 
$
122

 
$
(50
)
 
$
11,868

 
$
11,787

 
$
110

 
$
(29
)
Available-for-sale debt securities included in Short-term investments totaled $4.7 billion at March 31, 2014. Of the remaining debt securities, $10.3 billion mature within five years. At March 31, 2014 and December 31, 2013, there were no debt securities pledged as collateral.
Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest:
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity. Level 3 assets 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.
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.

- 13 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities measured at fair value on a recurring basis are summarized below:
 
Fair Value Measurements Using
 
Fair Value Measurements Using
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
($ in millions)
March 31, 2014
 
December 31, 2013
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate notes and bonds
$

 
$
7,883

 
$

 
$
7,883

 
$

 
$
7,054

 
$

 
$
7,054

Commercial paper

 
3,622

 

 
3,622

 

 
1,206

 

 
1,206

U.S. government and agency securities

 
1,882

 

 
1,882

 

 
1,236

 

 
1,236

Asset-backed securities (1)

 
1,230

 

 
1,230

 

 
1,300

 

 
1,300

Foreign government bonds

 
641

 

 
641

 

 
125

 

 
125

Mortgage-backed securities (1)

 
497

 

 
497

 

 
476

 

 
476

Equity securities
386

 

 

 
386

 
238

 

 

 
238

 
386

 
15,755

 

 
16,141

 
238

 
11,397

 

 
11,635

Other assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities held for employee compensation
195

 
56

 

 
251

 
186

 
47

 

 
233

Derivative assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased currency options

 
734

 

 
734

 

 
868

 

 
868

Forward exchange contracts

 
129

 

 
129

 

 
209

 

 
209

Interest rate swaps

 
14

 

 
14

 

 
13

 

 
13

 

 
877

 

 
877

 

 
1,090

 

 
1,090

Total assets
$
581

 
$
16,688

 
$

 
$
17,269

 
$
424

 
$
12,534

 
$

 
$
12,958

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward exchange contracts
$

 
$
58

 
$

 
$
58

 
$

 
$
134

 
$

 
$
134

Written currency options

 
26

 

 
26

 

 
25

 

 
25

Interest rate swaps

 
22

 

 
22

 

 
25

 

 
25

Total liabilities
$

 
$
106

 
$

 
$
106

 
$

 
$
184

 
$

 
$
184

(1) 
Primarily all of the asset-backed securities are highly-rated (Standard & Poor’s rating of AAA and Moody’s Investors Service rating of Aaa), secured primarily by credit card, auto loan, and home equity receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies.
(2) 
The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Company’s own credit risk, the effects of which were not significant.
There were no transfers between Level 1 and Level 2 during the first three months of 2014. As of March 31, 2014, Cash and cash equivalents of $15.8 billion included $14.7 billion of cash equivalents (considered Level 2 in the fair value hierarchy). The Company has liabilities related to contingent consideration (considered Level 3 in the fair value hierarchy) associated with business combinations, the fair values of which were $71 million and $69 million at March 31, 2014 and December 31, 2013, respectively.
Other Fair Value Measurements
Some of the Company’s financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature.
The estimated fair value of loans payable and long-term debt (including current portion) at March 31, 2014, was $28.9 billion compared with a carrying value of $28.1 billion and at December 31, 2013, was $25.5 billion compared with a carrying value of $25.1 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.

- 14 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

The majority of the Company’s accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business, taking into consideration global economic conditions and the ongoing sovereign debt issues in certain European countries. The Company continues to monitor the credit and economic conditions within Greece, Italy, Spain 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. At March 31, 2014 and December 31, 2013, Other assets included $275 million of accounts receivable not expected to be collected within 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 March 31, 2014, the Company’s accounts receivable in Greece, Italy, Spain and Portugal totaled approximately $940 million. Of this amount, hospital and public sector receivables were approximately $610 million in the aggregate, of which approximately 11%, 45%, 33% and 11% related to Greece, Italy, Spain and Portugal, respectively. At March 31, 2014, the Company’s total net accounts receivable outstanding for more than one year were approximately $180 million, of which approximately 50% related to accounts receivable in Greece, Italy, Spain and Portugal, mostly comprised of hospital and public sector receivables.
Additionally, the Company continues to expand in the emerging markets. Payment terms in these markets tend to be longer, resulting in an increase in accounts receivable balances in certain of these markets.
Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Company’s financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Company’s credit rating, and the credit rating of the counterparty. As of March 31, 2014 and December 31, 2013, the Company had received cash collateral of $478 million and $652 million, respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities. The Company had not advanced any cash collateral to counterparties as of March 31, 2014 or December 31, 2013.
5.
Inventories
Inventories consisted of:
($ in millions)
March 31, 2014
 
December 31, 2013
Finished goods
$
1,642

 
$
1,738

Raw materials and work in process
5,889

 
5,894

Supplies
222

 
225

Total (approximates current cost)
7,753

 
7,857

Increase to LIFO costs
116

 
73

 
$
7,869

 
$
7,930

Recognized as:
 
 
 
Inventories
$
6,376

 
$
6,226

Other assets
1,493

 
1,704

Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At March 31, 2014 and December 31, 2013, these amounts included $1.3 billion and $1.5 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $208 million and $177 million at March 31, 2014 and December 31, 2013, respectively, of inventories produced in preparation for product launches.


- 15 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

6.
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 first quarter of 2013, the Company recorded $30 million of IPR&D impairment charges within Research and development expenses primarily for pipeline programs that had previously been deprioritized and were subsequently deemed to have no alternative use in the period. 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.
7.
Joint Ventures and Other Equity Method Affiliates
Equity income from affiliates reflects the performance of the Company’s joint ventures and other equity method affiliates and was comprised of the following:
 
Three Months Ended 
 March 31,
($ in millions)
2014
 
2013
AstraZeneca LP
$
98

 
$
125

Other (1)
26

 
8

 
$
124

 
$
133

(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 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 April 2014, AstraZeneca notified the Company it was exercising its option to purchase Merck’s interest in KBI which will be based in part on the value of Merck’s interest in Nexium and Prilosec. AstraZeneca will make a payment to Merck upon closing (which is expected to occur on June 30, 2014) 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. As a result of AstraZeneca exercising its option, as of July 1, 2014 (if the closing occurs on June 30, 2014 as expected), the Company will no longer record equity income from AZLP and supply sales to AZLP will terminate. In addition, the Company will recognize a pretax gain of approximately $700 million which will be primarily non-cash.
Summarized financial information for AZLP is as follows:
 
Three Months Ended 
 March 31,
($ in millions)
2014
 
2013
Sales
$
1,082

 
$
1,158

Materials and production costs
480

 
552

Other expense, net
393

 
381

Income before taxes (1)
$
209

 
$
225

(1) 
Merck’s partnership returns from AZLP are generally contractually determined as noted above and are not based on a percentage of income from AZLP, other than with respect to Merck’s 1% limited partnership interest.
8.
Contingencies
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 (as defined below) for which a separate assessment is 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.

- 16 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

Given the nature of the litigation discussed below, including the Vioxx 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 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 90 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.
Merck has reached a resolution, approved by Judge Fallon, of all remaining federal court putative class actions that were brought on behalf of individual purchasers or users of Vioxx seeking reimbursement for alleged economic loss.
Under the settlement, Merck will pay up to $23 million to pay all properly documented claims submitted by class members, approved attorneys’ fees and expenses, and approved settlement notice costs and certain other administrative expenses. The court entered an order approving the settlement on January 6, 2014. The deadline for members to submit claims under the settlement was May 6, 2014.
Merck also settled a Missouri state court class action of plaintiffs who sought reimbursement for out-of-pocket costs relating to Vioxx. The Company established a reserve of $39 million in 2012 in connection with that settlement agreement, which is the minimum amount that the Company is required to pay under the agreement. The settlement was approved, and final judgment in the action has been entered. The court-approved process for class members to submit claims under the settlement closed in October 2013.
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.
Merck is also a defendant in lawsuits brought by state Attorneys General of four states — Alaska, Mississippi, Montana and Utah. All of these actions are pending 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. In November 2013, the Circuit Court of Franklin County, Kentucky approved a settlement in an action filed by the Kentucky Attorney General, under which Merck agreed to pay Kentucky $25 million to resolve its lawsuit and the related appeals.
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. In April 2012, plaintiffs filed a motion for class certification and, in January 2013, Judge Chesler granted that motion. In March 2013, plaintiffs filed a motion for leave to amend their complaint to add certain allegations to expand the class period. In May 2013, the court denied plaintiffs’ motion for leave to amend their complaint to expand the class period, but granted plaintiffs’ leave to amend their complaint to add certain allegations within the existing class period. In June 2013, plaintiffs filed their Sixth

- 17 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

Amended Class Action Complaint. In July 2013, defendants answered the Sixth Amended Class Action Complaint. Discovery has been completed and is now closed. Under the court’s scheduling order, dispositive motions have been fully briefed.
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, an individual securities lawsuit (the “KBC Lawsuit”) was filed in the District of New Jersey by several foreign institutional investors; that case is also consolidated with the Vioxx Securities Lawsuits. In January 2012, defendants filed motions to dismiss in one of the individual lawsuits (the “ABP Lawsuit”). Briefing on the motions to dismiss was completed in March 2012. In August 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. In September 2012, defendants answered the complaints in all individual actions other than the KBC Lawsuit; on the same day, defendants moved to dismiss the complaint in the KBC Lawsuit on statute of limitations grounds. In December 2012, Judge Chesler denied the motion to dismiss the KBC Lawsuit and, in January 2013, defendants answered the complaint in the KBC Lawsuit. Discovery has been completed and is now closed. Under the court’s scheduling order, dispositive motions have been fully briefed. In March 2014, two additional individual securities complaints were filed by institutional investors that opted out of the class action referred to above. The new complaints are substantially similar to the complaints in the other individual securities lawsuits.
Insurance
The Company has Directors and Officers insurance coverage applicable to the Vioxx Securities Lawsuits with remaining stated upper limits of approximately $165 million, which is currently being used to partially fund the Company’s legal fees. 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.
International Lawsuits
As previously disclosed, in addition to the lawsuits discussed above, Merck has been named as a defendant in litigation relating to Vioxx in Brazil, Canada, Europe and Israel (collectively, the “Vioxx International Lawsuits”). As previously disclosed, the Company has entered into an agreement to resolve all claims related to Vioxx in Canada pursuant to which the Company will pay a minimum of approximately $21 million but not more than an aggregate maximum of approximately $36 million. The agreement has been approved 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 International Lawsuits (collectively, the “Vioxx Litigation”) and will vigorously defend against them. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek indeterminate damages, the Company is unable to predict the outcome of these matters and, at this time, cannot reasonably estimate the possible loss or range of loss with respect to the remaining Vioxx Litigation. The Company has established a reserve with respect to the Canadian settlement, certain other Vioxx Product Liability Lawsuits and other immaterial settlements related to certain Vioxx International Lawsuits. The Company also has an immaterial remaining reserve relating to the previously disclosed Vioxx investigation for the non-participating states with which litigation is continuing. The Company has established no other liability reserves 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.
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 March 31, 2014, approximately 5,580 cases, which include approximately 5,850 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 1,150 of these actions, plaintiffs allege, among other things, that they have suffered osteonecrosis of the jaw (“ONJ”), generally subsequent to invasive dental procedures, such as tooth extraction or dental implants and/or delayed healing, in association with the use of Fosamax. In addition, plaintiffs in approximately 4,430 of these actions generally allege that they sustained femur fractures and/or other bone injuries (“Femur Fractures”) in association with the use of Fosamax.
In December 2013, Merck reached an agreement in principle with the Plaintiffs’ Steering Committee (“PSC”) in the Fosamax ONJ MDL (as defined below) to resolve pending ONJ cases not on appeal in the Fosamax ONJ MDL and in the state courts for an aggregate amount of $27.7 million, which the Company recorded as a liability in the fourth quarter of 2013. Merck and the PSC subsequently formalized the terms of this agreement in a Master Settlement Agreement that was executed in April

- 18 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

2014. All of plaintiffs’ counsel have advised the Company that they intend to participate in the settlement plan. As a condition to the settlement, 100% of the state and federal ONJ plaintiffs must also agree to participate in the settlement plan. Merck has exercised its right to extend the deadline for plaintiffs to agree to participate to May 15, 2014. If 100% participation is not achieved, Merck has 45 days from the final date to determine whether it will terminate the agreement, or waive the 100% participation requirement and agree to a lesser funding amount for the settlement fund. Merck has also settled the four ONJ cases on appeal for approximately $3.5 million in the aggregate. These settlements have no effect on the cases alleging Femur Fractures discussed below.
Cases Alleging ONJ and/or Other Jaw Related Injuries
In August 2006, the Judicial Panel on Multidistrict Litigation (“JPML”) ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation (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 860 of the cases are before Judge Keenan, although, as noted above, these cases are subject to the pending settlement.
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 March 31, 2014, approximately 285 ONJ cases were pending against Merck in Atlantic County, New Jersey, although these cases are also subject to the pending settlement described above.
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 1,120 cases were pending in the Fosamax Femur Fracture MDL as of March 31, 2014. A Case Management Order was entered requiring the parties to review 33 cases. Judge Joel Pisano selected four cases from that group to be tried as the initial bellwether cases in the Fosamax Femur Fracture MDL. The first bellwether case, Glynn v. Merck, began on April 8, 2013, and the jury returned a verdict in Merck’s favor on April 29, 2013; in addition, on June 27, 2013, Judge Pisano granted Merck’s motion for judgment as a matter of law in the Glynn case and held that the plaintiff’s failure to warn claim was preempted by federal law. Judge Pisano set a May 5, 2014, trial date for the bellwether trial of a case in which the alleged injury took place after January 31, 2011. Following the completion of fact discovery, the court selected Sweet v. Merck as the next Fosamax Femur Fracture MDL case to be tried on May 5, 2014, but plaintiffs subsequently dismissed that case. As a result, the May 2014 trial date was withdrawn.
In addition, Judge Pisano entered an order in August 2013 requiring plaintiffs in the Fosamax Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the court’s preemption decision in the Glynn case. Plaintiffs filed their responses to the show cause order at the end of September 2013 and Merck filed its reply to those responses at the end of October 2013. A hearing on the show cause order was held in January 2014 and, on March 26, 2014, Judge Pisano issued an opinion finding that all claims of the approximately 650 plaintiffs who allegedly suffered injuries prior to September 14, 2010 were preempted and ordered that those cases be dismissed. The majority of those plaintiffs are appealing that ruling to the U.S. Court of Appeals for the Third Circuit.
As of March 31, 2014, approximately 2,785 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 selected an initial group of 30 cases to be reviewed through fact discovery. Two additional groups of 50 cases each to be reviewed through fact discovery were selected in November 2013 and March 2014, respectively.
As of March 31, 2014, approximately 525 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. In March 2014, Judge Perk directed that a group of 10 discovery pool cases be reviewed through fact discovery and scheduled dates in February, April and June 2015 for trials of three individual cases that will be selected from that group. The parties are expected to identify the initial set of cases that will be included in the discovery pool in May 2014.
Additionally, there are six Femur Fracture cases pending in other state courts.
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.

- 19 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

Januvia/Janumet
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet. As of March 31, 2014, approximately 295 cases were served on, and are pending against, Merck alleging generally that use of Januvia and/or Janumet caused the development of pancreatic cancer. These complaints were filed in several different state and federal courts. Most of the claims are pending in a consolidated multidistrict litigation proceeding in the U.S. District Court for the Southern District of California called “In re Incretin-Based Therapies Products Liability Litigation.” That proceeding includes federal lawsuits alleging pancreatic cancer due to use of the following medicines: Januvia, Janumet, Byetta and Victoza, the latter two of which are products manufactured by other pharmaceutical companies. In addition to the cases noted above, the Company has agreed, as of March 31, 2014, to toll the statute of limitations for 11 additional claims. 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 (the “NuvaRing Litigation”), 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.
Merck and negotiating plaintiffs’ counsel have agreed to a settlement of the NuvaRing Litigation that is intended to resolve at least 95% of all cases filed as of February 7, 2014, and all unfiled claims under retainer by counsel prior to that date. Plaintiffs’ response to the courts’ census orders has disclosed approximately 1,405 of such unfiled claims. Merck has agreed to a lump total settlement of $100 million, provided there is participation in the settlement of at least 95% of plaintiffs and eligible claimants overall and in certain categories. The original deadline to opt into the settlement has been extended to May 9, 2014. The Company has certain insurance coverage available to it, which is currently being used to partially fund the Company’s legal fees. This insurance coverage will also be used to fund the settlement.
As of March 31, 2014, there were approximately 1,935 NuvaRing cases (excluding unfiled cases). Of these cases, approximately 1,715 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 210 are pending in coordinated proceedings in the Bergen County Superior Court of New Jersey before Judge Brian R. Martinotti. Seven additional cases are pending in various other state courts, including cases in a coordinated state proceeding in the San Francisco Superior Court in California before Judge John E. Munter. Certain state court cases are scheduled for trial in 2014.
Propecia/Proscar
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar. As of March 31, 2014, approximately 1,190 lawsuits involving a total of approximately 1,450 plaintiffs (in a few instances spouses are joined as plaintiffs 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. Approximately 35 of the plaintiffs also allege that Propecia or Proscar has caused or can cause prostate cancer or male breast cancer. The lawsuits have been filed in various federal courts and in state court in New Jersey. The federal lawsuits have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge 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. In addition, there is one matter pending in federal court in Massachusetts and one matter pending in state court in St. Louis, Missouri. The Company intends to defend against these lawsuits.
Vytorin/Zetia Litigation
On November 14, 2013, two complaints were filed in the District of New Jersey against Merck as successor to Schering-Plough, and other defendants, by certain institutional investors who “opted-out” of the previously-disclosed and now settled ENHANCE securities class action against Schering-Plough. In addition, on January 14, 2014, two complaints were filed in the District of New Jersey against Merck and other defendants by certain institutional investors who “opted-out” of the similar Vytorin/Zetia securities class action against Merck. The “opt-out” complaints contain allegations similar to those made by plaintiffs in the settled class actions against Schering-Plough and Merck. On March 27, 2014, the court stayed all four “opt-out” cases pending a decision by the U.S. Supreme Court in Public Employees’ Retirement System of Mississippi v. Indymac MBS Inc. et al. The Company intends to move to dismiss these complaints and otherwise to defend itself in the litigation.

- 20 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

Governmental Proceedings
The Company’s subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Company’s policy is to cooperate with these authorities and to provide responses as appropriate.
Patent Litigation
From time to time, generic manufacturers of pharmaceutical products file Abbreviated New Drug Applications with the U.S. Food and Drug Administration (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 products marketed via agreements with other companies) currently involved in such patent infringement litigation in the United States include: Cancidas, Emend for Injection, Integrilin, Nexium, and NuvaRing. Similar lawsuits defending the Company’s patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by generic companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through mergers and acquisitions, potentially significant intangible asset impairment charges.
Cancidas — In February 2014, a patent infringement lawsuit was filed in the United States against Xellia Pharmaceuticals ApS (“Xellia”) with respect to Xellia’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cancidas. The lawsuit automatically stays FDA approval of Xellia’s application until July 2016 or until an adverse court decision, if any, whichever may occur earlier.
Emend for Injection — In May 2012, a patent infringement lawsuit 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 Emend for Injection. The lawsuit automatically stays FDA approval of Sandoz’s application 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 Company has agreed with Intas to stay the lawsuit pending the outcome of the lawsuit with Sandoz.
Integrilin — In February 2009, a patent infringement lawsuit was filed (jointly with Millennium Pharmaceuticals, Inc.) 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 Integrilin. In October 2011, the parties entered into a settlement agreement allowing TPM to sell a generic version of Integrilin beginning June 2, 2015. In November 2012, a patent infringement lawsuit was filed against APP Pharmaceuticals, Inc. and Fresenius Kabi USA Inc. (collectively, “APP”) in respect of APP’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Integrilin. In March 2013, the parties entered into a settlement agreement allowing APP to sell a generic version of Integrilin beginning June 2, 2015. In September 2013, a patent infringement lawsuit was filed against Ben Venue Laboratories d/b/a Bedford Laboratories (“Bedford”) in respect of Bedford’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Integrilin. In February 2014, the parties entered into a settlement allowing Bedford to sell a generic version of Integrilin beginning June 2, 2015.
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.), Dr. Reddy’s Laboratories, Sandoz, Lupin Ltd., Hetero Drugs Limited Unit III 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 provided that Sun Pharma was entitled to bring its generic esomeprazole IV product to market in the United States on January 1, 2014. A patent infringement lawsuit was also filed (jointly with AstraZeneca) in the United States against Hanmi USA, Inc. (“Hanmi”) related to its application to the FDA seeking pre-patent expiry approval to sell a different salt of esomeprazole than is found in Nexium (the “Hanmi Product”). In a May 2013 agreement, Hanmi conceded the validity and enforceability of the patents in the lawsuit. The parties also agreed that the Hanmi Product would not infringe those patents under the District Court’s December 2012 claim interpretation order, which AstraZeneca and KBI appealed. On December 19, 2013, the Court of Appeals for the Federal Circuit denied the appeal and affirmed the District of Court’s claim interpretation order. Hanmi has launched its esomeprazole product at risk. The Company continues to believe the court’s order was incorrect and is considering its options for further review.

- 21 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

Additional patent infringement lawsuits have been filed (jointly with AstraZeneca) in the United States against Mylan Laboratories Limited (“Mylan Labs”), Actavis, Inc./Watson Pharma Company (collectively, “Actavis/Watson”), Wockhardt Limited and Wockhardt USA LLC (collectively, “Wockhardt”), Aurobindo Pharma Limited and Aurobindo Pharma USA Inc. (collectively, “Aurobindo”), and Kremers Urban Development Co. and Kremers Urban LLC (collectively, “Kremers”) related to their applications to the FDA seeking pre-patent expiry approval to sell generic versions of Nexium. The Mylan Labs, Actavis/Watson, Wockhardt, Aurobindo and Kremers applications to the FDA remain stayed until August 2014, October 2015, December 2015, April 2016 and April 2016, respectively, or until earlier adverse court decisions, if any, whichever may occur earlier.
NuvaRing — In December 2013, the Company filed a lawsuit against Warner Chilcott Company LLC (“Warner Chilcott”) in the United States in respect of Warner Chilcott’s application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing.
Patent Oppositions
As previously disclosed, Ono Pharmaceutical Co. (“Ono”) has a European patent that broadly claims the use of an anti-PD-1 antibody, such as the Company’s immunotherapy, MK-3475, for the treatment of cancer. Ono has previously licensed its commercial rights to an anti-PD-1 antibody to Bristol-Myers Squibb (“BMS”) in certain markets. The Company believes that this patent is invalid and has filed an opposition in the European Patent Office (the “EPO”) seeking its revocation. The Opposition Division of the EPO has scheduled a hearing in June 2014. The hearing panel has issued a preliminary opinion that the claims in the patent are valid. The hearing panel usually renders a decision, which is subject to further appeal, at the close of a hearing. If the patent survives these proceedings with similar breadth, Merck can file actions seeking to revoke the patent in each relevant national court in Europe. Ono could file patent infringement actions against the Company in each relevant national court in Europe at or around the time the company launches MK-3475 (if approved). If a national court determines that the Company infringed a valid claim in Ono’s patent, Ono may be entitled to monetary damages, including royalties on future sales of MK-3475, and potentially could seek an injunction to prevent the Company from marketing MK-3475 in that country. On April 30, 2014, the Company opposed another European patent owned by BMS and Ono that it believes is invalid. This patent, if valid, broadly claims anti-PD-1 antibodies that could include MK-3475. In addition, Ono and BMS have similar and other patents and applications, which the Company is closely monitoring, pending in the United States, Japan and other countries. The Company is confident that it will be able to market MK-3475 in any country in which it is approved and that it will not be prevented from doing so by the Ono patent or any pending patent.
Other Litigation
There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Company’s financial position, results of operations or cash flows either individually or in the aggregate.
Legal Defense Reserves
Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Company’s legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of March 31, 2014 and December 31, 2013 of approximately $190 million and $160 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.


- 22 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

9.
Equity
 
  
Common Stock
Other
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Loss
 
Treasury Stock
Non-
Controlling
Interests
Total
($ and shares in millions)
Shares
Par Value
Shares
Cost
Balance at January 1, 2013
3,577

$
1,788

$
40,646

$
39,985

$
(4,682
)
550

$
(24,717
)
$
2,443

$
55,463

Net income attributable to Merck & Co., Inc.



1,593





1,593

Cash dividends declared on common stock



(1,306
)




(1,306
)
Treasury stock shares purchased






14

(580
)

(580
)
Share-based compensation plans and other


(35
)


(4
)
168


133

Other comprehensive income




53





53

Supera joint venture


116





112

228

Net income attributable to noncontrolling interests







23

23

Distributions attributable to noncontrolling interests







(1
)
(1
)
Balance at March 31, 2013
3,577

$
1,788

$
40,727

$
40,272

$
(4,629
)
560

$
(25,129
)
$
2,577

$
55,606

Balance at January 1, 2014
3,577

$
1,788

$
40,508

$
39,257

$
(2,197
)
650

$
(29,591
)
$
2,561

$
52,326

Net income attributable to Merck & Co., Inc.



1,705





1,705

Cash dividends declared on common stock



(1,301
)




(1,301
)
Treasury stock shares purchased





21

(1,167
)

(1,167
)
Share-based compensation plans and other


(58
)


(23
)
1,013

3

958

Other comprehensive income




18




18

Net income attributable to noncontrolling interests







26

26

Distributions attributable to noncontrolling interests







(1
)
(1
)
Balance at March 31, 2014
3,577

$
1,788

$
40,450

$
39,661

$
(2,179
)
648

$
(29,745
)
$
2,589

$
52,564

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. As discussed in Note 7, AstraZeneca has exercised its option to acquire Merck’s interest in AZLP. Upon closing of that transaction, which is expected to occur on June 30, 2014, this preferred stock obligation will be retired.
10.
Share-Based Compensation Plans
The Company has share-based compensation plans under which the Company grants restricted stock units (“RSUs”) and performance share units (“PSUs”) to certain management level employees. In addition, employees, non-employee directors and employees of certain of the Company’s equity method investees may be granted options to purchase shares of Company common stock at the fair market value at the time of grant.
The following table provides amounts of share-based compensation cost recorded in the Consolidated Statement of Income:
 
Three Months Ended 
 March 31,
($ in millions)
2014
 
2013
Pretax share-based compensation expense
$
56

 
$
67

Income tax benefit
(17
)
 
(20
)
Total share-based compensation expense, net of taxes
$
39

 
$
47

During the first three months of 2014 and 2013, the Company granted 49 thousand RSUs with a weighted-average grant date fair value of $54.89 per RSU and 32 thousand RSUs with a weighted-average grant date fair value of $41.09 per RSU, respectively.

- 23 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

During the first three months of 2014, the Company granted 80 thousand stock options with a weighted-average exercise price of $54.89 per option. During the first three months of 2013, the Company did not grant any stock options. The weighted-average fair value of options granted for the first three months of 2014 was $8.10 per option and was determined using the following assumptions:
  
Three Months Ended March 31, 2014
Expected dividend yield
4.2
%
Risk-free interest rate
2.1
%
Expected volatility
24.2
%
Expected life (years)
7.0

At March 31, 2014, there was $657 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 2.3 years.
The Company typically communicates the value of annual share-based compensation awards to employees during the first quarter, but the related share amounts are not established and communicated until early May. Therefore, while the number of RSU and stock option grants disclosed above do not reflect any amounts relating to the annual grants, share-based compensation costs for the first quarter of 2014 and 2013 and unrecognized compensation expense at March 31, 2014 reflect an impact relating to the awards communicated to employees. For segment reporting, share-based compensation costs are unallocated expenses.
11.
Pension and Other Postretirement Benefit Plans
The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. The net periodic benefit cost of such plans consisted of the following components: 
  
Three Months Ended 
 March 31,
($ in millions)
2014
 
2013
Service cost
$
151

 
$
175

Interest cost
175

 
166

Expected return on plan assets
(300
)
 
(275
)
Net amortization
27

 
84

Termination benefits
14

 
2

Curtailments
(9
)
 

 
$
58

 
$
152

The Company provides medical benefits, principally to its eligible U.S. retirees and similar benefits to their dependents, through its other postretirement benefit plans. The net cost of such plans consisted of the following components: 
  
Three Months Ended 
 March 31,
($ in millions)
2014
 
2013
Service cost
$
19

 
$
24

Interest cost
28

 
27

Expected return on plan assets
(34
)
 
(31
)
Net amortization
(18
)
 
(12
)
Termination benefits
4

 

Curtailments
(20
)
 

 
$
(21
)
 
$
8

In connection with restructuring actions (see Note 2), termination charges were recorded on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring actions, curtailments were recorded on pension and other postretirement benefit plans as reflected in the tables above.


- 24 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

12.
Other (Income) Expense, Net
Other (income) expense, net, consisted of: 
 
Three Months Ended 
 March 31,
($ in millions)
2014
 
2013
Interest income
$
(61
)
 
$
(57
)
Interest expense
188

 
184

Exchange losses
34

 
212

Other, net
(200
)
 
(57
)
 
$
(39
)
 
$
282

The lower exchange losses in the first quarter of 2014 as compared with the first quarter of 2013 are due primarily to a Venezuelan currency devaluation. In February 2013, the Venezuelan government devalued its currency (Bolívar Fuertes) from 4.30 VEF per U.S. dollar to 6.30 VEF per U.S. dollar. The Company recognized losses due to exchange of approximately $140 million in the first quarter of 2013 resulting from the remeasurement of the local monetary assets and liabilities at the new rate. Since January 2010, Venezuela has been designated hyperinflationary and, as a result, local foreign operations are remeasured in U.S. dollars with the impact recorded in results of operations. Other, net in the first quarter of 2014 includes a gain of $182 million on the divestiture of Sirna (see Note 3).
Interest paid for the three months ended March 31, 2014 and 2013 was $168 million and $187 million, respectively.
13.
Taxes on Income
The effective income tax rates of 17.2% and (4.3)% for the first quarter of 2014 and 2013, respectively, reflect the impacts of acquisition-related costs and restructuring costs, partially offset by the beneficial impact of foreign earnings. In addition, the effective income tax rate for the first quarter of 2014 includes a benefit of approximately $300 million associated with a capital loss generated in the quarter associated with the sale of Sirna (see Note 3). The effective income tax rate for the first quarter of 2013 also reflects the favorable impact of various discrete items, including the impact of tax legislation enacted in the first quarter of 2013 that extended the R&D tax credit for both 2012 and 2013, a reduction in tax reserves upon expiration of applicable statute of limitations, as well as a benefit of approximately $160 million associated with the resolution of a previously disclosed federal income tax issue as discussed below.
In 2010, the Internal Revenue Service (the “IRS”) finalized its examination of Schering-Plough’s 2003-2006 tax years. In this audit cycle, the Company reached an agreement with the IRS on an adjustment to income related to intercompany pricing matters. This income adjustment mostly reduced net operating loss carryforwards and other tax credit carryforwards. The Company’s reserves for uncertain tax positions were adequate to cover all adjustments related to this examination period. Additionally, as previously disclosed, the Company was seeking resolution of one issue raised during this examination through the IRS administrative appeals process. In the first quarter of 2013, the Company recorded an out-of-period net tax benefit of $160 million related to this issue, which was settled in the fourth quarter of 2012, with final resolution relating to interest owed being reached in the first quarter of 2013. The Company’s unrecognized tax benefits related to this issue exceeded the settlement amount. Management concluded that the exclusion of this benefit was not material to prior period financial statements.
14.
Earnings Per Share
The calculations of earnings per share are as follows:
 
Three Months Ended 
 March 31,
($ and shares in millions except per share amounts)
2014
 
2013
Net income attributable to Merck & Co., Inc.
$
1,705

 
$
1,593

 
 
 
 
Average common shares outstanding
2,934

 
3,022

Common shares issuable (1)
37

 
31

Average common shares outstanding assuming dilution
2,971

 
3,053

 
 
 
 
Basic earnings per common share attributable to Merck & Co., Inc. common shareholders
$
0.58

 
$
0.53

Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders
$
0.57

 
$
0.52

(1) 
Issuable primarily under share-based compensation plans.

- 25 -

Notes to Interim Consolidated Financial Statements (unaudited) (continued)

For the three months ended March 31, 2014 and 2013, 1 million and 86 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.
15.
Other Comprehensive Income (Loss)
Changes in AOCI by component are as follows:
 
Three Months Ended March 31,
($ in millions)
Derivatives
 
Investments
 
Employee
Benefit
Plans
 
Cumulative
Translation
Adjustment
 
Accumulated Other
Comprehensive
Income (Loss)
Balance January 1, 2013, net of taxes
$
(97
)
 
$
73

 
$
(3,667
)
 
$
(991
)
 
$
(4,682
)
Other comprehensive income (loss) before reclassification adjustments, pretax
349

 
36

 
133

 
(253
)
 
265

Tax
(133
)
 
(12
)
 
(23
)
 
(92
)
 
(260
)
Other comprehensive income (loss) before reclassification adjustments, net of taxes
216

 
24

 
110

 
(345
)
 
5

Reclassification adjustments, pretax
32

 
(28
)
 
72

 

 
76

Tax
(12
)
 
5

 
(21
)
 

 
(28
)
Reclassification adjustments, net of taxes
20

(1) 
(23
)
(2) 
51

(3) 

 
48

Other comprehensive income (loss), net of taxes
236

 
1

 
161

 
(345
)
 
53

Balance March 31, 2013, net of taxes
$
139

 
$
74

 
$
(3,506
)
 
$
(1,336
)
 
$
(4,629
)
 
 
 
 
 
 
 
 
 
 
Balance January 1, 2014, net of taxes
$
132

 
$
54

 
$
(909
)
 
$
(1,474
)
 
$
(2,197
)
Other comprehensive income (loss) before reclassification adjustments, pretax
(102
)
 
(5
)
 
(14
)
 
76

 
(45
)
Tax
36

 
7

 
7

 
11

 
61

Other comprehensive income (loss) before reclassification adjustments, net of taxes
(66
)
 
2

 
(7
)
 
87

 
16

Reclassification adjustments, pretax

 
(5
)
 
9

 

 
4

Tax

 
1

 
(3
)
 

 
(2
)
Reclassification adjustments, net of taxes

(1) 
(4
)
(2) 
6

(3) 

 
2

Other comprehensive income (loss), net of taxes
(66
)
 
(2
)
 
(1
)