10-Q 1 mrk0630201610q.htm 2Q16 FORM 10-Q Document




 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the quarterly period ended June 30, 2016
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 July 31, 2016: 2,765,208,203
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
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(Unaudited, $ in millions except per share amounts)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2016
 
2015
 
2016
 
2015
Sales
$
9,844

 
$
9,785

 
$
19,156

 
$
19,210

Costs, Expenses and Other
 
 
 
 
 
 
 
Materials and production
3,578

 
3,754

 
7,150

 
7,323

Marketing and administrative
2,458

 
2,624

 
4,776

 
5,226

Research and development
2,151

 
1,670

 
3,810

 
3,407

Restructuring costs
134

 
191

 
225

 
273

Other (income) expense, net
19

 
739

 
67

 
793

 
8,340

 
8,978

 
16,028

 
17,022

Income Before Taxes
1,504

 
807

 
3,128

 
2,188

Taxes on Income
295

 
119

 
789

 
542

Net Income
1,209

 
688

 
2,339

 
1,646

Less: Net Income Attributable to Noncontrolling Interests
4

 
1

 
9

 
7

Net Income Attributable to Merck & Co., Inc.
$
1,205

 
$
687

 
$
2,330

 
$
1,639

Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders
$
0.44

 
$
0.24

 
$
0.84

 
$
0.58

Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders
$
0.43

 
$
0.24

 
$
0.83

 
$
0.57

Dividends Declared per Common Share
$
0.46

 
$
0.45

 
$
0.92

 
$
0.90

 
MERCK & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited, $ in millions)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2016
 
2015
 
2016
 
2015
Net Income Attributable to Merck & Co., Inc.
$
1,205

 
$
687

 
$
2,330

 
$
1,639

Other Comprehensive Income (Loss) Net of Taxes:
 
 
 
 
 
 
 
Net unrealized (loss) gain on derivatives, net of reclassifications
(91
)
 
(176
)
 
(293
)
 
76

Net unrealized gain (loss) on investments, net of reclassifications
63

 
(14
)
 
126

 
32

Benefit plan net (loss) gain and prior service (cost) credit, net of amortization
(108
)
 
42

 
(136
)
 
77

Cumulative translation adjustment
244

 
(17
)
 
365

 
(194
)
 
108

 
(165
)
 
62

 
(9
)
Comprehensive Income Attributable to Merck & Co., Inc.
$
1,313

 
$
522

 
$
2,392

 
$
1,630

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

- 2 -




MERCK & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited, $ in millions except per share amounts)
 
 
June 30, 2016
 
December 31, 2015
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
6,608

 
$
8,524

Short-term investments
5,226

 
4,903

Accounts receivable (net of allowance for doubtful accounts of $167 in 2016
and $165 in 2015) (excludes accounts receivable of $10 in 2016 and 2015
classified in Other assets)
6,916

 
6,484

Inventories (excludes inventories of $1,195 in 2016 and $1,569 in 2015
classified in Other assets - see Note 5)
5,248

 
4,700

Other current assets
3,928

 
5,140

Total current assets
27,926

 
29,751

Investments
11,879

 
13,039

Property, Plant and Equipment, at cost, net of accumulated depreciation of $16,005
in 2016 and $15,923 in 2015
11,987

 
12,507

Goodwill
17,809

 
17,723

Other Intangibles, Net
20,315

 
22,602

Other Assets
6,559

 
6,055

 
$
96,475

 
$
101,677

Liabilities and Equity
 
 
 
Current Liabilities
 
 
 
Loans payable and current portion of long-term debt
$
644

 
$
2,583

Trade accounts payable
2,514

 
2,533

Accrued and other current liabilities
9,255

 
11,216

Income taxes payable
1,213

 
1,560

Dividends payable
1,292

 
1,309

Total current liabilities
14,918

 
19,201

Long-Term Debt
23,642

 
23,829

Deferred Income Taxes
6,091

 
6,535

Other Noncurrent Liabilities
8,378

 
7,345

Merck & Co., Inc. Stockholders’ Equity
 
 
 
Common stock, $0.50 par value
Authorized - 6,500,000,000 shares
Issued - 3,577,103,522 shares in 2016 and 2015
1,788

 
1,788

Other paid-in capital
39,911

 
40,222

Retained earnings
45,121

 
45,348

Accumulated other comprehensive loss
(4,086
)
 
(4,148
)
 
82,734

 
83,210

Less treasury stock, at cost:
811,476,036 shares in 2016 and 795,975,449 shares in 2015
39,377

 
38,534

Total Merck & Co., Inc. stockholders’ equity
43,357

 
44,676

Noncontrolling Interests
89

 
91

Total equity
43,446

 
44,767

 
$
96,475

 
$
101,677

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

- 3 -




MERCK & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited, $ in millions)
 
 
Six Months Ended 
 June 30,
 
2016
 
2015
Cash Flows from Operating Activities
 
 
 
Net income
$
2,339

 
$
1,646

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
3,111

 
3,245

Intangible asset impairment charges
567

 
73

Foreign currency devaluation related to Venezuela

 
715

Equity income from affiliates
(38
)
 
(147
)
Dividends and distributions from equity affiliates
7

 
7

Deferred income taxes
(120
)
 
(383
)
Share-based compensation
148

 
146

Other
197

 
689

Net changes in assets and liabilities
(2,438
)
 
(1,010
)
Net Cash Provided by Operating Activities
3,773

 
4,981

Cash Flows from Investing Activities
 
 
 
Capital expenditures
(654
)
 
(474
)
Purchases of securities and other investments
(6,355
)
 
(8,621
)
Proceeds from sales of securities and other investments
7,388

 
12,628

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

 
(7,598
)
Acquisitions of other businesses, net of cash acquired
(157
)
 

Dispositions of businesses, net of cash divested

 
25

Other
21

 
(40
)
Net Cash Provided by (Used in) Investing Activities
243

 
(4,080
)
Cash Flows from Financing Activities
 
 
 
Net change in short-term borrowings
(9
)
 
(1,529
)
Proceeds from issuance of debt
8

 
7,940

Payments on debt
(2,351
)
 
(2,905
)
Purchases of treasury stock
(1,573
)
 
(1,724
)
Dividends paid to stockholders
(2,579
)
 
(2,582
)
Proceeds from exercise of stock options
381

 
377

Other
(109
)
 
(19
)
Net Cash Used in Financing Activities
(6,232
)
 
(442
)
Effect of Exchange Rate Changes on Cash and Cash Equivalents
300

 
(978
)
Net Decrease in Cash and Cash Equivalents
(1,916
)
 
(519
)
Cash and Cash Equivalents at Beginning of Year
8,524

 
7,441

Cash and Cash Equivalents at End of Period
$
6,608

 
$
6,922

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

- 4 -

Notes to Condensed Consolidated Financial Statements (unaudited)

1.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Merck & Co., Inc. (Merck or the Company) have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States for complete consolidated financial statements are not included herein. These interim statements should be read in conjunction with the audited financial statements and notes thereto included in Merck’s Form 10-K filed on February 26, 2016.
The results of operations of any interim period are not necessarily indicative of the results of operations for the full year. In the Company’s opinion, all adjustments necessary for a fair statement of these interim statements have been included and are of a normal and recurring nature. Certain reclassifications have been made to prior year amounts to conform to the current presentation.
Recently Adopted Accounting Standards
In the first quarter of 2016, the Company adopted accounting guidance issued by the Financial Accounting Standards Board (FASB) in April 2015, which requires debt issuance costs to be presented as a direct deduction from the carrying amount of that debt on the balance sheet as opposed to being presented as a deferred charge. Approximately $100 million of debt issuance costs were reclassified in the first quarter of 2016 as a result of the adoption of the new standard. Prior period amounts have been recast to conform to the new presentation.
In the second quarter of 2016, the Company elected to early adopt an accounting standards update issued by the FASB in March of 2016 intended to simplify the accounting and reporting for employee share-based payment transactions. Among other provisions, the new standard requires that excess tax benefits and deficiencies that arise upon vesting or exercise of share-based payments be recognized in the income statement (as opposed to existing guidance under which tax effects are recorded to Other paid-in-capital in certain instances). This aspect of the new guidance was adopted prospectively; accordingly, the Company recognized $29 million of excess tax benefits in Taxes on income arising from share-based payments in the second quarter of 2016. The new guidance also amended the presentation of certain share-based payment items in the statement of cash flows. Cash flows related to excess income tax benefits are now classified as an operating activity (formerly included as a financing activity). The Company elected to adopt this aspect of the new guidance prospectively. The standard also clarified that cash payments made to taxing authorities on the employees’ behalf for shares withheld should be presented as a financing activity. This aspect of the guidance was adopted retrospectively; accordingly, the Company reclassified $112 million of such payments from operating activities to financing activities in the Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2015 to conform to the current presentation. The Company has elected to continue to estimate the impact of forfeitures when determining the amount of compensation cost to be recognized each period rather than account for them as they occur.
Recently Issued Accounting Standards
In May 2014, the FASB issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. In August 2015, the FASB approved a one-year deferral of the effective date making this guidance effective for interim and annual periods beginning in 2018. Reporting entities may choose to adopt the standard as of the original effective date. The Company is currently assessing the impact of adoption on its consolidated financial statements.
In January 2016, the FASB issued revised guidance for the accounting and reporting of financial instruments. The new guidance requires that equity investments with readily determinable fair values currently classified as available-for-sale be measured at fair value with changes in fair value recognized in net income. The new guidance also simplifies the impairment testing of equity investments without readily determinable fair values and changes certain disclosure requirements. This guidance is effective for interim and annual periods beginning in 2018. Early adoption is not permitted. The Company is currently assessing the impact of adoption on its consolidated financial statements.
In February 2016, the FASB issued new accounting guidance for the accounting and reporting of leases. The new guidance requires that lessees recognize a right-of-use asset and a lease liability recorded on the balance sheet for each of its leases (other than leases that meet the definition of a short-term lease).  Leases will be classified as either operating or finance. Operating leases will result in straight-line expense in the income statement (similar to current operating leases) while finance leases will result in more expense being recognized in the earlier years of the lease term (similar to current capital leases). The new guidance will be effective for interim and annual periods beginning in 2019. Early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
In June 2016, the FASB issued amended guidance on the accounting for credit losses on financial instruments within its scope. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for interim and annual periods beginning in

- 5 -

Notes to Condensed Consolidated Financial Statements (unaudited)

2020, with earlier application permitted in 2019. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
2.
Acquisitions, Divestitures, Research Collaborations and License Agreements
The Company continues its strategy of establishing external alliances to complement its internal research capabilities, including research collaborations, licensing preclinical and clinical compounds to drive both near- and long-term growth. The Company supplements its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain products.
In July 2016, Merck acquired Afferent Pharmaceuticals (Afferent), a privately held pharmaceutical company focused on the development of therapeutic candidates targeting the P2X3 receptor for the treatment of common, poorly-managed, neurogenic conditions. Afferent’s lead investigational candidate, MK-7264 (formerly AF-219), is a selective, non-narcotic, orally-administered P2X3 antagonist currently being evaluated in a Phase 2b clinical trial for the treatment of refractory, chronic cough as well as in a Phase 2 clinical trial in idiopathic pulmonary fibrosis with cough. Merck acquired all outstanding stock of Afferent in exchange for a payment of $500 million in cash. In addition, former Afferent shareholders are eligible to receive a total of up to an additional $750 million contingent upon the attainment of certain clinical development and commercial milestones for multiple indications and candidates, including MK-7264. The Company is in the process of determining the preliminary fair value of assets acquired, liabilities assumed and total consideration transferred for this business acquisition. The transaction closed on July 26, 2016; accordingly, the results of operations of the acquired business will be included in the Company’s results of operations beginning after that date.
In July 2016, Merck, through its wholly owned subsidiary Healthcare Services & Solutions, LLC, acquired a majority ownership interest in The StayWell Company LLC (StayWell), a portfolio company of Vestar Capital Partners (Vestar). StayWell is a health engagement company that helps its clients engage and educate people to improve health and business results. Under the terms of the transaction, Merck paid $150 million for a majority ownership interest. Merck has an option to buy, and Vestar has an option to require Merck to buy, an additional ownership interest at a future date. The Company is in the process of determining the preliminary fair value of assets acquired and liabilities assumed for this business acquisition. The transaction closed on July 1, 2016; accordingly, the results of operations of the acquired business will be included in the Company’s results of operations beginning after that date.
Also in July 2016, Merck announced it had executed an agreement to acquire a controlling interest in Vallée S.A. (Vallée), a leading privately held producer of animal health products in Brazil. Vallée has an extensive portfolio of more than 100 products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck will acquire approximately 93% of the shares of Vallée in exchange for a payment estimated to be approximately $400 million, based on exchange rates at the time of the announcement. This agreement is subject to regulatory review and certain closing conditions.
In June 2016, Merck and Moderna Therapeutics (Moderna) entered into a strategic collaboration and license agreement to develop and commercialize novel messenger RNA (mRNA)-based personalized cancer vaccines. The collaboration will combine Merck’s established leadership in immuno-oncology with Moderna’s mRNA vaccine technology and GMP manufacturing capabilities to advance individually tailored cancer vaccines for patients across a spectrum of cancers. Moderna and Merck will develop personalized cancer vaccines that utilize Moderna’s mRNA vaccine technology to encode a patient’s specific neoantigens, unique mutations present in that specific patient’s tumor. The development program will entail multiple studies in several types of cancer and include the evaluation of mRNA-based personalized cancer vaccines in combination with Merck’s Keytruda. Pursuant to the terms of the agreement, Merck made an upfront cash payment to Moderna of $200 million in July 2016, which was accrued for and recorded in Research and development expenses in the second quarter of 2016. Following human proof of concept studies, Merck has the right to elect to make an additional payment to Moderna. If Merck exercises this right, the two companies will then equally share cost and profits under a worldwide collaboration for the development of personalized cancer vaccines. Moderna will have the right to elect to co-promote the personalized cancer vaccines in the United States. The agreement entails exclusivity around combinations with Keytruda. Moderna and Merck will each have the ability to combine mRNA-based personalized cancer vaccines with other (non-PD-1) agents. Merck and Moderna have an existing collaboration and license agreement focused on the discovery and development of mRNA-based infectious disease vaccines and passive immunity treatments.
As previously disclosed, in 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators, including Bayer’s Adempas (riociguat). The arrangement provided for potential future milestone payments of up to $1.1 billion based upon the achievement of agreed-upon

- 6 -

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

sales goals. During the second quarter of 2016, the Company determined it was probable that, in 2017, Adempas sales would exceed the threshold triggering a $350 million milestone payment from Merck to Bayer. Accordingly, in the second quarter of 2016, the Company recorded a $350 million liability and a corresponding intangible asset and also recognized $50 million of cumulative amortization expense within Materials and production costs. The remaining intangible asset of $300 million will be amortized over the remaining estimated useful life of the asset of 10.5 years as supported by projected future cash flows, subject to impairment testing. Additional potential future milestone payments of $775 million have not yet been accrued as they are not deemed by the Company to be probable at this time.
In January 2016, Merck acquired IOmet Pharma Ltd (IOmet), a privately held UK-based drug discovery company focused on the development of innovative medicines for the treatment of cancer, with a particular emphasis on the fields of cancer immunotherapy and cancer metabolism. The acquisition provides Merck with IOmet’s preclinical pipeline of IDO (indoleamine-2,3-dioxygenase 1), TDO (tryptophan-2,3-dioxygenase), and dual-acting IDO/TDO inhibitors. Total purchase consideration in the transaction of $227 million included a cash payment of $150 million and future additional milestone payments of up to $250 million that are contingent upon certain clinical and regulatory milestones being achieved, which the Company determined had a fair value of $77 million at the acquisition date. The transaction was accounted for as an acquisition of a business; accordingly, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date. Merck recognized intangible assets for in-process research and development (IPR&D) of $155 million and net deferred tax assets of $26 million. The excess of the consideration transferred over the fair value of net assets acquired of $46 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible assets related to IPR&D was determined using an income approach, through which fair value is estimated based upon the asset’s probability-adjusted future net cash flows, which reflects the stage of development of the project and the associated probability of successful completion. The net cash flows were then discounted to present value using a discount rate of 10.5%. The fair value of the contingent consideration was determined utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment also utilizing a discount rate of 10.5%. Actual cash flows are likely to be different than those assumed. This transaction closed on January 11, 2016; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. Pro forma financial information has not been included because IOmet’s historical financial results are not significant when compared with the Company’s financial results.
Also in January 2016, Merck sold the U.S. marketing rights to Cortrophin and Corticotropin Zinc Hydroxide to ANI Pharmaceuticals, Inc. (ANI). Under the terms of the agreement, ANI made a payment of $75 million, which was recorded in Sales in the first six months of 2016, and may make additional payments to the Company based on future sales. Merck does not have any ongoing supply or other performance obligations after the closing date.
In February 2015, Merck and NGM Biopharmaceuticals, Inc. (NGM), a privately held biotechnology company, entered into a multi-year collaboration to research, discover, develop and commercialize novel biologic therapies across a wide range of therapeutic areas. The collaboration includes multiple drug candidates currently in preclinical development at NGM, including NP201, which is being evaluated for the treatment of diabetes, obesity and nonalcoholic steatohepatitis. NGM will lead the research and development of the existing preclinical candidates and have the autonomy to identify and pursue other discovery stage programs at its discretion. Merck will have the option to license all resulting NGM programs following human proof-of-concept trials. If Merck exercises this option, Merck will lead global product development and commercialization for the resulting products, if approved. Under the terms of the agreement, Merck made an upfront payment to NGM of $94 million, which is included in Research and development expenses, and purchased a 15% equity stake in NGM for $106 million. Merck committed up to $250 million to fund all of NGM’s efforts under the initial five-year term of the collaboration, with the potential for additional funding if certain conditions are met. Prior to Merck initiating a Phase 3 study for a licensed program, NGM may elect to either receive milestone and royalty payments or, in certain cases, to co-fund development and participate in a global cost and revenue share arrangement of up to 50%. The agreement also provides NGM with the option to participate in the co-promotion of any co-funded program in the United States. Merck will have the option to extend the research agreement for two additional two-year terms. Each party has certain termination rights under the agreement in the event of an uncured material breach by the other party. Additionally, Merck has certain termination rights in the event of the occurrence of certain defined conditions. Upon a termination event, depending on the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of compounds discovered under the agreement and certain related payment obligations.
Acquisition of Cubist Pharmaceuticals, Inc.
In January 2015, Merck acquired Cubist Pharmaceuticals, Inc. (Cubist), a leader in the development of therapies to treat serious infections caused by a broad range of bacteria. This transaction closed on January 21, 2015; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. During the first six months of 2015, the Company incurred $324 million of transaction costs directly related to the acquisition of Cubist including share-based compensation costs, severance costs and legal and advisory fees which are reflected in Marketing and administrative expenses. Of this amount, $226 million was recorded in the first quarter of 2015 and $98 million was recorded in the second quarter of 2015, but should have been recorded in the first quarter of 2015 which was the period the acquisition closed.

- 7 -

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

The following unaudited supplemental pro forma data presents consolidated information as if the acquisition of Cubist had been completed on January 1, 2014:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
($ in millions, except per share amounts)
2015
 
2015
Sales
$
9,785

 
$
19,296

Net income attributable to Merck & Co., Inc.
764

 
1,811

Basic earnings per common share attributable to Merck & Co., Inc. common shareholders
0.27

 
0.64

Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders
0.27

 
0.63

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.
3.
Restructuring
The Company incurs substantial costs for restructuring program activities related to Merck’s productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. The non-facility related restructuring actions under these programs are substantially complete; the remaining activities primarily relate to ongoing facility rationalizations.
The Company recorded total pretax costs of $351 million and $328 million in the second quarter of 2016 and 2015, respectively, and $547 million and $553 million for the first six months of 2016 and 2015, respectively, related to restructuring program activities. Since inception of the programs through June 30, 2016, Merck has recorded total pretax accumulated costs of approximately $12.0 billion and eliminated approximately 39,330 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company expects to substantially complete the remaining actions under these programs by the end of 2017 and incur approximately $1.0 billion of additional pretax costs. The Company estimates that approximately two-thirds of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.
For segment reporting, restructuring charges are unallocated expenses.
The following tables summarize the charges related to restructuring program activities by type of cost:
 
Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
 
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Materials and production
$

 
$
29

 
$
37

 
$
66

 
$

 
$
51

 
$
62

 
$
113

Marketing and administrative

 
4

 
83

 
87

 

 
7

 
83

 
90

Research and development

 
64

 

 
64

 

 
119

 

 
119

Restructuring costs
85

 

 
49

 
134

 
111

 

 
114

 
225

 
$
85

 
$
97

 
$
169

 
$
351

 
$
111

 
$
177

 
$
259

 
$
547

 
Three Months Ended June 30, 2015
 
Six Months Ended June 30, 2015
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
 
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Materials and production
$

 
$
17

 
$
88

 
$
105

 
$

 
$
30

 
$
180

 
$
210

Marketing and administrative

 
14

 
3

 
17

 

 
48

 
5

 
53

Research and development

 
16

 
(1
)
 
15

 

 
16

 
1

 
17

Restructuring costs
59

 

 
132

 
191

 
88

 

 
185

 
273

 
$
59

 
$
47

 
$
222

 
$
328

 
$
88

 
$
94

 
$
371

 
$
553


- 8 -

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

Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. In the second quarter of 2016 and 2015, approximately 585 positions and 860 positions, respectively, and for the first six months of 2016 and 2015, approximately 1,055 positions and 1,950 positions, respectively, were eliminated under the restructuring program activities. These position eliminations were comprised of actual headcount reductions and the elimination of contractors and vacant positions.
Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the site, based upon the anticipated date the site will be closed or divested, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All of the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck recorded accelerated depreciation of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors.
Other activity in 2016 and 2015 includes asset abandonment, shut-down and other related costs, as well as pretax gains and losses resulting from sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 11) and share-based compensation.
The following table summarizes the charges and spending relating to restructuring program activities for the six months ended June 30, 2016:
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Restructuring reserves January 1, 2016
$
592

 
$

 
$
53

 
$
645

Expense
111

 
177

 
259

 
547

(Payments) receipts, net
(185
)
 

 
(126
)
 
(311
)
Non-cash activity

 
(177
)
 
(146
)
 
(323
)
Restructuring reserves June 30, 2016 (1)
$
518

 
$

 
$
40

 
$
558

(1) 
The remaining cash outlays are expected to be substantially completed by the end of 2017.
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 primary objective of the revenue hedging program is to reduce the potential for longer-term unfavorable changes in foreign exchange rates to decrease the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales that are expected to occur over its planning cycle, typically no more than three years into the future. The Company will layer in hedges over time, increasing the portion of third-party and intercompany distributor entity sales hedged as it gets closer to the expected date of the forecasted foreign currency denominated 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

- 9 -

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

currency sales. Conversely, if the U.S. dollar weakens, the options’ value reduces to zero, but the Company benefits from the increase in the U.S. dollar equivalent value of the anticipated foreign currency cash flows.
In connection with the Company’s revenue hedging program, a purchased collar option strategy may be utilized. With a purchased collar option strategy, the Company writes a local currency call option and purchases a local currency put option. As compared to a purchased put option strategy alone, a purchased collar strategy reduces the upfront costs associated with purchasing puts through the collection of premiums by writing call options. If the U.S. dollar weakens relative to the currency of the hedged anticipated sales, the purchased put option value of the collar strategy reduces to zero and the Company benefits from the increase in the U.S. dollar equivalent value of its anticipated foreign currency cash flows; however, this benefit would be capped at the strike level of the written call. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the written call option value of the collar strategy reduces to zero and the changes in the purchased put cash flows of the collar strategy would offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales.
The Company may also utilize forward contracts in its revenue hedging program. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the increase in the fair value of the forward contracts offsets the decrease in the expected future U.S. dollar cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the decrease in the fair value of the forward contracts offsets the increase in the value of the anticipated foreign currency cash flows.
The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Condensed Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other comprehensive income (OCI), depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the effective portion of the unrealized gains or losses on these contracts is recorded in Accumulated other comprehensive income (AOCI) and reclassified into Sales when the hedged anticipated revenue is recognized. The hedge relationship is highly effective and hedge ineffectiveness has been de minimis. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes.
The primary objective of the balance sheet risk management program is to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiary’s functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts, which enable the Company to buy and sell foreign currencies in the future at fixed exchange rates and economically offset the consequences of changes in foreign exchange from the monetary assets. Merck routinely enters into contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The Company will also minimize the effect of exchange on monetary assets and liabilities by managing operating activities and net asset positions at the local level. The cash flows from these contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows.
Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net. The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net. Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year.
The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates. The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within OCI, and remains in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Condensed Consolidated Statement of Cash Flows.
Foreign exchange risk is also managed through the use of foreign currency debt. The Company’s senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI. Included in the cumulative translation adjustment are pretax

- 10 -

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

losses of $29 million and pretax gains $247 million for the first six months of 2016 and 2015, respectively, from the euro-denominated notes.
Interest Rate Risk Management
The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk.
In May 2016, four interest rate swaps with notional amounts of $250 million each matured. These swaps effectively converted the Company’s $1.0 billion, 0.70% fixed-rate notes due 2016 to variable rate debt. At June 30, 2016, the Company was a party to 26 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below.
($ in millions)
June 30, 2016
Debt Instrument
Par Value of Debt
 
Number of Interest Rate Swaps Held
 
Total Swap Notional Amount
1.30% notes due 2018
$
1,000

 
4

 
$
1,000

5.00% notes due 2019
1,250

 
3

 
550

1.85% notes due 2020
1,250

 
5

 
1,250

3.875% notes due 2021
1,150

 
5

 
1,150

2.40% notes due 2022
1,000

 
4

 
1,000

2.35% notes due 2022
1,250

 
5

 
1,250

The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows.
Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments:
 
 
June 30, 2016
 
December 31, 2015
 
 
Fair Value of Derivative
 
U.S. Dollar
Notional
 
Fair Value of Derivative
 
U.S. Dollar
Notional
($ in millions)
Balance Sheet Caption
Asset
 
Liability
 
Asset
 
Liability
 
Derivatives Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts (noncurrent)
Other assets
$
217

 
$

 
$
6,200

 
$
42

 
$

 
$
2,700

Interest rate swap contracts (current)
Accrued and other current liabilities

 

 

 

 
1

 
1,000

Interest rate swap contracts (noncurrent)
Other noncurrent liabilities

 

 

 

 
23

 
3,500

Foreign exchange contracts (current)
Other current assets
346

 

 
4,722

 
579

 

 
4,171

Foreign exchange contracts (noncurrent)
Other assets
169

 

 
2,746

 
386

 

 
4,136

Foreign exchange contracts (current)
Accrued and other current liabilities

 
10

 
438

 

 
1

 
77

Foreign exchange contracts (noncurrent)
Other noncurrent liabilities

 
1

 
150

 

 

 

 
 
$
732


$
11


$
14,256


$
1,007


$
25


$
15,584

Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts (current)
Other current assets
$
180

 
$

 
$
7,029

 
$
212

 
$

 
$
8,783

Foreign exchange contracts (noncurrent)
Other assets

 

 

 
18

 

 
179

Foreign exchange contracts (current)
Accrued and other current liabilities

 
59

 
3,988

 

 
37

 
2,508

Foreign exchange contracts (noncurrent)
Other noncurrent liabilities

 
1

 
6

 

 
1

 
6

 
 
$
180

 
$
60

 
$
11,023

 
$
230

 
$
38

 
$
11,476

 
 
$
912


$
71


$
25,279


$
1,237


$
63


$
27,060


- 11 -

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

As noted above, the Company records its derivatives on a gross basis in the Condensed Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Company’s derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes:
 
June 30, 2016
 
December 31, 2015
($ in millions)
Asset
 
Liability
 
Asset
 
Liability
Gross amounts recognized in the consolidated balance sheet
$
912

 
$
71

 
$
1,237

 
$
63

Gross amount subject to offset in master netting arrangements not offset in the consolidated
balance sheet
(47
)
 
(47
)
 
(59
)
 
(59
)
Cash collateral (received) posted
(595
)
 

 
(862
)
 

Net amounts
$
270

 
$
24

 
$
316

 
$
4

The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a foreign currency cash flow hedging relationship, (iii) designated in a foreign currency net investment hedging relationship and (iv) not designated in a hedging relationship:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
($ in millions)
2016
 
2015
 
2016
 
2015
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)
$
(48
)
 
$
57

 
$
(198
)
 
$
32

Amount of loss (gain) recognized in Other (income) expense, net on hedged item (1)
47

 
(56
)
 
194

 
(34
)
Derivatives designated in foreign currency cash flow hedging relationships
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of gain reclassified from AOCI to Sales
(65
)
 
(191
)
 
(207
)
 
(358
)
Amount of loss (gain) recognized in OCI on derivatives
75

 
84

 
242

 
(481
)
 Derivatives designated in foreign currency net investment hedging relationships
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of gain recognized in Other (income) expense, net on derivatives (2)

 
(2
)
 

 
(3
)
Amount of gain recognized in OCI on derivatives

 
(26
)
 

 
(18
)
Derivatives not designated in a hedging relationship
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Amount of (gain) loss recognized in Other (income) expense, net on derivatives (3)
(140
)
 
43

 
(116
)
 
(205
)
Amount of gain recognized in Sales 

 

 

 
(1
)
(1) There was $1 million of ineffectiveness on the hedge during both the second quarter of 2016 and 2015, respectively, and $4 million and $2 million of ineffectiveness on the hedge for the first six months of 2016 and 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 June 30, 2016, the Company estimates $121 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales. The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity.


- 12 -

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

Investments in Debt and Equity Securities
Information on investments in debt and equity securities is as follows:
 
June 30, 2016
 
December 31, 2015
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
($ in millions)
Gains
 
Losses
 
Gains
 
Losses
Corporate notes and bonds
$
10,640

 
$
10,552

 
$
92

 
$
(4
)
 
$
10,259

 
$
10,299

 
$
7

 
$
(47
)
U.S. government and agency securities
2,357

 
2,345

 
12

 

 
1,761

 
1,767

 

 
(6
)
Commercial paper
2,031

 
2,031

 

 

 
2,977

 
2,977

 

 

Asset-backed securities
1,402

 
1,398

 
5

 
(1
)
 
1,284

 
1,290

 

 
(6
)
Mortgage-backed securities
784

 
779

 
6

 
(1
)
 
694

 
697

 
1

 
(4
)
Foreign government bonds
511

 
508

 
3

 

 
607

 
586

 
22

 
(1
)
Equity securities
394

 
306

 
90

 
(2
)
 
534

 
409

 
125

 

 
$
18,119

 
$
17,919

 
$
208

 
$
(8
)
 
$
18,116

 
$
18,025

 
$
155

 
$
(64
)
Available-for-sale debt securities included in Short-term investments totaled $5.2 billion at June 30, 2016. Of the remaining debt securities, $10.6 billion mature within five years. At June 30, 2016 and December 31, 2015, there were no debt securities pledged as collateral.
Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest:
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation.
If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

- 13 -

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

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities measured at fair value on a recurring basis are summarized below:
 
Fair Value Measurements Using
 
Fair Value Measurements Using
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
($ in millions)
June 30, 2016
 
December 31, 2015
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate notes and bonds
$

 
$
10,505

 
$

 
$
10,505

 
$

 
$
10,259

 
$

 
$
10,259

Commercial paper

 
2,031

 

 
2,031

 

 
2,977

 

 
2,977

U.S. government and agency securities
32

 
1,792

 

 
1,824

 

 
1,761

 

 
1,761

Asset-backed securities (1)

 
1,296

 

 
1,296

 

 
1,284

 

 
1,284

Mortgage-backed securities (1)

 
700

 

 
700

 

 
694

 

 
694

Foreign government bonds

 
510

 

 
510

 

 
607

 

 
607

Equity securities
239

 

 

 
239

 
360

 

 

 
360

 
271

 
16,834

 

 
17,105

 
360

 
17,582

 

 
17,942

Other assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency securities

 
533

 

 
533

 

 

 

 

Corporate notes and bonds

 
135

 

 
135

 

 

 

 

Asset-backed securities (1)

 
106

 

 
106

 

 

 

 

Mortgage-backed securities (1)

 
84

 

 
84

 

 

 

 

Foreign government bonds

 
1

 

 
1

 

 

 

 

Equity securities
155

 

 

 
155

 
155

 
19

 

 
174

 
155


859




1,014


155


19




174

Derivative assets (3)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased currency options

 
548

 

 
548

 

 
1,041

 

 
1,041

Interest rate swaps

 
217

 

 
217

 

 
42

 

 
42

Forward exchange contracts

 
147

 

 
147

 

 
154

 

 
154

 

 
912

 

 
912

 

 
1,237

 

 
1,237

Total assets
$
426


$
18,605


$


$
19,031


$
515


$
18,838


$


$
19,353

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
$

 
$

 
$
661

 
$
661

 
$

 
$

 
$
590

 
$
590

Derivative liabilities (3)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward exchange contracts

 
70

 

 
70

 

 
38

 

 
38

Written currency options

 
1

 

 
1

 

 
1

 

 
1

Interest rate swaps

 

 

 

 

 
24

 

 
24

 

 
71

 

 
71

 

 
63

 

 
63

Total liabilities
$


$
71


$
661


$
732


$


$
63


$
590


$
653

(1) 
Primarily all of the asset-backed securities are highly-rated (Standard & Poor’s rating of AAA and Moody’s Investors Service rating of Aaa), secured primarily by credit card, auto loan, and home equity receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies.
(2) 
The increase in investments included in Other assets reflects certain assets previously restricted for retiree benefits that became available to fund certain other health and welfare benefits during the second quarter of 2016 (see Note 11).
(3) 
The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Company’s own credit risk, the effects of which were not significant.
There were no transfers between Level 1 and Level 2 during the first six months of 2016. As of June 30, 2016, Cash and cash equivalents of $6.6 billion included $6.0 billion of cash equivalents (considered Level 2 in the fair value hierarchy).

- 14 -

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

Contingent Consideration
Summarized information about the changes in liabilities for contingent consideration is as follows:
 
Six Months Ended June 30,
($ in millions)
2016
 
2015
Fair value January 1
$
590

 
$
428

Changes in fair value (1)
19

 
76

Additions
77

 
123

Payments
(25
)
 
(50
)
Fair value June 30
$
661

 
$
577

(1) Recorded in Research and development expenses and Materials and production costs.
The Company recognized liabilities for contingent consideration related to the acquisition of IOmet in the first six months of 2016 and the acquisition of Cubist for the first six months of 2015, reflected as “Additions” in the table above (see Note 2). The payments of contingent consideration reflected in the table above for 2016 relate to the first commercial sale of Zerbaxa in the European Union and for 2015 relate to the first commercial sale of Zerbaxa in the United States.
Other Fair Value Measurements
Some of the Company’s financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature.
The estimated fair value of loans payable and long-term debt (including current portion) at June 30, 2016, was $26.2 billion compared with a carrying value of $24.3 billion and at December 31, 2015, was $27.0 billion compared with a carrying value of $26.4 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy.
Concentrations of Credit Risk
On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards as specified in the Company’s investment policy guidelines.
The majority of the Company’s accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business, taking into consideration global economic conditions and the ongoing sovereign debt issues in certain European countries. At June 30, 2016, the Company’s total net accounts receivable outstanding for more than one year were approximately $115 million. The Company does not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on its financial position, liquidity or results of operations.
Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Company’s financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Company’s credit rating, and the credit rating of the counterparty. As of June 30, 2016 and December 31, 2015, the Company had received cash collateral of $595 million and $862 million, respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities. The Company had not advanced any cash collateral to counterparties as of June 30, 2016 or December 31, 2015.


- 15 -

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

5.
Inventories
Inventories consisted of:
($ in millions)
June 30, 2016
 
December 31, 2015
Finished goods
$
1,437

 
$
1,343

Raw materials and work in process
4,480

 
4,374

Supplies
169

 
168

Total (approximates current cost)
6,086

 
5,885

Increase to LIFO costs
357

 
384

 
$
6,443

 
$
6,269

Recognized as:
 
 
 
Inventories
$
5,248

 
$
4,700

Other assets
1,195

 
1,569

Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At June 30, 2016 and December 31, 2015, these amounts included $1.1 billion and $1.5 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $69 million and $63 million at June 30, 2016 and December 31, 2015, respectively, of inventories produced in preparation for product launches.
6.
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.
During the second quarter and first six months of 2016, the Company recorded $95 million and $347 million, respectively, of intangible asset impairment charges within Materials and production costs. During the second quarter of 2016, the Company wrote-off $95 million that had been capitalized in connection with in-licensed products Grastek and Ragwitek, allergy immunotherapy tablets that, for business reasons, the Company has determined it will return to the licensor. The remaining $252 million of impairment charges in the year-to-date period relate to Zontivity, a product marketed by the Company for the reduction of thrombotic cardiovascular events in patients with a history of myocardial infarction or with peripheral arterial disease. In March 2016, following several business decisions that reduced sales expectations for Zontivity in the United States and Europe, the Company lowered its cash flow projections for Zontivity. The Company utilized market participant assumptions and considered several different scenarios to determine the fair value of the intangible asset related to Zontivity that, when compared with its related carrying value, resulted in the impairment charge noted above.
Also during the second quarter and first six months of 2016, the Company recorded $195 million and $220 million, respectively, of IPR&D impairment charges within Research and development expenses. Of these amounts, $112 million relates to a charge for an in-licensed program for house dust mite allergies that, for business reasons, will be returned to the licensor. The remaining IPR&D impairment charges for the second quarter and first six months of 2016 primarily relate to deprioritized pipeline programs that were deemed to have no alternative use during the period, including a $79 million impairment charge for MK-8342B, an investigational candidate for contraception. During the second quarter and first six months of 2015, the Company recorded $59 million and $61 million, respectively, of IPR&D impairment charges. Of these amounts, $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.
The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material.
7.
Joint Ventures and Other Equity Method Affiliates
Equity income from affiliates reflects the performance of the Company’s joint ventures and other equity method affiliates including Sanofi Pasteur MSD (SPMSD) and certain investment funds. Equity income from affiliates was $4 million and $2 million for the second quarter of 2016 and 2015, respectively, and $38 million and $147 million for the first six months of 2016 and 2015, respectively, and is included in Other (income) expense, net (see Note 12).
Sanofi Pasteur MSD
In March 2016, Merck and Sanofi Pasteur announced their intention to end their joint vaccines operations in Europe. The joint venture SPMSD, owned equally by Sanofi Pasteur and Merck, was created in 1994 to develop and commercialize vaccines

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

originating from both companies’ pipelines to improve and promote public health in 19 European countries. Sanofi Pasteur and Merck expect the project to be completed by the end of 2016, subject to local labor laws and regulations and regulatory approvals. Upon concluding the joint venture, Merck plans to integrate its European vaccine business into its operations, manage its product portfolio and pursue its growth strategy in Europe. Joint venture vaccine sales were $202 million and $175 million for the second quarter of 2016 and 2015, respectively, and were $383 million and $337 million for the first six months of 2016 and 2015, respectively.
AstraZeneca LP
In 1998, Merck and Astra completed the restructuring of the ownership and operations of their existing joint venture whereby Merck acquired Astra’s interest in KBI Inc. (KBI) and contributed KBI’s operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the Partnership). Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership. The Partnership, renamed AstraZeneca LP (AZLP) upon Astra’s 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights. In connection with AstraZeneca’s 2014 exercise of its option to purchase Merck’s interest in KBI, the Company deferred $327 million of the exercise price, which reflected an estimate of the fair value of Merck’s interest in Nexium and Prilosec. This amount, which is subject to a true-up in 2018 based on actual sales from closing in 2014 to June 2018, was deferred and recognized over time in Other (income) expense, net as the contingency was eliminated as sales occurred. The deferred income amount has been fully amortized based on the sales performance of Nexium and Prilosec subsequent to the 2014 option exercise. Beginning in the first quarter of 2016, the Company is recognizing income and a corresponding receivable for amounts that will be due to Merck from AstraZeneca based on the sales performance of Nexium and Prilosec subject to the true-up in June 2018. The Company recognized $54 million of such income in the first six months of 2016.
8.
Contingencies
The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Company’s financial position, results of operations or cash flows.
Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation.
The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable.
The Company’s decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities effective August 1, 2004.
Vioxx Litigation
Product Liability Lawsuits
As previously disclosed, Merck is a defendant in approximately 30 putative class action lawsuits alleging economic injury as a result of the purchase of Vioxx. All but one of those cases are coordinated in a multidistrict litigation in the U.S. District Court for the Eastern District of Louisiana (the Vioxx MDL) before Judge Eldon E. Fallon. Merck has reached a resolution, approved by Judge Fallon, of these class actions. 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 (together with the above-referenced lawsuits, the Vioxx Product Liability Lawsuits) brought by state Attorneys General of three states — Alaska, Montana and Utah. The lawsuits are pending in state courts. These

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

actions allege that Merck misrepresented the safety of Vioxx and seek recovery for expenditures on Vioxx by government-funded health care programs, such as Medicaid, and/or penalties for alleged Consumer Fraud Act violations. Trial has been scheduled in the Montana case for September 12, 2016, and trial has been set in the Alaska case for January 9, 2017. A motion for judgment on the pleadings in the Montana case is currently pending. Merck’s motion to dismiss in Utah and motion for judgment on the pleadings in Alaska were both recently denied.
Shareholder Lawsuits
As previously disclosed, in addition to the Vioxx Product Liability Lawsuits, various putative class actions and individual lawsuits have been filed against Merck and certain former employees alleging that the defendants violated federal securities laws by making alleged material misstatements and omissions with respect to the cardiovascular safety of Vioxx (Vioxx Securities Lawsuits). The Vioxx Securities Lawsuits are coordinated in a multidistrict litigation in the U.S. District Court for the District of New Jersey before Judge Stanley R. Chesler. As previously disclosed, Merck has reached a resolution of the Vioxx securities class action for which a reserve was recorded in 2015 and under which Merck created a settlement fund in 2016 of $830 million (the Settlement Class Fund) and agreed to pay an additional amount for approved attorneys’ fees and expenses up to $232 million (the Fee/Expense Fund). On June 28, 2016, the court approved the settlement and awarded attorneys’ fees and expenses in the amount of $222 million; the remaining amount of the Fee/Expense Fund will be added to the Settlement Class Fund. The Company paid the total settlement amount into escrow in April 2016. After available funds under certain insurance policies, Merck’s net cash payment for the settlement and fees was approximately $680 million. The settlement covers all claims relating to Vioxx by settlement class members who purchased Merck securities between May 21, 1999, and October 29, 2004. The settlement is not an admission of wrongdoing and, as part of the settlement agreement, defendants continue to deny the allegations.
In addition, Merck has reached a resolution of the above referenced 13 individual securities lawsuits filed by foreign and domestic institutional investors, which were also consolidated with the Vioxx Securities Lawsuits.
As a result of these settlements, Merck has resolved all of the Vioxx Securities Lawsuits.
Insurance
As a result of the previously disclosed insurance arbitration, the Company’s insurers paid insurance proceeds of approximately $380 million in connection with the settlement of the class action. The Company also has Directors and Officers insurance coverage applicable to the Vioxx Securities Lawsuits with remaining stated upper limits of approximately $145 million, which the Company has not received. There are disputes with the insurers about the availability of the Company’s Directors and Officers insurance coverage for these claims. The amounts actually recovered under the Directors and Officers policies discussed in this paragraph may be less than the stated upper limits.
International Lawsuits
As previously disclosed, in addition to the lawsuits discussed above, Merck has been named as a defendant in litigation relating to Vioxx in Brazil and Europe (collectively, the Vioxx International Lawsuits). The litigation in these jurisdictions is generally in procedural stages and Merck expects that the litigation may continue for a number of years.
Reserves
The Company has an immaterial reserve with respect to certain Vioxx Product Liability Lawsuits and also has an immaterial remaining reserve relating to the previously disclosed Vioxx litigation for the non-participating states with which litigation is continuing. The Company has established no other liability reserves for, and believes that it has meritorious defenses to, the remaining Vioxx Product Liability Lawsuits and Vioxx International Lawsuits and will vigorously defend against them.
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 June 30, 2016, approximately 4,400 cases are filed and 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 20 of these actions, plaintiffs allege, among other things, that they have suffered osteonecrosis of the jaw (ONJ), generally subsequent to invasive dental procedures, such as tooth extraction or dental implants and/or delayed healing, in association with the use of Fosamax. In addition, plaintiffs in approximately 4,380 of these actions generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax.
Cases Alleging ONJ and/or Other Jaw Related Injuries
In August 2006, the Judicial Panel on Multidistrict Litigation (JPML) ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation (Fosamax ONJ MDL) for coordinated pre-trial proceedings.

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

In December 2013, Merck reached an agreement in principle with the Plaintiffs’ Steering Committee (PSC) in the Fosamax ONJ MDL to resolve pending ONJ cases not on appeal in the Fosamax ONJ MDL and in the state courts for an aggregate amount of $27.7 million. Merck and the PSC subsequently formalized the terms of this agreement in a Master Settlement Agreement (ONJ Master Settlement Agreement) that was executed in April 2014 and included over 1,200 plaintiffs. In July 2014, Merck elected to proceed with the ONJ Master Settlement Agreement at a reduced funding level of $27.3 million since the participation level was approximately 95%. Merck has fully funded the ONJ Master Settlement Agreement and the escrow agent under the agreement has been making settlement payments to qualifying plaintiffs. The claims of approximately 20 non-participants’ will remain once the settlement is complete. The ONJ Master Settlement Agreement has no effect on the cases alleging Femur Fractures discussed below.
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 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, in June 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, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases are appealing that decision to the U.S. Court of Appeals for the Third Circuit. In June 2015, the Femur Fracture MDL court dismissed without prejudice another approximately 520 cases pending plaintiffs’ appeal of the preemption ruling to the Third Circuit. On June 30, 2016, the Third Circuit heard oral argument on plaintiffs’ appeal of the preemption ruling and the parties await the decision.
In June 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 June 30, 2016, approximately 20 cases were pending in the Femur Fracture MDL, excluding the 515 cases dismissed with prejudice on preemption grounds that are pending appeal and the 520 cases dismissed without prejudice that are also pending the aforementioned appeal.
As of June 30, 2016, approximately 3,020 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, and Merck has recently begun selecting the next group of cases to be reviewed through fact discovery.
As of June 30, 2016, approximately 295 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 in February 2015 and the jury returned a verdict in Merck’s favor in April 2015, and plaintiff has appealed that verdict to the California appellate court. The next Femur Fracture trial in California that was scheduled to begin in April 2016, was stayed at plaintiffs’ request and a new trial date has not been set.
Additionally, there are five Femur Fracture cases pending in other state courts.
Discovery is ongoing in the Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits.

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

Januvia/Janumet
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet. As of June 30, 2016, approximately 1,140 product user claims have been served on Merck alleging generally that use of Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. These complaints were filed in several different state and federal courts.
Most of the claims were filed in a consolidated multidistrict litigation proceeding in the U.S. District Court for the Southern District of California called “In re Incretin-Based Therapies Products Liability Litigation” (MDL). The MDL includes federal lawsuits alleging pancreatic cancer due to use of the following medicines: Januvia, Janumet, Byetta and Victoza, the latter two of which are products manufactured by other pharmaceutical companies. The majority of claims not filed in the MDL were filed in the Superior Court of California, County of Los Angeles (California State Court). As of June 30, 2016, 12 product users have claims pending against Merck in state courts other than the California State Court.
In November 2015, the MDL and California State Court – in separate opinions – granted summary judgment to defendants on grounds of preemption. Of the approximately 1,140 served product user claims, these rulings resulted in the dismissal of approximately 1,100 product user claims.
Plaintiffs are appealing the MDL and California State Court preemption rulings.
In addition to the claims noted above, the Company has agreed, as of June 30, 2016, to toll the statute of limitations for approximately 45 additional claims. The Company intends to continue defending against these lawsuits.
Propecia/Proscar
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar. As of June 30, 2016, approximately 1,360 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 50 of the plaintiffs also allege that Propecia or Proscar has caused or can cause prostate cancer, testicular cancer or male breast cancer. The lawsuits have been filed in various federal courts and in state court in New Jersey. The federal lawsuits have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Brian Cogan of the Eastern District of New York. The matters pending in state court in New Jersey have been consolidated before Judge Mayer in Middlesex County. In addition, there is one matter pending in state court in Massachusetts and one matter pending in state court in New York. The Company intends to defend against these lawsuits.
Governmental Proceedings
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.
Patent Litigation
From time to time, generic manufacturers of pharmaceutical products file Abbreviated New Drug Applications with the U.S. Food and Drug Administration (FDA) seeking to market generic forms of the Company’s products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Certain products of the Company (or products marketed via agreements with other companies) currently involved in such patent infringement litigation in the United States include: Cancidas, Cubicin, Invanz, Nasonex, Noxafil, and NuvaRing. Similar lawsuits defending the Company’s patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by generic companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges.
Cancidas — In February 2014, a patent infringement lawsuit was filed in the United States against Xellia Pharmaceuticals ApS (Xellia) with respect to Xellia’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cancidas. In June 2015, the district court found that Xellia infringed the Company’s patent and ordered that Xellia’s application not be approved until the patent expires in September 2017 (including pediatric exclusivity). Xellia appealed this decision, and the appeal was heard in March 2016. In May 2016, the parties reached a settlement whereby Xellia can launch its generic version in August 2017, or earlier under certain conditions. 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.

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

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 expired in June 2016, to be valid and infringed. Later patents, expiring in September 2019 and November 2020, were found to be invalid. Hospira appealed the finding that the composition patent is not invalid and the Company cross-appealed the finding that the later patents are invalid. In November 2015, the U.S. Court of Appeals for the Federal Circuit affirmed the lower court decision. In May 2016, the United States Supreme Court declined to review this decision. As of June 2016, there is no longer any patent impediment to the approval of Hospira’s application.
As a result of the Hospira decision and the expiration of the composition patent in June 2016, there is no longer any patent impediment to the approval of a number of generic manufacturers’ applications to the FDA for generic versions of Cubicin.
Invanz — In July 2014, a patent infringement lawsuit was filed in the United States against Hospira in respect of Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The lawsuit automatically stays FDA approval of Hospira’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. The trial in this matter was held in April 2016 and the Company is awaiting the court’s decision. In August 2015, a patent infringement lawsuit was filed in the United States against Savior Lifetec Corporation (Savior) in respect of Savior’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The lawsuit automatically stays FDA approval of Savior’s application until November 2017 or until an adverse court decision, if any, whichever may occur earlier.
Nasonex — In July 2014, a patent infringement lawsuit was filed in the United States against Teva Pharmaceuticals USA, Inc. (Teva Pharma) in respect of Teva Pharma’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Teva Pharma’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. The trial in this matter was held in June 2016 and the Company is preparing post-trial submissions. In March 2015, a patent infringement lawsuit was filed in the United States against Amneal Pharmaceuticals LLC (Amneal) in respect of Amneal’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Amneal’s application until August 2017 or until an adverse court decision, if any, whichever may occur earlier. The trial in this matter was held in June 2016 and the Company is preparing post-trial submissions.
A previous decision, issued in June 2013, held that the Merck patent in the Teva Pharma and Amneal lawsuits covering mometasone furoate monohydrate was valid, but that it was not infringed by Apotex Corp.’s proposed product. In April 2015, a patent infringement lawsuit was filed against Apotex Inc. and Apotex Corp. (Apotex) in respect of Apotex’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex that the Company believes differs from the generic version in the previous lawsuit.
Noxafil In August 2015, the Company filed a lawsuit against Actavis Laboratories Fl, Inc. (Actavis) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. The lawsuit automatically stays FDA approval of Actavis’s application until December 2017 or until an adverse court decision, if any, whichever may occur earlier.
In March 2016, the Company filed a lawsuit against Roxane Laboratories, Inc. (Roxane) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. The lawsuit automatically stays FDA approval of Roxane’s application until August 2018 or until an adverse court decision, if any, whichever may occur earlier.
In February 2016, the Company filed a lawsuit against Par Sterile Products LLC, Par Pharmaceutical, Inc., Par Pharmaceutical Companies, Inc. and Par Pharmaceutical Holdings, Inc. (collectively, Par) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. Since Par did not challenge an earlier expiring patent at issue in other pertinent litigation, if that patent is upheld, Par’s application to the FDA will not be approved until at least that patent expires in July 2019. If that patent is not upheld, the lawsuit automatically stays FDA approval of Roxane’s application until August 2018 or until an adverse court decision in this litigation, if any, whichever may occur earlier.
NuvaRing — In December 2013, the Company filed a lawsuit against a subsidiary of Allergan plc in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing. The trial in this matter was held in January 2016 and the Company is awaiting the court’s decision. In September 2015, the Company filed a lawsuit against Teva Pharma in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing.
The Company had been involved in ongoing litigation in Canada with Apotex concerning the Company’s patents related to lovastatin, alendronate, and norfloxacin. All of the litigation has now been either settled or concluded. As a consequence of the conclusion of all of this litigation, in the second quarter of 2016, the Company recorded a net gain of $115 million included in Other (income) expense, net (see Note 12).

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

Anti-PD-1 Antibody Patent Oppositions and Litigation
As previously disclosed, Ono Pharmaceutical Co. (Ono) has a European patent (EP 1 537 878) (’878) that broadly claims the use of an anti-PD-1 antibody, such as the Company’s immunotherapy, Keytruda, for the treatment of cancer. Ono has previously licensed its commercial rights to an anti-PD-1 antibody to Bristol-Myers Squibb (BMS) in certain markets. The Company believes that the ’878 patent is invalid and filed an opposition in the European Patent Office (EPO) seeking its revocation. In June 2014, the Opposition Division of the EPO found the claims in the ’878 patent are valid. The Company received the Opposition Division’s written opinion in September 2014 and the Company submitted its substantive appeal in February 2015. In April 2014, the Company, and three other companies, opposed another European patent (EP 2 161 336) (’336) owned by BMS and Ono that it believes is invalid. The ’336 patent, as granted, broadly claimed anti-PD-1 antibodies that could include Keytruda. In February 2015 and May 2016, BMS and Ono submitted requests to amend the claims of the ’336 patent. During a hearing in July 2016, the EPO allowed the May 2016 amendment and, as a result, the claims of the ’336 patent no longer broadly claim anti-PD-1 antibodies such as Keytruda.
In May 2014, the Company filed a lawsuit in the UK seeking revocation of the UK national versions of both the ’878 and ’336 patents. In July 2014, Ono and BMS sued the Company seeking a declaration that the ’878 patent would be infringed in the UK by the marketing of Keytruda. The Company has sought a declaration from the UK court that Keytruda will not infringe the ’336 patent in the UK. BMS and Ono notified the Company of their request to amend the claims of the EPO ’336 patent and of their intention to seek permission from the court to similarly amend the UK national version so that the claims of the ’336 patent would no longer broadly claim anti-PD-1 antibodies such as Keytruda. A trial was held in the UK in July 2015. At that trial, the issues of validity and infringement of the ’878 patent were heard at the same time by the court. In October 2015, the court issued its judgment, finding the ’878 patent valid and infringed. Merck appealed this judgment. The appeal is scheduled to be heard in March 2017. BMS and Ono have concurrently started a proceeding to determine the amount of damages and royalties the Company would pay should the appeal be denied. A hearing in that proceeding is scheduled for October 2017.
In February 2015, the Company filed lawsuits in the Netherlands seeking revocation of the Dutch national versions of both the ’878 and ’336 patents. BMS and Ono amended the claims of the ’336 patent so that the claims of the ’336 patent no longer broadly claim anti-PD-1 antibodies such as Keytruda. Trial regarding the validity and infringement of the ’878 patent was held in January 2016. In June 2016, the District Court in The Hague issued its judgment finding the Dutch ‘878 patent valid and infringed. Merck will appeal this judgment.
In December 2015, BMS and Ono filed lawsuits against the Company in France, Ireland, Switzerland and Germany alleging infringement of the ’878 patent. In January 2016, BMS and Ono filed a lawsuit against the Company in Spain alleging infringement of the ’878 patent. In France, BMS and Ono filed for preliminary relief seeking payment of damages while the case is pending. A hearing on this preliminary relief was held in February 2016 and BMS’s and Ono’s request for preliminary relief was denied. Dates for trials regarding the validity and infringement of the Irish, French, Swiss and Spanish national versions of the ’878 patent have not yet been scheduled. A trial concerning the infringement of the German version of the ’878 patent is currently scheduled to begin in March 2017.
The Company continues to believe the ’878 patent is invalid.
The Company can file lawsuits seeking revocation of the ’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 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 United States Patent and Trademark Office (USPTO) granted US Patent Nos. 8,728,474 to Ono and 8,779,105 to Ono and BMS in May 2014. These patents are equivalent to the ’878 and ’336 patents, respectively. In September 2014, BMS and Ono filed a lawsuit in the United States alleging that, by marketing Keytruda, the Company will infringe US Patent No. 8,728,474. BMS and Ono are not seeking to prevent or stop the marketing of Keytruda in the United States. The trial in this matter is currently scheduled to begin in April 2017. The Company believes that the 8,728,474 patent and the 8,779,105 patent are both invalid. In June 2015 and July 2015, 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 June 2016, the Company filed petitions for Inter Partes Review (IPR) in the USPTO alleging that the 9,067,999 and 9,073,994 patents are invalid.
In April 2016, the Company filed a declaratory judgment action in the United States against BMS and Ono seeking a ruling that US Patent Nos. 8,779,105 and 9,084,776 are invalid and/or not infringed by the sale of Keytruda. These patents are equivalents of the ’336 patent, as originally granted. In June 2016, Ono and BMS filed a counterclaim that the Company’s marketing, making, using, selling, offering for sale, and/or importing Keytruda in the United States for the treatment of certain cancers, including melanoma and non-small-cell lung cancer, infringes these patents.

- 22 -

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

In September 2014, the Company filed a lawsuit in Australia seeking revocation of Australian Patent No. 2011203119, which is equivalent to the ’336 patent as originally granted. In March 2015, BMS and Ono counterclaimed in this matter alleging that the Company’s manufacture and supply of Keytruda to the Australian market will infringe Australian Patent No. 2011203119. A trial on this patent is scheduled for September 2017.
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.
In October 2015, PDL Biopharma (PDL) filed a lawsuit in the United States against the Company alleging that the manufacture of Keytruda infringed US Patent No. 5,693,761 (’761 patent), which expired in December 2014. This patent claims platform technology used in the creation and manufacture of recombinant antibodies and PDL is seeking damages for pre-expiry infringement of the ’761 patent.
In July 2016, the Company filed a declaratory judgment action in the United States against Genentech and City of Hope seeking a ruling that US Patent No. 7,923,221 (the Cabilly III patent), which claims platform technology used in the creation and manufacture of recombinant antibodies, is invalid and that Keytruda and bezlotoxumab do not infringe the Cabilly III patent. In July 2016, the Company also filed a petition in the USPTO for IPR of certain claims of US Patent No. 6,331,415 (the Cabilly II patent), which claims platform technology used in the creation and manufacture of recombinant antibodies and is also owned by Genentech and City of Hope, as being invalid. The USPTO has six months to decide this petition.
Gilead Patent Litigation and Opposition
In August 2013, Gilead Sciences, Inc. (Gilead) filed a lawsuit in the United States District Court for the Northern District of California seeking a declaration that two Company patents were invalid and not infringed by the sale of their two sofosbuvir containing products, Solvadi and Harvoni. The Company filed a counterclaim that the sale of these products did infringe these two patents and sought a reasonable royalty for the past, present and future sales of these products. In March 2016, at the conclusion of a jury trial, the patents were found to be not invalid and infringed. The jury awarded the Company $200 million as a royalty for sales of these products up to December 2015. After the conclusion of the jury trial, the court held a bench trial on the equitable defenses raised by Gilead. In June 2016, the court found for Gilead and determined that Merck could not collect the jury award and that the patents were unenforceable with respect to Gilead. The Company has appealed the court’s decision. Gilead has also asked the court to overturn the jury’s decision on validity. [The court held a hearing on Gilead’s motion on August 4, 2016, and the Company is awaiting the court’s decision.] The Company will pay 20%, net of legal fees, of damages or royalties, if any, that it is awarded to Ionis Pharmaceuticals, Inc.
The Company, through its Idenix Pharmaceuticals, Inc. subsidiary, has pending litigations against Gilead in the United States, the UK, Norway, Canada, Germany, France, and Australia based on different patent estates that would also be infringed by Gilead’s sales of these two products. Gilead has opposed the European patent at the EPO. Trial in the United States is currently scheduled for October and December 2016. In the UK, Norway, Australia and Canada, the Company was initially unsuccessful and those cases are currently under appeal. The EPO opposition division revoked the European patent, and the Company is currently analyzing the decision and considering its options. The cases in France and Germany have been stayed pending the final decision of the EPO.
Other Litigation
There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Company’s financial position, results of operations or cash flows either individually or in the aggregate.
Legal Defense Reserves
Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Company’s legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of June 30, 2016 and December 31, 2015 of approximately $235 million and $245 million, respectively, represents the Company’s best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue

- 23 -

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

to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so.
9.
Equity
 
  
Common Stock
Other
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Loss
 
Treasury Stock
Non-
Controlling
Interests
Total
($ and shares in millions)
Shares
Par Value
Shares
Cost
Balance at January 1, 2015
3,577

$
1,788

$
40,423

$
46,021

$
(4,323
)
739

$
(35,262
)
$
144

$
48,791

Net income attributable to Merck & Co., Inc.



1,639





1,639

Cash dividends declared on common stock



(2,557
)




(2,557
)
Treasury stock shares purchased





29

(1,724
)

(1,724
)
Share-based compensation plans and other


(317
)


(15
)
761

5

449

Other comprehensive loss




(9
)



(9
)
Changes in noncontrolling ownership interests


8





37

45

Net income attributable to noncontrolling interests







7

7

Distributions attributable to noncontrolling interests







(3
)
(3
)
Balance at June 30, 2015
3,577

$
1,788

$
40,114

$
45,103

$
(4,332
)
753

$
(36,225
)
$
190

$
46,638

Balance at January 1, 2016
3,577

$
1,788

$
40,222

$
45,348

$
(4,148
)
796

$
(38,534
)
$
91

$
44,767

Net income attributable to Merck & Co., Inc.



2,330





2,330

Cash dividends declared on common stock



(2,557
)




(2,557
)
Treasury stock shares purchased





30

(1,573
)

(1,573
)
Share-based compensation plans and other


(311
)


(15
)
730


419

Other comprehensive income




62




62

Net income attributable to noncontrolling interests







9

9

Distributions attributable to noncontrolling interests







(11
)
(11
)
Balance at June 30, 2016
3,577

$
1,788

$
39,911

$
45,121

$
(4,086
)
811

$
(39,377
)
$
89

$
43,446

10.
Share-Based Compensation Plans
The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. The Company also issues RSUs to employees of certain of the Company’s equity method investees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant.
The following table provides the amounts of share-based compensation cost recorded in the Condensed Consolidated Statement of Income:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
($ in millions)
2016
 
2015
 
2016
 
2015
Pretax share-based compensation expense
$
80

 
$
83

 
$
148

 
$
146

Income tax benefit
(25
)
 
(26
)
 
(45
)
 
(45
)
Total share-based compensation expense, net of taxes
$
55

 
$
57

 
$
103

 
$
101

Amounts in the table above do not reflect share-based compensation costs to settle non-vested Cubist equity awards attributable to postcombination service that were recognized as transaction expense in 2015 (see Note 2).
During the first six months of 2016 and 2015, the Company granted 5 million RSUs with a weighted-average grant date fair value of $54.54 per RSU and 4 million RSUs with a weighted-average grant date fair value of $59.83 per RSU, respectively. During the first six months of 2016 and 2015, the Company granted 6 million stock options with a weighted-average exercise price of $54.61 per option and 5 million stock options with a weighted-average exercise price of $59.83 per option, respectively. The weighted-average fair value of options granted for the first six months of 2016 and 2015 was $5.89 and $6.47 per option, respectively, and was determined using the following assumptions:

- 24 -

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

  
Six Months Ended June 30,
 
2016
 
2015
Expected dividend yield
3.8
%
 
4.1
%
Risk-free interest rate
1.4
%
 
1.7
%
Expected volatility
19.6
%
 
19.9
%
Expected life (years)
6.2

 
6.2

At June 30, 2016, there was $603 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted-average period of 2.3 years. For segment reporting, share-based compensation costs are unallocated expenses.
11.
Pension and Other Postretirement Benefit Plans
The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. The net periodic benefit cost (credit) of such plans consisted of the following components: 
  
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2016
 
2015
 
2016