10-Q 1 mrk0930201510q.htm 3Q15 FORM 10-Q 10-Q




 
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 September 30, 2015
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.
2000 Galloping Hill Road
Kenilworth, N.J. 07033
(908) 740-4000
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 October 31, 2015: 2,793,543,137
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 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Sales
$
10,073

 
$
10,557

 
$
29,283

 
$
31,755

Costs, Expenses and Other
 
 
 
 
 
 
 
Materials and production
3,761

 
4,223

 
11,084

 
13,019

Marketing and administrative
2,472

 
2,975

 
7,698

 
8,681

Research and development
1,500

 
1,659

 
4,906

 
4,897

Restructuring costs
113

 
376

 
386

 
664

Other (income) expense, net
(170
)
 
(166
)
 
624

 
(978
)
 
7,676

 
9,067

 
24,698

 
26,283

Income Before Taxes
2,397

 
1,490

 
4,585

 
5,472

Income Tax Provision
566

 
648

 
1,108

 
865

Net Income
1,831

 
842

 
3,477

 
4,607

Less: Net Income (Loss) Attributable to Noncontrolling Interests
5

 
(53
)
 
12

 
3

Net Income Attributable to Merck & Co., Inc.
$
1,826

 
$
895

 
$
3,465

 
$
4,604

Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders
$
0.65

 
$
0.31

 
$
1.23

 
$
1.58

Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders
$
0.64

 
$
0.31

 
$
1.22

 
$
1.57

Dividends Declared per Common Share
$
0.45

 
$
0.44

 
$
1.35

 
$
1.32

 
MERCK & CO., INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited, $ in millions)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Net Income Attributable to Merck & Co., Inc.
$
1,826

 
$
895

 
$
3,465

 
$
4,604

Other Comprehensive Income (Loss) Net of Taxes:
 
 
 
 
 
 
 
Net unrealized (loss) gain on derivatives, net of reclassifications
(118
)
 
254

 
(42
)
 
149

Net unrealized (loss) gain on investments, net of reclassifications
(67
)
 
(29
)
 
(35
)
 
33

Benefit plan net gain (loss) and prior service credit (cost), net of amortization
29

 
(463
)
 
106

 
(795
)
Cumulative translation adjustment
(85
)
 
(316
)
 
(279
)
 
(188
)
 
(241
)
 
(554
)
 
(250
)
 
(801
)
Comprehensive Income Attributable to Merck & Co., Inc.
$
1,585

 
$
341

 
$
3,215

 
$
3,803

 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)
 
 
September 30, 2015
 
December 31, 2014
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
7,548

 
$
7,441

Short-term investments
4,541

 
8,278

Accounts receivable (net of allowance for doubtful accounts of $163 in 2015
and $153 in 2014) (excludes accounts receivable of $30 in 2015 and $80 in 2014
classified in Other assets - see Note 4)
6,414

 
6,626

Inventories (excludes inventories of $1,534 in 2015 and $1,664 in 2014
classified in Other assets - see Note 5)
5,123

 
5,571

Deferred income taxes and other current assets
4,941

 
5,257

Total current assets
28,567

 
33,173

Investments
13,080

 
13,515

Property, Plant and Equipment, at cost, net of accumulated depreciation of $16,043
in 2015 and $18,004 in 2014
12,482

 
13,136

Goodwill
17,761

 
12,992

Other Intangibles, Net
23,724

 
20,386

Other Assets
5,618

 
5,133

 
$
101,232

 
$
98,335

Liabilities and Equity
 
 
 
Current Liabilities
 
 
 
Loans payable and current portion of long-term debt
$
2,543

 
$
2,704

Trade accounts payable
2,023

 
2,625

Accrued and other current liabilities
9,610

 
10,523

Income taxes payable
2,119

 
1,606

Dividends payable
1,288

 
1,308

Total current liabilities
17,583

 
18,766

Long-Term Debt
24,124

 
18,699

Deferred Income Taxes
5,959

 
4,266

Other Noncurrent Liabilities
7,887

 
7,813

Merck & Co., Inc. Stockholders’ Equity
 
 
 
Common stock, $0.50 par value
Authorized - 6,500,000,000 shares
Issued - 3,577,103,522 shares in 2015 and 2014
1,788

 
1,788

Other paid-in capital
40,139

 
40,423

Retained earnings
45,660

 
46,021

Accumulated other comprehensive loss
(4,573
)
 
(4,323
)
 
83,014

 
83,909

Less treasury stock, at cost:
774,869,058 shares in 2015 and 738,963,326 shares in 2014
37,427

 
35,262

Total Merck & Co., Inc. stockholders’ equity
45,587

 
48,647

Noncontrolling Interests
92

 
144

Total equity
45,679

 
48,791

 
$
101,232

 
$
98,335

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)
 
 
Nine Months Ended 
 September 30,
 
2015
 
2014
Cash Flows from Operating Activities
 
 
 
Net income
$
3,477

 
$
4,607

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
4,815

 
5,118

Intangible asset impairment charges
80

 
1,209

Foreign currency devaluation related to Venezuela
715

 

Gain on AstraZeneca option exercise

 
(741
)
Equity income from affiliates
(210
)
 
(241
)
Dividends and distributions from equity affiliates
12

 
132

Deferred income taxes
(846
)
 
(1,773
)
Share-based compensation
221

 
209

Other
697

 
(446
)
Net changes in assets and liabilities
(787
)
 
950

Net Cash Provided by Operating Activities
8,174

 
9,024

Cash Flows from Investing Activities
 
 
 
Capital expenditures
(790
)
 
(827
)
Purchases of securities and other investments
(12,425
)
 
(16,231
)
Proceeds from sales of securities and other investments
16,531

 
11,807

Acquisition of Cubist Pharmaceuticals, Inc., net of cash acquired
(7,598
)
 

Acquisition of Idenix Pharmaceuticals, Inc., net of cash acquired

 
(3,700
)
Acquisitions of other businesses, net of cash acquired
(110
)
 

Dispositions of businesses, net of cash divested
151

 
1,048

Proceeds from AstraZeneca option exercise

 
419

Other
100

 
(94
)
Net Cash Used in Investing Activities
(4,141
)
 
(7,578
)
Cash Flows from Financing Activities
 
 
 
Net change in short-term borrowings
(1,526
)
 
3,077

Proceeds from issuance of debt
7,938

 
1

Payments on debt
(2,905
)
 
(7
)
Purchases of treasury stock
(3,005
)
 
(6,083
)
Dividends paid to stockholders
(3,854
)
 
(3,911
)
Proceeds from exercise of stock options
434

 
1,381

Other
55

 
72

Net Cash Used in Financing Activities
(2,863
)
 
(5,470
)
Effect of Exchange Rate Changes on Cash and Cash Equivalents
(1,063
)
 
(227
)
Net Increase (Decrease) in Cash and Cash Equivalents
107

 
(4,251
)
Cash and Cash Equivalents at Beginning of Year
7,441

 
15,621

Cash and Cash Equivalents at End of Period
$
7,548

 
$
11,370

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, 2015.
On January 21, 2015, the Company acquired Cubist Pharmaceuticals, Inc. (Cubist) and, on July 31, 2015, Merck acquired cCAM Biotherapeutics Ltd. (cCAM). The results of Cubist’s and cCAM’s businesses have been included in Merck’s financial statements subsequent to their respective acquisition dates.
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 (FASB) issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. In August 2015, the FASB approved a one-year deferral of the effective date making this guidance effective for annual and interim periods beginning in 2018. Reporting entities may choose to adopt the standard as of the original effective date. The Company is currently assessing the impact of adoption on its consolidated financial statements.
2.
Restructuring
2013 Restructuring Program
In 2013, the Company initiated actions under a global restructuring program (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 $102 million and $437 million in the third quarter of 2015 and 2014, respectively, and $318 million and $826 million in the first nine months of 2015 and 2014, respectively, related to this restructuring program. Since inception of the 2013 Restructuring Program through September 30, 2015, Merck has recorded total pretax accumulated costs of approximately $2.8 billion and eliminated approximately 7,715 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 $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 (Merger), the Company commenced actions under a global restructuring program (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.
The Company recorded total pretax costs of $115 million and $175 million in the third quarter of 2015 and 2014, respectively, and $452 million and $533 million in the first nine months of 2015 and 2014, respectively, related to this restructuring program. Since inception of the Merger Restructuring Program through September 30, 2015, Merck has recorded total pretax accumulated costs of approximately $8.3 billion and eliminated approximately 29,420 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. Approximately 2,050 position eliminations remain pending under this program as of September 30, 2015. 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 primarily relate to ongoing manufacturing facility rationalizations, which are expected to be substantially completed by the end of 2016. The Company expects the estimated total cumulative pretax costs for this program to be approximately $8.5 billion. The Company estimates that approximately two-thirds of the cumulative pretax costs relate to cash outlays, primarily related to employee separation expense.

- 5 -

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

Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.
For segment reporting, restructuring charges are unallocated expenses.
The following tables summarize the charges related to restructuring program activities by type of cost:
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
 
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
2013 Restructuring Program
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Materials and production
$

 
$
13

 
$
(12
)
 
$
1

 
$

 
$
27

 
$
2

 
$
29

Marketing and administrative

 
2

 
12

 
14

 

 
46

 
17

 
63

Research and development

 
8

 
8

 
16

 

 
24

 
9

 
33

Restructuring costs
36

 

 
35

 
71

 
105

 

 
88

 
193

 
36

 
23

 
43

 
102

 
105

 
97

 
116

 
318

Merger Restructuring Program
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Materials and production

 
4

 
65

 
69

 

 
20

 
231

 
251

Marketing and administrative

 
3

 

 
3

 

 
7

 

 
7

Research and development

 
1

 

 
1

 

 
1

 

 
1

Restructuring costs
(24
)
 

 
66

 
42

 
(5
)
 

 
198

 
193

 
(24
)
 
8

 
131

 
115

 
(5
)
 
28

 
429

 
452

 
$
12

 
$
31

 
$
174

 
$
217

 
$
100

 
$
125

 
$
545

 
$
770

 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
 
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
2013 Restructuring Program
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Materials and production
$

 
$
5

 
$

 
$
5

 
$

 
$
189

 
$
17

 
$
206

Marketing and administrative

 
45

 

 
45

 

 
92

 

 
92

Research and development

 
75

 
6

 
81

 

 
160

 
14

 
174

Restructuring costs
310

 

 
(4
)
 
306

 
387

 

 
(33
)
 
354

 
310

 
125

 
2

 
437

 
387

 
441

 
(2
)
 
826

Merger Restructuring Program
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Materials and production

 
67

 
15

 
82

 

 
219

 
(48
)
 
171

Marketing and administrative

 
29

 
(6
)
 
23

 

 
54

 
(3
)
 
51

Research and development

 

 

 

 

 

 
1

 
1

Restructuring costs
5

 

 
65

 
70

 
104

 

 
206

 
310

 
5

 
96

 
74

 
175

 
104

 
273

 
156

 
533

 
$
315

 
$
221

 
$
76

 
$
612

 
$
491

 
$
714

 
$
154

 
$
1,359

Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. In the third quarter of 2015 and 2014, approximately 425 positions and 830 positions, respectively, and in the first nine months of 2015 and 2014, approximately 1,620 positions and 3,425 positions, respectively, were eliminated under the 2013 Restructuring Program. In the third quarter of 2015 and 2014, approximately 260 positions and 185 positions, respectively, and in the first nine months of 2015 and 2014, approximately 1,015 positions and 975 positions, respectively, were eliminated under the Merger Restructuring Program. These position eliminations were comprised of actual headcount reductions and the elimination of contractors and vacant positions.
Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the site, based upon the anticipated date the site will be closed or divested, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All of the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck was required to accelerate depreciation of the site assets rather than record an impairment charge. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors.

- 6 -

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

Other activity in 2015 and 2014 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 12) and share-based compensation.
The following table summarizes the charges and spending relating to restructuring activities by program for the nine months ended September 30, 2015:
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
2013 Restructuring Program
 
 
 
 
 
 
 
Restructuring reserves January 1, 2015
$
495

 
$

 
$
14

 
$
509

Expense
105

 
97

 
116

 
318

(Payments) receipts, net
(308
)
 

 
(127
)
 
(435
)
Non-cash activity

 
(97
)
 
1

 
(96
)
Restructuring reserves September 30, 2015 (1)
$
292

 
$

 
$
4

 
$
296

Merger Restructuring Program
 
 
 
 
 
 
 
Restructuring reserves January 1, 2015
$
536

 
$

 
$
6

 
$
542

Expense
(5
)
 
28

 
429

 
452

(Payments) receipts, net
(224
)
 

 
(163
)
 
(387
)
Non-cash activity

 
(28
)
 
(216
)
 
(244
)
Restructuring reserves September 30, 2015 (1)
$
307

 
$

 
$
56

 
$
363

(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 the end of 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.
Acquisition of Cubist Pharmaceuticals, Inc.
In January 2015, Merck acquired Cubist, a leader in the development of therapies to treat serious infections caused by a broad range of bacteria. The acquisition complements Merck’s existing hospital acute care business, which is a priority area for the Company. Total consideration transferred of $8.3 billion includes cash paid for outstanding Cubist shares of $7.8 billion, as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Cubist. Share-based compensation payments to settle non-vested equity awards attributable to postcombination service were recognized as transaction expense in 2015. In addition, the Company assumed all of the outstanding convertible debt of Cubist, which had a fair value of approximately $1.9 billion at the acquisition date. Merck redeemed this debt in February 2015. The transaction was accounted for as an acquisition of a business; accordingly, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date.
A preliminary allocation of the fair value of assets acquired and liabilities assumed from Cubist was made as of the acquisition date. The Company subsequently adjusted the preliminary values assigned to certain assets and liabilities in order to reflect additional information obtained since the preliminary allocation that pertained to facts and circumstances that existed as of the acquisition date. These measurement period adjustments have been reflected in the opening balance sheet; however, since the adjustments did not have a significant impact on the Company’s consolidated statements of income or cash flows in any period, the interim financial statements were not retrospectively adjusted. The revised allocation is as follows:

- 7 -

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

($ millions)
 
Cash and cash equivalents
$
733

Accounts receivable
123

Inventories
216

Other current assets
55

Property, plant and equipment
151

Identifiable intangible assets:
 
Products and product rights (11 year weighted-average useful life)
6,923

In-process research and development (IPR&D)
50

Other noncurrent assets
184

Current liabilities (1)
(233
)
Deferred income tax liabilities
(2,518
)
Long-term debt
(1,900
)
Other noncurrent liabilities (1)
(122
)
Total identifiable net assets
3,662

Goodwill (2)
4,669

Consideration transferred
$
8,331

(1) 
Included in current liabilities and other noncurrent liabilities is contingent consideration of $73 million and $50 million, respectively.
(2) 
The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Pharmaceutical segment. The goodwill is not deductible for tax purposes.

The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an “income approach” through which fair value is estimated based on market participant expectations of each asset’s discounted projected net cash flows. The Company’s estimates of projected net cash flows considered historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the extent and timing of potential new product introductions by the Company’s competitors; and the life of each asset’s underlying patent. The net cash flows were then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product were then discounted to present value utilizing a discount rate of 8%. Actual cash flows are likely to be different than those assumed. The most significant intangible assets relate to Zerbaxa (ceftolozane and tazobactam), Cubicin (daptomycin for injection) and Sivextro (tedizolid phosphate).
The Company recorded the fair value of incomplete research project surotomycin (MK-4261) which, at the time of acquisition, had not reached technological feasibility and had no alternative future use. The amount was capitalized and accounted for as an indefinite-lived intangible asset, subject to impairment testing until completion or abandonment of the project. The fair value of surotomycin was determined by using an income approach, through which fair value is estimated based on the asset’s probability-adjusted future net cash flows, which reflects the stage of development of the project and the associated probability of successful completion. The net cash flows were then discounted to present value using a discount rate of 9%. During the second quarter of 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity of surotomycin, resulted in an IPR&D impairment charge (see Note 6).
In connection with the Cubist acquisition, liabilities were recorded for the potential for future consideration that is contingent upon the achievement of future sales-based milestones. The fair value of contingent consideration liabilities was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and a risk-adjusted discount rate of 8% used to present value the probability-weighted cash flows. Changes in the inputs could result in a different fair value measurement.
This transaction closed on January 21, 2015; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. Cubist contributed sales of $362 million and $899 million in the third quarter and first nine months of 2015, respectively, to Merck’s results. The Company is no longer able to provide the results of operations attributable to Cubist during the period as the operations of Cubist have been largely integrated. During the first nine months of 2015, the Company incurred $324 million of transaction costs directly related to the acquisition of Cubist including share-based compensation costs, severance costs and legal and advisory fees which are reflected in Marketing and administrative expenses.

- 8 -

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

The following unaudited supplemental pro forma data presents consolidated information as if the acquisition of Cubist had been completed on January 1, 2014:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
($ in millions)
2015
 
2014
 
2015
 
2014
Sales
$
10,073

 
$
10,866

 
$
29,369

 
$
32,620

Net income attributable to Merck & Co., Inc.
1,833

 
703

 
3,645

 
3,789

Basic earnings per common share attributable to Merck & Co., Inc. common shareholders
0.65

 
0.24

 
1.29

 
1.30

Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders
0.65

 
0.24

 
1.28

 
1.29

The unaudited supplemental pro forma data reflects the historical information of Merck and Cubist adjusted to include additional amortization expense based on the fair value of assets acquired, additional interest expense that would have been incurred on borrowings used to fund the acquisition, transaction costs associated with the acquisition, and the related tax effects of these adjustments. The pro forma data should not be considered indicative of the results that would have occurred if the acquisition had been consummated on January 1, 2014, nor are they indicative of future results.
Other transactions
In July 2015, Merck acquired cCAM, a privately held biopharmaceutical company focused on the discovery and development of novel cancer immunotherapies. The acquisition provides Merck with cCAM’s lead pipeline candidate, CM-24, a novel monoclonal antibody targeting the immune checkpoint protein CEACAM1 that is currently being evaluated in a Phase 1 study for the treatment of advanced or recurrent malignancies, including melanoma, non-small-cell lung, bladder, gastric, colorectal, and ovarian cancers. Total purchase consideration in the transaction of $201 million included an upfront payment of $96 million in cash and future additional payments of up to $510 million associated with the attainment of certain clinical development, regulatory and commercial milestones, which the Company determined had a fair value of $105 million at the acquisition date. The transaction was accounted for as an acquisition of a business; accordingly, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date. The determination of fair value requires management to make significant estimates and assumptions. Merck recognized an intangible asset for IPR&D of $180 million and other net assets of $7 million. The excess of the consideration transferred over the fair value of net assets acquired of $14 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPR&D was determined using an income approach, through which fair value is estimated based upon the asset’s probability-adjusted future net cash flows, which reflects the stage of development of the project and the associated probability of successful completion. The net cash flows were then discounted to present value using a discount rate of 10.5%. The fair value of the contingent consideration was determined utilizing a probability weighted estimated cash flow stream adjusted for the expected timing of each payment also utilizing a discount rate of 10.5%. Actual cash flows are likely to be different than those assumed. This transaction closed on July 31, 2015; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. Pro forma financial information has not been included because cCAM’s historical financial results are not significant when compared with the Company’s financial results.
Also in July 2015, Merck and Allergan plc (Allergan) entered into an agreement pursuant to which Allergan acquired the exclusive worldwide rights to MK-1602 and MK-8031, Merck’s investigational small molecule oral calcitonin gene-related peptide (CGRP) receptor antagonists, which are being developed for the treatment and prevention of migraine. Under the terms of the agreement, Allergan acquired these rights for upfront payments of $250 million, $125 million of which was paid in August 2015 upon closing of the transaction and $125 million of which is payable in April of 2016. Merck will additionally be entitled to receive potential development and commercial milestone payments and tiered double-digit royalties based on commercialization of the programs. Allergan will be fully responsible for development of the CGRP programs, as well as manufacturing and commercialization upon approval and launch of the products. The Company recorded a gain of $250 million within Other (income) expense, net in the third quarter and first nine months of 2015 related to the transaction.
In February 2015, Merck and NGM Biopharmaceuticals, Inc. (NGM), a privately held biotechnology company, entered into a multi-year collaboration to research, discover, develop and commercialize novel biologic therapies across a wide range of therapeutic areas. The collaboration includes multiple drug candidates currently in preclinical development at NGM, including NP201, which is being evaluated for the treatment of diabetes, obesity and nonalcoholic steatohepatitis. NGM will lead the research and development of the existing preclinical candidates and have the autonomy to identify and pursue other discovery stage programs at its discretion. Merck will have the option to license all resulting NGM programs following human proof of concept trials. If Merck exercises this option, Merck will lead global product development and commercialization for the resulting products, if approved. Under the terms of the agreement, Merck made an upfront payment to NGM of $94 million, which is included in Research and development expenses, and purchased a 15% equity stake in NGM for $106 million. Merck committed up to $250

- 9 -

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

million to fund all of NGM’s efforts under the initial five-year term of the collaboration, with the potential for additional funding if certain conditions are met. Prior to Merck initiating a Phase 3 study for a licensed program, NGM may elect to either receive milestone and royalty payments or, in certain cases, to co-fund development and participate in a global cost and revenue share arrangement of up to 50%. The agreement also provides NGM with the option to participate in the co-promotion of any co-funded program in the United States. Merck will have the option to extend the research agreement for two additional two-year terms. Each party has certain termination rights under the agreement in the event of an uncured material breach by the other party. Additionally, Merck has certain termination rights in the event of the occurrence of certain defined conditions. Upon a termination event, depending on the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of compounds discovered under the agreement and certain related payment obligations.
In August 2014, Merck completed the acquisition of Idenix Pharmaceuticals, Inc. (Idenix) for approximately $3.9 billion in cash ($3.7 billion net of cash acquired). Idenix was a biopharmaceutical company engaged in the discovery and development of medicines for the treatment of human viral diseases, whose primary focus was on the development of next-generation oral antiviral therapeutics to treat hepatitis C virus (HCV) infection. The transaction was accounted for as an acquisition of a business; accordingly, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date. The determination of fair value requires management to make significant estimates and assumptions. Merck recognized an intangible asset for IPR&D of $3.2 billion related to MK-3682 (formerly IDX21437), net deferred tax liabilities of $951 million and other net liabilities of approximately $12 million. MK-3682 is a nucleotide prodrug in Phase 2 clinical development being evaluated for potential inclusion in the development of all oral, pan-genotypic fixed-dose combination regimens. The excess of the consideration transferred over the fair value of net assets acquired of $1.5 billion was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPR&D was determined using an income approach, through which fair value is estimated based upon the asset’s probability-adjusted future net cash flows, which reflects the stage of development of the project and the associated probability of successful completion. The net cash flows were then discounted to present value using a discount rate of 11.5%. Actual cash flows are likely to be different than those assumed. This transaction closed on August 5, 2014; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. Pro forma financial information has not been included because Idenix’s historical financial results are not significant when compared with the Company’s financial results.
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 agreement provided that Santen make upfront payments 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 period. Upon closing of the transaction in most markets on July 1, 2014, the Company received $515 million of upfront payments from Santen, net of certain adjustments, and an additional $50 million upon closing of the remaining markets on October 1, 2014. Merck recognized gains of $396 million and $84 million on the transaction in the third and fourth quarters of 2014, respectively, included in Other (income) expense, net.
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 a gain of $204 million in Other (income) expense, net in the first nine months of 2014 related to this transaction. 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 nine months of 2014.
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 nine months of 2014, and will make additional payments to Merck based on defined sales milestones. In addition, as part of this transaction, Merck agreed to supply product to Forest (subsequently acquired by Allergan) until patent expiry.
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 (infliximab), 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 (golimumab), a fully human monoclonal antibody. The Company has 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

- 10 -

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

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 (EU) following the receipt of pricing and reimbursement approval within the EU. Remicade lost market exclusivity in major European markets in February 2015 and no longer has market exclusivity in any of its marketing territories. The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Merck’s exclusive distribution of the two products in these countries are equally divided between Merck and J&J.
4.
Financial Instruments
Derivative Instruments and Hedging Activities
The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments.
A significant portion of the Company’s revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Company’s foreign currency risk management program, as well as its interest rate risk management activities are discussed below.
Foreign Currency Risk Management
The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates.
The objective of the revenue hedging program is to reduce the potential for longer-term unfavorable changes in foreign exchange rates to decrease the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales that are expected to occur over its planning cycle, typically no 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 premiums by writing call options. If the U.S. dollar weakens relative to the currency of the hedged anticipated sales, the purchased put option value of the collar strategy reduces to zero and the Company benefits from the increase in the U.S. dollar equivalent value of its anticipated foreign currency cash flows; however, this benefit would be capped at the strike level of the written call. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the written call option value of the collar strategy reduces to zero and the changes in the purchased put cash flows of the collar strategy would offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales.
The Company may also utilize forward contracts in its revenue hedging program. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the increase in the fair value of the forward contracts offsets the decrease in the expected future U.S. dollar cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the decrease in the fair value of the forward contracts offsets the increase in the value of the anticipated foreign currency cash flows.
The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the 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

- 11 -

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

been de minimis. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes.
The primary objective of the balance sheet risk management program is to mitigate the exposure of foreign currency denominated net monetary assets of foreign subsidiaries where the U.S. dollar is the functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts, which enable the Company to buy and sell foreign currencies in the future at fixed exchange rates and economically offset the consequences of changes in foreign exchange from the monetary assets. Merck routinely enters into contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro. 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 Statement of Cash Flows.
Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net. The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net. Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year.
The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates. The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within OCI, and remains in AOCI until either the sale or complete or substantially complete liquidation of 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 $255 million and $166 million for the first nine months of 2015 and 2014, 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 September 30, 2015, the Company was a party to 30 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below.
 
September 30, 2015
Debt Instrument
Par Value of Debt
 
Number of Interest Rate Swaps Held
 
Total Swap Notional Amount
0.70% notes due 2016
$
1,000

 
4

 
$
1,000

1.30% notes due 2018
1,000

 
4

 
1,000

5.00% notes due 2019
1,250

 
3

 
550

1.85% notes due 2020
1,250

 
5

 
1,250

3.875% notes due 2021
1,150

 
5

 
1,150

2.40% notes due 2022
1,000

 
4

 
1,000

2.35% notes due 2022
1,250

 
5

 
1,250


- 12 -

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

The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.
Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments:
 
 
September 30, 2015
 
December 31, 2014
 
 
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 (current)
Deferred income taxes and other current assets
$
1

 
$

 
$
1,000

 
$

 
$

 
$

Interest rate swap contracts (non-current)
Other assets
101

 

 
6,200

 
19

 

 
1,950

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

 

 

 

 
15

 
2,000

Foreign exchange contracts (current)
Deferred income taxes and other current assets
710

 

 
4,876

 
772

 

 
5,513

Foreign exchange contracts (non-current)
Other assets
491

 

 
4,854

 
691

 

 
6,253

Foreign exchange contracts (current)
Accrued and other current liabilities

 
1

 
34

 

 

 

 
 
$
1,303


$
1


$
16,964


$
1,482


$
15


$
15,716

Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts (current)
Deferred income taxes and other current assets
$
154

 
$

 
$
4,615

 
$
365

 
$

 
$
6,966

Foreign exchange contracts (non-current)
Other assets
18

 

 
179

 

 

 

Foreign exchange contracts (current)
Accrued and other current liabilities

 
55

 
4,192

 

 
88

 
3,386

 
 
$
172

 
$
55

 
$
8,986

 
$
365

 
$
88

 
$
10,352

 
 
$
1,475


$
56


$
25,950


$
1,847


$
103


$
26,068

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:
 
September 30, 2015
 
December 31, 2014
($ in millions)
Asset
 
Liability
 
Asset
 
Liability
Gross amounts recognized in the consolidated balance sheet
$
1,475

 
$
56

 
$
1,847

 
$
103

Gross amount subject to offset in master netting arrangements not offset in the consolidated
balance sheet
(31
)
 
(31
)
 
(97
)
 
(97
)
Cash collateral (received) posted
(1,054
)
 

 
(1,410
)
 

Net amounts
$
390

 
$
25

 
$
340

 
$
6


- 13 -

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 
 September 30,
 
Nine Months Ended 
 September 30,
($ in millions)
2015
 
2014
 
2015
 
2014
Derivatives designated in a fair value hedging relationship
 
 
 
 
 
 
 
Interest rate swap contracts
 
 
 
 
 
 
 
Amount of (gain) loss recognized in Other (income) expense, net on derivatives (1)
$
(130
)
 
$
23

 
$
(97
)
 
$
2

Amount of loss (gain) recognized in Other (income) expense, net on hedged item (1)
125

 
(23
)
 
91

 
(3
)
Derivatives designated in foreign currency cash flow hedging relationships
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of gain reclassified from AOCI to Sales
(170
)
 
(42
)
 
(528
)
 
(45
)
Amount of loss (gain) recognized in OCI on derivatives
17

 
(433
)
 
(464
)
 
(276
)
 Derivatives designated in foreign currency net investment hedging relationships
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of gain recognized in Other (income) expense, net on derivatives (2)
(1
)
 
(1
)
 
(4
)
 
(3
)
Amount of loss (gain) recognized in OCI on derivatives
13

 
(116
)
 
(5
)
 
(67
)
Derivatives not designated in a hedging relationship
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of gain recognized in Other (income) expense, net on derivatives (3)
(155
)
 
(290
)
 
(360
)
 
(314
)
Amount of loss (gain) recognized in Sales 

 
5

 
(1
)
 
5

(1) There was $5 million and $6 million of ineffectiveness on the hedge during the third quarter and first nine months of 2015, respectively.
(2) There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing.
(3) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates.
At September 30, 2015, the Company estimates $497 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:
 
September 30, 2015
 
December 31, 2014
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
($ in millions)
Gains
 
Losses
 
Gains
 
Losses
Corporate notes and bonds
$
10,806

 
$
10,805

 
$
30

 
$
(29
)
 
$
10,107

 
$
10,102

 
$
22

 
$
(17
)
Commercial paper
2,448

 
2,448

 

 

 
6,970

 
6,970

 

 

Asset-backed securities
1,384

 
1,383

 
2

 
(1
)
 
1,460

 
1,462

 
1

 
(3
)
U.S. government and agency securities
1,272

 
1,268

 
4

 

 
1,774

 
1,775

 
1

 
(2
)
Mortgage-backed securities
737

 
734

 
4

 
(1
)
 
602

 
604

 
2

 
(4
)
Foreign government bonds
638

 
636

 
2

 

 
385

 
385

 

 

Equity securities
528

 
428

 
100

 

 
730

 
557

 
173

 

 
$
17,813

 
$
17,702

 
$
142

 
$
(31
)
 
$
22,028

 
$
21,855

 
$
199

 
$
(26
)
Available-for-sale debt securities included in Short-term investments totaled $4.5 billion at September 30, 2015. Of the remaining debt securities, $11.8 billion mature within five years. At September 30, 2015 and December 31, 2014, 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:

- 14 -

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 or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation.
If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
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)
September 30, 2015
 
December 31, 2014
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate notes and bonds
$

 
$
10,806

 
$

 
$
10,806

 
$

 
$
10,107

 
$

 
$
10,107

Commercial paper

 
2,448

 

 
2,448

 

 
6,970

 

 
6,970

Asset-backed securities (1)

 
1,384

 

 
1,384

 

 
1,460

 

 
1,460

U.S. government and agency securities

 
1,272

 

 
1,272

 

 
1,774

 

 
1,774

Mortgage-backed securities (1)

 
737

 

 
737

 

 
602

 

 
602

Foreign government bonds

 
638

 

 
638

 

 
385

 

 
385

Equity securities
336

 

 

 
336

 
495

 

 

 
495

 
336

 
17,285

 

 
17,621

 
495

 
21,298

 

 
21,793

Other assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities held for employee compensation
174

 
18

 

 
192

 
181

 
54

 

 
235

Derivative assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased currency options

 
1,161

 

 
1,161

 

 
1,252

 

 
1,252

Forward exchange contracts

 
212

 

 
212

 

 
576

 

 
576

Interest rate swaps

 
102

 

 
102

 

 
19

 

 
19

 

 
1,475

 

 
1,475

 

 
1,847

 

 
1,847

Total assets
$
510

 
$
18,778

 
$

 
$
19,288

 
$
676

 
$
23,199

 
$

 
$
23,875

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
$

 
$

 
$
614

 
$
614

 
$

 
$

 
$
428

 
$
428

Derivative liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward exchange contracts

 
56

 

 
56

 

 
46

 

 
46

Written currency options

 

 

 

 

 
42

 

 
42

Interest rate swaps

 

 

 

 

 
15

 

 
15

 

 
56

 

 
56

 

 
103

 

 
103

Total liabilities
$


$
56


$
614


$
670


$


$
103


$
428


$
531

(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 nine months of 2015. As of September 30, 2015, Cash and cash equivalents of $7.5 billion included $6.5 billion of cash equivalents (considered Level 2 in the fair value hierarchy).

- 15 -

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

Contingent Consideration
Summarized information about the changes in liabilities for contingent consideration is as follows:
 
Nine Months Ended September 30,
($ in millions)
2015
 
2014
Fair value January 1
$
428

 
$
69

Changes in fair value (1)
8

 
6

Additions
228

 

Payments
(50
)
 

Fair value September 30
$
614

 
$
75

(1) Recorded in Research and development expenses and Materials and production costs.
In the first nine months of 2015, the Company recognized liabilities for contingent consideration of $123 million related to the acquisition of Cubist and$105 million related to the acquisition of cCAM (see Note 3). In addition, in the first nine months of 2015, the Company paid $50 million of contingent consideration related to the first commercial sale of Zerbaxa in the United States.
Other Fair Value Measurements
Some of the Company’s financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature.
The estimated fair value of loans payable and long-term debt (including current portion) at September 30, 2015, was $27.2 billion compared with a carrying value of $26.7 billion and at December 31, 2014, was $22.5 billion compared with a carrying value of $21.4 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy.
Concentrations of Credit Risk
On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards as specified in the Company’s investment policy guidelines.
The majority of the Company’s accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business, taking into consideration global economic conditions and the ongoing sovereign debt issues in certain European countries. At September 30, 2015 and December 31, 2014, Other assets included $30 million and $80 million, respectively, of accounts receivable not expected to be collected within one year. At September 30, 2015, the Company’s total net accounts receivable outstanding for more than one year were approximately $130 million. The Company does not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on its financial position, liquidity or results of operations.
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 September 30, 2015 and December 31, 2014, the Company had received cash collateral of $1.1 billion and $1.4 billion, 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 September 30, 2015 or December 31, 2014.


- 16 -

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

5.
Inventories
Inventories consisted of:
($ in millions)
September 30, 2015
 
December 31, 2014
Finished goods
$
1,528

 
$
1,588

Raw materials and work in process
4,586

 
5,141

Supplies
177

 
197

Total (approximates current cost)
6,291

 
6,926

Increase to LIFO costs
366

 
309

 
$
6,657

 
$
7,235

Recognized as:
 
 
 
Inventories
$
5,123

 
$
5,571

Other assets
1,534

 
1,664

Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At September 30, 2015 and December 31, 2014, these amounts included $1.5 billion and $1.6 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $67 million and $74 million at September 30, 2015 and December 31, 2014, respectively, of inventories produced in preparation for product launches.
6.
Goodwill and Other Intangibles
In connection with acquisitions, the Company measures the fair value of marketed products and research and development pipeline programs and capitalizes these amounts. As a result of the acquisition of Cubist in January 2015, the Company recorded $6.9 billion of intangible assets for currently marketed products, $50 million of IPR&D (related to surotomycin) and $4.7 billion of goodwill (see Note 3). In addition, as a result of the acquisition of cCAM in July 2015, the Company recorded $180 million of IPR&D (see Note 3).
During the first nine months of 2015, the Company recorded $62 million of IPR&D impairment charges within Research and development expenses. Of this amount, $50 million relates to the surotomycin clinical development program obtained in connection with the acquisition of Cubist. During the second quarter of 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity of surotomycin, resulted in the IPR&D impairment charge noted above. During the third quarter and first nine months of 2014, the Company recorded $36 million of IPR&D impairment charges primarily as a result of changes in cash flow assumptions for certain compounds obtained in connection with the Supera joint venture. The changes in cash flow assumptions for the Supera compounds, as well as for certain currently marketed products of Supera, also resulted in the write-off of the goodwill balance related to the joint venture with Supera, which was $93 million at existing exchange rates.
Also, during the first nine months of 2015, the Company recorded an intangible asset impairment charge of $12 million within Materials and production costs related to Rebetol (ribavirin USP), a product marketed by the Company for the treatment of chronic HCV infection. Sales of Rebetol are being adversely affected by loss of market share as a result of the availability of newer therapeutic options, which led to changes in the cash flow assumptions for Rebetol that indicated that the Rebetol intangible asset value was not recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Rebetol that, when compared with its related carrying value, resulted in the impairment charge noted above.
During the third quarter and first nine months of 2014, the Company recorded intangible asset impairment charges of $412 million and $1.1 billion, respectively, within Materials and Production costs related to certain products marketed by the Company for the treatment of chronic HCV infection, including PegIntron (peginterferon alpha-2b), Victrelis (boceprevir) and Rebetol (ribavirin USP). Rapid developments in the competitive HCV treatment market led to market share losses that were greater than the Company had predicted, causing deterioration in cash flow projections. These revisions to cash flows indicated that the intangible asset values associated with these products 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, Victrelis and Rebetol that, when compared with their related carrying values, resulted in the impairment charges noted above.
The Company may recognize additional non-cash impairment charges in the future related to other pipeline programs or marketed products and such charges could be material.


- 17 -

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

7.
Joint Ventures and Other Equity Method Affiliates
Equity income from affiliates reflects the performance of the Company’s joint ventures and other equity method affiliates including Sanofi Pasteur MSD, certain investments funds, as well as AstraZeneca LP (AZLP) until the termination of the Company’s relationship with AZLP on June 30, 2014 as discussed below. Equity income from affiliates was $63 million and $24 million for the third quarter of 2015 and 2014, respectively, and $210 million and $241 million for the first nine months of 2015 and 2014, respectively, and is included in Other (income) expense, net (see Note 13).
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. (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 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 is being recognized over time in Other (income) expense, net as the contingency is eliminated as sales occur. During the third quarter and first nine months of 2015, $50 million and $153 million, respectively, of the deferred income was recognized in Other (income) expense, net bringing the total deferred income recognized through September 30, 2015 to $293 million. The remaining exercise price of $91 million primarily represents a multiple of ten times Merck’s average 1% annual profit allocation in the partnership for the three years prior to exercise. Merck recognized the $91 million as a gain in the first nine 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 first nine months of 2014 within Other (income) expense, net resulting from the retirement of $2.4 billion of KBI preferred stock (see Note 10), 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 first nine 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. Equity income from AZLP was $192 million in 2014 through the June 30 termination date.
Summarized financial information for AZLP through the June 30, 2014 termination date is as follows:
 
Six Months Ended June 30,
($ in millions)
2014
Sales
$
2,205

Materials and production costs
1,044

Other expense, net
604

Income before taxes (1)
$
557

(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.


- 18 -

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

8.
Long-Term Debt
In February 2015, Merck issued $8.0 billion aggregate principal amount of senior unsecured notes consisting of $300 million principal amount of floating rate notes due 2017, $700 million principal amount of floating rate notes due 2020, $1.25 billion principal amount of 1.85% notes due 2020, $1.25 billion aggregate principal amount of 2.35% notes due 2022, $2.5 billion aggregate principal amount of 2.75% notes due 2025 and $2.0 billion aggregate principal amount of 3.70% notes due 2045. The Company used a portion of the net proceeds of the offering of $7.9 billion to repay commercial paper issued to substantially finance the Company’s acquisition of Cubist. Any remaining net proceeds were used for general corporate purposes, including for repurchases of the Company’s common stock, and the repayment of outstanding commercial paper borrowings and debt maturities.
Also, in February 2015, the Company redeemed $1.9 billion of legacy Cubist debt acquired in the acquisition (see Note 3).
9.
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 certain additional matters including 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 most product liabilities effective August 1, 2004.
Vioxx Litigation
Product Liability Lawsuits
As previously disclosed, Merck is a defendant in approximately 20 active federal and state lawsuits (Vioxx Product Liability Lawsuits) alleging personal injury as a result of the use of Vioxx. Most of these cases are coordinated in a multidistrict litigation in the U.S. District Court for the Eastern District of Louisiana (Vioxx MDL) before Judge Eldon E. Fallon.
As previously disclosed, Merck is also a defendant in approximately 30 putative class action lawsuits alleging economic injury as a result of the purchase of Vioxx. All but one of those cases are in the Vioxx MDL. Merck has reached a resolution, approved by Judge Fallon, of these class actions in the Vioxx MDL. Under the settlement, Merck will pay up to $23 million to resolve all properly documented claims submitted by class members, approved attorneys’ fees and expenses, and approved settlement notice costs and certain other administrative expenses. The court entered an order approving the settlement in January 2014 and the claims review process was recently completed.
Merck is also a defendant in lawsuits brought by state Attorneys General of three states — Alaska, Montana and Utah. The lawsuits are pending in state courts. These actions allege that Merck misrepresented the safety of Vioxx and seek recovery for expenditures on Vioxx by government-funded health care programs, such as Medicaid, and/or penalties for alleged Consumer Fraud Act violations. Trial has been scheduled in the Montana case for September 12, 2016, and trial has been set in the Alaska case for January 2, 2017. Motions for judgment on the pleadings in the Alaska and Montana cases are currently pending.
Shareholder Lawsuits
As previously disclosed, in addition to the Vioxx Product Liability Lawsuits, various putative class actions and individual lawsuits have been filed against Merck and certain former employees alleging that the defendants violated federal securities laws

- 19 -

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

by making alleged material misstatements and omissions with respect to the cardiovascular safety of Vioxx (Vioxx Securities Lawsuits). The Vioxx Securities Lawsuits are coordinated in a multidistrict litigation in the U.S. District Court for the District of New Jersey before Judge Stanley R. Chesler, and have been consolidated for all purposes. In August 2011, Judge Chesler granted in part and denied in part Merck’s motion to dismiss the Fifth Amended Class Action Complaint in the consolidated securities action. Among other things, the court dismissed certain defendants from the case, and also dismissed claims based on statements made on or after the voluntary withdrawal of Vioxx on September 30, 2004. In October 2011,the remaining defendants answered the Fifth Amended Class Action Complaint. In April 2012, plaintiffs filed a motion for class certification for the period from May 21, 1999, through September 29, 2004, which the court granted in January 2013. 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. On May 13, 2015, the court granted in part and denied in part defendants’ motions for summary judgment; the court granted judgment in defendants’ favor on five of the alleged misstatements, including all statements prior to March 27, 2000, but denied the motion with respect to the remaining statements. The trial in this matter is currently scheduled to begin on March 1, 2016.
As previously disclosed, 13 individual securities lawsuits filed by foreign and domestic institutional investors also are consolidated with the Vioxx Securities Lawsuits. Discovery has been completed in eight of those actions, and is ongoing in the remaining five individual actions. The allegations in the individual actions are substantially similar to the allegations in the Vioxx Securities Lawsuits. All individual securities actions are consolidated with the Vioxx Securities Lawsuits for all purposes, including for trial.
Insurance
The Company has Directors and Officers insurance coverage applicable to the Vioxx Securities Lawsuits with remaining stated upper limits of approximately $145 million. As a result of the previously disclosed insurance arbitration, additional insurance coverage for these claims should also be available, if needed, under upper-level excess policies that provide coverage for a variety of risks. There are disputes with the insurers about the availability of some or all of the Company’s insurance coverage for these claims and there are likely to be additional disputes. The amounts actually recovered under the policies discussed in this paragraph may be less than the stated upper limits.
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 and Europe (collectively, the Vioxx International Lawsuits). As previously disclosed, the Company has entered into an agreement to resolve all claims related to Vioxx in Canada pursuant to which the Company will pay a minimum of approximately $21 million but not more than an aggregate maximum of approximately $36 million. The agreement has been approved by courts in Canada’s provinces.
Reserves
The Company believes that it has meritorious defenses to the remaining Vioxx Product Liability Lawsuits, Vioxx Securities Lawsuits and Vioxx International Lawsuits (collectively, the Vioxx Litigation) and will vigorously defend against them. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek indeterminate damages, the Company is unable to predict the outcome of these matters and, at this time, cannot reasonably estimate the possible loss or range of loss with respect to the remaining Vioxx Litigation. The Company has established a reserve with respect to the Canadian settlement and certain other Vioxx Product Liability 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 (Fosamax Litigation). As of September 30, 2015, approximately 4,880 cases had been filed and were pending against Merck in either federal or state court, including one case which seeks class action certification, as well as damages and/or medical monitoring. In approximately 375 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; however, substantially all of those actions are subject to the settlement discussed below. In addition, plaintiffs in approximately 4,505 of these actions generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax.

- 20 -

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

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 (Fosamax ONJ MDL) for coordinated pre-trial proceedings.
In December 2013, Merck reached an agreement in principle with the Plaintiffs’ Steering Committee (PSC) in the Fosamax ONJ MDL to resolve pending ONJ cases not on appeal in the Fosamax ONJ MDL and in the state courts for an aggregate amount of $27.7 million. Merck and the PSC subsequently formalized the terms of this agreement in a Master Settlement Agreement (ONJ Master Settlement Agreement) that was executed in April 2014. As a condition to the settlement, 100% of the state and federal ONJ plaintiffs had to agree to participate in the settlement plan or Merck could either terminate the ONJ Master Settlement Agreement, or waive the 100% participation requirement and agree to a lesser funding amount for the settlement fund. On July 14, 2014, Merck elected to proceed with the ONJ Master Settlement Agreement at a reduced funding level since the participation level was approximately 95%. Merck has fully funded the Master Settlement Agreement and the escrow agent under the agreement has begun making settlement payments to qualifying plaintiffs. In addition, the judge overseeing the Fosamax ONJ MDL granted a motion filed by Merck and has entered an order that requires the approximately 40 non-participants whose cases will remain in the Fosamax ONJ MDL once the settlement is complete 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 Femur Fractures
In March 2011, Merck submitted a Motion to Transfer to the JPML seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. The Motion to Transfer was granted in May 2011, and all federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (the Femur Fracture MDL). Judge Pisano presided over the Femur Fracture MDL until March 10, 2015, at which time the Femur Fracture MDL was reassigned from Judge Pisano to Judge Freda L. Wolfson following Judge Pisano’s retirement. In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck, the jury returned a verdict in Merck’s favor. In addition, on June 27, 2013, the Femur Fracture MDL court granted Merck’s motion for judgment as a matter of law in the Glynn case and held that the plaintiff’s failure to warn claim was preempted by federal law.
In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the court’s preemption decision in the Glynn case. Pursuant to the show cause order, on March 26, 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 500 of those cases are appealing that decision to the U.S. Court of Appeals for the Third Circuit. In June 2015, the Femur Fracture MDL court dismissed without prejudice another approximately 520 cases pending plaintiffs’ appeal of the preemption ruling to the Third Circuit.
On June 17, 2014, Judge Pisano granted Merck summary judgment in the Gaynor v. Merck case and found that Merck’s updates in January 2011 to the Fosamax label regarding atypical femur fractures were adequate as a matter of law and that Merck adequately communicated those changes. The plaintiffs in Gaynor have appealed Judge Pisano’s decision to the Third Circuit. In August 2014, Merck filed a motion requesting that Judge Pisano enter a further order requiring all plaintiffs in the Femur Fracture MDL who claim that the 2011 Fosamax label is inadequate and the proximate cause of their alleged injuries to show cause why their cases should not be dismissed based on the court’s preemption decision and its ruling in the Gaynor case. In November 2014, the court granted Merck’s motion and entered the requested show cause order.
As of September 30, 2015, approximately 1,045 cases were pending in the Femur Fracture MDL including the 500 cases dismissed with prejudice on preemption grounds which are pending appeal and the 520 cases dismissed without prejudice.
As of September 30, 2015, approximately 3,090 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge Jessica Mayer in Middlesex County. The parties selected an initial group of 30 cases to be reviewed through fact discovery. Two additional groups of 50 cases each to be reviewed through fact discovery were selected in November 2013 and March 2014, respectively. A further group of 25 cases to be reviewed through fact discovery was selected by Merck in July 2015.
As of September 30, 2015, approximately 370 cases alleging Femur Fractures have been filed and are pending in California state court. A petition was filed seeking to coordinate all Femur Fracture cases filed in California state court before a single judge in Orange County, California. The petition was granted and Judge Thierry Colaw is currently presiding over the coordinated proceedings. In March 2014, the court directed that a group of 10 discovery pool cases be reviewed through fact discovery and subsequently scheduled the Galper v. Merck case, which plaintiffs’ selected, as the first trial. The Galper trial began on February 17, 2015 and the jury returned a verdict in Merck’s favor on April 3, 2015. The next Femur Fracture trial in California is currently scheduled to be held on March 14, 2016.
Additionally, there are five Femur Fracture cases pending in other state courts.

- 21 -

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

Discovery is ongoing in the Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits.
Januvia/Janumet
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet. As of September 30, 2015, approximately 1,035 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 September 30, 2015, to toll the statute of limitations for approximately 20 additional claims. The Company intends to defend against these lawsuits.
NuvaRing
As previously disclosed, beginning in May 2007, a number of product liability complaints were filed in various jurisdictions asserting claims against the Company and its subsidiaries relating to NuvaRing, a combined hormonal contraceptive vaginal ring. The plaintiffs contend the Company, 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 were pending in a federal multidistrict litigation venued in Missouri.
Pursuant to a settlement agreement between Merck and negotiating plaintiffs’ counsel, which became effective as of June 4, 2014, Merck paid 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. Plaintiffs in approximately 3,700 cases joined the settlement program. Each filed case is to be dismissed with prejudice once the settlement administration process is completed. Those dismissals began in the second quarter and will continue on a rolling basis throughout 2015. 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 was also used to fund the settlement.
As of September 30, 2015, there were 13 cases pending outside of the settlement program, inclusive of cases filed after the settlement program closed. Of these cases, 12 are pending in the multidistrict litigation and are subject to individual case management orders requiring plaintiffs to meet various discovery and evidentiary requirements. As of September 30, 2015, these 12 plaintiffs were meeting those requirements and continuing to prosecute their cases.
Propecia/Proscar
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar. As of September 30, 2015, approximately 1,385 lawsuits have been filed by plaintiffs who allege that they have experienced persistent sexual side effects following cessation of treatment with Propecia and/or Proscar. Approximately 60 of the plaintiffs also allege that Propecia or Proscar has caused or can cause prostate cancer, testicular cancer or male breast cancer. The lawsuits have been filed in various federal courts and in state court in New Jersey. The federal lawsuits have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge John Gleeson of the Eastern District of New York. The matters pending in state court in New Jersey have been consolidated before Judge Jessica Mayer in Middlesex County. In addition, there is one matter pending in state court in Massachusetts. The Company intends to defend against these lawsuits.
Governmental Proceedings
As previously disclosed, the Company’s subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Company’s policy is to cooperate with these authorities and to provide responses as appropriate.
The Company has received a civil investigative demand from the U.S. Attorney’s Office, Eastern District of Pennsylvania which requests information relating to the Company’s contracting and pricing of Dulera Inhalation Aerosol with certain pharmacy benefit managers and Medicare Part D plans. The Company is cooperating with the investigation.


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

Patent Litigation
From time to time, generic manufacturers of pharmaceutical products file Abbreviated New Drug Applications with the U.S. Food and Drug Administration (FDA) seeking to market generic forms of the Company’s products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Certain products of the Company (or products marketed via agreements with other companies) currently involved in such patent infringement litigation in the United States include: Cancidas, Cubicin, Emend for Injection, Invanz, Nasonex, Noxafil, and NuvaRing. Similar lawsuits defending the Company’s patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by generic companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through 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. In June 2015, the district court found that Xellia infringed the Company’s patent and ordered that Xellia’s application not be approved until the patent expires in September 2017 (including pediatric exclusivity). Xellia has appealed this decision. In August 2014, a patent infringement lawsuit was filed in the United States against Fresenius Kabi USA, LLC (Fresenius) in respect of Fresenius’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cancidas. The lawsuit automatically stays FDA approval of Fresenius’s application until December 2016 or until an adverse court decision, if any, whichever may occur earlier.
Cubicin In March 2012, a patent infringement lawsuit was filed in the United States against Hospira, Inc. (Hospira), with respect to Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. A trial was held in February 2014, and in December 2014 the district court found the composition patent, which expires in June 2016, to be valid and infringed. Later patents, expiring in September 2019 and November 2020, were found to be invalid. Hospira has appealed the finding that the composition patent is not invalid and the Company has cross-appealed the finding that the later patents are invalid. The appeal was heard in July 2015, and the Company is currently awaiting the decision. If the decision is upheld on appeal, Hospira’s application will not be approved until at least June 2016.
In October 2013, a patent infringement lawsuit was filed in the United States against Strides, Inc. and Agila Specialties Private Limited (Strides/Agila), with respect to Strides/Agila’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. The lawsuit automatically stays FDA approval of Strides/Agila’s application until February 2016 or until an adverse court decision, if any, whichever may occur earlier. If the Hospira decision is upheld on appeal, Strides/Agila’s application will not be approved until at least June 2016.
In July 2014, a patent infringement lawsuit was filed in the United States against Fresenius, with respect to Fresenius’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. The lawsuit automatically stays FDA approval of Fresenius’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. If the Hospira decision is upheld on appeal, Fresenius’s application will not be approved until at least June 2016.
An earlier district court action against Teva Parenteral Medicines Inc., Teva Pharmaceuticals USA, Inc. and Teva Pharmaceutical Industries Ltd. (collectively, Teva) resulted in a settlement whereby Teva can launch a generic version of Cubicin in December 2017 (June 2018 if the Company obtains pediatric marketing exclusivity on Cubicin). If the Hospira decision is upheld on appeal, Teva will be able to launch in June 2016.
In October 2014, Agila Specialties Inc. and Mylan Pharmaceuticals Inc. (Agila/Mylan) filed petitions for Inter Partes Review (IPR) at the United States Patent and Trademark Office (USPTO) seeking the invalidity of the September 2019 and November 2020 patents. In April 2015, Agila/Mylan withdrew its petitions for IPR in exchange for the Company agreeing to narrow the issues in the Strides/Agila lawsuit referenced above. In November 2014, Fresenius filed petitions for IPR at the USPTO seeking the invalidity of the September 2019 patents. In May 2015, the USPTO granted Fresenius’s petition for an IPR on the September 2019 patents. In July 2015, Fresenius filed petitions for IPR seeking invalidity of the November 2020 patents. The USPTO has six months from filing to determine whether it will institute the requested IPR proceedings.
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. The trial in the lawsuit against Sandoz was recently completed in the U.S. District Court for the District of New Jersey. In August 2015, the court found that the Company’s patent was infringed and not invalid. The court ordered that Sandoz’s application not be approved until the expiration of the Company’s patent in 2019. 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 agreed with Intas to stay the lawsuit until the outcome of the lawsuit with

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

Sandoz. In October 2015, following the Sandoz decision, the court found that the Company’s patent was infringed and not invalid. The court ordered that Intas’s application not be approved until the expiration of the Company’s patent in 2019. In July 2014, a patent infringement lawsuit was filed in the United States against Fresenius in respect of Fresenius’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 Fresenius’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. In December 2014, Apotex Inc. filed a petition for IPR at the USPTO seeking the invalidity of claims in the compound patent covering Emend for Injection. The USPTO rejected Apotex’s petition in June 2015.
Invanz — In July 2014, a patent infringement lawsuit was filed in the United States against Hospira in respect of Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The lawsuit automatically stays FDA approval of Hospira’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. Since Hospira did not challenge an earlier patent covering Invanz, its application to the FDA will not be approved until at least that patent expires in May 2016. In August 2015, a patent infringement lawsuit was filed in the United States against Savior Lifetec Corporation (Savior) in respect of Savior’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The lawsuit automatically stays FDA approval of Savior’s application until November 2017 or until an adverse court decision, if any, whichever may occur earlier. Since Savior did not challenge an earlier patent covering Invanz, its application to the FDA will not be approved until at least that patent expires in May 2016.
Nasonex — In July 2014, a patent infringement lawsuit was filed in the United States against Teva Pharmaceuticals USA, Inc. (Teva Pharma) in respect of Teva Pharma’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Teva Pharma’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. In March 2015, a patent infringement lawsuit was filed in the United States against Amneal Pharmaceuticals LLC (Amneal), in respect of Amneal’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Amneal’s application until August 2017 or until an adverse court decision, if any, whichever may occur earlier.
A previous decision, issued in June 2013, held that the Merck patent in the Teva Pharma and Amneal lawsuits covering mometasone furoate monohydrate was valid, but that it was not infringed by Apotex Corp.’s proposed product. In April 2015, a patent infringement lawsuit was filed against Apotex Inc. and Apotex Corp. (Apotex) in respect of Apotex’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex that allegedly differs from the generic version in the previous lawsuit.
Noxafil In August 2015, the Company filed a lawsuit against Actavis Laboratories Fl, Inc. (Actavis) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. The lawsuit automatically stays FDA approval of Actavis’s application until December 2017 or until an adverse court decision, if any, whichever may occur earlier.
NuvaRing — In December 2013, the Company filed a lawsuit against a subsidiary of Allergan in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing. The trial in this matter is scheduled to begin in January 2016. In September 2015, the Company filed a lawsuit against Teva Pharma in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing.
Anti-PD-1 Antibody Patent Oppositions and Litigation
As previously disclosed, Ono Pharmaceutical Co. (Ono) has a European patent (EP 1 537 878) (’878) that broadly claims the use of an anti-PD-1 antibody, such as the Company’s immunotherapy, Keytruda, for the treatment of cancer. Ono has previously licensed its commercial rights to an anti-PD-1 antibody to Bristol-Myers Squibb (BMS) in certain markets. The Company believes that the ’878 patent is invalid and filed an opposition in the European Patent Office (EPO) seeking its revocation. In June 2014, the Opposition Division of the EPO found the claims in the ’878 patent are valid. The Company received the Opposition Division’s written opinion in September 2014 and the Company submitted its substantive appeal in February 2015. In April 2014, the Company, and three other companies, opposed another European patent (EP 2 161 336) (’336) owned by BMS and Ono that it believes is invalid. The ’336 patent, if valid, broadly claims anti-PD-1 antibodies that could include Keytruda. BMS and Ono recently submitted a request to amend the claims of the ’336 patent. If the EPO allows this amendment, the claims of the ’336 patent would no longer broadly claim anti-PD-1 antibodies such as Keytruda.
In May 2014, the Company filed a lawsuit in the 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 Keytruda. The Company has sought a declaration from the UK court that Keytruda will not infringe the ’336 patent in the UK. BMS and Ono notified the Company of their request to amend the claims of the EPO ’336 patent and of their intention to seek permission from the court to similarly amend the UK national version so that the claims of the ’336 patent would no longer broadly claim anti-PD-1 antibodies such as Keytruda. A trial was held in the UK in July 2015.

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

At that trial, the issues of validity and infringement of the ’878 patent were heard at the same time by the court. In October 2015, the court issued its judgment, finding the ’878 patent valid and infringed. Merck will seek leave to appeal this judgment.
In February 2015, the Company filed lawsuits in the Netherlands seeking revocation of the Dutch national versions of both the ’878 and ’336 patents. BMS and Ono recently notified the company that it will amend the claims of the ‘336 patent so that the claims of the ‘336 patent would no longer broadly claim anti-PD-1 antibodies such as Keytruda. Trial regarding the validity and infringement of the ’878 patent is scheduled to begin in January 2016.
The Company can file lawsuits seeking revocation of the ’336 and ’878 patents in other national courts in Europe at any time, and Ono and BMS can file patent infringement actions against the Company in other national courts in Europe at or around the time the Company launches Keytruda. If a national court determines that the Company infringed a valid claim in the ’878 or ’336 patent, Ono and BMS may be entitled to monetary damages, including royalties on future sales of Keytruda, and potentially could seek an injunction to prevent the Company from marketing Keytruda in that country.
The USPTO granted US Patent Nos. 8,728,474 to Ono and 8,779,105 to Ono and BMS. These patents are equivalent to the ’878 and ’336 patents, respectively. In September 2014, BMS and Ono filed a lawsuit in the United States alleging that, by marketing Keytruda, the Company will infringe US Patent No. 8,728,474. BMS and Ono are not seeking to prevent or stop the marketing of Keytruda in the United States. The trial in this matter is currently scheduled to begin in November 2016. The Company believes that the 8,728,474 patent and the 8,779,105 patent are both invalid. Recently, Ono filed lawsuits in the United States alleging that, by marketing Keytruda, the Company will infringe US Patent Nos. 9,067,999 and 9,073,994, which are patents related to the 8,728,474 patent. The Company believes the 9,067,999 and 9,073,994 patents are also invalid.
In September 2014, the Company filed a lawsuit in Australia seeking the revocation of Australian patent No. 2011203119, which is equivalent to the ’336 patent. In March 2015, BMS and Ono counterclaimed in this matter alleging that the Company’s manufacture and supply of Keytruda to the Australian market will infringe Australian patent No. 2011203119.
Ono and BMS have similar and other patents and applications, which the Company is closely monitoring, pending in the United States, Japan and other countries.
The Company is confident that it will be able to market Keytruda in any country in which it is approved and that it will not be prevented from doing so by the Ono or BMS patents or any pending applications.
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 September 30, 2015 and December 31, 2014 of approximately $255 million and $215 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.


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

10.
Equity
 
  
Common Stock