MRK 03.31.2015 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| For the quarterly period ended March 31, 2015 |
OR
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¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| 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
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| | |
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, 2015: 2,825,221,749
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer x | | Accelerated filer ¨ | | Non-accelerated filer ¨ | | Smaller reporting company ¨ |
| | (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Part I - Financial Information
Item 1. Financial Statements
MERCK & CO., INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF INCOME
(Unaudited, $ in millions except per share amounts)
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| | | | | | | |
| Three Months Ended March 31, |
| 2015 | | 2014 |
Sales | $ | 9,425 |
| | $ | 10,264 |
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Costs, Expenses and Other | | | |
Materials and production | 3,569 |
| | 3,903 |
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Marketing and administrative | 2,601 |
| | 2,734 |
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Research and development | 1,737 |
| | 1,574 |
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Restructuring costs | 82 |
| | 125 |
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Other (income) expense, net | 55 |
| | (163 | ) |
| 8,044 |
| | 8,173 |
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Income Before Taxes | 1,381 |
| | 2,091 |
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Taxes on Income | 423 |
| | 360 |
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Net Income | 958 |
| | 1,731 |
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Less: Net Income Attributable to Noncontrolling Interests | 5 |
| | 26 |
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Net Income Attributable to Merck & Co., Inc. | $ | 953 |
| | $ | 1,705 |
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Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders | $ | 0.34 |
| | $ | 0.58 |
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Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders | $ | 0.33 |
| | $ | 0.57 |
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Dividends Declared per Common Share | $ | 0.45 |
| | $ | 0.44 |
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MERCK & CO., INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited, $ in millions)
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| | | | | | | |
| Three Months Ended March 31, |
| 2015 | | 2014 |
Net Income Attributable to Merck & Co., Inc. | $ | 953 |
| | $ | 1,705 |
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Other Comprehensive Income (Loss) Net of Taxes: | | | |
Net unrealized gain (loss) on derivatives, net of reclassifications | 252 |
| | (66 | ) |
Net unrealized gain (loss) on investments, net of reclassifications | 46 |
| | (2 | ) |
Benefit plan net gain (loss) and prior service credit (cost), net of amortization | 35 |
| | (1 | ) |
Cumulative translation adjustment | (177 | ) | | 87 |
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| 156 |
| | 18 |
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Comprehensive Income Attributable to Merck & Co., Inc. | $ | 1,109 |
| | $ | 1,723 |
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The accompanying notes are an integral part of these consolidated financial statements.
MERCK & CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Unaudited, $ in millions except per share amounts)
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| | | | | | | |
| March 31, 2015 | | December 31, 2014 |
Assets | | | |
Current Assets | | | |
Cash and cash equivalents | $ | 7,980 |
| | $ | 7,441 |
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Short-term investments | 7,621 |
| | 8,278 |
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Accounts receivable (net of allowance for doubtful accounts of $141 in 2015 and $153 in 2014) (excludes accounts receivable of $65 in 2015 and $80 in 2014 classified in Other assets - see Note 4) | 6,670 |
| | 6,626 |
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Inventories (excludes inventories of $1,578 in 2015 and $1,664 in 2014 classified in Other assets - see Note 5) | 5,539 |
| | 5,571 |
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Deferred income taxes and other current assets | 5,117 |
| | 5,257 |
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Total current assets | 32,927 |
| | 33,173 |
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Investments | 13,092 |
| | 13,515 |
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Property, Plant and Equipment, at cost, net of accumulated depreciation of $16,794 in 2015 and $18,004 in 2014 | 12,910 |
| | 13,136 |
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Goodwill | 17,740 |
| | 12,992 |
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Other Intangibles, Net | 26,080 |
| | 20,386 |
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Other Assets | 5,596 |
| | 5,133 |
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| $ | 108,345 |
| | $ | 98,335 |
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Liabilities and Equity | | | |
Current Liabilities | | | |
Loans payable and current portion of long-term debt | $ | 4,728 |
| | $ | 2,704 |
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Trade accounts payable | 2,091 |
| | 2,625 |
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Accrued and other current liabilities | 9,867 |
| | 10,523 |
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Income taxes payable | 2,450 |
| | 1,606 |
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Dividends payable | 1,306 |
| | 1,308 |
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Total current liabilities | 20,442 |
| | 18,766 |
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Long-Term Debt | 25,506 |
| | 18,699 |
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Deferred Income Taxes | 6,803 |
| | 4,266 |
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Other Noncurrent Liabilities | 7,677 |
| | 7,813 |
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Merck & Co., Inc. Stockholders’ Equity | | | |
Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2015 and 2014 | 1,788 |
| | 1,788 |
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Other paid-in capital | 40,355 |
| | 40,423 |
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Retained earnings | 45,692 |
| | 46,021 |
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Accumulated other comprehensive loss | (4,167 | ) | | (4,323 | ) |
| 83,668 |
| | 83,909 |
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Less treasury stock, at cost: 748,715,051 shares in 2015 and 738,963,326 shares in 2014 | 35,903 |
| | 35,262 |
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Total Merck & Co., Inc. stockholders’ equity | 47,765 |
| | 48,647 |
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Noncontrolling Interests | 152 |
| | 144 |
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Total equity | 47,917 |
| | 48,791 |
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| $ | 108,345 |
| | $ | 98,335 |
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The accompanying notes are an integral part of this consolidated financial statement.
MERCK & CO., INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited, $ in millions)
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| | | | | | | |
| Three Months Ended March 31, |
| 2015 | | 2014 |
Cash Flows from Operating Activities | | | |
Net income | $ | 958 |
| | $ | 1,731 |
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Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 1,637 |
| | 1,754 |
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Intangible asset impairment charges | 14 |
| | — |
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Equity income from affiliates | (145 | ) | | (124 | ) |
Dividends and distributions from equity affiliates | 3 |
| | 66 |
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Deferred income taxes | (179 | ) | | (304 | ) |
Share-based compensation | 63 |
| | 56 |
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Other | 551 |
| | (115 | ) |
Net changes in assets and liabilities | (618 | ) | | (703 | ) |
Net Cash Provided by Operating Activities | 2,284 |
| | 2,361 |
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Cash Flows from Investing Activities | | | |
Capital expenditures | (203 | ) | | (205 | ) |
Purchases of securities and other investments | (5,039 | ) | | (6,825 | ) |
Proceeds from sales of securities and other investments | 6,287 |
| | 2,632 |
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Acquisition of Cubist Pharmaceuticals, Inc., net of cash acquired | (7,598 | ) | | — |
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Dispositions of businesses, net of cash divested | — |
| | 533 |
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Other | (52 | ) | | 58 |
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Net Cash Used in Investing Activities | (6,605 | ) | | (3,807 | ) |
Cash Flows from Financing Activities | | | |
Net change in short-term borrowings | 2,177 |
| | 3,149 |
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Proceeds from issuance of debt | 7,941 |
| | — |
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Payments on debt | (2,902 | ) | | (3 | ) |
Purchases of treasury stock | (1,015 | ) | | (1,167 | ) |
Dividends paid to stockholders | (1,280 | ) | | (1,290 | ) |
Proceeds from exercise of stock options | 242 |
| | 931 |
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Other | (8 | ) | | — |
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Net Cash Provided by Financing Activities | 5,155 |
| | 1,620 |
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Effect of Exchange Rate Changes on Cash and Cash Equivalents | (295 | ) | | 33 |
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Net Increase in Cash and Cash Equivalents | 539 |
| | 207 |
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Cash and Cash Equivalents at Beginning of Year | 7,441 |
| | 15,621 |
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Cash and Cash Equivalents at End of Period | $ | 7,980 |
| | $ | 15,828 |
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The accompanying notes are an integral part of this consolidated financial statement.
Notes to Interim Consolidated Financial Statements (unaudited)
The accompanying unaudited interim consolidated financial statements of Merck & Co., Inc. (“Merck” or the “Company”) have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States for complete consolidated financial statements are not included herein. These interim statements should be read in conjunction with the audited financial statements and notes thereto included in Merck’s Form 10-K filed on February 27, 2015.
On January 21, 2015, the Company acquired Cubist Pharmaceuticals, Inc. (“Cubist”). The results of Cubist’s business have been included in Merck’s financial statements subsequent to the acquisition date.
The results of operations of any interim period are not necessarily indicative of the results of operations for the full year. In the Company’s opinion, all adjustments necessary for a fair presentation of these interim statements have been included and are of a normal and recurring nature. Certain reclassifications have been made to prior year amounts to conform to the current presentation.
Recently Issued Accounting Standards
In May 2014, the Financial Accounting Standards Board issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. This guidance is effective for annual and interim periods beginning in 2017. Early adoption is not permitted. The Company is currently assessing the impact of adoption on its consolidated financial statements.
2013 Restructuring Program
In 2013, the Company initiated actions under a global restructuring program (the “2013 Restructuring Program”) as part of a global initiative to sharpen its commercial and research and development focus. As part of the program, the Company expects to reduce its total workforce by approximately 8,500 positions. These workforce reductions will primarily come from the elimination of positions in sales, administrative and headquarters organizations, as well as research and development. The Company will also reduce its global real estate footprint and continue to improve the efficiency of its manufacturing and supply network. The Company will continue to hire employees in strategic growth areas of the business as necessary.
The Company recorded total pretax costs of $58 million and $160 million in the first quarter of 2015 and 2014, respectively, related to this restructuring program. Since inception of the 2013 Restructuring Program through March 31, 2015, Merck has recorded total pretax accumulated costs of approximately $2.5 billion and eliminated approximately 6,830 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The actions under the 2013 Restructuring Program are expected to be substantially completed by the end of 2015 with the cumulative pretax costs estimated to be approximately $3.0 billion. The Company estimates that approximately two-thirds of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.
Merger Restructuring Program
In 2010, subsequent to the Merck and Schering-Plough Corporation (“Schering-Plough”) merger (the “Merger”), the Company commenced actions under a global restructuring program (the “Merger Restructuring Program”) designed to streamline the cost structure of the combined company. Further actions under this program were initiated in 2011. The actions under this program primarily reflect the elimination of positions in sales, administrative and headquarters organizations, as well as from the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities.
The Company recorded total pretax costs of $167 million and $166 million in the first quarter of 2015 and 2014, respectively, related to this restructuring program. Since inception of the Merger Restructuring Program through March 31, 2015, Merck has recorded total pretax accumulated costs of approximately $8.1 billion and eliminated approximately 28,760 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. Approximately 2,995 position eliminations remain pending under this program as of March 31, 2015. The non-manufacturing related restructuring actions under the Merger Restructuring Program were substantially completed by the end of 2013. The remaining actions under this program primarily relate to ongoing manufacturing facility rationalizations, which are expected to be substantially completed by 2016. The Company expects the estimated total cumulative pretax costs for this program to be approximately $8.5 billion. The Company estimates that approximately two-thirds of the cumulative pretax costs relate to cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.
For segment reporting, restructuring charges are unallocated expenses.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
The following tables summarize the charges related to restructuring program activities by type of cost:
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| Three Months Ended March 31, 2015 |
($ in millions) | Separation Costs | | Accelerated Depreciation | | Other | | Total |
2013 Restructuring Program | | | | | | | |
Materials and production | $ | — |
| | $ | 1 |
| | $ | 4 |
| | $ | 5 |
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Marketing and administrative | — |
| | 32 |
| | 2 |
| | 34 |
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Research and development | — |
| | — |
| | 2 |
| | 2 |
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Restructuring costs | 20 |
| | — |
| | (3 | ) | | 17 |
|
| 20 |
| | 33 |
| | 5 |
| | 58 |
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Merger Restructuring Program | | | | | | | |
Materials and production | — |
| | 12 |
| | 88 |
| | 100 |
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Marketing and administrative | — |
| | 2 |
| | — |
| | 2 |
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Research and development | — |
| | — |
| | — |
| | — |
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Restructuring costs | 9 |
| | — |
| | 56 |
| | 65 |
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| 9 |
| | 14 |
| | 144 |
| | 167 |
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| $ | 29 |
| | $ | 47 |
| | $ | 149 |
| | $ | 225 |
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| | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2014 |
($ in millions) | Separation Costs | | Accelerated Depreciation | | Other | | Total |
2013 Restructuring Program | | | | | | | |
Materials and production | $ | — |
| | $ | 81 |
| | $ | 6 |
| | $ | 87 |
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Marketing and administrative | — |
| | 19 |
| | — |
| | 19 |
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Research and development | — |
| | 41 |
| | 7 |
| | 48 |
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Restructuring costs | 25 |
| | — |
| | (19 | ) | | 6 |
|
| 25 |
| | 141 |
| | (6 | ) | | 160 |
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Merger Restructuring Program | | | | | | | |
Materials and production | — |
| | 68 |
| | (36 | ) | | 32 |
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Marketing and administrative | — |
| | 12 |
| | — |
| | 12 |
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Research and development | — |
| | 2 |
| | 1 |
| | 3 |
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Restructuring costs | 29 |
| | — |
| | 90 |
| | 119 |
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| 29 |
| | 82 |
| | 55 |
| | 166 |
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| $ | 54 |
| | $ | 223 |
| | $ | 49 |
| | $ | 326 |
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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 2015 and 2014, approximately 735 positions and 1,220 positions, respectively, were eliminated under the 2013 Restructuring Program. In the first quarter of 2015 and 2014, approximately 350 positions and 360 positions, respectively, were eliminated under the Merger Restructuring Program. These position eliminations were comprised of actual headcount reductions and the elimination of contractors and vacant positions.
Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the site, based upon the anticipated date the site will be closed or divested, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All of the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck was required to accelerate depreciation of the site assets rather than record an impairment charge. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors.
Other activity in 2015 and 2014 includes pretax gains and losses resulting from sales of facilities and related assets, as well as asset abandonment, shut-down and other related costs. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 12) and share-based compensation.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
The following table summarizes the charges and spending relating to restructuring activities by program for the three months ended March 31, 2015:
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($ in millions) | Separation Costs | | Accelerated Depreciation | | Other | | Total |
2013 Restructuring Program | | | | | | | |
Restructuring reserves January 1, 2015 | $ | 495 |
| | $ | — |
| | $ | 14 |
| | $ | 509 |
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Expense | 20 |
| | 33 |
| | 5 |
| | 58 |
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(Payments) receipts, net | (183 | ) | | — |
| | (11 | ) | | (194 | ) |
Non-cash activity | — |
| | (33 | ) | | 6 |
| | (27 | ) |
Restructuring reserves March 31, 2015 (1) | $ | 332 |
| | $ | — |
| | $ | 14 |
| | $ | 346 |
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Merger Restructuring Program | | | | | | | |
Restructuring reserves January 1, 2015 | $ | 536 |
| | $ | — |
| | $ | 6 |
| | $ | 542 |
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Expense | 9 |
| | 14 |
| | 144 |
| | 167 |
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(Payments) receipts, net | (116 | ) | | — |
| | (59 | ) | | (175 | ) |
Non-cash activity | — |
| | (14 | ) | | (86 | ) | | (100 | ) |
Restructuring reserves March 31, 2015 (1) | $ | 429 |
| | $ | — |
| | $ | 5 |
| | $ | 434 |
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(1) | The cash outlays associated with the 2013 Restructuring Program are expected to be substantially completed by the end of 2015. The non-manufacturing cash outlays associated with the Merger Restructuring Program were substantially completed by the end of 2013; the remaining cash outlays are expected to be substantially completed by the end of 2016. |
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3. | Acquisitions, Divestitures, Research Collaborations and License Agreements |
The Company continues its strategy of establishing external alliances to complement its substantial internal research capabilities, including research collaborations, licensing preclinical and clinical compounds to drive both near- and long-term growth. The Company supplements its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain products.
Acquisition of Cubist Pharmaceuticals, Inc.
In January 2015, Merck acquired Cubist, a leader in the development of therapies to treat serious infections caused by a broad range of bacteria. The acquisition complements Merck’s existing hospital acute care business, which is a key priority area for the Company. Total consideration transferred of $8.3 billion includes cash paid for outstanding Cubist shares of $7.8 billion, as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Cubist. Share-based compensation payments to settle non-vested equity awards attributable to postcombination service were recognized as transaction expense in the first quarter of 2015. In addition, the Company assumed all of the outstanding convertible debt of Cubist, which had a fair value of approximately $1.9 billion at the acquisition date. Merck redeemed this debt in February 2015.
The transaction was accounted for as an acquisition of a business; accordingly, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
The preliminary determination of the fair value of assets acquired and liabilities assumed from Cubist is as follows:
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| | | |
($ millions) | |
Cash and cash equivalents | $ | 733 |
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Accounts receivable | 123 |
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Inventories | 203 |
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Other current assets | 58 |
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Property, plant and equipment | 179 |
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Identifiable intangible assets: | |
Products and product rights (11 year weighted-average useful life) | 7,003 |
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In-process research and development (“IPR&D”) | 50 |
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Other noncurrent assets | 177 |
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Current liabilities (1) | (371 | ) |
Deferred income tax liabilities | (2,475 | ) |
Long-term debt | (1,900 | ) |
Other noncurrent liabilities (1) | (65 | ) |
Total identifiable net assets | 3,715 |
|
Goodwill (2) | 4,616 |
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Consideration transferred | $ | 8,331 |
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| |
(1) | Included in current liabilities and other noncurrent liabilities is contingent consideration of $73 million and $50 million, respectively. |
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(2) | The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Pharmaceutical segment. The goodwill is not deductible for tax purposes. |
The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an “income approach” through which fair value is estimated based on market participant expectations of each asset’s discounted projected net cash flows. The Company’s estimates of projected net cash flows considered historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the extent and timing of potential new product introductions by the Company’s competitors; and the life of each asset’s underlying patent. The net cash flows were then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product were then discounted to present value utilizing a discount rate of 8%. Actual cash flows are likely to be different than those assumed. The most significant intangible assets relate to Zerbaxa (ceftolozone/tazobactum) and Cubicin (daptomycin for injection). The Company is in the process of finalizing the fair values of certain currently marketed products and expects to complete the valuation in the second quarter of 2015.
The Company recorded the fair value of incomplete research project surotomycin (MK-4261) which, at the time of acquisition, had not reached technological feasibility and had no alternative future use. The amount was capitalized and is being accounted for as an indefinite-lived intangible asset, subject to impairment testing until completion or abandonment of the project. Upon successful completion of the project, Merck will make a determination as to the then useful life of the asset and begin amortization. The fair value of surotomycin was determined by using an income approach, through which fair value is estimated based on the asset’s probability adjusted future net cash flows, which reflects the stage of development of the project and the associated probability of successful completion. The net cash flows were then discounted to present value using a discount rate of 9%. Actual cash flows are likely to be different than those assumed.
In connection with the Cubist acquisition, liabilities were recorded for the potential for future consideration that is contingent upon the achievement of future sales-based milestones. The fair value of contingent consideration liabilities was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and a risk-adjusted discount rate of 8% used to present value the probability-weighted cash flows. Changes in the inputs could result in a different fair value adjustment.
This transaction closed on January 21, 2015; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. Cubist contributed sales of $208 million and estimated earnings of $48 million to Merck’s results for the first quarter of 2015. During the first quarter of 2015, the Company incurred $225 million of transaction costs directly related to the acquisition of Cubist including share-based compensation costs, severance costs and legal and advisory fees which are reflected in Marketing and administrative expenses.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
The following unaudited supplemental pro forma data presents consolidated information as if the acquisition of Cubist had been completed on January 1, 2014:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2015 | | 2014 |
Sales | $ | 9,511 |
| | $ | 10,525 |
|
Net income attributable to Merck & Co., Inc. | 1,017 |
| | 1,357 |
|
Basic earnings per common share attributable to Merck & Co., Inc. common shareholders | 0.36 |
| | 0.46 |
|
Earnings per common share assuming dilution attributable to Merck & Co. Inc. common shareholders | 0.35 |
| | 0.46 |
|
The unaudited supplemental pro forma data reflects the historical information of Merck and Cubist adjusted to include additional amortization expense based on the preliminary fair value of assets acquired, additional interest expense that would have been incurred on borrowings used to fund the acquisition, transaction costs associated with the acquisition, and the related tax effects of these adjustments. The pro forma data should not be considered indicative of the results that would have occurred if the acquisition had been consummated on January 1, 2014, nor are they indicative of future results.
Other transactions
In February 2015, Merck and NGM Biopharmaceuticals, Inc. (“NGM”), a privately-held biotechnology company, entered into a multi-year collaboration to research, discover, develop and commercialize novel biologic therapies across a wide range of therapeutic areas. The collaboration includes multiple drug candidates currently in preclinical development at NGM, including NP201, which is being evaluated for the treatment of diabetes, obesity and nonalcoholic steatohepatitis. NGM will lead the research and development of the existing preclinical candidates and have the autonomy to identify and pursue other discovery stage programs at its discretion. Merck will have the option to license all resulting NGM programs following human proof of concept trials. If Merck exercises this option, Merck will lead global product development and commercialization for the resulting products, if approved. Under the terms of the agreement, Merck made an upfront payment to NGM of $94 million, which is included in Research and development expenses, and purchased a 15% equity stake in NGM for $106 million. Merck committed up to $250 million to fund all of NGM’s efforts under the initial five-year term of the collaboration, with the potential for additional funding if certain conditions are met. Prior to Merck initiating a Phase 3 study for a licensed program, NGM may elect to either receive milestone and royalty payments or, in certain cases, to co-fund development and participate in a global cost and revenue share arrangement of up to 50%. The agreement also provides NGM with the option to participate in the co-promotion of any co-funded program in the United States. Merck will have the option to extend the research agreement for two additional two-year terms. Each party has certain termination rights under the agreement in the event of an uncured material breach by the other party. Additionally, Merck has certain termination rights in the event of the occurrence of certain defined conditions. Upon a termination event, depending on the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of compounds discovered under the agreement and certain related payment obligations.
In August 2014, Merck completed the acquisition of Idenix Pharmaceuticals, Inc. (“Idenix”) for approximately $3.9 billion in cash ($3.7 billion net of cash acquired). Idenix is a biopharmaceutical company engaged in the discovery and development of medicines for the treatment of human viral diseases, whose primary focus is on the development of next-generation oral antiviral therapeutics to treat hepatitis C virus (“HCV”) infection. The transaction was accounted for as an acquisition of a business; accordingly, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date. The determination of fair value requires management to make significant estimates and assumptions. Merck recognized an intangible asset for IPR&D of $3.2 billion related to MK-3682 (formerly IDX21437), net deferred tax liabilities of $951 million and other net assets and liabilities of approximately $12 million. MK-3682 is a nucleotide prodrug in Phase 2 clinical development being evaluated for potential inclusion in the development of all oral, pan-genotypic fixed-dose combination regimens. The excess of the consideration transferred over the fair value of net assets acquired of $1.5 billion was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPR&D was determined using an income approach, through which fair value is estimated based upon the asset’s probability adjusted future net cash flows, which reflects the stage of development of the project and the associated probability of successful completion. The net cash flows were then discounted to present value using a discount rate of 11.5%. This transaction closed on August 5, 2014; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. Pro forma financial information has not been included because Idenix’s historical financial results are not significant when compared with the Company’s financial results.
In March 2014, Merck divested its Sirna Therapeutics, Inc. (“Sirna”) subsidiary to Alnylam Pharmaceuticals, Inc. (“Alnylam”) for consideration of $25 million and 2,520,044 shares of Alnylam common stock. Merck is eligible to receive future payments associated with the achievement of certain regulatory and commercial milestones, as well as royalties on future sales. Under the terms of the agreement, Merck received 85% of the Alnylam shares in the first quarter of 2014 (valued at $172 million
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
at the time of closing) and the remaining 15% of the shares in the second quarter of 2014 (valued at $22 million at the time the shares were received). Merck recorded gains of $182 million in the first quarter of 2014 and $22 million in the second quarter of 2014 related to this transaction that are included in Other (income) expense, net. The excess of Merck’s tax basis in its investment in Sirna over the value received resulted in an approximate $300 million tax benefit recorded in the first quarter of 2014.
In January 2014, Merck sold the U.S. marketing rights to Saphris (asenapine), an antipsychotic indicated for the treatment of schizophrenia and bipolar I disorder in adults to Forest Laboratories, Inc. (“Forest”). Under the terms of the agreement, Forest made upfront payments of $232 million, which were recorded in Sales in the first quarter of 2014, and will make additional payments to Merck based on defined sales milestones. In addition, as part of this transaction, Merck agreed to supply product to Forest (subsequently acquired by Actavis plc) until patent expiry.
Remicade/Simponi
In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (“Centocor”), a Johnson & Johnson (“J&J”) company, to market Remicade (infliximab), which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Plough’s subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi (golimumab), a fully human monoclonal antibody. The Company has exclusive marketing rights to both products throughout Europe, Russia and Turkey. In December 2007, Schering-Plough and Centocor revised their distribution agreement regarding the development, commercialization and distribution of both Remicade and Simponi, extending the Company’s rights to exclusively market Remicade to match the duration of the Company’s exclusive marketing rights for Simponi. In addition, Schering-Plough and Centocor agreed to share certain development costs relating to Simponi’s auto-injector delivery system. On October 6, 2009, the European Commission approved Simponi as a treatment for rheumatoid arthritis and other immune system disorders in two presentations – a novel auto-injector and a prefilled syringe. As a result, the Company’s marketing rights for both products extend for 15 years from the first commercial sale of Simponi in the European Union (the “EU”) following the receipt of pricing and reimbursement approval within the EU. Remicade lost market exclusivity in major European markets in February 2015. All profits derived from Merck’s exclusive distribution of the two products in these countries are equally divided between Merck and J&J.
Derivative Instruments and Hedging Activities
The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments.
A significant portion of the Company’s revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Company’s foreign currency risk management program, as well as its interest rate risk management activities are discussed below.
Foreign Currency Risk Management
The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates.
The objective of the revenue hedging program is to reduce the potential for longer-term unfavorable changes in foreign exchange rates to decrease the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales that are expected to occur over its planning cycle, typically no more than three years into the future. The Company will layer in hedges over time, increasing the portion of third-party and intercompany distributor entity sales hedged as it gets closer to the expected date of the forecasted foreign currency denominated sales. The portion of sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The hedged anticipated sales are a specified component of a portfolio of similarly denominated foreign currency-based sales transactions, each of which responds to the hedged currency risk in the same manner. The Company manages its anticipated transaction exposure principally with purchased local currency put options, which provide the Company with a right, but not an obligation, to sell foreign currencies in the future at a predetermined price. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, total changes in the options’ cash flows offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the options’ value reduces to zero, but the Company benefits from the increase in the U.S. dollar equivalent value of the anticipated foreign currency cash flows.
In connection with the Company’s revenue hedging program, a purchased collar option strategy may be utilized. With a purchased collar option strategy, the Company writes a local currency call option and purchases a local currency put option. As
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
compared to a purchased put option strategy alone, a purchased collar strategy reduces the upfront costs associated with purchasing puts through the collection of premium by writing call options. If the U.S. dollar weakens relative to the currency of the hedged anticipated sales, the purchased put option value of the collar strategy reduces to zero and the Company benefits from the increase in the U.S. dollar equivalent value of its anticipated foreign currency cash flows; however, this benefit would be capped at the strike level of the written call. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the written call option value of the collar strategy reduces to zero and the changes in the purchased put cash flows of the collar strategy would offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales.
The Company may also utilize forward contracts in its revenue hedging program. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the increase in the fair value of the forward contracts offsets the decrease in the expected future U.S. dollar cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the decrease in the fair value of the forward contracts offsets the increase in the value of the anticipated foreign currency cash flows.
The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other comprehensive income (“OCI”), depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the effective portion of the unrealized gains or losses on these contracts is recorded in Accumulated other comprehensive income (“AOCI”) and reclassified into Sales when the hedged anticipated revenue is recognized. The hedge relationship is highly effective and hedge ineffectiveness has been de minimis. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes.
The primary objective of the balance sheet risk management program is to mitigate the exposure of foreign currency denominated net monetary assets of foreign subsidiaries where the U.S. dollar is the functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts, which enable the Company to buy and sell foreign currencies in the future at fixed exchange rates and economically offset the consequences of changes in foreign exchange from the monetary assets. Merck routinely enters into contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The Company will also minimize the effect of exchange on monetary assets and liabilities by managing operating activities and net asset positions at the local level. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.
Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net. The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net. Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year.
The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates. The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within OCI, and remains in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows.
Foreign exchange risk is also managed through the use of foreign currency debt. The Company’s senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI. Included in the cumulative translation adjustment are pretax gains of $334 million and $12 million for the first three months of 2015 and 2014, respectively, from the euro-denominated notes.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
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, 2015, the Company was a party to 27 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.
|
| | | | | | | | | | |
| March 31, 2015 |
Debt Instrument | Par Value of Debt | | Number of Interest Rate Swaps Held | | Total Swap Notional Amount |
0.70% notes due 2016 | $ | 1,000 |
| | 4 |
| | $ | 1,000 |
|
1.30% notes due 2018 | 1,000 |
| | 4 |
| | 1,000 |
|
5.00% notes due 2019 | 1,250 |
| | 3 |
| | 550 |
|
1.85% notes due 2020 | 1,250 |
| | 5 |
| | 1,250 |
|
3.875% notes due 2021 | 1,150 |
| | 5 |
| | 1,150 |
|
2.40% notes due 2022 | 1,000 |
| | 1 |
| | 250 |
|
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 are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.
Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2015 | | December 31, 2014 |
| | Fair Value of Derivative | | U.S. Dollar Notional | | Fair Value of Derivative | | U.S. Dollar Notional |
($ in millions) | Balance Sheet Caption | Asset | | Liability | | Asset | | Liability | |
Derivatives Designated as Hedging Instruments | | | | | | | | | | | | |
Interest rate swap contracts (non-current) | Other assets | $ | 44 |
| | $ | — |
| | $ | 2,950 |
| | $ | 19 |
| | $ | — |
| | $ | 1,950 |
|
Interest rate swap contracts (non-current) | Other noncurrent liabilities | — |
| | 14 |
| | 3,500 |
| | — |
| | 15 |
| | 2,000 |
|
Foreign exchange contracts (current) | Deferred income taxes and other current assets | 1,005 |
| | — |
| | 6,190 |
| | 772 |
| | — |
| | 5,513 |
|
Foreign exchange contracts (non-current) | Other assets | 815 |
| | — |
| | 5,944 |
| | 691 |
| | — |
| | 6,253 |
|
Foreign exchange contracts (current) | Accrued and other current liabilities | — |
| | 2 |
| | 140 |
| | — |
| | — |
| | — |
|
| | $ | 1,864 |
|
| $ | 16 |
|
| $ | 18,724 |
|
| $ | 1,482 |
|
| $ | 15 |
|
| $ | 15,716 |
|
Derivatives Not Designated as Hedging Instruments | | | | | | | | | | | | |
Foreign exchange contracts (current) | Deferred income taxes and other current assets | $ | 232 |
| | $ | — |
| | $ | 4,912 |
| | $ | 365 |
| | $ | — |
| | $ | 6,966 |
|
Foreign exchange contracts (current) | Accrued and other current liabilities | — |
| | 99 |
| | 3,192 |
| | — |
| | 88 |
| | 3,386 |
|
| | $ | 232 |
| | $ | 99 |
| | $ | 8,104 |
| | $ | 365 |
| | $ | 88 |
| | $ | 10,352 |
|
| | $ | 2,096 |
|
| $ | 115 |
|
| $ | 26,828 |
|
| $ | 1,847 |
|
| $ | 103 |
|
| $ | 26,068 |
|
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Company’s derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes:
|
| | | | | | | | | | | | | | | |
| March 31, 2015 | | December 31, 2014 |
($ in millions) | Asset | | Liability | | Asset | | Liability |
Gross amounts recognized in the consolidated balance sheet | $ | 2,096 |
| | $ | 115 |
| | $ | 1,847 |
| | $ | 103 |
|
Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet | (98 | ) | | (98 | ) | | (97 | ) | | (97 | ) |
Cash collateral (received) posted | (1,594 | ) | | — |
| | (1,410 | ) | | — |
|
Net amounts | $ | 404 |
| | $ | 17 |
| | $ | 340 |
| | $ | 6 |
|
The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a foreign currency cash flow hedging relationship, (iii) designated in a foreign currency net investment hedging relationship and (iv) not designated in a hedging relationship:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2015 | | 2014 |
Derivatives designated in a fair value hedging relationship | | | |
Interest rate swap contracts | | | |
Amount of gain recognized in Other (income) expense, net on derivatives (1) | $ | (25 | ) | | $ | (4 | ) |
Amount of loss recognized in Other (income) expense, net on hedged item | 22 |
| | 4 |
|
Derivatives designated in foreign currency cash flow hedging relationships | | | |
Foreign exchange contracts | | | |
Amount of (gain) loss reclassified from AOCI to Sales | (167 | ) | | 2 |
|
Amount of (gain) loss recognized in OCI on derivatives | (565 | ) | | 102 |
|
Derivatives designated in foreign currency net investment hedging relationships | | | |
Foreign exchange contracts | | | |
Amount of gain recognized in Other (income) expense, net on derivatives (2) | (1 | ) | | (2 | ) |
Amount of loss recognized in OCI on derivatives | 8 |
| | 42 |
|
Derivatives not designated in a hedging relationship | | | |
Foreign exchange contracts | | | |
Amount of gain recognized in Other (income) expense, net on derivatives (3) | (248 | ) | | (82 | ) |
Amount of gain recognized in Sales | (1 | ) | | (1 | ) |
(1) There was $3 million of ineffectiveness on the hedge during the first quarter of 2015.
(2) There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing.
(3) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates.
At March 31, 2015, the Company estimates $716 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales. The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
Investments in Debt and Equity Securities
Information on available-for-sale investments is as follows:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2015 | | December 31, 2014 |
| Fair Value | | Amortized Cost | | Gross Unrealized | | Fair Value | | Amortized Cost | | Gross Unrealized |
($ in millions) | Gains | | Losses | | Gains | | Losses |
Corporate notes and bonds | $ | 10,163 |
| | $ | 10,110 |
| | $ | 55 |
| | $ | (2 | ) | | $ | 10,107 |
| | $ | 10,102 |
| | $ | 22 |
| | $ | (17 | ) |
Commercial paper | 5,949 |
| | 5,949 |
| | — |
| | — |
| | 6,970 |
| | 6,970 |
| | — |
| | — |
|
U.S. government and agency securities | 1,597 |
| | 1,590 |
| | 7 |
| | — |
| | 1,774 |
| | 1,775 |
| | 1 |
| | (2 | ) |
Asset-backed securities | 1,356 |
| | 1,354 |
| | 3 |
| | (1 | ) | | 1,460 |
| | 1,462 |
| | 1 |
| | (3 | ) |
Mortgage-backed securities | 672 |
| | 672 |
| | 4 |
| | (4 | ) | | 602 |
| | 604 |
| | 2 |
| | (4 | ) |
Foreign government bonds | 453 |
| | 451 |
| | 2 |
| | — |
| | 385 |
| | 385 |
| | — |
| | — |
|
Equity securities | 761 |
| | 561 |
| | 200 |
| | — |
| | 730 |
| | 557 |
| | 173 |
| | — |
|
| $ | 20,951 |
| | $ | 20,687 |
| | $ | 271 |
| | $ | (7 | ) | | $ | 22,028 |
| | $ | 21,855 |
| | $ | 199 |
| | $ | (26 | ) |
Available-for-sale debt securities included in Short-term investments totaled $7.4 billion at March 31, 2015. Of the remaining debt securities, $11.9 billion mature within five years. At March 31, 2015 and December 31, 2014, there were no debt securities pledged as collateral.
Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest:
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.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities measured at fair value on a recurring basis are summarized below:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Fair Value Measurements Using | | Fair Value Measurements Using |
| Quoted Prices In Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total | | Quoted Prices In Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total |
($ in millions) | March 31, 2015 | | December 31, 2014 |
Assets | | | | | | | | | | | | | | | |
Investments | | | | | | | | | | | | | | | |
Corporate notes and bonds | $ | — |
| | $ | 10,163 |
| | $ | — |
| | $ | 10,163 |
| | $ | — |
| | $ | 10,107 |
| | $ | — |
| | $ | 10,107 |
|
Commercial paper | — |
| | 5,949 |
| | — |
| | 5,949 |
| | — |
| | 6,970 |
| | — |
| | 6,970 |
|
U.S. government and agency securities | — |
| | 1,597 |
| | — |
| | 1,597 |
| | — |
| | 1,774 |
| | — |
| | 1,774 |
|
Asset-backed securities (1) | — |
| | 1,356 |
| | — |
| | 1,356 |
| | — |
| | 1,460 |
| | — |
| | 1,460 |
|
Mortgage-backed securities (1) | — |
| | 672 |
| | — |
| | 672 |
| | — |
| | 602 |
| | — |
| | 602 |
|
Foreign government bonds | — |
| | 453 |
| | — |
| | 453 |
| | — |
| | 385 |
| | — |
| | 385 |
|
Equity securities | 523 |
| | — |
| | — |
| | 523 |
| | 495 |
| | — |
| | — |
| | 495 |
|
| 523 |
| | 20,190 |
| | — |
| | 20,713 |
| | 495 |
| | 21,298 |
| | — |
| | 21,793 |
|
Other assets | | | | | | | | | | | | | | | |
Securities held for employee compensation | 186 |
| | 52 |
| | — |
| | 238 |
| | 181 |
| | 54 |
| | — |
| | 235 |
|
Derivative assets (2) | | | | | | | | | | | | | | | |
Purchased currency options | — |
| | 1,568 |
| | — |
| | 1,568 |
| | — |
| | 1,252 |
| | — |
| | 1,252 |
|
Forward exchange contracts | — |
| | 484 |
| | — |
| | 484 |
| | — |
| | 576 |
| | — |
| | 576 |
|
Interest rate swaps | — |
| | 44 |
| | — |
| | 44 |
| | — |
| | 19 |
| | — |
| | 19 |
|
| — |
| | 2,096 |
| | — |
| | 2,096 |
| | — |
| | 1,847 |
| | — |
| | 1,847 |
|
Total assets | $ | 709 |
| | $ | 22,338 |
| | $ | — |
| | $ | 23,047 |
| | $ | 676 |
| | $ | 23,199 |
| | $ | — |
| | $ | 23,875 |
|
Liabilities | | | | | | | | | | | | | | | |
Other liabilities | | | | | | | | | | | | | | | |
Contingent consideration | $ | — |
| | $ | — |
| | $ | 562 |
| | $ | 562 |
| | $ | — |
| | $ | — |
| | $ | 428 |
| | $ | 428 |
|
Derivative liabilities (2) | | | | | | | | | | | | | | | |
Forward exchange contracts | — |
| | 57 |
| | — |
| | 57 |
| | — |
| | 46 |
| | — |
| | 46 |
|
Written currency options | — |
| | 44 |
| | — |
| | 44 |
| | — |
| | 42 |
| | — |
| | 42 |
|
Interest rate swaps | — |
| | 14 |
| | — |
| | 14 |
| | — |
| | 15 |
| | — |
| | 15 |
|
| — |
| | 115 |
| | — |
| | 115 |
| | — |
| | 103 |
| | — |
| | 103 |
|
Total liabilities | $ | — |
|
| $ | 115 |
|
| $ | 562 |
|
| $ | 677 |
|
| $ | — |
|
| $ | 103 |
|
| $ | 428 |
|
| $ | 531 |
|
| |
(1) | Primarily all of the asset-backed securities are highly-rated (Standard & Poor’s rating of AAA and Moody’s Investors Service rating of Aaa), secured primarily by credit card, auto loan, and home equity receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies. |
| |
(2) | The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Company’s own credit risk, the effects of which were not significant. |
There were no transfers between Level 1 and Level 2 during the first three months of 2015. As of March 31, 2015, Cash and cash equivalents of $8.0 billion included $6.6 billion of cash equivalents (considered Level 2 in the fair value hierarchy).
Notes to Interim 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, |
| 2015 | | 2014 |
Fair value January 1 | $ | 428 |
| | $ | 69 |
|
Changes in fair value (recorded in Research and development expenses) | 61 |
| | 2 |
|
Additions | 123 |
| | — |
|
Payments | (50 | ) | | — |
|
Fair value March 31 | $ | 562 |
| | $ | 71 |
|
In the first quarter of 2015, the Company recognized a liability of $123 million for contingent consideration related to the acquisition of Cubist (see Note 3). In addition, in the first quarter of 2015, the Company paid $50 million of contingent consideration related to the first commercial sale of Zerbaxa in the United States.
Other Fair Value Measurements
Some of the Company’s financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature.
The estimated fair value of loans payable and long-term debt (including current portion) at March 31, 2015, was $31.6 billion compared with a carrying value of $30.2 billion and at December 31, 2014, was $22.5 billion compared with a carrying value of $21.4 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy.
Concentrations of Credit Risk
On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards as specified in the Company’s investment policy guidelines.
The majority of the Company’s accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business, taking into consideration global economic conditions and the ongoing sovereign debt issues in certain European countries. At March 31, 2015 and December 31, 2014, Other assets included $65 million and $80 million, respectively, of accounts receivable not expected to be collected within one year. At March 31, 2015, the Company’s total net accounts receivable outstanding for more than one year were approximately $125 million. The Company does not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on its financial position, liquidity or results of operations.
Additionally, the Company continues to expand in the emerging markets. Payment terms in these markets tend to be longer, resulting in an increase in accounts receivable balances in certain of these markets.
Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Company’s financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Company’s credit rating, and the credit rating of the counterparty. As of March 31, 2015 and December 31, 2014, the Company had received cash collateral of $1.6 billion and $1.4 billion, respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities. The Company had not advanced any cash collateral to counterparties as of March 31, 2015 or December 31, 2014.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
Inventories consisted of:
|
| | | | | | | |
($ in millions) | March 31, 2015 | | December 31, 2014 |
Finished goods | $ | 1,698 |
| | $ | 1,588 |
|
Raw materials and work in process | 4,903 |
| | 5,141 |
|
Supplies | 182 |
| | 197 |
|
Total (approximates current cost) | 6,783 |
| | 6,926 |
|
Increase to LIFO costs | 334 |
| | 309 |
|
| $ | 7,117 |
| | $ | 7,235 |
|
Recognized as: | | | |
Inventories | $ | 5,539 |
| | $ | 5,571 |
|
Other assets | 1,578 |
| | 1,664 |
|
Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At March 31, 2015 and December 31, 2014, these amounts included $1.5 billion and $1.6 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $86 million and $74 million at March 31, 2015 and December 31, 2014, respectively, of inventories produced in preparation for product launches.
| |
6. | Goodwill and Other Intangibles |
In connection with acquisitions, the Company measures the fair value of marketed products and research and development pipeline programs and capitalizes these amounts. As a result of the acquisition of Cubist in January 2015, the Company recorded $7.0 billion of intangible assets for currently marketed products, $50 million of IPR&D and $4.6 billion of goodwill (see Note 3).
During the first quarter of 2015, the Company recorded an intangible asset impairment charge of $12 million within Materials and production costs related to Rebetol (ribavirin USP), a product marketed by the Company for the treatment of chronic HCV infection. Sales of Rebetol are being adversely affected by loss of market share as a result of the availability of newer therapeutic options, which led to changes in the cash flow assumptions for Rebetol that indicated that the Rebetol intangible asset value was not recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Rebetol that, when compared with its related carrying value, resulted in an impairment charge of $12 million.
The Company may recognize additional non-cash impairment charges in the future related to other marked products or pipeline programs and such charges could be material.
| |
7. | Joint Ventures and Other Equity Method Affiliates |
Equity income from affiliates reflects the performance of the Company’s joint ventures and other equity method affiliates including Sanofi Pasteur MSD, certain investments funds, as well as AstraZeneca LP (“AZLP”) until the termination of the Company’s relationship with AZLP on June 30, 2014 as discussed below. Equity income from affiliates was $145 million and $124 million for the first quarter of 2015 and 2104, respectively, and is included in Other (income) expense, net (see Note 13).
AstraZeneca LP
In 1998, Merck and Astra completed the restructuring of the ownership and operations of their existing joint venture whereby Merck acquired Astra’s interest in KBI Inc. (“KBI”) and contributed KBI’s operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the “Partnership”), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AZLP upon Astra’s 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights.
On June 30, 2014, AstraZeneca exercised its option to purchase Merck’s interest in KBI for $419 million in cash. Of this amount, $327 million reflects an estimate of the fair value of Merck’s interest in Nexium and Prilosec. This portion of the exercise price, which is subject to a true-up in 2018 based on actual sales from closing in 2014 to June 2018, was deferred and is being recognized over time in Other (income) expense, net as the contingency is eliminated as sales occur. During the first quarter of 2015, $49 million of the deferred revenue was recognized in Other income (expense), net bringing the total deferred revenue recognized through March 31, 2015 to $189 million. The remaining exercise price of $91 million primarily represents a multiple of ten times Merck’s average 1% annual profit allocation in the partnership for the three years prior to exercise. Merck recognized
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
the $91 million as a gain in the second quarter of 2014 within Other (income) expense, net. As a result of AstraZeneca’s option exercise, the Company’s remaining interest in AZLP was redeemed. Accordingly, the Company also recognized a non-cash gain of approximately $650 million in the second quarter of 2014 within Other (income) expense, net resulting from the retirement of $2.4 billion of KBI preferred stock (see Note 10), the elimination of the Company’s $1.4 billion investment in AZLP and a $340 million reduction of goodwill. This transaction resulted in a net tax benefit of $517 million in the second quarter of 2014 primarily reflecting the reversal of deferred taxes on the AZLP investment balance.
As a result of AstraZeneca exercising its option, as of July 1, 2014, the Company no longer records equity income from AZLP and supply sales to AZLP have terminated. Equity income from AZLP was $98 million in the first quarter of 2014.
Summarized financial information for AZLP is as follows:
|
| | | |
| Three Months Ended March 31, |
($ in millions) | 2014 |
Sales | $ | 1,082 |
|
Materials and production costs | 480 |
|
Other expense, net | 393 |
|
Income before taxes (1) | $ | 209 |
|
| |
(1) | Merck’s partnership returns from AZLP were generally contractually determined as noted above and were not based on a percentage of income from AZLP, other than with respect to Merck’s 1% limited partnership interest. |
In February 2015, Merck issued $8.0 billion aggregate principal amount of senior unsecured notes consisting of $300 million principal amount of floating rate notes due 2017, $700 million principal amount of floating rate notes due 2020, $1.25 billion principal amount of 1.85% notes due 2020, $1.25 billion aggregate principal amount of 2.35% notes due 2022, $2.5 billion aggregate principal amount of 2.75% notes due 2025 and $2.0 billion aggregate principal amount of 3.70% notes due 2045. The Company used a portion of the net proceeds of the offering of $7.9 billion to repay commercial paper issued to substantially finance the Company’s acquisition of Cubist. Any remaining net proceeds were used for general corporate purposes, including for repurchases of the Company’s common stock, and the repayment of outstanding commercial paper borrowings and debt maturities.
Also, in February 2015, the Company redeemed $1.9 billion of legacy Cubist debt acquired in the acquisition (see Note 3).
The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including environmental matters. Except for the Vioxx Litigation (as defined below) for which a separate assessment is provided in this Note, in the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Company’s financial position, results of operations or cash flows.
Given the nature of the litigation discussed below, including the Vioxx Litigation, and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation.
The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable.
The Company’s decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for certain product liabilities effective August 1, 2004.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
Vioxx Litigation
Product Liability Lawsuits
As previously disclosed, Merck is a defendant in approximately 20 active federal and state lawsuits (the “Vioxx Product Liability Lawsuits”) alleging personal injury as a result of the use of Vioxx. Most of these cases are coordinated in a multidistrict litigation in the U.S. District Court for the Eastern District of Louisiana (the “Vioxx MDL”) before Judge Eldon E. Fallon.
As previously disclosed, Merck is also a defendant in approximately 30 putative class action lawsuits alleging economic injury as a result of the purchase of Vioxx. All but one of those cases are in the Vioxx MDL. Merck has reached a resolution, approved by Judge Fallon, of these class actions in the Vioxx MDL. Under the settlement, Merck will pay up to $23 million to pay all properly documented claims submitted by class members, approved attorneys’ fees and expenses, and approved settlement notice costs and certain other administrative expenses. The court entered an order approving the settlement in January 2014.
Merck is also a defendant in lawsuits brought by state Attorneys General of three states — Alaska, Montana and Utah. These actions were previously pending in the Vioxx MDL proceeding, but on October 10, 2014, the Judicial Panel on Multidistrict Litigation (“JPML”) issued an order remanding the actions back to their original federal courts. These actions allege that Merck misrepresented the safety of Vioxx and seek recovery for expenditures on Vioxx by government-funded health care programs, such as Medicaid, and/or penalties for alleged Consumer Fraud Act violations. On February 6, 2015, the federal district judge in Anchorage remanded the Alaska lawsuit to state court and a trial has been scheduled for September 2016. On February 24, 2015, the federal district judge in Helena remanded the Montana lawsuit to state court. On March 27, 2015, the Utah Attorney General filed a motion to remand the case to Utah state court.
Shareholder Lawsuits
As previously disclosed, in addition to the Vioxx Product Liability Lawsuits, various putative class actions and individual lawsuits under federal securities laws and state laws have been filed against Merck and various current and former officers and directors (the “Vioxx Securities Lawsuits”). The Vioxx Securities Lawsuits are coordinated in a multidistrict litigation in the U.S. District Court for the District of New Jersey before Judge Stanley R. Chesler, and have been consolidated for all purposes. In August 2011, Judge Chesler granted in part and denied in part Merck’s motion to dismiss the Fifth Amended Class Action Complaint in the consolidated securities action. Among other things, the claims based on statements made on or after the voluntary withdrawal of Vioxx on September 30, 2004, have been dismissed. In October 2011, defendants answered the Fifth Amended Class Action Complaint. In April 2012, plaintiffs filed a motion for class certification and, in January 2013, Judge Chesler granted that motion. In March 2013, plaintiffs filed a motion for leave to amend their complaint to add certain allegations to expand the class period. In May 2013, the court denied plaintiffs’ motion for leave to amend their complaint to expand the class period, but granted plaintiffs’ leave to amend their complaint to add certain allegations within the existing class period. In June 2013, plaintiffs filed their Sixth Amended Class Action Complaint. In July 2013, defendants answered the Sixth Amended Class Action Complaint. Discovery has been completed and is now closed. Dispositive motions have been fully briefed.
As previously disclosed, several individual securities lawsuits filed by foreign institutional investors also are consolidated with the Vioxx Securities Lawsuits. In October 2011, plaintiffs filed amended complaints in each of the pending individual securities lawsuits. Also in October 2011, an individual securities lawsuit (the “KBC Lawsuit,” together with the prior individual actions, the “Direct Actions”) was filed in the District of New Jersey by several foreign institutional investors; that case is also consolidated with the Vioxx Securities Lawsuits. In January 2012, defendants filed motions to dismiss in one of the individual lawsuits (the “ABP Lawsuit”). Briefing on the motions to dismiss was completed in March 2012. In August 2012, Judge Chesler granted in part and denied in part the motions to dismiss the ABP Lawsuit. Among other things, certain alleged misstatements and omissions were dismissed as inactionable and all state law claims were dismissed in full. In September 2012, defendants answered the complaints in all of the Direct Actions other than the KBC Lawsuit; on the same day, defendants moved to dismiss the complaint in the KBC Lawsuit on statute of limitations grounds. In December 2012, Judge Chesler denied the motion to dismiss the KBC Lawsuit and, in January 2013, defendants answered the complaint in the KBC Lawsuit. Discovery has been completed in the Direct Actions and is now closed. Dispositive motions have been fully briefed in the Direct Actions. Between March 2014 and February 2015, six additional individual securities complaints were filed by institutional investors that opted out of the class action referred to above. The new complaints are substantially similar to the complaints in the Direct Actions and are consolidated with the Vioxx Securities Lawsuits.
Insurance
The Company has Directors and Officers insurance coverage applicable to the Vioxx Securities Lawsuits with remaining stated upper limits of approximately $145 million. As a result of the previously disclosed insurance arbitration, additional insurance coverage for these claims should also be available, if needed, under upper-level excess policies that provide coverage for a variety of risks. There are disputes with the insurers about the availability of some or all of the Company’s insurance coverage for these claims and there are likely to be additional disputes. The amounts actually recovered under the policies discussed in this paragraph may be less than the stated upper limits.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
International Lawsuits
As previously disclosed, in addition to the lawsuits discussed above, Merck has been named as a defendant in litigation relating to Vioxx in Brazil, Canada and Europe (collectively, the “Vioxx International Lawsuits”). As previously disclosed, the Company has entered into an agreement to resolve all claims related to Vioxx in Canada pursuant to which the Company will pay a minimum of approximately $21 million but not more than an aggregate maximum of approximately $36 million. The agreement has been approved by courts in Canada’s provinces.
Reserves
The Company believes that it has meritorious defenses to the remaining Vioxx Product Liability Lawsuits, Vioxx Securities Lawsuits and Vioxx International Lawsuits (collectively, the “Vioxx Litigation”) and will vigorously defend against them. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek indeterminate damages, the Company is unable to predict the outcome of these matters and, at this time, cannot reasonably estimate the possible loss or range of loss with respect to the remaining Vioxx Litigation. The Company has established a reserve with respect to the Canadian settlement and certain other Vioxx Product Liability Lawsuits. The Company also has an immaterial remaining reserve relating to the previously disclosed Vioxx investigation for the non-participating states with which litigation is continuing. The Company has established no other liability reserves with respect to the Vioxx Litigation. Unfavorable outcomes in the Vioxx Litigation could have a material adverse effect on the Company’s financial position, liquidity and results of operations.
Other Product Liability Litigation
Fosamax
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax (the “Fosamax Litigation”). As of March 31, 2015, approximately 5,585 cases had been filed and were pending against Merck in either federal or state court, including one case which seeks class action certification, as well as damages and/or medical monitoring. In approximately 975 of these actions, plaintiffs allege, among other things, that they have suffered osteonecrosis of the jaw (“ONJ”), generally subsequent to invasive dental procedures, such as tooth extraction or dental implants and/or delayed healing, in association with the use of Fosamax; however, substantially all of those actions are subject to the settlement discussed below. In addition, plaintiffs in approximately 4,610 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 JPML ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation (the “Fosamax ONJ MDL”) for coordinated pre-trial proceedings.
In December 2013, Merck reached an agreement in principle with the Plaintiffs’ Steering Committee (“PSC”) in the Fosamax ONJ MDL to resolve pending ONJ cases not on appeal in the Fosamax ONJ MDL and in the state courts for an aggregate amount of $27.7 million. Merck and the PSC subsequently formalized the terms of this agreement in a Master Settlement Agreement (“ONJ Master Settlement Agreement”) that was executed in April 2014. As a condition to the settlement, 100% of the state and federal ONJ plaintiffs had to agree to participate in the settlement plan or Merck could either terminate the ONJ Master Settlement Agreement, or waive the 100% participation requirement and agree to a lesser funding amount for the settlement fund. On July 14, 2014, Merck elected to proceed with the ONJ Master Settlement Agreement at a reduced funding level since the participation level was approximately 95%. In addition, the judge overseeing the Fosamax ONJ MDL granted a motion filed by Merck and has entered an order that requires the approximately 40 non-participants whose cases will remain in the Fosamax ONJ MDL once the settlement is complete to submit expert reports in order for their cases to proceed any further. The ONJ Master Settlement Agreement has no effect on the cases alleging Femur Fractures discussed below.
Cases Alleging Femur Fractures
In March 2011, Merck submitted a Motion to Transfer to the JPML seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. The Motion to Transfer was granted in May 2011, and all federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (the “Fosamax Femur Fracture MDL”). As a result of the JPML order, approximately 1,040 cases were pending in the Fosamax Femur Fracture MDL as of March 31, 2015. A Case Management Order was entered requiring the parties to review 33 cases. Judge Joel Pisano selected four cases from that group to be tried as the initial bellwether cases in the Fosamax Femur Fracture MDL. The first bellwether case, Glynn v. Merck, began on April 8, 2013, and the jury returned a verdict in Merck’s favor on April 29, 2013; in addition, on June 27, 2013, Judge Pisano granted Merck’s motion for judgment as a matter of law in the Glynn case and held that the plaintiff’s failure to warn claim was preempted by federal law.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
In addition, Judge Pisano entered an order in August 2013 requiring plaintiffs in the Fosamax Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the court’s preemption decision in the Glynn case. A hearing on the show cause order was held in January 2014 and, on March 26, 2014, Judge Pisano issued an opinion finding that all claims of the approximately 650 plaintiffs who allegedly suffered injuries prior to September 14, 2010, were preempted and ordered that those cases be dismissed. The majority of those plaintiffs are appealing that ruling to the U.S. Court of Appeals for the Third Circuit. Furthermore, on June 17, 2014, Judge Pisano granted Merck summary judgment in the Gaynor v. Merck case and found that Merck’s updates in January 2011 to the Fosamax label regarding atypical femur fractures were adequate as a matter of law and that Merck adequately communicated those changes. The plaintiffs in Gaynor have appealed Judge Pisano’s decision to the Third Circuit. In August 2014, Merck filed a motion requesting that Judge Pisano enter a further order requiring all remaining plaintiffs in the Fosamax 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. Plaintiffs opposed that motion and asked the court to stay the remaining cases in the Fosamax Femur Fracture MDL until the Third Circuit rules on their appeal of Judge Pisano’s preemption decision, but Judge Pisano granted Merck’s motion and entered the requested show cause order in November 2014. In September 2014, Judge Pisano also ordered the parties to participate in a mediation process. On March 10, 2015, the Femur Fracture MDL was reassigned from Judge Pisano to Judge Freda L. Wolfson.
As of March 31, 2015, approximately 3,050 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.
As of March 31, 2015, approximately 515 cases alleging Femur Fractures have been filed in California state court. A petition was filed seeking to coordinate all Femur Fracture cases filed in California state court before a single judge in Orange County, California. The petition was granted and Judge Thierry Colaw is currently presiding over the coordinated proceedings. In March 2014, the court directed that a group of 10 discovery pool cases be reviewed through fact discovery and subsequently scheduled the Galper v. Merck case, which plaintiffs’ selected, as the first trial. The Galper trial began on February 17, 2015 and the jury returned a verdict in Merck’s favor on April 3, 2015. Two additional trials are scheduled for July and October 2015.
Additionally, there are six Femur Fracture cases pending in other state courts.
Discovery is ongoing in the Fosamax Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits.
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, 2015, approximately 860 product user claims were served on, and are pending against, Merck alleging generally that use of Januvia and/or Janumet caused the development of pancreatic cancer. These complaints were filed in several different state and federal courts. Most of the claims are pending in a consolidated multidistrict litigation proceeding in the U.S. District Court for the Southern District of California called “In re Incretin-Based Therapies Products Liability Litigation.” That proceeding includes federal lawsuits alleging pancreatic cancer due to use of the following medicines: Januvia, Janumet, Byetta and Victoza, the latter two of which are products manufactured by other pharmaceutical companies. In addition to the cases noted above, the Company has agreed, as of March 31, 2015, to toll the statute of limitations for approximately 20 additional claims. The Company intends to defend against these lawsuits.
NuvaRing
As previously disclosed, beginning in May 2007, a number of complaints were filed in various jurisdictions asserting claims against the Company’s subsidiaries Organon USA, Inc., Organon Pharmaceuticals USA, Inc., Organon International (collectively, “Organon”), and the Company arising from Organon’s marketing and sale of NuvaRing (the “NuvaRing Litigation”), a combined hormonal contraceptive vaginal ring. The plaintiffs contend that Organon and Schering-Plough, among other things, failed to adequately design and manufacture NuvaRing and failed to adequately warn of the alleged increased risk of venous thromboembolism (“VTE”) posed by NuvaRing, and/or downplayed the risk of VTE. The plaintiffs seek damages for injuries allegedly sustained from their product use, including some alleged deaths, heart attacks and strokes. The majority of the cases were pending in a federal multidistrict litigation (the “NuvaRing MDL”) venued in Missouri and in a coordinated proceeding in New Jersey state court.
Pursuant to a settlement agreement between Merck and negotiating plaintiffs’ counsel, which became effective as of June 4, 2014, Merck paid a lump total settlement of $100 million to resolve more than 95% of the cases filed and under retainer by counsel as of February 7, 2014. Plaintiffs in approximately 3,700 cases have joined the settlement program. The filed cases will be dismissed with prejudice once the settlement administration process is completed. The Company expects the first dismissals to begin in the second quarter and continue on a rolling basis throughout 2015. The Company has certain insurance coverage
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
available to it, which is currently being used to partially fund the Company’s legal fees. This insurance coverage has also been used to fund the settlement.
Plaintiffs not participating in the settlement who chose to proceed with their case in the NuvaRing MDL or New Jersey state court were obligated to meet various discovery and evidentiary requirements under the case management orders of the NuvaRing MDL and New Jersey state court. The majority of plaintiffs failed to fully and timely satisfy these requirements under set deadlines and were subject to an Order to Show Cause why their case should not be dismissed with prejudice. On January 22, 2015, the six cases in the New Jersey state court proceeding not participating in the settlement program were dismissed with prejudice for failing to satisfy the requirements set forth in the case management orders. For the same reason, in February and March 2015, approximately 60 cases were dismissed with prejudice in the NuvaRing MDL.
As of March 31, 2015, there were approximately 10 cases pending outside of the settlement program, inclusive of cases filed after the settlement program closed. Of these cases, nine are pending in the MDL and are subject to the case management orders requiring plaintiffs to meet various discovery and evidentiary requirements. As of March 31, 2015, five plaintiffs have met those requirements and will be permitted to continue to prosecute their cases.
Propecia/Proscar
As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar. As of March 31, 2015, approximately 1,290 lawsuits involving a total of approximately 1,580 plaintiffs (in a few instances spouses are joined as plaintiffs in the suits) who allege that they have experienced persistent sexual side effects following cessation of treatment with Propecia and/or Proscar have been filed against Merck. Approximately 55 of the plaintiffs also allege that Propecia or Proscar has caused or can cause prostate cancer or male breast cancer. The lawsuits have been filed in various federal courts and in state court in New Jersey. The federal lawsuits have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge John Gleeson of the Eastern District of New York. The matters pending in state court in New Jersey have been consolidated before Judge Jessica Mayer in Middlesex County. In addition, there is one matter pending in federal court in California. The Company intends to defend against these lawsuits.
Governmental Proceedings
As previously disclosed, the Company’s subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Company’s policy is to cooperate with these authorities and to provide responses as appropriate.
Patent Litigation
From time to time, generic manufacturers of pharmaceutical products file Abbreviated New Drug Applications (“ANDAs”) with the U.S. Food and Drug Administration (the “FDA”) seeking to market generic forms of the Company’s products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Certain products of the Company (or products marketed via agreements with other companies) currently involved in such patent infringement litigation in the United States include: Cancidas, Cubicin, Emend for Injection, Invanz, Nasonex, and NuvaRing. Similar lawsuits defending the Company’s patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by generic companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through mergers and acquisitions, potentially significant intangible asset impairment charges.
Cancidas — In February 2014, a patent infringement lawsuit was filed in the United States against Xellia Pharmaceuticals ApS (“Xellia”) with respect to Xellia’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cancidas. The lawsuit automatically stays FDA approval of Xellia’s application until July 2016 or until an adverse court decision, if any, whichever may occur earlier. In August 2014, a patent infringement lawsuit was filed in the United States against Fresenius Kabi USA, LLC (“Fresenius”) in respect of Fresenius’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cancidas. The lawsuit automatically stays FDA approval of Fresenius’s application until December 2016 or until an adverse court decision, if any, whichever may occur earlier.
Cubicin — In March 2012, a patent infringement lawsuit was filed in the United States against Hospira, Inc. (“Hospira”), with respect to Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. A trial was held in February 2014, and in December 2014 the district court found the composition patent, which expires in June 2016, to be valid and infringed. Later patents, expiring in September 2019 and November 2020, were found to be invalid. Hospira has appealed the finding that the composition patent is not invalid and the Company has cross-appealed the finding that the later patents are invalid. If the decision is upheld on appeal, Hospira’s application will not be approved until at least June 2016.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
In October 2013, a patent infringement lawsuit was filed in the United States against Strides, Inc. and Agila Specialties Private Limited (“Strides/Agila”), with respect to Strides/Agila’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. The lawsuit automatically stays FDA approval of Strides/Agila’s application until February 2016 or until an adverse court decision, if any, whichever may occur earlier. If the Hospira decision is upheld on appeal, Strides/Agila’s application will not be approved until at least June 2016.
In July 2014, a patent infringement lawsuit was filed in the United States against Fresenius, with respect to Fresenius’s application to the FDA seeking pre-patent expiry approval to market a generic version of Cubicin. The lawsuit automatically stays FDA approval of Fresenius’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. If the Hospira decision is upheld on appeal, Fresenius’s application will not be approved until at least June 2016.
An earlier district court action against Teva Parenteral Medicines Inc., Teva Pharmaceuticals USA, Inc. and Teva Pharmaceutical Industries Ltd. (collectively, “Teva”) resulted in a settlement whereby Teva can launch in December 2017 (June 2018 if the Company obtains pediatric marketing exclusivity on Cubicin). If the Hospira decision is upheld on appeal, Teva will be able to launch in June 2016.
In October 2014, Agila Specialties Inc. and Mylan Pharmaceuticals Inc. (“Agila/Mylan”) filed petitions for Inter Partes Review (“IPR”) at the United States Patent and Trademark Office (“USPTO”) seeking the invalidity of the September 2019 and November 2020 patents. In April 2015, Agila/Mylan withdrew its petitions for IPR in exchange for the Company agreeing to narrow the issues in the Strides/Agila lawsuit referenced above. In November 2014, Fresenius filed petitions for IPR at the USPTO seeking the invalidity of the September 2019 patents. The USPTO has six months from filing to determine whether it will institute the requested IPR proceedings.
Emend for Injection — In May 2012, a patent infringement lawsuit was filed in the United States against Sandoz Inc. (“Sandoz”) in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to market a generic version of Emend for Injection. The lawsuit automatically stays FDA approval of Sandoz’s application until July 2015 or until an adverse court decision, if any, whichever may occur earlier. The trial in the lawsuit against Sandoz was recently completed in the U.S. District Court for the District of New Jersey. The Company is currently awaiting the court’s decision. In June 2012, a patent infringement lawsuit was filed in the United States against Accord Healthcare, Inc. US, Accord Healthcare, Inc. and Intas Pharmaceuticals Ltd (collectively, “Intas”) in respect of Intas’ application to the FDA seeking pre-patent expiry approval to market a generic version of Emend for Injection. The Company has agreed with Intas to stay the lawsuit pending the outcome of the lawsuit with Sandoz. In July 2014, a patent infringement lawsuit was filed in the United States against Fresenius in respect of Fresenius’s application to the FDA seeking pre-patent expiry approval to market a generic version of Emend for Injection. The lawsuit automatically stays FDA approval of Fresenius’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. In December 2014, Apotex Inc. filed a petition for IPR at the USPTO seeking the invalidity of claims in the compound patent covering Emend for Injection. The USPTO has six months to determine whether it will institute the requested IPR proceedings.
Invanz — In July 2014, a patent infringement lawsuit was filed in the United States against Hospira in respect of Hospira’s application to the FDA seeking pre-patent expiry approval to market a generic version of Invanz. The lawsuit automatically stays FDA approval of Hospira’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. Also in July 2014, a patent infringement lawsuit was filed in the United States against Sandoz in respect to Sandoz’s application to the FDA seeking pre-patent approval to market a generic version of Invanz. As neither Hospira nor Sandoz challenged an earlier patent covering Invanz, both parties’ application to the FDA will not be approved until at least that patent expires in May 2016. In April 2015, Sandoz informed the FDA that it was no longer seeking pre-patent expiry approval.
Nasonex — In July 2014, a patent infringement lawsuit was filed in the United States against Teva Pharmaceuticals USA, Inc. (“Teva Pharma”) in respect of Teva Pharma’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Teva Pharma’s application until November 2016 or until an adverse court decision, if any, whichever may occur earlier. In March 2015, a patent infringement lawsuit was filed in the United States against Amneal Pharmaceuticals LLC (“Amneal”), in respect of Amneal’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex. The lawsuit automatically stays FDA approval of Amneal’s application until August 2017 or until an adverse court decision, if any, whichever may occur earlier.
A previous decision, issued in June 2013, held that the Merck patent in the Teva Pharma and Amneal lawsuits covering mometasone furoate monohydrate was valid, but that it was not infringed by Apotex Corp.’s proposed product. In April 2015, a patent infringement lawsuit was filed against Apotex Inc. and Apotex Corp. (“Apotex”) in respect of Apotex’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex that allegedly differs from the generic version in the previous lawsuit.
NuvaRing — In December 2013, the Company filed a lawsuit against a subsidiary of Actavis 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.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
Anti-PD-1 Antibody Patent Oppositions and Litigation
As previously disclosed, Ono Pharmaceutical Co. (“Ono”) has a European patent (EP 1 537 878) (“’878”) that broadly claims the use of an anti-PD-1 antibody, such as the Company’s immunotherapy, Keytruda, for the treatment of cancer. Ono has previously licensed its commercial rights to an anti-PD-1 antibody to Bristol-Myers Squibb (“BMS”) in certain markets. The Company believes that the ’878 patent is invalid and filed an opposition in the European Patent Office (the “EPO”) seeking its revocation. In June 2014, the Opposition Division of the EPO found the claims in the ’878 patent are valid. The Company received the Opposition Division’s written opinion in September 2014 and the Company submitted its substantive appeal in February 2015. In April 2014, the Company, and three other companies, opposed another European patent (EP 2 161 336) (“’336”) owned by BMS and Ono that it believes is invalid. The ’336 patent, if valid, broadly claims anti-PD-1 antibodies that could include Keytruda. BMS and Ono recently submitted a request to amend the claims of the ’336 patent. If the EPO allows this amendment, the claims of the ’336 patent would no longer broadly claim anti-PD-1 antibodies such as Keytruda.
In May 2014, the Company filed a lawsuit in the United Kingdom (“UK”) seeking revocation of the UK national versions of both the ’878 and ’336 patents. In July 2014, Ono and BMS sued the Company seeking a declaration that the ’878 patent would be infringed in the UK by the marketing of Keytruda. The Company has sought a declaration from the UK court that Keytruda will not infringe the ’336 patent in the UK. It is anticipated that the issues of validity and infringement of both patents will be heard at the same time by the UK court, which has scheduled the trial to begin in July 2015. BMS and Ono recently notified the Company of their request to amend the claims of the EPO ’336 patent and of their intention to seek permission from the court to similarly amend the UK national version so that the claims of the ’336 patent would no longer broadly claim anti-PD-1 antibodies such as Keytruda.
In February 2015, the Company filed lawsuits in the Netherlands seeking revocation of the Dutch national versions of both the ’878 and ’336 patents. Trials in these litigations are scheduled to begin in January and February 2016, respectively.
The Company can file lawsuits seeking revocation of the ’336 and ’878 patents in other national courts in Europe at any time, and Ono and BMS can file patent infringement actions against the Company in other national courts in Europe at or around the time the Company launches Keytruda (if approved). If a national court determines that the Company infringed a valid claim in the ’878 or ’336 patent, Ono and BMS may be entitled to monetary damages, including royalties on future sales of Keytruda, and potentially could seek an injunction to prevent the Company from marketing Keytruda in that country.
The USPTO granted US Patent Nos. 8,728,474 to Ono and 8,779,105 to Ono and BMS. These patents are equivalent to the ’878 and ’336 patents, respectively. In September 2014, BMS and Ono filed a lawsuit in the United States alleging that, by marketing Keytruda, the Company will infringe US Patent No. 8,728,474. BMS and Ono are not seeking to prevent or stop the marketing of Keytruda in the United States. The trial in this matter is currently scheduled to begin in November 2016. The Company believes that the 8,728,474 patent and the 8,779,105 patent are both invalid.
In September 2014, the Company filed a lawsuit in Australia seeking the revocation of Australian patent No. 2011203119, which is equivalent to the ’336 patent. In March 2015, BMS and Ono counterclaimed in this matter alleging that the Company’s manufacture and supply of Keytruda to the Australian market will infringe Australian patent No. 2011203119.
Ono and BMS have similar and other patents and applications, which the Company is closely monitoring, pending in the United States, Japan and other countries.
The Company is confident that it will be able to market Keytruda in any country in which it is approved and that it will not be prevented from doing so by the Ono or BMS patents or any pending applications.
Other Litigation
There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Company’s financial position, results of operations or cash flows either individually or in the aggregate.
Legal Defense Reserves
Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Company’s legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of March 31, 2015 and December 31, 2014 of approximately $240 million and $215 million, respectively, represents the Company’s best estimate of the minimum amount of defense costs to be incurred in
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so.
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Common Stock | Other Paid-In Capital | Retained Earnings | Accumulated Other Comprehensive Loss | Treasury Stock | Non- Controlling Interests | Total |
($ and shares in millions) | Shares | Par Value | Shares | Cost |
Balance at January 1, 2014 | 3,577 |
| $ | 1,788 |
| $ | 40,508 |
| $ | 39,257 |
| $ | (2,197 | ) | 650 |
| $ | (29,591 | ) | $ | 2,561 |
| $ | 52,326 |
|
Net income attributable to Merck & Co., Inc. | — |
| — |
| — |
| 1,705 |
| — |
| — |
| — |
| — |
| 1,705 |
|
Cash dividends declared on common stock | — |
| — |
| — |
| (1,301 | ) | — |
| — |
| — |
| — |
| (1,301 | ) |
Treasury stock shares purchased | — |
| — |
| — |
| — |
| — |
| 21 |
| (1,167 | ) | — |
| (1,167 | ) |
Share-based compensation plans and other | — |
| — |
| (58 | ) | — |
| — |
| (23 | ) | 1,013 |
| 3 |
| 958 |
|
Other comprehensive income | — |
| — |
| — |
| — |
| 18 |
| — |
| — |
| — |
| 18 |
|
Net income attributable to noncontrolling interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| 26 |
| 26 |
|
Distributions attributable to noncontrolling interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| (1 | ) | (1 | ) |
Balance at March 31, 2014 | 3,577 |
| $ | 1,788 |
| $ | 40,450 |
| $ | 39,661 |
| $ | (2,179 | ) | 648 |
| $ | (29,745 | ) | $ | 2,589 |
| $ | 52,564 |
|
Balance at January 1, 2015 | 3,577 |
| $ | 1,788 |
| $ | 40,423 |
| $ | 46,021 |
| $ | (4,323 | ) | 739 |
| $ | (35,262 | ) | $ | 144 |
| $ | 48,791 |
|
Net income attributable to Merck & Co., Inc. | — |
| — |
| — |
| 953 |
| — |
| — |
| — |
| — |
| 953 |
|
Cash dividends declared on common stock | — |
| — |
| — |
| (1,282 | ) | — |
| — |
| — |
| — |
| (1,282 | ) |
Treasury stock shares purchased | — |
| — |
| — |
| — |
| — |
| 17 |
| (1,015 | ) | — |
| (1,015 | ) |
Share-based compensation plans and other | — |
| — |
| (68 | ) | — |
| — |
| (7 | ) | 374 |
| 5 |
| 311 |
|
Other comprehensive income | — |
| — |
| — |
| — |
| 156 |
| — |
| — |
| — |
| 156 |
|
Net income attributable to noncontrolling interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| 5 |
| 5 |
|
Distributions attributable to noncontrolling interests | — |
| — |
| — |
| — |
| — |
| — |
| — |
| (2 | ) | (2 | ) |
Balance at March 31, 2015 | 3,577 |
| $ | 1,788 |
| $ | 40,355 |
| $ | 45,692 |
| $ | (4,167 | ) | 749 |
| $ | (35,903 | ) | $ | 152 |
| $ | 47,917 |
|
In connection with the 1998 restructuring of Astra Merck Inc., the Company assumed $2.4 billion par value preferred stock with a dividend rate of 5% per annum, which was carried by KBI and included in Noncontrolling interests on the Consolidated Balance Sheet. As discussed in Note 7, on June 30, 2014, AstraZeneca exercised its option to acquire Merck’s interest in AZLP and this preferred stock obligation was retired.
| |
11. | Share-Based Compensation Plans |
The Company has share-based compensation plans under which the Company grants restricted stock units (“RSUs”) and performance share units (“PSUs”) to certain management level employees. In addition, employees, non-employee directors and employees of certain of the Company’s equity method investees may be granted options to purchase shares of Company common stock at the fair market value at the time of grant.
The following table provides amounts of share-based compensation cost recorded in the Consolidated Statement of Income:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2015 | | 2014 |
Pretax share-based compensation expense | $ | 63 |
| | $ | 56 |
|
Income tax benefit | (19 | ) | | (17 | ) |
Total share-based compensation expense, net of taxes | $ | 44 |
| | $ | 39 |
|
Amounts in the table above do not reflect share-based compensation costs to settle non-vested Cubist equity awards attributable to postcombination service that were recognized as transaction expense in the first quarter of 2015 (see Note 3).
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
During the first three months of 2015 and 2014, the Company granted 87 thousand RSUs with a weighted-average grant date fair value of $58.33 per RSU and 49 thousand RSUs with a weighted-average grant date fair value of $54.89 per RSU, respectively. During the first three months of 2015 and 2014, the Company granted 95 thousand stock options with a weighted-average exercise price of $58.33 per option and 80 thousand stock options with a weighted-average exercise price of $54.89 per option, respectively. The weighted-average fair value of options granted for the first three months of 2015 and 2014 was $6.98 and $8.10 per option, respectively, and was determined using the following assumptions:
|
| | | | | |
| Three Months Ended March 31, |
| 2015 | | 2014 |
Expected dividend yield | 4.2 | % | | 4.2 | % |
Risk-free interest rate | 1.7 | % | | 2.1 | % |
Expected volatility | 21.7 | % | | 24.2 | % |
Expected life (years) | 6.3 |
| | 7.0 |
|
At March 31, 2015, there was $660 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted-average period of 2.3 years. For segment reporting, share-based compensation costs are unallocated expenses.
The Company typically communicates the value of annual share-based compensation awards to employees during the first quarter, but the related share amounts are not established and communicated until early May. Therefore, while the number of RSU and stock option grants disclosed above do not reflect any amounts relating to the annual grants, share-based compensation costs for the first quarter of 2015 and 2014 and unrecognized compensation expense at March 31, 2015 reflect an impact relating to the awards communicated to employees. For segment reporting, share-based compensation costs are unallocated expenses.
| |
12. | Pension and Other Postretirement Benefit Plans |
The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. The net periodic benefit cost of such plans consisted of the following components:
|
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2015 | | 2014 |
($ in millions) | U.S. | | International | | U.S. | | International |
Service cost | $ | 83 |
| | $ | 66 |
| | $ | 83 |
| | $ | 68 |
|
Interest cost | 109 |
| | 53 |
| | 107 |
| | 68 |
|
Expected return on plan assets | (206 | ) | | (97 | ) | | (195 | ) | | (105 | ) |
Net amortization | 43 |
| | 27 |
| | 14 |
| | 13 |
|
Termination benefits | 16 |
| | 1 |
| | 13 |
| | 1 |
|
Curtailments | (7 | ) | | — |
| | (9 | ) | | — |
|
Settlements | — |
| | 2 |
| | — |
| | — |
|
| $ | 38 |
| | $ | 52 |
| | $ | 13 |
| | $ | 45 |
|
The Company provides medical benefits, principally to its eligible U.S. retirees and similar benefits to their dependents, through its other postretirement benefit plans. The net cost of such plans consisted of the following components:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2015 | | 2014 |
Service cost | $ | 20 |
| | $ | 19 |
|
Interest cost | 27 |
| | 28 |
|
Expected return on plan assets | (36 | ) | | (34 | ) |
Net amortization | (15 | ) | | (18 | ) |
Termination benefits | 4 |
| | 4 |
|
Curtailments | (6 | ) | | (20 | ) |
| $ | (6 | ) | | $ | (21 | ) |
In connection with restructuring actions (see Note 2), termination charges were recorded on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
restructuring actions, curtailments and settlements were recorded on pension and other postretirement benefit plans as reflected in the tables above.
| |
13. | Other (Income) Expense, Net |
Other (income) expense, net, consisted of:
|
| | | | | | | |
| Three Months Ended March 31, |
($ in millions) | 2015 | | 2014 |
Interest income | $ | (74 | ) | | $ | (61 | ) |
Interest expense | 164 |
| | 188 |
|
Exchange losses | 95 |
| | 34 |
|
Equity income from affiliates | (145 | ) | | (124 | ) |
Other, net | 15 |
| | (200 | ) |
| $ | 55 |
| | $ | (163 | ) |
The increase in equity income from affiliates is due to higher equity income from certain research investment funds, partially offset by lower equity income resulting from the termination of the Company’s relationship with AZLP (see Note 7) on June 30, 2014. Other, net in the first quarter of 2015 includes an expense of $78 million for a contribution of investments in equity securities to the Merck Company Foundation. Other, net in the first quarter of 2014 includes a gain of $182 million related to the divestiture of Sirna (see Note 3).
Interest paid for the three months ended March 31, 2015 and 2014 was $138 million and $168 million, respectively.
The effective income tax rates of 30.6% and 17.2% for the first quarter of 2015 and 2014, respectively, reflect the impacts of acquisition and divestiture-related costs and restructuring costs, partially offset by the beneficial impact of foreign earnings. The effective income tax rate for the first quarter of 2014 includes a benefit of approximately $300 million associated with a capital loss generated in the quarter related to the sale of Sirna (see Note 3).
The calculations of earnings per share are as follows:
|
| | | | | | | |
| Three Months Ended March 31, |
($ and shares in millions except per share amounts) | 2015 | | 2014 |
Net income attributable to Merck & Co., Inc. | $ | 953 |
| | $ | 1,705 |
|
| | | |
Average common shares outstanding | 2,835 |
| | 2,934 |
|
Common shares issuable (1) | 30 |
| | 37 |
|
Average common shares outstanding assuming dilution | 2,865 |
| | 2,971 |
|
| | | |
Basic earnings per common share attributable to Merck & Co., Inc. common shareholders | $ | 0.34 |
| | $ | 0.58 |
|
Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders | $ | 0.33 |
| | $ | 0.57 |
|
| |
(1) | Issuable primarily under share-based compensation plans. |
For the three months ended March 31, 2015 and 2014, 3 million and 1 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.
Notes to Interim Consolidated Financial Statements (unaudited) (continued)
| |
16. | Other Comprehensive Income (Loss) |