10-Q 1 mrk0331201710q.htm 1Q17 FORM 10-Q Document



 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the quarterly period ended March 31, 2017
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 April 30, 2017: 2,735,164,510
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     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     No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
 
 
 
 
Non-accelerated filer
(Do not check if a smaller reporting company)
Smaller reporting company
 
 
 
 
 
 
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   No 
 





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 
 March 31,
 
2017
 
2016
Sales
$
9,434

 
$
9,312

Costs, Expenses and Other
 
 
 
Materials and production
3,015

 
3,572

Marketing and administrative
2,411

 
2,318

Research and development
1,796

 
1,659

Restructuring costs
151

 
91

Other (income) expense, net
58

 
48

 
7,431

 
7,688

Income Before Taxes
2,003

 
1,624

Taxes on Income
447

 
494

Net Income
1,556

 
1,130

Less: Net Income Attributable to Noncontrolling Interests
5

 
5

Net Income Attributable to Merck & Co., Inc.
$
1,551

 
$
1,125

Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders
$
0.56

 
$
0.41

Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders
$
0.56

 
$
0.40

Dividends Declared per Common Share
$
0.47

 
$
0.46

 
MERCK & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited, $ in millions)
 
 
Three Months Ended 
 March 31,
 
2017
 
2016
Net Income Attributable to Merck & Co., Inc.
$
1,551

 
$
1,125

Other Comprehensive Income (Loss) Net of Taxes:
 
 
 
Net unrealized loss on derivatives, net of reclassifications
(232
)
 
(202
)
Net unrealized gain on investments, net of reclassifications
43

 
63

Benefit plan net gain (loss) and prior service credit (cost), net of amortization
26

 
(28
)
Cumulative translation adjustment
309

 
121

 
146

 
(46
)
Comprehensive Income Attributable to Merck & Co., Inc.
$
1,697

 
$
1,079

 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)
 
 
March 31, 2017
 
December 31, 2016
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
11,708

 
$
6,515

Short-term investments
3,541

 
7,826

Accounts receivable (net of allowance for doubtful accounts of $195 in 2017
and 2016)
7,066

 
7,018

Inventories (excludes inventories of $1,090 in 2017 and $1,117 in 2016
classified in Other assets - see Note 5)
5,146

 
4,866

Other current assets
4,069

 
4,389

Total current assets
31,530

 
30,614

Investments
11,896

 
11,416

Property, Plant and Equipment, at cost, net of accumulated depreciation of $16,171
in 2017 and $15,749 in 2016
12,042

 
12,026

Goodwill
18,358

 
18,162

Other Intangibles, Net
16,863

 
17,305

Other Assets
5,872

 
5,854

 
$
96,561

 
$
95,377

Liabilities and Equity
 
 
 
Current Liabilities
 
 
 
Loans payable and current portion of long-term debt
$
5,037

 
$
568

Trade accounts payable
2,484

 
2,807

Accrued and other current liabilities
8,658

 
10,274

Income taxes payable
2,330

 
2,239

Dividends payable
1,314

 
1,316

Total current liabilities
19,823

 
17,204

Long-Term Debt
23,437

 
24,274

Deferred Income Taxes
4,889

 
5,077

Other Noncurrent Liabilities
8,324

 
8,514

Merck & Co., Inc. Stockholders’ Equity
 
 
 
Common stock, $0.50 par value
Authorized - 6,500,000,000 shares
Issued - 3,577,103,522 shares in 2017 and 2016
1,788

 
1,788

Other paid-in capital
39,899

 
39,939

Retained earnings
44,387

 
44,133

Accumulated other comprehensive loss
(5,080
)
 
(5,226
)
 
80,994

 
80,634

Less treasury stock, at cost:
836,667,641 shares in 2017 and 828,372,200 shares in 2016
41,157

 
40,546

Total Merck & Co., Inc. stockholders’ equity
39,837

 
40,088

Noncontrolling Interests
251

 
220

Total equity
40,088

 
40,308

 
$
96,561

 
$
95,377

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)
 
 
Three Months Ended 
 March 31,
 
2017
 
2016
Cash Flows from Operating Activities
 
 
 
Net income
$
1,556

 
$
1,130

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
1,193

 
1,561

Intangible asset impairment charges
80

 
277

Deferred income taxes
(54
)
 
(70
)
Share-based compensation
74

 
68

Other
(28
)
 
82

Net changes in assets and liabilities
(2,535
)
 
(875
)
Net Cash Provided by Operating Activities
286

 
2,173

Cash Flows from Investing Activities
 
 
 
Capital expenditures
(339
)
 
(279
)
Purchases of securities and other investments
(2,929
)
 
(2,367
)
Proceeds from sales of securities and other investments
6,819

 
4,620

Acquisitions of businesses, net of cash acquired
(306
)
 
(147
)
Other
(52
)
 
(86
)
Net Cash Provided by Investing Activities
3,193

 
1,741

Cash Flows from Financing Activities
 
 
 
Net change in short-term borrowings
3,784

 

Payments on debt
(300
)
 
(851
)
Purchases of treasury stock
(1,019
)
 
(913
)
Dividends paid to stockholders
(1,294
)
 
(1,279
)
Proceeds from exercise of stock options
313

 
202

Other
(23
)
 
(25
)
Net Cash Provided by (Used in) Financing Activities
1,461

 
(2,866
)
Effect of Exchange Rate Changes on Cash and Cash Equivalents
253

 
144

Net Increase in Cash and Cash Equivalents
5,193

 
1,192

Cash and Cash Equivalents at Beginning of Year
6,515

 
8,524

Cash and Cash Equivalents at End of Period
$
11,708

 
$
9,716

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 28, 2017.
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.
On December 31, 2016, Merck and Sanofi Pasteur S.A. terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. Beginning in 2017, Merck is recording vaccine sales in the European markets that were previously part of the joint venture.
Recently Issued Accounting Standards
In May 2014, the Financial Accounting Standards Board (FASB) issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. In August 2015, the FASB approved a one-year deferral of the effective date making this guidance effective for interim and annual periods beginning in 2018. The new standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of adopting the guidance being recognized at the date of initial application (modified retrospective method). The Company will adopt the new standard on January 1, 2018 and currently plans to use the modified retrospective method. The majority of the Company’s business is ship and bill and, on that primary revenue stream, Merck does not expect significant differences. However, the Company’s analysis is preliminary and subject to change. Merck has not completed its assessment of multiple element arrangements and certain discount and trade promotion programs.
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 August 2016, the FASB issued guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice. The guidance is effective for interim and annual periods beginning in 2018. Early adoption is permitted. The guidance is to be applied retrospectively to all periods presented but may be applied prospectively if retrospective application would be impracticable. The Company is currently evaluating the effect of the standard on its Consolidated Statement of Cash Flows.
In October 2016, the FASB issued guidance on the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Under existing guidance, the recognition of current and deferred income taxes for an intra-entity asset transfer is prohibited until the asset has been sold to a third party. The new guidance will require the recognition of the income tax consequences of an intra-entity transfer of an asset (with the exception of inventory) when the intra-entity transfer occurs. The guidance is effective for interim and annual periods beginning in 2018. Early adoption is permitted. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings in the beginning of the period of adoption. The Company does not anticipate the adoption of the new guidance will have a material effect on its consolidated financial statements.
In November 2016, the FASB issued guidance requiring that amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The guidance is effective for interim and annual periods beginning in 2018 and should be applied using a retrospective transition method to each period presented. Early adoption is permitted. The Company is currently evaluating the effect of the standard on its Consolidated Statement of Cash Flows.
In March 2017, the FASB amended the guidance related to net periodic benefit cost for defined benefit plans that requires entities to (1) disaggregate the current service cost component from the other components of net benefit cost and present it with other employee compensation costs in the income statement within operations if such a subtotal is presented; (2) present the other components of net benefit cost separately in the income statement and outside of income from operations; and (3) only capitalize the service cost component when applicable. The new guidance is effective for interim and annual periods in 2018.

- 5 -

Notes to Condensed Consolidated Financial Statements (unaudited)

Entities must use a retrospective transition method to adopt the requirement for separate presentation in the income statement of service costs and other components and a prospective transition method to adopt the requirement to limit the capitalization of benefit costs to the service cost component. The Company is currently evaluating 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 2020, with earlier application permitted in 2019. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
In January 2017, the FASB issued guidance that provides for the elimination of Step 2 from the goodwill impairment test. If impairment charges are recognized, the amount recorded will be the amount by which the carrying amount exceeds the reporting unit’s fair value with certain limitations. The new guidance is effective for interim and annual periods in 2020. Early adoption is permitted. The Company does not anticipate the adoption of the new guidance will have a material effect on its consolidated financial statements.
2.
Acquisitions, Divestitures, Research Collaborations and License Agreements
The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. 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 marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Company’s financial results.
In March 2017, Merck acquired 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 products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5% of the shares of Vallée for $358 million. Of the total purchase price, $176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $297 million related to currently marketed products, net deferred tax liabilities of $95 million, other net assets of $1 million and noncontrolling interest of $25 million. In addition, the Company recorded liabilities of $37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $37 million, representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $180 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach through which fair value is estimated based on market participant expectations of each asset’s discounted projected net cash flows. The probability-adjusted future net cash flows of each product were then discounted to present value utilizing a discount rate of 15.5%. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years.
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. The transaction was accounted for as an acquisition of a business. Total purchase consideration in the transaction 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. The Company determined the fair value of the contingent consideration was $94 million at the acquisition date utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment utilizing a

- 6 -

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

discount rate of 10.5%. Merck recognized intangible assets for in-process research and development (IPR&D) of $155 million and net deferred tax assets of $32 million. The excess of the consideration transferred over the fair value of net assets acquired of $57 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPR&D were determined using an income approach. The assets’ probability-adjusted future net cash flows were then discounted to present value also using a discount rate of 10.5%. Actual cash flows are likely to be different than those assumed.
Additionally, 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 quarter 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.
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 $215 million and $196 million in the first quarter of 2017 and 2016, respectively, related to restructuring program activities. Since inception of the programs through March 31, 2017, Merck has recorded total pretax accumulated costs of approximately $12.8 billion and eliminated approximately 41,445 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 $500 million 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 March 31, 2017
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Materials and production
$

 
$
51

 
$
12

 
$
63

Marketing and administrative

 

 
1

 
1

Research and development

 
(2
)
 
2

 

Restructuring costs
84

 

 
67

 
151

 
$
84

 
$
49

 
$
82

 
$
215

 
Three Months Ended March 31, 2016
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Materials and production
$

 
$
22

 
$
25

 
$
47

Marketing and administrative

 
3

 

 
3

Research and development

 
55

 

 
55

Restructuring costs
26

 

 
65

 
91

 
$
26

 
$
80

 
$
90

 
$
196

Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. In the first quarter of 2017 and 2016, approximately 545 positions and 470 positions, respectively, were eliminated under restructuring program activities.
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 asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions.

- 7 -

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

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 is recording accelerated depreciation over the revised useful life 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 2017 and 2016 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 10) and share-based compensation.
The following table summarizes the charges and spending relating to restructuring program activities for the three months ended March 31, 2017:
($ in millions)
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Restructuring reserves January 1, 2017
$
395

 
$

 
$
146

 
$
541

Expense
84

 
49

 
82

 
215

(Payments) receipts, net
(103
)
 

 
(118
)
 
(221
)
Non-cash activity

 
(49
)
 
27

 
(22
)
Restructuring reserves March 31, 2017 (1)
$
376

 
$

 
$
137

 
$
513

(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 objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect 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 (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted foreign currency denominated sales. The portion of forecasted 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 Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts and purchased collar options.
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 Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program 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 to offset the

- 8 -

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

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 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 may also use 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 that are recorded in Other (income) expense, net. 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 losses of $135 million and $58 million for the first three months of 2017 and 2016, respectively, from the euro-denominated notes.
Interest Rate Risk Management
The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk.
At March 31, 2017, the Company was a party to 26 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below.
($ in millions)
March 31, 2017
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.

- 9 -

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

Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments:
 
 
March 31, 2017
 
December 31, 2016
 
 
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
Other assets
$
11

 
$

 
$
2,700

 
$
20

 
$

 
$
2,700

Interest rate swap contracts
Other noncurrent liabilities

 
35

 
3,500

 

 
29

 
3,500

Foreign exchange contracts
Other current assets
330

 

 
5,049

 
616

 

 
6,063

Foreign exchange contracts
Other assets
56

 

 
1,815

 
129

 

 
2,075

Foreign exchange contracts
Accrued and other current liabilities

 
21

 
915

 

 
1

 
48

Foreign exchange contracts
Other noncurrent liabilities

 
1

 
20

 

 
1

 
12

 
 
$
397


$
57


$
13,999


$
765


$
31


$
14,398

Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
$
232

 
$

 
$
8,037

 
$
230

 
$

 
$
8,210

Foreign exchange contracts
Accrued and other current liabilities

 
89

 
6,479

 

 
103

 
2,931

 
 
$
232

 
$
89

 
$
14,516

 
$
230

 
$
103

 
$
11,141

 
 
$
629


$
146


$
28,515


$
995


$
134


$
25,539

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:
 
March 31, 2017
 
December 31, 2016
($ in millions)
Asset
 
Liability
 
Asset
 
Liability
Gross amounts recognized in the consolidated balance sheet
$
629

 
$
146

 
$
995

 
$
134

Gross amount subject to offset in master netting arrangements not offset in the consolidated
balance sheet
(144
)
 
(144
)
 
(131
)
 
(131
)
Cash collateral received
(222
)
 

 
(529
)
 

Net amounts
$
263

 
$
2

 
$
335

 
$
3

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 and (iii) not designated in a hedging relationship:
 
Three Months Ended 
 March 31,
($ in millions)
2017
 
2016
Derivatives designated in a fair value hedging relationship
 
 
 
Interest rate swap contracts
 
 
 
Amount of loss (gain) recognized in Other (income) expense, net on derivatives (1)
$
15

 
$
(150
)
Amount of (gain) loss recognized in Other (income) expense, net on hedged item (1)
(16
)
 
147

Derivatives designated in foreign currency cash flow hedging relationships
 
 
 
Foreign exchange contracts
 
 
 
Amount of gain reclassified from AOCI to Sales
(94
)
 
(143
)
Amount of loss recognized in OCI on derivatives
263

 
167

Derivatives not designated in a hedging relationship
 
 
 
Foreign exchange contracts
 
 
 
Amount of (gain) loss recognized in Other (income) expense, net on derivatives (2)
(47
)
 
24

(1) There was $1 million and $3 million of ineffectiveness on the hedge during the first quarter of 2017 and 2016, respectively.
(2) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates.
At March 31, 2017, the Company estimates $167 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.

- 10 -

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:
 
March 31, 2017
 
December 31, 2016
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
($ in millions)
Gains
 
Losses
 
Gains
 
Losses
Corporate notes and bonds
$
10,445

 
$
10,455

 
$
19

 
$
(29
)
 
$
10,577

 
$
10,601

 
$
15

 
$
(39
)
U.S. government and agency securities
2,011

 
2,021

 
1

 
(11
)
 
2,232

 
2,244

 
1

 
(13
)
Asset-backed securities
1,410

 
1,411

 
2

 
(3
)
 
1,376

 
1,380

 
1

 
(5
)
Commercial paper
773

 
773

 

 

 
4,330

 
4,330

 

 

Mortgage-backed securities
712

 
717

 

 
(5
)
 
796

 
801

 
1

 
(6
)
Foreign government bonds
560

 
561

 
1

 
(2
)
 
519

 
521

 

 
(2
)
Equity securities
356

 
278

 
79

 
(1
)
 
349

 
281

 
71

 
(3
)
 
$
16,267

 
$
16,216

 
$
102

 
$
(51
)
 
$
20,179

 
$
20,158

 
$
89

 
$
(68
)
Available-for-sale debt securities included in Short-term investments totaled $3.5 billion at March 31, 2017. Of the remaining debt securities, $10.6 billion mature within five years. At March 31, 2017 and December 31, 2016, 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.

- 11 -

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)
March 31, 2017
 
December 31, 2016
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate notes and bonds
$

 
$
10,287

 
$

 
$
10,287

 
$

 
$
10,389

 
$

 
$
10,389

U.S. government and agency securities
66

 
1,647

 

 
1,713

 
29

 
1,890

 

 
1,919

Asset-backed securities (1)

 
1,312

 

 
1,312

 

 
1,257

 

 
1,257

Commercial paper

 
773

 

 
773

 

 
4,330

 

 
4,330

Mortgage-backed securities (1)

 
595

 

 
595

 

 
628

 

 
628

Foreign government bonds

 
559

 

 
559

 

 
518

 

 
518

Equity securities
198

 

 

 
198

 
201

 

 

 
201

 
264

 
15,173

 

 
15,437

 
230

 
19,012

 

 
19,242

Other assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency securities

 
298

 

 
298

 

 
313

 

 
313

Corporate notes and bonds

 
158

 

 
158

 

 
188

 

 
188

Mortgage-backed securities (1)

 
117

 

 
117

 

 
168

 

 
168

Asset-backed securities (1)

 
98

 

 
98

 

 
119

 

 
119

Foreign government bonds

 
1

 

 
1

 

 
1

 

 
1

Equity securities
158

 

 

 
158

 
148

 

 

 
148

 
158


672




830


148


789




937

Derivative assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased currency options

 
354

 

 
354

 

 
644

 

 
644

Forward exchange contracts

 
264

 

 
264

 

 
331

 

 
331

Interest rate swaps

 
11

 

 
11

 

 
20

 

 
20

 

 
629

 

 
629

 

 
995

 

 
995

Total assets
$
422


$
16,474


$


$
16,896


$
378


$
20,796


$


$
21,174

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
$

 
$

 
$
925

 
$
925

 
$

 
$

 
$
891

 
$
891

Derivative liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward exchange contracts

 
110

 

 
110

 

 
93

 

 
93

Interest rate swaps

 
35

 

 
35

 

 
29

 

 
29

Written currency options

 
1

 

 
1

 

 
12

 

 
12

 

 
146

 

 
146

 

 
134

 

 
134

Total liabilities
$


$
146


$
925


$
1,071


$


$
134


$
891


$
1,025

(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 auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies.
(2) 
The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Company’s own credit risk, the effects of which were not significant.
There were no transfers between Level 1 and Level 2 during the first three months of 2017. As of March 31, 2017, Cash and cash equivalents of $11.7 billion included $10.9 billion of cash equivalents (considered Level 2 in the fair value hierarchy).

- 12 -

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

Contingent Consideration
Summarized information about the changes in liabilities for contingent consideration is as follows:
 
Three Months Ended March 31,
($ in millions)
2017
 
2016
Fair value January 1
$
891

 
$
590

Changes in fair value (1)
34

 
10

Additions

 
77

Payments

 
(25
)
Fair value March 31
$
925

 
$
652

(1) Recorded in Research and development expenses, Materials and production costs and Other (income) expense, net. Includes cumulative translation adjustments.
The additions to contingent consideration in the first quarter of 2016 relate to the acquisition of IOmet (see Note 2). The payments of contingent consideration in the first quarter of 2016 relate to the first commercial sale of Zerbaxa in the European Union.
Other Fair Value Measurements
Some of the Company’s financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature.
The estimated fair value of loans payable and long-term debt (including current portion) at March 31, 2017, was $29.3 billion compared with a carrying value of $28.5 billion and at December 31, 2016, was $25.7 billion compared with a carrying value of $24.8 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 March 31, 2017, the Company’s total net accounts receivable outstanding for more than one year were approximately $135 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 March 31, 2017 and December 31, 2016, the Company had received cash collateral of $222 million and $529 million, respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities. The Company had not advanced any cash collateral to counterparties as of March 31, 2017 or December 31, 2016.


- 13 -

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

5.
Inventories
Inventories consisted of:
($ in millions)
March 31, 2017
 
December 31, 2016
Finished goods
$
1,355

 
$
1,304

Raw materials and work in process
4,446

 
4,222

Supplies
160

 
155

Total (approximates current cost)
5,961

 
5,681

Increase to LIFO costs
275

 
302

 
$
6,236

 
$
5,983

Recognized as:
 
 
 
Inventories
$
5,146

 
$
4,866

Other assets
1,090

 
1,117

Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At March 31, 2017 and December 31, 2016, these amounts included $1.0 billion of inventories not expected to be sold within one year. In addition, these amounts included $80 million at March 31, 2017 and December 31, 2016 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. See Note 2 for information on intangible assets acquired as a result of business acquisitions in the first quarter of 2017 and 2016.
During the first quarter of 2016, the Company recorded an intangible asset impairment charge of $252 million within Materials and production costs related to Zontivity, a product 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 first quarter of 2016, the Company recorded $25 million of IPR&D impairment charges within Research and development expenses primarily related to deprioritized pipeline programs that were deemed to have no alternative use during the period.
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.
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.

- 14 -

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

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.
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 March 31, 2017, approximately 4,215 cases are filed and pending against Merck in either federal or state court. 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 4,195 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.
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 ONJ Master Settlement Agreement has no effect on the cases alleging Femur Fractures discussed below.
Discovery is currently ongoing in some of the approximately 20 remaining ONJ cases that are pending in various federal and state courts and the Company intends to defend against these lawsuits.
Cases Alleging Femur Fractures
In March 2011, Merck submitted a Motion to Transfer to the JPML seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. The Motion to Transfer was granted in May 2011, and all federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). 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. The Glynn decision was not appealed by plaintiff.
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 appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). The Femur Fracture MDL court also dismissed without prejudice another approximately 540 cases pending plaintiffs’ appeal of the preemption ruling to the Third Circuit. On March 22, 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL court’s preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. On April 5, 2017, Merck filed a petition seeking a rehearing on the Third Circuit’s March 22, 2017 decision, which was denied on April 24, 2017.
In addition, in June 2014, the Femur Fracture MDL court 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 did not appeal the Femur Fracture MDL court’s findings with respect to the adequacy of the 2011 label change but did appeal the dismissal of their case based on preemption grounds, and the Third Circuit subsequently reversed that dismissal in its March 22, 2017 decision. In August 2014, Merck filed a motion requesting that the Femur Fracture MDL court 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. No plaintiffs responded to or appealed the November 2014 show cause order.

- 15 -

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

As of March 31, 2017, seven cases were pending in the Femur Fracture MDL, excluding the 515 cases dismissed with prejudice on preemption grounds that are pending the final resolution of all appeals of the Femur Fracture MDL court’s March 2014 preemption decision and the 540 cases dismissed without prejudice that are also pending the final resolution of the aforementioned appeal.
As of March 31, 2017, approximately 2,855 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 continued to select additional cases to be reviewed through fact discovery during 2016 and 2017.
As of March 31, 2017, approximately 280 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. Oral argument on plaintiff’s appeal in Galper was held on November 17, 2016 and, on April 24, 2017, the California appellate court issued a decision affirming the lower court’s judgment in favor of Merck. 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.
Januvia/Janumet
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet. As of March 31, 2017, Merck is aware of approximately 1,200 product user claims 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).
In November 2015, the MDL and California State Court - in separate opinions - granted summary judgment to defendants on grounds of preemption. Of the approximately 1,200 product user claims, these rulings resulted in the dismissal of approximately 1,150 product user claims.
Plaintiffs are appealing the MDL and California State Court preemption rulings.
As of March 31, 2017, eight product users have claims pending against Merck in state courts other than the California State Court, including four active product user claims pending in Illinois state court. On March 30, 2017, the Illinois court held oral argument on Merck’s motion for summary judgment on grounds of preemption. A decision is expected in May 2017.
In addition to the claims noted above, the Company has agreed, as of March 31, 2017, to toll the statute of limitations for approximately 50 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 March 31, 2017, approximately 1,260 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 California and one matter pending in state court in Ohio. The Company intends to defend against these lawsuits.

- 16 -

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

Commercial and Other Litigation
K-DUR Antitrust Litigation
In June 1997 and January 1998, Schering-Plough Corporation (Schering-Plough) settled patent litigation with Upsher-Smith, Inc. (Upsher-Smith) and ESI Lederle, Inc. (Lederle), respectively, relating to generic versions of Schering-Plough’s long-acting potassium chloride product supplement used by cardiac patients, for which Lederle and Upsher-Smith had filed Abbreviated New Drug Applications (ANDAs). Following the commencement of an administrative proceeding by the U.S. Federal Trade Commission in 2001 alleging anti-competitive effects from those settlements (which was resolved in Schering-Plough’s favor), putative class and non-class action suits were filed on behalf of direct and indirect purchasers of K‑DUR against Schering-Plough, Upsher-Smith and Lederle and were consolidated in a multidistrict litigation in the U.S. District Court for the District of New Jersey. These suits claimed violations of federal and state antitrust laws, as well as other state statutory and common law causes of action, and sought unspecified damages. In April 2008, the indirect purchasers voluntarily dismissed their case. In February 2016, the District Court denied the Company’s motion for summary judgment relating to all of the direct purchasers’ claims concerning the settlement with Upsher-Smith and granted the Company’s motion for summary judgment relating to all of the direct purchasers’ claims concerning the settlement with Lederle. In anticipation of trial, the parties filed motions to exclude certain expert opinions and other evidence, and defendants filed a motion for summary judgment.
As previously disclosed, in February 2017, Merck and Upsher-Smith reached a settlement in principle with the class of direct purchasers and the opt-outs to the class. Merck will contribute approximately $80 million in the aggregate towards the overall settlement. On April 5, 2017, the claims of the opt-outs were dismissed with prejudice pursuant to a written settlement agreement with those parties. Merck and Upsher-Smith are working with the class of direct purchasers on a definitive settlement agreement of its claims, which will be subject to approval by the District Court.
Merck KGaA Litigation
In January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), operating as the EMD Group in the United States, alleging it improperly uses the name “Merck” in the United States. KGaA has filed suit against the Company in France, the United Kingdom (UK), Germany, Switzerland, Mexico, and India alleging breach of the parties’ co-existence agreement, unfair competition and/or trademark infringement. In December 2015, the Paris Court of First Instance issued a judgment finding that certain activities by the Company directed towards France did not constitute trademark infringement and unfair competition while other activities were found to infringe. The Company and KGaA have both appealed the decision, and the appeal is scheduled to be heard in May 2017. In January 2016, the UK High Court issued a judgment finding that the Company had breached the co-existence agreement and infringed KGaA’s trademark rights as a result of certain activities directed towards the UK based on use of the word MERCK on promotional and information activity. As noted in the UK decision, this finding was not based on the Company’s use of the sign MERCK in connection with the sale of products or any material pharmaceutical business transacted in the UK. The Company and KGaA have both appealed this decision, and the appeal is scheduled to be heard in June 2017.
Patent Litigation
From time to time, generic manufacturers of pharmaceutical products file ANDAs 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: 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 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.
Invanz — In July 2014, a patent infringement lawsuit was filed in the United States against Hospira, Inc. (Hospira) in respect of Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The trial in this matter was held in April 2016 and, in October 2016, the district court ruled that the patent is valid and infringed. 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 trial in this matter was held in June 2016. In November 2016, the district court ruled that the patent was valid but not infringed. In March 2017, the parties reached a settlement whereby Teva Pharma can launch its generic version in September 2017, or earlier under certain conditions.

- 17 -

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

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 trial in this matter was held in June 2016. In January 2017, the district court ruled that the patent was valid but not infringed. The Company has appealed this decision.
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 now-launched product 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. The trial in this matter is currently scheduled to begin in July 2017. 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. In October 2016, the parties reached a settlement whereby Par can launch its generic version in January 2023, or earlier under certain conditions.
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. In August 2016, the district court ruled that the patent was invalid and the Company has appealed this 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. Based on its ruling in the Allergan plc matter, the district court dismissed the Company’s lawsuit in December 2016. The Company has appealed this decision.
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. BMS and Ono also own European Patent EP 2 161 336 (’336) that, as granted, broadly claimed anti-PD-1 antibodies that could include Keytruda.
As previously disclosed, the Company and BMS and Ono were engaged in worldwide litigation, including in the United States, over the validity and infringement of the ’878 patent, the ’336 patent and their equivalents.
In January 2017, the Company announced that it had entered into a settlement and license agreement with BMS and Ono resolving the worldwide patent infringement litigation related to the use of an anti-PD-1 antibody for the treatment of cancer, such as Keytruda. Under the settlement and license agreement, the Company made a one-time payment of $625 million (which was recorded as an expense in the Company’s 2016 financial results) to BMS and will pay royalties on the worldwide sales of Keytruda for a non-exclusive license to market Keytruda in any market in which it is approved. For global net sales of Keytruda, the Company will pay royalties as follows:
6.5% of net sales occurring from January 1, 2017 through and including December 31, 2023; and
2.5% of net sales occurring from January 1, 2024 through and including December 31, 2026.
The parties also agreed to dismiss all claims worldwide in the relevant legal proceedings.
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 April 2017, the parties reached a settlement pursuant to which, in exchange for a lump sum, PDL dismissed its lawsuit with prejudice and granted the Company a fully paid-up non-exclusive license to 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 Inter Partes Review (IPR) of certain claims of US Patent

- 18 -

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

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. In December 2016, the USPTO denied the petition but allowed the Company to join an IPR filed previously by another party. In May 2017, the parties reached a settlement pursuant to which the Company dismissed its lawsuit with prejudice and moved to terminate the IPR and Genentech and City of Hope granted the Company a fully paid-up non-exclusive license to the Cabilly II and Cabilly III patents.
Gilead Patent Litigation and Opposition
In August 2013, Gilead Sciences, Inc. (Gilead) filed a lawsuit in the U.S. 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 in August 2016, and the court subsequently rejected Gilead’s request. The Company will pay 20%, net of legal fees, of damages or royalties, if any, that it receives to Ionis Pharmaceuticals, Inc.
The Company, through its Idenix Pharmaceuticals, Inc. subsidiary, has pending litigation 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 European Patent Office (EPO). Trial in the United States was held in December 2016 and the jury returned a verdict for the Company, awarding damages of $2.54 billion. The Company is currently briefing post-trial motions, including on the issues of enhanced damages and future royalties. Gilead is briefing post-trial motions for judgment as a matter of law. In Australia and Canada, the Company was initially unsuccessful and those cases are currently under appeal. In the UK and Norway, the patent was held invalid and no further appeal was filed. The EPO opposition division revoked the European patent, and the Company has appealed this decision. 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 March 31, 2017 and December 31, 2016 of approximately $175 million and $185 million, respectively, represents the Company’s best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so.


- 19 -

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

8.
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, 2016
3,577

$
1,788

$
40,222

$
45,348

$
(4,148
)
796

$
(38,534
)
$
91

$
44,767

Net income attributable to Merck & Co., Inc.



1,125





1,125

Other comprehensive loss, net of tax




(46
)



(46
)
Cash dividends declared on common stock



(1,281
)




(1,281
)
Treasury stock shares purchased





18

(913
)

(913
)
Share-based compensation plans and other


(77
)


(6
)
322


245

Net income attributable to noncontrolling interests







5

5

Distributions attributable to noncontrolling interests







(1
)
(1
)
Balance at March 31, 2016
3,577

$
1,788

$
40,145

$
45,192

$
(4,194
)
808

$
(39,125
)
$
95

$
43,901

Balance at January 1, 2017
3,577

$
1,788

$
39,939

$
44,133

$
(5,226
)
828

$
(40,546
)
$
220

$
40,308

Net income attributable to Merck & Co., Inc.



1,551





1,551

Other comprehensive income, net of tax




146




146

Cash dividends declared on common stock



(1,297
)




(1,297
)
Treasury stock shares purchased





16

(1,019
)

(1,019
)
Share-based compensation plans and other


(40
)


(7
)
408


368

Acquisition of Vallée







25

25

Net income attributable to noncontrolling interests







5

5

Other changes in noncontrolling ownership interests







1

1

Balance at March 31, 2017
3,577

$
1,788

$
39,899

$
44,387

$
(5,080
)
837

$
(41,157
)
$
251

$
40,088

9.
Share-Based Compensation Plans
The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees 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 
 March 31,
($ in millions)
2017
 
2016
Pretax share-based compensation expense
$
74

 
$
68

Income tax benefit
(22
)
 
(20
)
Total share-based compensation expense, net of taxes
$
52

 
$
48

During the first three months of 2017 and 2016, the Company granted 86 thousand RSUs with a weighted-average grant date fair value of $64.20 per RSU and 133 thousand RSUs with a weighted-average grant date fair value of $48.83 per RSU, respectively. During the first three months of 2017 and 2016, the Company granted 190 thousand stock options with a weighted-average exercise price of $64.20 per option and 74 thousand stock options with a weighted-average exercise price of $48.83 per option, respectively. The weighted-average fair value of options granted for the first three months of 2017 and 2016 was $7.89 and $5.76 per option, respectively, and was determined using the following assumptions:
  
Three Months Ended March 31,
 
2017
 
2016
Expected dividend yield
3.7
%
 
3.8
%
Risk-free interest rate
2.0
%
 
1.3
%
Expected volatility
19.7
%
 
21.0
%
Expected life (years)
6.2

 
6.2


- 20 -

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

At March 31, 2017, there was $681 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 2.4 years. The Company typically communicates the value of annual share-based compensation awards to employees during the first quarter, but the related share amounts are not established and communicated until early May. Therefore, while the number of RSU and stock option grants disclosed above do not reflect any amounts relating to the annual grants, share-based compensation costs for the first quarter of 2017 and 2016 and unrecognized compensation expense at March 31, 2017 reflect an impact relating to the awards communicated to employees. For segment reporting, share-based compensation costs are unallocated expenses.
10.
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 
 March 31,
 
2017
 
2016
($ in millions)
U.S.
 
International
 
U.S.
 
International
Service cost
$
77

 
$
61

 
$
73

 
$
58

Interest cost
113

 
41

 
113

 
52

Expected return on plan assets
(218
)
 
(94
)
 
(210
)
 
(95
)
Amortization of unrecognized prior service credit
(13
)
 
(2
)
 
(14
)
 
(3
)
Net loss amortization
44

 
23

 
29

 
22

Termination benefits
5

 
1

 
4

 

Curtailments
3

 

 

 
1

 
$
11

 
$
30

 
$
(5
)
 
$
35

The Company provides medical benefits, principally to its eligible U.S. retirees and similar benefits to their dependents, through its other postretirement benefit plans. The net cost (credit) of such plans consisted of the following components: 
  
Three Months Ended 
 March 31,
($ in millions)
2017
 
2016
Service cost
$
14

 
$
13

Interest cost
20

 
21

Expected return on plan assets
(19
)
 
(35
)
Amortization of unrecognized prior service credit
(25
)
 
(26
)
Termination benefits
1

 
1

Curtailments
(3
)
 
(1
)
 
$
(12
)
 
$
(27
)
In connection with restructuring actions (see Note 3), termination charges were recorded on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring actions, curtailments were recorded on pension and other postretirement benefit plans as reflected in the tables above.


- 21 -

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

11.
Other (Income) Expense, Net
Other (income) expense, net, consisted of: 
 
Three Months Ended 
 March 31,
($ in millions)
2017
 
2016
Interest income
$
(97
)
 
$
(79
)
Interest expense
182

 
172

Exchange (gains) losses
(8
)
 
38

Equity loss (income) from affiliates
13

 
(34
)
Other, net
(32
)
 
(49
)
 
$
58

 
$
48

The change in equity loss (income) from affiliates in the first quarter of 2017 as compared with the first quarter of 2016 was driven primarily by certain research investment funds, which generated equity losses in the first quarter of 2017 compared with equity income in the first quarter of 2016, as well as by the termination of the SPMSD joint venture on December 31, 2016.
Interest paid for the three months ended March 31, 2017 and 2016 was $162 million and $160 million, respectively.
12.
Taxes on Income
The effective income tax rates of 22.3% and 30.4% for the first quarter of 2017 and 2016, respectively, reflect the impacts of acquisition and divestiture-related costs and restructuring costs, partially offset by the beneficial impact of foreign earnings.
The Company is under examination by numerous tax authorities in various jurisdictions globally. The ultimate finalization of the Company’s examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. However, there is one item that is currently under discussion with the Internal Revenue Service relating to the 2006 through 2008 examination. The Company has concluded that its position should be sustained upon audit. However, if this item were to result in an unfavorable outcome or settlement, it could have a material adverse impact on the Company’s financial position, liquidity and results of operations.
13.
Earnings Per Share
The calculations of earnings per share are as follows:
 
Three Months Ended 
 March 31,
($ and shares in millions except per share amounts)
2017
 
2016
Net income attributable to Merck & Co., Inc.
$
1,551

 
$
1,125

Average common shares outstanding
2,745

 
2,774

Common shares issuable (1)
21

 
21

Average common shares outstanding assuming dilution
2,766

 
2,795

Basic earnings per common share attributable to Merck & Co., Inc. common shareholders
$
0.56

 
$
0.41

Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders
$
0.56

 
$
0.40

(1) 
Issuable primarily under share-based compensation plans.
For the three months ended March 31, 2017 and 2016, 2 million and 10 million, respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive.


- 22 -

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

14.
Other Comprehensive Income (Loss)
Changes in AOCI by component are as follows:
 
Three Months Ended March 31,
($ in millions)
Derivatives
 
Investments
 
Employee
Benefit
Plans
 
Cumulative
Translation
Adjustment
 
Accumulated Other
Comprehensive
Income (Loss)
Balance January 1, 2016, net of taxes
$
404

 
$
41

 
$
(2,407
)
 
$
(2,186
)
 
$
(4,148
)
Other comprehensive income (loss) before reclassification adjustments, pretax
(167
)
 
54

 
(35
)
 
99

 
(49
)
Tax
58

 
16

 
(1
)
 
22

 
95

Other comprehensive income (loss) before reclassification adjustments, net of taxes
(109
)
 
70

 
(36
)
 
121

 
46

Reclassification adjustments, pretax
(143
)
(1) 
(11
)
(2) 
7

(3) 

 
(147
)
Tax
50

 
4

 
1

 

 
55

Reclassification adjustments, net of taxes
(93
)

(7
)

8



 
(92
)
Other comprehensive income (loss), net of taxes
(202
)
 
63

 
(28
)
 
121

 
(46
)
Balance March 31, 2016, net of taxes
$
202

 
$
104

 
$
(2,435
)
 
$
(2,065
)
 
$
(4,194
)
 
 
 
 
 
 
 
 
 
 
Balance January 1, 2017, net of taxes
$
338

 
$
(3
)
 
$
(3,206
)
 
$
(2,355
)
 
$
(5,226
)
Other comprehensive income (loss) before reclassification adjustments, pretax
(263
)
 
87

 
(4
)
 
263

 
83

Tax
92

 
(7
)
 
9

 
46

 
140

Other comprehensive income (loss) before reclassification adjustments, net of taxes
(171
)
 
80

 
5

 
309

 
223

Reclassification adjustments, pretax
(95
)
(1) 
(57
)
(2) 
28

(3) 

 
(124
)
Tax
34

 
20

 
(7
)
 

 
47

Reclassification adjustments, net of taxes
(61
)

(37
)

21



 
(77
)
Other comprehensive income (loss), net of taxes
(232
)
 
43

 
26

 
309

 
146

Balance March 31, 2017, net of taxes
$
106

 
$
40

 
$
(3,180
)
 
$
(2,046
)
 
$
(5,080
)
(1) 
Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales.
(2) 
Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net.
(3) 
Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 10).
 
15.
Segment Reporting
The Company’s operations are principally managed on a products basis and include the Pharmaceutical, Animal Health, Healthcare Services and Alliances operating segments. The Animal Health, Healthcare Services and Alliances segments are not material for separate reporting.
The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. Sales of vaccines in most major European markets were marketed through the Company’s SPMSD joint venture until its termination on December 31, 2016.
The Company also has animal health operations that discover, develop, manufacture and market animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Company’s Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients.


- 23 -

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

Sales of the Company’s products were as follows:
 
Three Months Ended 
 March 31,
 ($ in millions)
2017
 
2016
Primary Care and Women’s Health
 
 
 
Cardiovascular
 
 
 
Zetia
$
334

 
$
612

Vytorin
241

 
277

Liptruzet
49

 
23

Adempas
84

 
33

Diabetes
 
 
 
Januvia
839

 
906

Janumet
496

 
506

General Medicine and Women’s Health
 
 
 
Implanon/Nexplanon
170

 
134

NuvaRing
160

 
175

Follistim AQ
81

 
94

Hospital and Specialty
 
 
 
Hepatitis
 
 
 
Zepatier
378

 
50

HIV
 
 
 
Isentress
305

 
340

Hospital Acute Care
 
 
 
Bridion
148

 
90

Noxafil
141

 
145

Invanz
136

 
114

Cancidas
121

 
133

Cubicin
96

 
292

Primaxin
62