10-Q 1 mrk0630201410q.htm 10-Q MRK 06.30.2014 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 June 30, 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 July 31, 2014: 2,884,632,033
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 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Sales
$
10,934

 
$
11,010

 
$
21,198

 
$
21,681

Costs, Expenses and Other
 
 
 
 
 
 
 
Materials and production
4,893

 
4,284

 
8,796

 
8,243

Marketing and administrative
2,973

 
3,140

 
5,707

 
6,126

Research and development
1,664

 
2,101

 
3,238

 
4,008

Restructuring costs
163

 
155

 
288

 
274

Equity income from affiliates
(92
)
 
(116
)
 
(217
)
 
(249
)
Other (income) expense, net
(558
)
 
201

 
(596
)
 
484

 
9,043

 
9,765

 
17,216

 
18,886

Income Before Taxes
1,891

 
1,245

 
3,982

 
2,795

Taxes on Income
(142
)
 
310

 
218

 
244

Net Income
2,033

 
935

 
3,764

 
2,551

Less: Net Income Attributable to Noncontrolling Interests
29

 
29

 
55

 
52

Net Income Attributable to Merck & Co., Inc.
$
2,004

 
$
906

 
$
3,709

 
$
2,499

Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders
$
0.69

 
$
0.30

 
$
1.27

 
$
0.83

Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders
$
0.68

 
$
0.30

 
$
1.25

 
$
0.82

Dividends Declared per Common Share
$
0.44

 
$
0.43

 
$
0.88

 
$
0.86

 
MERCK & CO., INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited, $ in millions)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Net Income Attributable to Merck & Co., Inc.
$
2,004

 
$
906

 
$
3,709

 
$
2,499

Other Comprehensive Income (Loss) Net of Taxes:
 
 
 
 
 
 
 
Net unrealized (loss) gain on derivatives, net of reclassifications
(39
)
 
35

 
(105
)
 
271

Net unrealized gain (loss) on investments, net of reclassifications
64

 
(81
)
 
62

 
(80
)
Benefit plan net (loss) gain and prior service (credit) cost, net of amortization
(331
)
 
51

 
(332
)
 
212

Cumulative translation adjustment
41

 
(136
)
 
128

 
(481
)
 
(265
)
 
(131
)
 
(247
)
 
(78
)
Comprehensive Income Attributable to Merck & Co., Inc.
$
1,739

 
$
775

 
$
3,462

 
$
2,421

 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)
 
 
June 30, 2014
 
December 31, 2013
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
9,743

 
$
15,621

Short-term investments
3,652

 
1,865

Accounts receivable (net of allowance for doubtful accounts of $167 in 2014
and $146 in 2013) (excludes accounts receivable of $275 in 2014 and 2013
classified in Other assets - see Note 4)
7,022

 
7,184

Inventories (excludes inventories of $1,623 in 2014 and $1,704 in 2013
classified in Other assets - see Note 5)
6,136

 
6,226

Deferred income taxes and other current assets
3,659

 
4,763

    Assets held for sale
3,375

 
26

Total current assets
33,587

 
35,685

Investments
12,618

 
9,770

Property, Plant and Equipment, at cost, net of accumulated depreciation of $18,866
in 2014 and $18,121 in 2013
13,893

 
14,973

Goodwill
11,789

 
12,301

Other Intangibles, Net
18,830

 
23,801

Other Assets
7,143

 
9,115

 
$
97,860

 
$
105,645

Liabilities and Equity
 
 
 
Current Liabilities
 
 
 
Loans payable and current portion of long-term debt
$
4,477

 
$
4,521

Trade accounts payable
2,326

 
2,274

Accrued and other current liabilities
8,829

 
9,501

Income taxes payable
192

 
251

Dividends payable
1,303

 
1,321

    Liabilities held for sale
801

 

Total current liabilities
17,928

 
17,868

Long-Term Debt
18,590

 
20,539

Deferred Income Taxes
4,651

 
6,776

Other Noncurrent Liabilities
8,175

 
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
40,199

 
40,508

Retained earnings
40,366

 
39,257

Accumulated other comprehensive loss
(2,444
)
 
(2,197
)
 
79,909

 
79,356

Less treasury stock, at cost:
677,393,158 shares in 2014 and 649,576,808 shares in 2013
31,551

 
29,591

Total Merck & Co., Inc. stockholders’ equity
48,358

 
49,765

Noncontrolling Interests
158

 
2,561

Total equity
48,516

 
52,326

 
$
97,860

 
$
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)
 
 
Six Months Ended 
 June 30,
 
2014
 
2013
Cash Flows from Operating Activities
 
 
 
Net income
$
3,764

 
$
2,551

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
3,507

 
3,329

Intangible asset impairment charges
660

 
594

Gain on AstraZeneca option exercise
(741
)
 

Equity income from affiliates
(217
)
 
(249
)
Dividends and distributions from equity affiliates
125

 
68

Deferred income taxes
(1,246
)
 
(319
)
Share-based compensation
134

 
142

Other
(192
)
 
372

Net changes in assets and liabilities
(1,118
)
 
(1,809
)
Net Cash Provided by Operating Activities
4,676

 
4,679

Cash Flows from Investing Activities
 
 
 
Capital expenditures
(507
)
 
(764
)
Purchases of securities and other investments
(12,380
)
 
(8,818
)
Proceeds from sales of securities and other investments
8,102

 
7,195

Dispositions of businesses, net of cash divested
558

 

Proceeds from AstraZeneca option exercise
419

 

Other
(48
)
 
99

Net Cash Used in Investing Activities
(3,856
)
 
(2,288
)
Cash Flows from Financing Activities
 
 
 
Net change in short-term borrowings
(1,886
)
 
1,702

Proceeds from issuance of debt
1

 
6,467

Payments on debt
(5
)
 
(515
)
Purchases of treasury stock
(3,413
)
 
(6,105
)
Dividends paid to stockholders
(2,629
)
 
(2,638
)
Proceeds from exercise of stock options
1,134

 
641

Other
49

 
(3
)
Net Cash Used in Financing Activities
(6,749
)
 
(451
)
Effect of Exchange Rate Changes on Cash and Cash Equivalents
51

 
(301
)
Net (Decrease) Increase in Cash and Cash Equivalents
(5,878
)
 
1,639

Cash and Cash Equivalents at Beginning of Year
15,621

 
13,451

Cash and Cash Equivalents at End of Period
$
9,743

 
$
15,090

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.
Recently Issued Accounting Standards
In May 2014, the Financial Accounting Standards Board issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. This guidance is effective for annual and interim periods beginning in 2017. Early adoption is not permitted. The Company is currently assessing the impact of adoption on its consolidated financial statements.
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 $229 million and $389 million in the second quarter and first six months of 2014, respectively, related to this restructuring program. Since inception of the 2013 Restructuring Program through June 30, 2014, Merck has recorded total pretax accumulated costs of approximately $1.6 billion and eliminated approximately 4,135 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 $192 million and $265 million in the second quarter of 2014 and 2013, respectively, and $358 million and $418 million in the first six months of 2014 and 2013, respectively, related to this restructuring program. Since inception of the Merger Restructuring Program through June 30, 2014, Merck has recorded total pretax accumulated costs of approximately $7.5 billion and eliminated approximately 27,670 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. Approximately 4,890 position eliminations remain pending under this program as of June 30, 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

- 5 -

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

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 $7.9 billion to $8.2 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.
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 $13 million and $54 million were recorded in the second quarter and first six months of 2013, respectively, 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 June 30, 2014
 
Six Months Ended June 30, 2014
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
 
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
2013 Restructuring Program
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Materials and production
$

 
$
103

 
$
11

 
$
114

 
$

 
$
184

 
$
17

 
$
201

Marketing and administrative

 
28

 

 
28

 

 
47

 

 
47

Research and development

 
44

 
1

 
45

 

 
85

 
8

 
93

Restructuring costs
52

 

 
(10
)
 
42

 
77

 

 
(29
)
 
48

 
52

 
175

 
2

 
229

 
77

 
316

 
(4
)
 
389

Merger Restructuring Program
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Materials and production

 
84

 
(27
)
 
57

 

 
152

 
(63
)
 
89

Marketing and administrative

 
13

 
3

 
16

 

 
25

 
3

 
28

Research and development

 
(2
)
 

 
(2
)
 

 

 
1

 
1

Restructuring costs
70

 

 
51

 
121

 
99

 

 
141

 
240

 
70

 
95

 
27

 
192

 
99

 
177

 
82

 
358

 
$
122

 
$
270

 
$
29

 
$
421

 
$
176

 
$
493

 
$
78

 
$
747


 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
 
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Merger Restructuring Program
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Materials and production
$

 
$
30

 
$
62

 
$
92

 
$

 
$
61

 
$
71

 
$
132

Marketing and administrative

 
9

 
5

 
14

 

 
24

 
5

 
29

Research and development

 
14

 

 
14

 

 
29

 

 
29

Restructuring costs
129

 

 
16

 
145

 
194

 

 
34

 
228

 
129

 
53

 
83

 
265

 
194

 
114

 
110

 
418

2008 Restructuring Program
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Materials and production

 
(2
)
 
3

 
1

 

 
(2
)
 
6

 
4

Marketing and administrative

 
2

 

 
2

 

 
4

 

 
4

Restructuring costs
2

 

 
8

 
10

 
34

 

 
12

 
46

 
2

 

 
11

 
13

 
34

 
2

 
18

 
54

 
$
131

 
$
53

 
$
94

 
$
278

 
$
228

 
$
116

 
$
128

 
$
472

Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. In the second quarter and first six months of 2014, approximately 1,375 positions and 2,595 positions, respectively, were eliminated under the 2013 Restructuring Program. In the second quarter of 2014 and 2013, approximately 430 positions and 670 positions, respectively, and in the first six months of 2014 and 2013, approximately 790 positions and 1,405 positions, respectively, were eliminated under the Merger Restructuring Program. In addition, approximately 10 positions and 55 positions were eliminated in the second quarter and first six months of 2013, respectively, 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,

- 6 -

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

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.
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 six months ended June 30, 2014:
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
2013 Restructuring Program
 
 
 
 
 
 
 
Restructuring reserves January 1, 2014
$
745

 
$

 
$
23

 
$
768

Expense
77

 
316

 
(4
)
 
389

(Payments) receipts, net
(375
)
 

 
(33
)
 
(408
)
Non-cash activity

 
(316
)
 
30

 
(286
)
Restructuring reserves June 30, 2014 (1)
$
447

 
$

 
$
16

 
$
463

Merger Restructuring Program
 
 
 
 
 
 
 
Restructuring reserves January 1, 2014
$
725

 
$

 
$
12

 
$
737

Expense
99

 
177

 
82

 
358

(Payments) receipts, net
(163
)
 

 
(92
)
 
(255
)
Non-cash activity

 
(177
)
 
7

 
(170
)
Restructuring reserves June 30, 2014 (1)
$
661

 
$

 
$
9

 
$
670

(1) 
The cash outlays associated with the 2013 Restructuring Program are expected to be substantially completed by the end of 2015. The non-manufacturing cash outlays associated with the Merger Restructuring Program were substantially completed by the end of 2013; the remaining cash outlays 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 August 2014, Merck completed the acquisition of Idenix Pharmaceuticals, Inc. (“Idenix”) for $24.50 per share in cash for a total of approximately $3.85 billion. Idenix is a biopharmaceutical company engaged in the discovery and development of medicines for the treatment of human viral diseases, whose primary focus is on the development of next-generation oral antiviral therapeutics to treat hepatitis C virus (“HCV”) infection. Idenix currently has three HCV drug candidates in clinical development: two nucleotide prodrugs (IDX21437 and IDX21459) and a NS5A inhibitor (samatasvir). These novel candidates are being evaluated for their potential inclusion in the development of all oral, pan-genotypic fixed-dose combination regimens.
In May 2014, Merck entered into an agreement to sell certain ophthalmic products to Santen Pharmaceutical Co., Ltd. (“Santen”) in Japan and markets in Europe and Asia Pacific. The ophthalmic products included in the agreement are Cosopt (dorzolamide hydrochloride-timolol maleate ophthalmic solution), Cosopt PF (dorzolamide hydrochloride-timolol maleate ophthalmic solution) 2%/0.5%, Trusopt (dorzolamide hydrochloride ophthalmic solution) sterile ophthalmic solution 2%, Trusopt PF (dorzolamide hydrochloride ophthalmic solution) preservative-free, Timoptic (timolol maleate ophthalmic solution), Timoptic PF (timolol maleate preservative free ophthalmic solution in unit dose dispenser), Timoptic XE (timolol maleate ophthalmic gel forming solution), Saflutan (tafluprost) and Taptiqom (tafluprost-timolol maleate ophthalmic solution, in development). The agreement provides that Santen make upfront payments of approximately $600 million and additional payments based on defined sales milestones. Santen will also purchase supply of ophthalmology products covered by the agreement for a two- to five-year

- 7 -

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

period. Upon closing of the transaction in most markets on July 1, 2014, Santen made $548 million of the upfront payments to the Company. The remaining markets continue to be subject to certain closing conditions and are expected to close by the end of 2014.
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. Merck is eligible to receive future payments associated with the achievement of certain regulatory and commercial milestones, as well as royalties on future sales. 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 in the second quarter of 2014 (valued at $22 million at the time the shares were received). Merck recorded gains of $22 million and $204 million in the second quarter and first six months of 2014, respectively, related to this transaction that are included in Other (income) expense, net. 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 six months of 2014. In the second quarter of 2014, the Company recorded a $36 million impairment charge within Other (income) expense, net on the Alnylam shares received in the first quarter of 2014 as the Company determined these shares were other than temporarily impaired.
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 six months 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 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 the first six months 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 expects the pretax gain from the sale of MCC to be between $11.0 billion and $11.3 billion. Merck expects to close the sale of MCC in the second half of 2014, subject to customary closing conditions, including regulatory approvals.

- 8 -

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

Information with respect to Consumer Care assets and liabilities held for sale is as follows:
($ millions)
June 30, 2014
Assets
 
Accounts receivable, net
$
204

Inventories
232

Deferred income taxes and other current assets
246

Property, plant and equipment, net
212

Goodwill
137

Other intangibles, net
2,194

  Other assets
67

 
$
3,292

Liabilities
 
Trade accounts payable
$
71

Accrued and other current liabilities
175

Deferred income taxes
543

Other noncurrent liabilities
12

 
$
801

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 $1.0 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 formation of this collaboration is subject to the closing of the MCC sale to Bayer.
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.


- 9 -

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

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 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

- 10 -

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

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 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 $34 million and $40 million for the first six 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 June 30, 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.

- 11 -

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

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:
 
 
June 30, 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
$
23

 
$

 
$
1,550

 
$
13

 
$

 
$
1,550

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

 
14

 
2,000

 

 
25

 
2,000

Foreign exchange contracts (current)
Deferred income taxes and other current assets
361

 

 
6,072

 
493

 

 
4,427

Foreign exchange contracts (non-current)
Other assets
313

 

 
5,904

 
515

 

 
6,676

Foreign exchange contracts (current)
Accrued and other current liabilities

 
1

 
450

 

 
19

 
1,659

Foreign exchange contracts (non-current)
Other noncurrent liabilities

 
5

 
520

 

 

 

 
 
$
697


$
20


$
16,496


$
1,021


$
44


$
16,312

Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts (current)
Deferred income taxes and other current assets
$
45

 
$

 
$
4,306

 
$
69

 
$

 
$
5,705

Foreign exchange contracts (current)
Accrued and other current liabilities

 
67

 
6,253

 

 
140

 
7,892

 
 
$
45

 
$
67

 
$
10,559

 
$
69

 
$
140

 
$
13,597

 
 
$
742


$
87


$
27,055


$
1,090


$
184


$
29,909

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:
 
June 30, 2014
 
December 31, 2013
 
($ in millions)
Asset
 
Liability
 
Asset
 
Liability
 
Gross amounts recognized in the consolidated balance sheet
$
742

 
$
87

 
$
1,090

 
$
184

 
Gross amount subject to offset in master netting arrangements
not offset in the consolidated balance sheet
(85
)
 
(85
)
 
(147
)
 
(147
)
 
Cash collateral (received) posted
(427
)
 

 
(652
)
 

 
Net amounts
$
230

 
$
2

 
$
291

 
$
37

 

- 12 -

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

The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a 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 
 June 30,
 
Six Months Ended 
 June 30,
($ in millions)
2014
 
2013
 
2014
 
2013
Derivatives designated in a fair value hedging relationship
 
 
 
 
 
 
 
Interest rate swap contracts
 
 
 
 
 
 
 
Amount of (gain) loss recognized in Other (income) expense, net on derivatives
$
(17
)
 
$
33

 
$
(21
)
 
$
33

Amount of loss (gain) recognized in Other (income) expense, net on hedged item
16

 
(33
)
 
20

 
(33
)
Derivatives designated in foreign currency cash flow hedging relationships
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of (gain) loss reclassified from AOCI to Sales
(4
)
 
2

 
(2
)
 
34

Amount of loss (gain) recognized in OCI on derivatives
55

 
(36
)
 
157

 
(385
)
 Derivatives designated in foreign currency net investment hedging relationships
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of gain recognized in Other (income) expense, net on derivatives (1)
(1
)
 
(1
)
 
(3
)
 
(3
)
Amount of loss (gain) recognized in OCI on derivatives
7

 
(65
)
 
50

 
(244
)
Derivatives not designated in a hedging relationship
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of loss (gain) recognized in Other (income) expense, net on derivatives (2)
59

 
(32
)
 
(23
)
 
(8
)
Amount of loss (gain) recognized in Sales 

 
7

 

 
(3
)
(1) There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing.
(2) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates.
At June 30, 2014, the Company estimates $49 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales. The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity.

Investments in Debt and Equity Securities
Information on available-for-sale investments is as follows:
 
June 30, 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
$
8,843

 
$
8,790

 
$
55

 
$
(2
)
 
$
7,054

 
$
7,037

 
$
32

 
$
(15
)
Commercial paper
2,927

 
2,927

 

 

 
1,206

 
1,206

 

 

U.S. government and agency securities
1,747

 
1,745

 
3

 
(1
)
 
1,236

 
1,239

 
1

 
(4
)
Asset-backed securities
1,350

 
1,349

 
3

 
(2
)
 
1,300

 
1,303

 
1

 
(4
)
Mortgage-backed securities
514

 
514

 
2

 
(2
)
 
476

 
479

 
2

 
(5
)
Foreign government bonds
464

 
463

 
1

 

 
125

 
126

 

 
(1
)
Equity securities
673

 
578

 
95

 

 
471

 
397

 
74

 

 
$
16,518

 
$
16,366

 
$
159

 
$
(7
)
 
$
11,868

 
$
11,787

 
$
110

 
$
(29
)
Available-for-sale debt securities included in Short-term investments totaled $3.7 billion at June 30, 2014. Of the remaining debt securities, $11.3 billion mature within five years. At June 30, 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:

- 13 -

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

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.
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities measured at fair value on a recurring basis are summarized below:
 
Fair Value Measurements Using
 
Fair Value Measurements Using
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
($ in millions)
June 30, 2014
 
December 31, 2013
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate notes and bonds
$

 
$
8,843

 
$

 
$
8,843

 
$

 
$
7,054

 
$

 
$
7,054

Commercial paper

 
2,927

 

 
2,927

 

 
1,206

 

 
1,206

U.S. government and agency securities

 
1,747

 

 
1,747

 

 
1,236

 

 
1,236

Asset-backed securities (1)

 
1,350

 

 
1,350

 

 
1,300

 

 
1,300

Mortgage-backed securities (1)

 
514

 

 
514

 

 
476

 

 
476

Foreign government bonds

 
464

 

 
464

 

 
125

 

 
125

Equity securities
425

 

 

 
425

 
238

 

 

 
238

 
425

 
15,845

 

 
16,270

 
238

 
11,397

 

 
11,635

Other assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities held for employee compensation
193

 
55

 

 
248

 
186

 
47

 

 
233

Derivative assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased currency options

 
623

 

 
623

 

 
868

 

 
868

Forward exchange contracts

 
96

 

 
96

 

 
209

 

 
209

Interest rate swaps

 
23

 

 
23

 

 
13

 

 
13

 

 
742

 

 
742

 

 
1,090

 

 
1,090

Total assets
$
618

 
$
16,642

 
$

 
$
17,260

 
$
424

 
$
12,534

 
$

 
$
12,958

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward exchange contracts
$

 
$
54

 
$

 
$
54

 
$

 
$
134

 
$

 
$
134

Written currency options

 
19

 

 
19

 

 
25

 

 
25

Interest rate swaps

 
14

 

 
14

 

 
25

 

 
25

Total liabilities
$

 
$
87

 
$

 
$
87

 
$

 
$
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 six months of 2014. As of June 30, 2014, Cash and cash equivalents of $9.7 billion included $8.7 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 $73 million and $69 million at June 30, 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.

- 14 -

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

The estimated fair value of loans payable and long-term debt (including current portion) at June 30, 2014, was $24.2 billion compared with a carrying value of $23.1 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.
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 June 30, 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 June 30, 2014, the Company’s accounts receivable in Greece, Italy, Spain and Portugal totaled approximately $1.0 billion. Of this amount, hospital and public sector receivables were approximately $665 million in the aggregate, of which approximately 11%, 42%, 36% and 11% related to Greece, Italy, Spain and Portugal, respectively. At June 30, 2014, the Company’s total net accounts receivable outstanding for more than one year were approximately $200 million, of which approximately 45% 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 June 30, 2014 and December 31, 2013, the Company had received cash collateral of $427 million and $652 million, respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities. The Company had not advanced any cash collateral to counterparties as of June 30, 2014 or December 31, 2013.
5.
Inventories
Inventories consisted of:
($ in millions)
June 30, 2014
 
December 31, 2013
Finished goods
$
2,125

 
$
1,738

Raw materials and work in process
5,249

 
5,894

Supplies
216

 
225

Total (approximates current cost)
7,590

 
7,857

Increase to LIFO costs
169

 
73

 
$
7,759

 
$
7,930

Recognized as:
 
 
 
Inventories
$
6,136

 
$
6,226

Other assets
1,623

 
1,704

Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At June 30, 2014 and December 31, 2013, these amounts included $1.4 billion and $1.5 billion, respectively, of inventories not

- 15 -

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

expected to be sold within one year. In addition, these amounts included $201 million and $177 million at June 30, 2014 and December 31, 2013, respectively, of inventories produced in preparation for product launches.
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 second quarter and first six months of 2014, the Company recorded intangible asset impairment charges of $660 million within Materials and production costs related to certain products marketed by the Company for the treatment of chronic HCV. Of this amount, $523 million related to PegIntron and $137 million related to Victrelis. Sales of PegIntron and Victrelis are being adversely affected by loss of market share or patient treatment delays in markets anticipating the availability of new therapeutic options. During the second quarter, these trends accelerated more rapidly than previously anticipated by the Company, which led to changes in the cash flow assumptions for both PegIntron and Victrelis. These revisions to cash flows indicated that the PegIntron and Victrelis intangible asset values were not recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair values of the intangible assets related to PegIntron and Victrelis that, when compared with their related carrying values, resulted in impairment charges noted above.
During the second quarter and first six months of 2013, the Company recorded an intangible asset impairment charge of $330 million within Materials and production costs resulting from lower cash flow projections for Saphris/Sycrest due to reduced expectations in international markets and in the United States. These revisions to cash flows indicated that the Saphris/Sycrest intangible asset value was not recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions and considered several different scenarios to determine its best estimate of the fair value of the intangible asset related to Saphris/Sycrest that, when compared with its related carrying values, resulted in the impairment charge noted above.
In addition, during the second quarter and first six months of 2013, the Company recorded $234 million and $264 million of IPR&D impairment charges within Research and development expenses. Of these amounts, $181 million related to the write-off of the intangible asset associated with preladenant as a result of the discontinuation of the clinical development program for this compound. In addition, the Company recorded impairment charges resulting from changes in cash flow assumptions for certain compounds. The remaining impairment charges for the first six months of 2013 related to 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 marked products or pipeline programs and such charges could be material.
7.
Joint Ventures and Other Equity Method Affiliates
Equity income from affiliates reflects the performance of the Company’s joint ventures and other equity method affiliates and was comprised of the following:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
($ in millions)
2014
 
2013
 
2014
 
2013
AstraZeneca LP (1)
$
94

 
$
105

 
$
192

 
$
230

Other (2)
(2
)
 
11

 
25

 
19

 
$
92

 
$
116

 
$
217

 
$
249

(1) 
As noted below, as of July 1, 2014, the Company no longer records equity income from AZLP.
(2) 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.
On June 30, 2014, AstraZeneca exercised its option to purchase Merck’s interest in KBI for $419 million in cash. Of this amount, $327 million reflects an estimate of the fair value of Merck’s interest in Nexium and Prilosec. This portion of the exercise price, which is subject to a true-up in 2018 based on actual sales from closing in 2014 to June 2018, was deferred and will be recognized over time in Other (income) expense, net as the contingency is eliminated as sales occur. The remaining exercise price of $91 million primarily represents a multiple of ten times Merck’s average 1% annual profit allocation in the partnership

- 16 -

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

for the three years prior to exercise. Merck recognized the $91 million as a gain in the second quarter and first six months of 2014 within Other (income) expense, net. As a result of AstraZeneca’s option exercise, the Company’s remaining interest in AZLP was redeemed. Accordingly, the Company also recognized a non-cash gain of approximately $650 million in the second quarter and first six months of 2014 within Other (income) expense, net resulting from the retirement of $2.4 billion of KBI preferred stock (see Note 9), the elimination of the Company’s $1.4 billion investment in AZLP and a $340 million reduction of goodwill. This transaction resulted in a net tax benefit of $517 million in the second quarter and first six months of 2014 primarily reflecting the reversal of deferred taxes on the AZLP investment balance.
As a result of AstraZeneca exercising its option, as of July 1, 2014, the Company no longer records equity income from AZLP and supply sales to AZLP have terminated.
Summarized financial information for AZLP is as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
($ in millions)
2014
 
2013
 
2014
 
2013
Sales
$
1,123

 
$
1,142

 
$
2,205

 
$
2,300

Materials and production costs
581

 
575

 
1,044

 
1,126

Other expense, net
194

 
419

 
604

 
801

Income before taxes (1)
$
348

 
$
148

 
$
557

 
$
373

(1) 
Merck’s partnership returns from AZLP were generally contractually determined as noted above and were 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.
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 50 federal and state lawsuits (the “Vioxx Product Liability Lawsuits”) alleging personal injury as a result of the use of Vioxx. Most of these cases are coordinated in a multidistrict litigation in the U.S. District Court for the Eastern District of Louisiana (the “Vioxx MDL”) before Judge Eldon E. Fallon.
As previously disclosed, Merck is also a defendant in approximately 30 putative class action lawsuits alleging economic injury as a result of the purchase of Vioxx. All but two of those cases are in the Vioxx MDL. Merck has reached a resolution, approved by Judge Fallon, of these class actions in the Vioxx MDL. One objector to the settlement has filed an appeal from the approval order, which is pending before the U.S. Court of Appeals for the Fifth Circuit. 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

- 17 -

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

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 and the claims administrator is currently reviewing claims submitted under the settlement protocol.
Merck is also a defendant in lawsuits brought by state Attorneys General of four states — Alaska, Mississippi, Montana and Utah. All of these actions were pending in the Vioxx MDL proceeding, although Judge Fallon asked that the Judicial Panel on Multidistrict Litigation (“JPML”) remand the Alaska, Montana and Utah cases to their original federal courts. The JPML then issued conditional remand orders in all three cases, and set a briefing schedule for any objections to the remand. Merck has filed motions to vacate the remand orders. These four actions allege that Merck misrepresented the safety of Vioxx and seek recovery for expenditures on Vioxx by government-funded health care programs, such as Medicaid, and/or penalties for alleged Consumer Fraud Act violations. 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 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 and April 2014, four 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 $145 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.

- 18 -

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

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 June 30, 2014, approximately 5,510 cases, which include approximately 5,720 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 1,080 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 (“ONJ Master Settlement Agreement”) that was executed in April 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 or Merck can either terminate the agreement, or waive the 100% participation requirement and agree to a lesser funding amount for the settlement fund. On July 14, 2014, Merck elected to proceed with the ONJ Master Settlement Agreement at a reduced funding level since the current participation level is approximately 95%. Merck has also requested, without objection from the PSC, that the judge overseeing the Fosamax ONJ MDL enter an order that will require all non-participants in the Fosamax ONJ MDL to submit expert reports in order for their cases to proceed any further. The ONJ Master Settlement Agreement has no effect on the cases alleging Femur Fractures discussed below.
Cases Alleging ONJ and/or Other Jaw Related Injuries
In August 2006, the JPML ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation (the “Fosamax ONJ MDL”) for coordinated pre-trial proceedings. The Fosamax ONJ MDL has been transferred to Judge John Keenan in the U.S. District Court for the Southern District of New York. As a result of the JPML order, approximately 795 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 June 30, 2014, approximately 280 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 1,020 cases were pending in the Fosamax Femur Fracture MDL as of June 30, 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

- 19 -

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

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. Furthermore, on June 17, 2014, Judge Pisano granted Merck summary judgment in the Gaynor case and found that Merck’s updates in January 2011 to the Fosamax label regarding atypical femur fractures were adequate as a matter of law and that Merck adequately communicated those changes.
As of June 30, 2014, approximately 2,880 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 June 30, 2014, approximately 515 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.
Additionally, there are four 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.
Januvia/Janumet
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet. As of June 30, 2014, approximately 490 product user claims 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 June 30, 2014, to toll the statute of limitations for 16 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.
As of June 30, 2014, there were approximately 1,940 NuvaRing cases (excluding unfiled cases). Of these cases, approximately 1,720 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. Eight 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.

- 20 -

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

Merck and negotiating plaintiffs’ counsel agreed to a settlement of the NuvaRing Litigation to resolve all filed cases as of February 7, 2014, and all unfiled claims under retainer by counsel prior to that date. Pursuant to this settlement agreement, which became effective as of June 4, 2014, Merck will pay a lump total settlement of $100 million to resolve more than 95% of the cases filed and under retainer by counsel as of February 7, 2014. The vast majority of the plaintiffs with pending lawsuits have opted into the settlement and all participants in the settlement have tendered dismissals of their cases to the settlement administrator. The dismissals will be filed with the courts upon completion of the settlement administration process. 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. Any plaintiffs not participating in the settlement who choose to proceed with their case, as well as any future plaintiffs, in the NuvaRing MDL or New Jersey state court will be obligated to meet various discovery and evidentiary requirements under the case management orders of the NuvaRing MDL and New Jersey state courts. Plaintiffs who fail to fully and timely satisfy these requirements under set deadlines will be subject to dismissal with prejudice.
Propecia/Proscar
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar. As of June 30, 2014, approximately 1,280 lawsuits involving a total of approximately 1,550 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 45 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. The Company intends to defend against these lawsuits.
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.
Commercial Litigation
Coupon Litigation
In 2012, as previously disclosed, a number of private health plans filed separate putative class action lawsuits against the Company alleging that Merck’s coupon programs injured health insurers by reducing beneficiary co-payment amounts and, thereby, allegedly causing beneficiaries to purchase higher-priced drugs than they otherwise would have purchased and increasing the insurers’ reimbursement costs. The actions, which were assigned to a District Judge in the U.S. District Court for the District of New Jersey, sought damages and injunctive relief barring the Company from issuing coupons that would reduce beneficiary co-pays on behalf of putative nationwide classes of health insurers. Similar actions relating to manufacturer coupon programs were filed against several other pharmaceutical manufacturers in a variety of federal courts. On June 30, 2014, the District Court granted in part and denied in part Merck’s motion to dismiss the consolidated amended complaint, dismissing without prejudice plaintiffs’ claims under the federal Racketeering Influenced and Corrupt Organizations statute, but allowing plaintiffs to proceed with their claims of tortious interference with contract under state law.
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, Invanz, Nasonex, 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.

- 21 -

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

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. In July 2014, a patent infringement lawsuit was filed in the United States against Fresenius Kabi USA, LLC (“Fresenius”) in respect of Fresenius’ 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 Fresenius’ application until November 2016 or until an adverse court decision, if any, whichever may occur earlier.
Invanz — In July 2014, a patent infringement lawsuit was filed in the United States against Hospira Inc. (“Hospira”) in respect of Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The lawsuit automatically stays FDA approval of Hospira’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. Also in July 2014, a patent infringement lawsuit was filed in the United States against Sandoz in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. As neither Hospira nor Sandoz challenged an earlier patent covering Invanz, both parties’ application to the FDA will not be approved until at least that patent expires in May 2015.
Nasonex — In July 2014, a patent infringement lawsuit was filed in the United States against Teva Pharmaceuticals USA, Inc. (“Teva”) in respect of Teva’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Teva’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. A decision issued in June 2013 held that the Merck patent covering mometasone furoate monohydrate was valid, but that it was not infringed by Apotex Corp.’s proposed product.
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.
Anti-PD-1 Antibody Patent Oppositions and Litigation
As previously disclosed, Ono Pharmaceutical Co. (“Ono”) has a European patent (EP 1 537 878) (“’878”) that broadly claims the use of an anti-PD-1 antibody, such as the Company’s immunotherapy, pembrolizumab (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 the ‘878 patent is invalid and filed an opposition in the European Patent Office (the “EPO”) seeking its revocation. In June 2014, the Opposition Division of the EPO found the claims in the ‘878 patent are valid. The Company expects to receive the Opposition Division’s written opinion in the third quarter of 2014, after which it will begin the appeal process. On April 30, 2014, the Company, and three other companies, opposed another European patent (EP 2 161 336) (“’336”) owned by BMS and Ono that it believes is invalid. The ‘336 patent, if valid, broadly claims anti-PD-1 antibodies that could include pembrolizumab.
In May 2014, the Company filed a lawsuit in the United Kingdom (“UK”) seeking revocation of the UK national versions of both the ‘878 and ‘336 patents. In July 2014, Ono and BMS sued the Company seeking a declaration that the ‘878 patent would be infringed in the UK by the marketing of pembrolizumab. Separately, the Company has sought confirmation from Ono and BMS that pembrolizumab would not infringe the ‘336 patent in the UK. The Company will seek a declaration of non-infringement from the UK court if BMS does not provide such confirmation. It is anticipated that the issues of validity and infringement of both patents will be heard at the same time by the UK court, which has scheduled the trial to begin in July 2015.
The Company can file lawsuits seeking revocation of the ‘336 and ‘878 patents in other national courts in Europe at any time, and Ono and BMS can file patent infringement actions against the Company in other national courts in Europe at or around the time the Company launches pembrolizumab (if approved). If a national court determines that the Company infringed a valid claim in the ‘878 or ‘336 patent, Ono may be entitled to monetary damages, including royalties on future sales of pembrolizumab, and potentially could seek an injunction to prevent the Company from marketing pembrolizumab in that country.
The United States Patent and Trademark Office recently granted US Patent Nos. 8,728,474 to Ono and 8,779,105 to Ono and BMS. These patents, which the Company believes are invalid, are equivalent to the ‘878 and ‘336 patents, respectively. 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 pembrolizumab in any country in which it is approved and that it will not be prevented from doing so by the Ono or BMS patents or any pending applications.

- 22 -

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

Other Litigation
There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Company’s financial position, results of operations or cash flows either individually or in the aggregate.
Legal Defense Reserves
Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Company’s legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of June 30, 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.
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.



2,499





2,499

Cash dividends declared on common stock



(2,569
)




(2,569
)
Treasury stock shares purchased


(500
)



124

(5,605
)

(6,105
)
Share-based compensation plans and other


(371
)


(23
)
988

1

618

Other comprehensive loss




(78
)




(78
)
Supera joint venture


116





112

228

Net income attributable to noncontrolling interests







52

52

Distributions attributable to noncontrolling interests







(3
)
(3
)
Balance at June 30, 2013
3,577

$
1,788

$
39,891

$
39,915

$
(4,760
)
651

$
(29,334
)
$
2,605

$
50,105

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.



3,709





3,709

Cash dividends declared on common stock



(2,600
)




(2,600
)
Treasury stock shares purchased





60

(3,413
)

(3,413
)
Share-based compensation plans and other


(309
)