Item 8. Financial Statements and Supplementary Data.

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Item 8. Financial Statements and Supplementary Data.


(a)	Financial Statements

The consolidated balance sheet of Merck & Co., Inc. and subsidiaries as of December 31, 2018 and 2017, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2018, the notes to consolidated financial statements, and the report dated February 27, 2019 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows:

Consolidated Statement of Income

Merck & Co., Inc. and Subsidiaries

Years Ended December 31

($ in millions except per share amounts)



	2018			2017			2016
Sales	$	42,294		$	40,122		$	39,807
Costs, Expenses and Other
Cost of sales	13,509			12,912			14,030
Selling, general and administrative	10,102			10,074			10,017
Research and development	9,752			10,339			10,261
Restructuring costs	632			776			651
Other (income) expense, net	(402		)	(500		)	189
	33,593			33,601			35,148
Income Before Taxes	8,701			6,521			4,659
Taxes on Income	2,508			4,103			718
Net Income	6,193			2,418			3,941
Less: Net (Loss) Income Attributable to Noncontrolling Interests	(27		)	24			21
Net Income Attributable to Merck & Co., Inc.	$	6,220		$	2,394		$	3,920
Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders	$	2.34		$	0.88		$	1.42
Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders	$	2.32		$	0.87		$	1.41

Consolidated Statement of Comprehensive Income

Merck & Co., Inc. and Subsidiaries

Years Ended December 31

($ in millions)



	2018			2017			2016
Net Income Attributable to Merck & Co., Inc.	$	6,220		$	2,394		$	3,920
Other Comprehensive (Loss) Income Net of Taxes:
Net unrealized gain (loss) on derivatives, net of reclassifications	297			(446		)	(66		)
Net unrealized loss on investments, net of reclassifications	(10		)	(58		)	(44		)
Benefit plan net (loss) gain and prior service (cost) credit, net of amortization	(425		)	419			(799		)
Cumulative translation adjustment	(223		)	401			(169		)
	(361		)	316			(1,078		)
Comprehensive Income Attributable to Merck & Co., Inc.	$	5,859		$	2,710		$	2,842

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

Consolidated Balance Sheet

Merck & Co., Inc. and Subsidiaries

December 31

($ in millions except per share amounts)



	2018			2017
Assets
Current Assets
Cash and cash equivalents	$	7,965		$	6,092
Short-term investments	899			2,406
Accounts receivable (net of allowance for doubtful accounts of $119 in 2018 and $159 in 2017)	7,071			6,873
Inventories (excludes inventories of $1,417 in 2018 and $1,187 in 2017 classified in Other assets - see Note 7)	5,440			5,096
Other current assets	4,500			4,299
Total current assets	25,875			24,766
Investments	6,233			12,125
Property, Plant and Equipment (at cost)
Land	333			365
Buildings	11,486			11,726
Machinery, equipment and office furnishings	14,441			14,649
Construction in progress	3,355			2,301
	29,615			29,041
Less: accumulated depreciation	16,324			16,602
	13,291			12,439
Goodwill	18,253			18,284
Other Intangibles, Net	11,431			14,183
Other Assets	7,554			6,075
	$	82,637		$	87,872
Liabilities and Equity
Current Liabilities
Loans payable and current portion of long-term debt	$	5,308		$	3,057
Trade accounts payable	3,318			3,102
Accrued and other current liabilities	10,151			10,427
Income taxes payable	1,971			708
Dividends payable	1,458			1,320
Total current liabilities	22,206			18,614
Long-Term Debt	19,806			21,353
Deferred Income Taxes	1,702			2,219
Other Noncurrent Liabilities	12,041			11,117
Merck & Co., Inc. Stockholders’ Equity
Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2018 and 2017	1,788			1,788
Other paid-in capital	38,808			39,902
Retained earnings	42,579			41,350
Accumulated other comprehensive loss	(5,545		)	(4,910		)
	77,630			78,130
Less treasury stock, at cost: 984,543,979 shares in 2018 and 880,491,914 shares in 2017	50,929			43,794
Total Merck & Co., Inc. stockholders’ equity	26,701			34,336
Noncontrolling Interests	181			233
Total equity	26,882			34,569
	$	82,637		$	87,872

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

Consolidated Statement of Equity

Merck & Co., Inc. and Subsidiaries

Years Ended December 31

($ in millions except per share amounts)



	Common Stock		Other Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Treasury Stock			Non- controlling Interests			Total
Balance January 1, 2016		$1,788	$	40,222		$	45,348		$	(4,148	)	$	(38,534	)	$	91		$	44,767
Net income attributable to Merck & Co., Inc.	—		—			3,920			—			—			—			3,920
Other comprehensive loss, net of taxes	—		—			—			(1,078		)	—			—			(1,078		)
Cash dividends declared on common stock ($1.85 per share)	—		—			(5,135		)	—			—			—			(5,135		)
Treasury stock shares purchased	—		—			—			—			(3,434		)	—			(3,434		)
Acquisition of The StayWell Company LLC	—		—			—			—			—			124			124
Net income attributable to noncontrolling interests	—		—			—			—			—			21			21
Distributions attributable to noncontrolling interests	—		—			—			—			—			(16		)	(16		)
Share-based compensation plans and other	—		(283		)	—			—			1,422			—			1,139
Balance December 31, 2016	1,788		39,939			44,133			(5,226		)	(40,546		)	220			40,308
Net income attributable to Merck & Co., Inc.	—		—			2,394			—			—			—			2,394
Other comprehensive income, net of taxes	—		—			—			316			—			—			316
Cash dividends declared on common stock ($1.89 per share)	—		—			(5,177		)	—			—			—			(5,177		)
Treasury stock shares purchased	—		—			—			—			(4,014		)	—			(4,014		)
Acquisition of Vallée S.A.	—		—			—			—			—			7			7
Net income attributable to noncontrolling interests	—		—			—			—			—			24			24
Distributions attributable to noncontrolling interests	—		—			—			—			—			(18		)	(18		)
Share-based compensation plans and other	—		(37		)	—			—			766			—			729
Balance December 31, 2017	1,788		39,902			41,350			(4,910		)	(43,794		)	233			34,569
Net income attributable to Merck & Co., Inc.	—		—			6,220			—			—			—			6,220
Adoption of new accounting standards (see Note 2)	—		—			322			(274		)	—			—			48
Other comprehensive loss, net of taxes	—		—			—			(361		)	—			—			(361		)
Cash dividends declared on common stock ($1.99 per share)	—		—			(5,313		)	—			—			—			(5,313		)
Treasury stock shares purchased	—		(1,000		)	—			—			(8,091		)	—			(9,091		)
Net loss attributable to noncontrolling interests	—		—			—			—			—			(27		)	(27		)
Distributions attributable to noncontrolling interests	—		—			—			—			—			(25		)	(25		)
Share-based compensation plans and other	—		(94		)	—			—			956			—			862
Balance December 31, 2018	$	1,788	$	38,808		$	42,579		$	(5,545	)	$	(50,929	)	$	181		$	26,882

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

Consolidated Statement of Cash Flows

Merck & Co., Inc. and Subsidiaries

Years Ended December 31

($ in millions)



	2018			2017			2016
Cash Flows from Operating Activities
Net income	$	6,193		$	2,418		$	3,941
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	4,519			4,676			5,471
Intangible asset impairment charges	296			646			3,948
Charge for future payments related to collaboration license options	650			500			—
Provisional charge for one-time transition tax related to the enactment of U.S. tax legislation	—			5,347			—
Charge related to the settlement of worldwide Keytruda patent litigation	—			—			625
Deferred income taxes	(509		)	(2,621		)	(1,521		)
Share-based compensation	348			312			300
Other	978			190			213
Net changes in assets and liabilities:
Accounts receivable	(418		)	297			(619		)
Inventories	(911		)	(145		)	206
Trade accounts payable	230			254			278
Accrued and other current liabilities	(341		)	(922		)	(2,018		)
Income taxes payable	827			(3,291		)	124
Noncurrent liabilities	(266		)	(123		)	(809		)
Other	(674		)	(1,087		)	237
Net Cash Provided by Operating Activities	10,922			6,451			10,376
Cash Flows from Investing Activities
Capital expenditures	(2,615		)	(1,888		)	(1,614		)
Purchases of securities and other investments	(7,994		)	(10,739		)	(15,651		)
Proceeds from sales of securities and other investments	15,252			15,664			14,353
Acquisitions, net of cash acquired	(431		)	(396		)	(780		)
Other	102			38			482
Net Cash Provided by (Used in) Investing Activities	4,314			2,679			(3,210		)
Cash Flows from Financing Activities
Net change in short-term borrowings	5,124			(26		)	—
Payments on debt	(4,287		)	(1,103		)	(2,386		)
Proceeds from issuance of debt	—			—			1,079
Purchases of treasury stock	(9,091		)	(4,014		)	(3,434		)
Dividends paid to stockholders	(5,172		)	(5,167		)	(5,124		)
Proceeds from exercise of stock options	591			499			939
Other	(325		)	(195		)	(118		)
Net Cash Used in Financing Activities	(13,160		)	(10,006		)	(9,044		)
Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash	(205		)	457			(131		)
Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash	1,871			(419		)	(2,009		)
Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $4 million of restricted cash at January 1, 2018 included in Other Assets)	6,096			6,515			8,524
Cash, Cash Equivalents and Restricted Cash at End of Year (includes $2 million of restricted cash at December 31, 2018 included in Other Assets)	$	7,967		$	6,096		$	6,515

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

Notes to Consolidated Financial Statements

Merck & Co., Inc. and Subsidiaries

($ in millions except per share amounts)

Nature of Operations

Merck & Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Company’s operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments.

The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. In 2017, Merck began recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate.

The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers.

The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients.

The Alliances segment primarily includes activity from the Company’s relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018 (see Note 9).

Summary of Accounting Policies

Principles of Consolidation — The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders’ interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis.

Acquisitions — In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. 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. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Company’s intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Company’s consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the

definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPR&D) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date.

Foreign Currency Translation — The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) (AOCI) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net.

Cash Equivalents — Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months.

Inventories — Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process.

Investments — Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Company’s investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or 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. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income (OCI). The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net, is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI. Realized gains and losses for debt securities are included in Other (income) expense, net.

Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net. Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net. Realized gains and losses for equity securities are included in Other (income) expense, net.

Revenue Recognition — On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers, and subsequent amendments (ASC 606 or new guidance), using the modified retrospective method. Merck applied the new guidance to all contracts with customers within the scope of the standard that were in effect on January 1, 2018 and recognized the cumulative effect of initially applying the new guidance as an adjustment to the opening balance of retained earnings (see “Recently Adopted Accounting Standards” below). Comparative information for prior periods has not been restated and continues to be reported under the accounting standards in effect for those periods.

The new guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services. The new guidance introduces a 5-step model to recognize revenue when or as control is transferred: identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when or as the performance obligations are satisfied. Changes to the Company’s revenue recognition policy as a result of adopting ASC 606 are described below. See Note 19 for disaggregated revenue disclosures.

Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Company’s contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation.

The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. Certain Merck entities, including U.S. entities, have contract terms under which control of the goods passes to the customer upon shipment; however, either pursuant to the terms of the contract or as a business practice, Merck retains responsibility for goods lost or damaged in transit. Prior to the adoption of the new standard, Merck would recognize revenue for these entities upon delivery of the goods. Under the new guidance, the Company is now recognizing revenue at time of shipment for these entities.

The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation, Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile. This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance.

For businesses within the Company’s Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material.

The nature of the Company’s business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts.

In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year.

The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $10.7 billion in 2018, $10.7 billion in 2017 and $9.7 billion in 2016. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Company’s wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts

are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $245 million and $2.4 billion, respectively, at December 31, 2018 and were $198 million and $2.4 billion, respectively, at December 31, 2017.

Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the government’s total unbudgeted spending and the Company’s specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale.

The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. Outside of the United States, returns are only allowed in certain countries on a limited basis.

Merck’s payment terms for U.S. pharmaceutical customers are typically net 36 days from receipt of invoice and for U.S. animal health customers are typically net 30 days from receipt of invoice; however, certain products, including Keytruda, have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms.

The following table provides the effects of adopting ASC 606 on the Consolidated Statement of Income:



Year Ended December 31, 2018	As Reported		Effects of Adopting ASC 606			Amounts Without Adoption of ASC 606
Sales	$	42,294	$	(2	)	$	42,292
Cost of sales	13,509		(6		)	13,503
Income before taxes	8,701		4			8,705
Taxes on income	2,508		1			2,509
Net income attributable to Merck & Co., Inc.	6,220		3			6,223

The following table provides the effects of adopting ASC 606 on the Consolidated Balance Sheet:



December 31, 2018	As Reported		Effects of Adopting ASC 606			Amounts Without Adoption of ASC 606
Assets
Accounts receivable	$	7,071	$	(13	)	$	7,058
Inventories	5,440		7			5,447
Liabilities
Accrued and other current liabilities	10,151		(3		)	10,148
Income taxes payable	1,971		(1		)	1,970
Equity
Retained earnings	42,579		(2		)	42,577

Depreciation — Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings, and from 3 to 15 years for Machinery, equipment and office furnishings. Depreciation expense was $1.4 billion in 2018, $1.5 billion in 2017 and $1.6 billion in 2016.

Advertising and Promotion Costs — Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $2.1 billion, $2.2 billion and $2.1 billion in 2018, 2017 and 2016, respectively.

Software Capitalization — The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. Capitalized software costs are included in Property, plant and equipment and amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with projects that are being amortized over 6 to 10 years (including the Company’s on-going multi-year implementation of an enterprise-wide resource planning system) were $439 million and $449 million, net of accumulated amortization at December 31, 2018 and 2017, respectively. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred.

Goodwill — Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill).

Acquired Intangibles — Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 20 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows.

Acquired In-Process Research and Development — Acquired IPR&D that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company tests IPR&D for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPR&D intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPR&D intangible asset with its carrying value is performed. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results.

Contingent Consideration — Certain of the Company’s business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is 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 the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings.

Research and Development — Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the

activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPR&D impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval.

Collaborative Arrangements — Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales. When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses.

In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued when probable of being achieved and capitalized, subject to cumulative amortization catch-up. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing.

Share-Based Compensation — The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards.

Restructuring Costs — The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period.

Contingencies and Legal Defense Costs — The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated.

Taxes on Income — Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest

and penalties associated with uncertain tax positions as a component of Taxes on income in the Consolidated Statement of Income.

Use of Estimates — The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on management’s best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPR&D, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates.

Reclassifications — Certain reclassifications have been made to prior year amounts to conform to the current year presentation.

Recently Adopted Accounting Standards — In May 2014, the Financial Accounting Standards Board (FASB) issued amended accounting guidance on revenue recognition (ASU 2014-09) that applies 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. The new standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of adopting the guidance being recognized at the date of initial application (modified retrospective method). The new standard was effective as of January 1, 2018 and was adopted using the modified retrospective method. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $5 million.

In January 2016, the FASB issued revised guidance for the accounting and reporting of financial instruments (ASU 2016-01) and in 2018 issued related technical corrections (ASU 2018-03). The new guidance requires that equity investments with readily determinable fair values currently classified as available for sale be measured at fair value with changes in fair value recognized in net income. The Company has elected to measure equity investments without readily determinable fair values at cost, adjusted for subsequent observable price changes and less impairments, which will be recognized in net income. The new guidance also changed certain disclosure requirements. ASU 2016-01 was effective as of January 1, 2018 and was adopted using a modified retrospective approach. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $8 million. ASU 2018-03 was also adopted as of January 1, 2018 on a prospective basis and did not result in any additional impacts upon adoption.

In October 2016, the FASB issued guidance on the accounting for the income tax consequences of intra-entity transfers of assets other than inventory (ASU 2016-16). The new guidance requires the recognition of the income tax consequences of an intra-entity transfer of an asset (with the exception of inventory) when the intra-entity transfer occurs, replacing the prohibition against doing so. The current exception to defer the recognition of any tax impact on the transfer of inventory within the consolidated entity until it is sold to a third party remains unaffected. The new standard was effective as of January 1, 2018 and was adopted using a modified retrospective approach. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $54 million with a corresponding decrease to Deferred Income Taxes.

In August 2017, the FASB issued new guidance on hedge accounting (ASU 2017-12) that is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The new guidance makes more financial and nonfinancial hedging strategies eligible for hedge accounting, amends the presentation and disclosure requirements, and changes how companies assess effectiveness. The Company elected to early adopt this guidance as of January 1, 2018 on a modified retrospective basis. The new guidance was applied to all existing hedges as of the adoption date. For fair value hedges of interest rate risk outstanding as of the date of adoption, the Company recorded a cumulative-effect adjustment upon adoption to the basis adjustment on the hedged item resulting from applying the benchmark component of the coupon guidance. This adjustment decreased Retained earnings by $11 million. Also, in

accordance with the transition provisions of ASU 2017-12, the Company was required to eliminate the separate measurement of ineffectiveness for its cash flow hedging instruments existing as of the adoption date through a cumulative-effect adjustment to retained earnings; however, all such amounts were de minimis.

In February 2018, the FASB issued new guidance to address a narrow-scope financial reporting issue that arose as a consequence of the Tax Cuts and Jobs Act of 2017 (TCJA) (ASU 2018-02). Existing guidance requires that deferred tax liabilities and assets be adjusted for a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. That guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income (rather than in net income), such as amounts related to benefit plans and hedging activity. As a result, the tax effects of items within accumulated other comprehensive income do not reflect the appropriate tax rate (the difference is referred to as stranded tax effects). The new guidance allows for a reclassification of the stranded tax effects resulting from the TCJA from accumulated other comprehensive income to retained earnings thereby eliminating these stranded tax effects. The Company elected to early adopt the new guidance in the first quarter of 2018 and reclassified the stranded income tax effects of the TCJA, increasing Accumulated other comprehensive loss in the amount of $266 million with a corresponding increase to Retained earnings (see Note 18). The Company’s policy for releasing disproportionate income tax effects from Accumulated other comprehensive loss is to utilize the item-by-item approach.

The impact of adopting the above standards is as follows:



($ in millions)	ASU 2014-09 (Revenue)		ASU 2016-01 (Financial Instruments)		ASU 2016-16 (Intra-Entity Transfers of Assets Other than Inventory)		ASU 2017-12 (Derivatives and Hedging)		ASU 2018-02 (Reclassification of Certain Tax Effects)		Total
Assets - Increase (Decrease)
Accounts receivable	$	5									$	5
Liabilities - Increase (Decrease)
Income Taxes Payable							(3	)			(3		)
Debt							14				14
Deferred Income Taxes					(54	)					(54		)
Equity - Increase (Decrease)
Retained earnings	5		8		54		(11	)	266		322
Accumulated other comprehensive loss			(8	)					(266	)	(274		)

In March 2017, the FASB issued amended guidance on retirement benefits (ASU 2017-07) related to net periodic benefit cost for defined benefit plans that requires entities to (1) disaggregate the current service cost component from the other components of net benefit cost and present it with other employee compensation costs in the income statement within operations if such a subtotal is presented; (2) present the other components of net benefit cost separately in the income statement and outside of income from operations; and (3) only capitalize the service cost component when applicable. The Company adopted the new standard as of January 1, 2018 using a retrospective transition method as to the requirement for separate presentation in the income statement of service costs and other components, and a prospective transition method as to the requirement to limit the capitalization of benefit costs to the service cost component. The Company utilized a practical expedient that permits it to use the amounts disclosed in its pension and other postretirement benefit plan note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. Upon adoption, net periodic benefit cost (credit) other than service cost of $(512) million and $(531) million for the years ended December 31, 2017 and 2016, respectively, was reclassified to Other (income) expense, net from the previous classification within Cost of sales, Selling, general and administrative expenses and Research and development expenses (see Note 15).

In August 2016, the FASB issued guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice. The Company adopted the new standard effective as of January 1, 2018 using a retrospective application. There were no changes to the presentation of the Consolidated Statement of Cash Flows in the previous years presented as a result of adopting the new standard.

In November 2016, the FASB issued guidance requiring that amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard was effective as of January 1, 2018 and was adopted using a retrospective application. The adoption of the new guidance did not have a material effect on the Company’s Consolidated Statement of Cash Flows.

In May 2017, the FASB issued guidance clarifying when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The Company adopted the new standard effective as of January 1, 2018 and will apply the new guidance to future share-based payment award modifications should they occur.

In January 2017, the FASB issued guidance that provides for the elimination of Step 2 from the goodwill impairment test. Under the new guidance, impairment charges are recognized to the extent the carrying amount of a reporting unit exceeds its fair value with certain limitations. The Company adopted the new standard in the fourth quarter of 2018 and applied the new guidance for purposes of its fourth quarter goodwill impairment assessment. The adoption of the new guidance had an immaterial effect on its consolidated financial statements.

Recently Issued Accounting Standards Not Yet Adopted —In February 2016, the FASB issued new accounting guidance for the accounting and reporting of leases and subsequently issued several updates to the new guidance. The new guidance requires that lessees recognize a right-of-use asset and a lease liability recorded on the balance sheet for each of its leases (other than leases that meet the definition of a short-term lease). Leases will be classified as either operating or finance. Operating leases will result in straight-line expense in the income statement (similar to current operating leases) while finance leases will result in more expense being recognized in the earlier years of the lease term (similar to current capital leases). The new standard is effective as of January 1, 2019 and will be adopted using a modified retrospective approach. Merck will elect the transition method that allows for application of the standard at the adoption date rather than at the beginning of the earliest comparative period presented in the financial statements. The Company intends to elect available practical expedients. Merck has implemented a lease accounting software application and has completed data validation of the Company’s portfolio of leases, including its assessment of potential embedded leases. Upon adoption, the Company anticipates it will recognize approximately $1 billion of additional assets and corresponding liabilities on its consolidated balance sheet, subject to finalization.

In June 2016, the FASB issued amended guidance on the accounting for credit losses on financial instruments. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for interim and annual periods beginning in 2020, with earlier application permitted in 2019. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings in the beginning of the period of adoption. The Company is currently evaluating the impact of adoption on its consolidated financial statements.

In April 2018, the FASB issued new guidance on the accounting for costs incurred to implement a cloud computing arrangement that is considered a service arrangement. The new guidance requires the capitalization of such costs, aligning it with the accounting for costs associated with developing or obtaining internal-use software. The new guidance is effective for interim and annual periods beginning in 2020. Early adoption is permitted, including adoption in any interim period. Prospective adoption for eligible costs incurred on or after the date of adoption or retrospective adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements and may elect to early adopt this guidance.

In November 2018, the FASB issued new guidance for collaborative arrangements intended to reduce diversity in practice by clarifying whether certain transactions between collaborative arrangement participants should be accounted for under the recently issued guidance on revenue recognition (ASC 606). The new guidance is effective for interim and annual periods beginning in 2020. Early adoption is permitted, including adoption in any interim period. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings. The Company is currently evaluating the impact of adoption on its consolidated financial statements.

Acquisitions, Divestitures, Research Collaborations and License Agreements

The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Company’s financial results.

Recently Announced Transaction

In December 2018, Merck and privately held Antelliq Group (Antelliq) signed a definitive agreement under which Merck will acquire Antelliq from funds advised by BC Partners. Antelliq is a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck will make a cash payment of approximately €2.1 billion (approximately $2.4 billion based on exchange rates at the time of the announcement) to acquire all outstanding shares of Antelliq and will assume Antelliq’s debt of €1.1 billion (approximately $1.3 billion), which it intends to repay shortly after the closing of the acquisition. The transaction is subject to clearance by antitrust and competition law authorities and other customary closing conditions, and is expected to close in the second quarter of 2019.

2018 Transactions

In 2018, the Company recorded an aggregate charge of $423 million within Cost of sales in conjunction with the termination of a collaboration agreement entered into in 2014 with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine. The charge reflects a termination payment of $155 million, which represents the reimbursement of all fees previously paid by Samsung to Merck under the agreement, plus interest, as well as the release of Merck’s ongoing obligations under the agreement. The charge also included fixed asset abandonment charges of $137 million, inventory write-offs of $122 million, as well as other related costs of $9 million. The termination of this agreement has no impact on the Company’s other collaboration with Samsung.

In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ($378 million). The transaction provided Merck with full rights to Cavatak (V937, formerly CVA21), Viralytics’s investigational oncolytic immunotherapy. Cavatak is based on Viralytics’s proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. Cavatak is currently being evaluated in multiple Phase 1 and Phase 2 clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda. Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and Cavatak combination in melanoma, prostate, lung and bladder cancers. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $34 million (primarily cash) at the acquisition date and Research and development expenses of $344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition.

In March 2018, Merck and Eisai Co., Ltd. (Eisai) entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai (see Note 4).

2017 Transactions

In October 2017, Merck acquired Rigontec GmbH (Rigontec). Rigontec is a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontec’s lead candidate, MK-4621 (formerly RGT100), is currently in Phase I development evaluating treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of €119 million ($140 million) and may make additional contingent payments of up to €349 million (of which €184 million are related to the achievement of research milestones and regulatory approvals and €165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017.

In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZeneca’s Lynparza for multiple cancer types (see Note 4).

In March 2017, Merck acquired a controlling interest in Vallée S.A. (Vallée), a leading privately held producer of animal health products in Brazil. Vallée has an extensive portfolio of products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5% of the shares of Vallée for $358 million. Of the total purchase price, $176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $297 million related to currently marketed products, net deferred tax liabilities of $102 million, other net assets of $32 million and noncontrolling interest of $25 million. In addition, the Company recorded liabilities of $37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $37 million, representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $156 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The probability-adjusted future net cash flows of each product were discounted to present value utilizing a discount rate of 15.5%. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years. In the fourth quarter of 2017, Merck acquired an additional 4.5% interest in Vallée for $18 million, which reduced the noncontrolling interest related to Vallée.

2016 Transactions

In July 2016, Merck acquired Afferent Pharmaceuticals (Afferent), a privately held pharmaceutical company focused on the development of therapeutic candidates targeting the P2X3 receptor for the treatment of common, poorly-managed, neurogenic conditions. Afferent’s lead investigational candidate, MK-7264 (formerly AF-219), gefapixant, is a selective, non-narcotic, orally-administered P2X3 antagonist being evaluated for the treatment of refractory, chronic cough and for the treatment of endometriosis-related pain. Total consideration transferred of $510 million included cash paid for outstanding Afferent shares of $487 million, as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Afferent. In addition, former Afferent shareholders are eligible to receive a total of up to an additional $750 million contingent upon the attainment of certain clinical development and commercial milestones for multiple indications and candidates, including MK-7264. This transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $223 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payment. Merck recognized an intangible asset for IPR&D of $832 million, net deferred tax liabilities of $258 million, and other net assets of $29 million (primarily consisting of cash acquired). The excess of the consideration transferred over the fair value of net assets acquired of $130 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPR&D was determined using an income approach. The asset’s probability-adjusted future net cash flows were discounted to present value using a discount rate of 11.5%. Actual cash flows are likely to be different than those assumed. In 2018, as a result of the achievement of a clinical development milestone, Merck made a $175 million payment, which was accrued for at estimated fair value at the time of acquisition as noted above. The contingent consideration liability was then remeasured at current fair value at each subsequent reporting period until payment was made (see Note 6).

In June 2016, Merck and Moderna Therapeutics (Moderna) entered into a strategic collaboration and license agreement to develop and commercialize novel messenger RNA (mRNA)-based personalized cancer vaccines. The development program will entail multiple studies in several types of cancer and include the evaluation of mRNA-based personalized cancer vaccines in combination with Merck’s Keytruda. Pursuant to the terms of the agreement, Merck made an upfront cash payment to Moderna of $200 million, which was recorded in Research and development expenses. Following human proof of concept studies, Merck has the right to elect to make an additional payment to Moderna. If Merck exercises this right, the two companies will then equally share costs and profits under a worldwide collaboration for the development of personalized cancer vaccines. Moderna will have the right to elect to co-promote the personalized cancer vaccines in the United States. The agreement entails exclusivity around combinations with Keytruda. Moderna and Merck each have the ability to combine mRNA-based personalized cancer vaccines with other (non-PD-1) agents.

In January 2016, Merck acquired IOmet Pharma Ltd (IOmet), a privately held UK-based drug discovery company focused on the development of innovative medicines for the treatment of cancer, with a particular emphasis on the fields of cancer immunotherapy and cancer metabolism. The acquisition provided Merck with IOmet’s preclinical pipeline of IDO (indoleamine-2,3-dioxygenase 1), TDO (tryptophan-2,3-dioxygenase), and dual-acting IDO/TDO inhibitors. The transaction was accounted for as an acquisition of a business. Total purchase consideration in the transaction included a cash payment of $150 million and future additional milestone payments of up to $250 million contingent upon certain clinical and regulatory milestones being achieved. The Company determined the fair value of the contingent consideration was $94 million at the acquisition date utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment utilizing a discount rate of 10.5%. Merck recognized intangible assets for IPR&D of $155 million and net deferred tax assets of $32 million. The excess of the consideration transferred over the fair value of net assets acquired of $57 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPR&D were determined using an income approach. The assets’ probability-adjusted future net cash flows were discounted to present value also using a discount rate of 10.5%. Actual cash flows are likely to be different than those assumed. In 2017, as a result of the achievement of a clinical development milestone, Merck made a $100 million payment, which was accrued for at estimated fair value at the time of acquisition as noted above. The contingent consideration liability was then remeasured at current fair value at each subsequent reporting period until payment was made (see Note 6).

Remicade/Simponi

In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson & Johnson (J&J) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Plough’s subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi, a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in 2015 and the Company no longer has market exclusivity in any of its marketing territories. The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Merck’s distribution of the two products in these countries are equally divided between Merck and J&J.

Collaborative Arrangements

Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Merck’s more significant collaborative arrangements are discussed below.

AstraZeneca

In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZeneca’s Lynparza for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies will also jointly develop and commercialize AstraZeneca’s selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities.

Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies are shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. AstraZeneca is currently the principal on Lynparza sales transactions. Merck records its share of Lynparza product sales, net of cost of sales and commercialization costs, as alliance revenue within the Pharmaceutical segment and its share of development costs associated with the collaboration as part of Research

and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs.

As part of the agreement, Merck made an upfront payment to AstraZeneca of $1.6 billion and will make payments of up to $750 million over a multi-year period for certain license options (of which $250 million was paid in December 2017, $400 million was paid in December 2018 and $100 million is expected be paid in 2019). The Company recorded an aggregate charge of $2.35 billion in Research and development expenses in 2017 related to the upfront payment and future license option payments. In addition, the agreement provides for additional contingent payments from Merck to AstraZeneca related to the successful achievement of regulatory and sales-based milestones.

In 2018, Merck determined it was probable that annual sales of Lynparza in the future would trigger three sales-based milestone payments from Merck to AstraZeneca aggregating $600 million. Accordingly, in 2018, Merck recorded $600 million of liabilities and a corresponding increase to the intangible asset related to Lynparza, and recognized $58 million of cumulative amortization expense within Cost of sales. During 2018, one of the sales-based milestones was triggered, resulting in a $150 million payment to AstraZeneca. In 2018, Merck made an additional $100 million sales-based milestone payment, which was accrued for in 2017 when the Company deemed to the payment to be probable. The remaining $3.4 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time.

In 2018, Lynparza received approval in the United States for the treatment of certain patients with metastatic breast cancer and for use in the first-line maintenance setting for advanced ovarian cancer, triggering capitalized milestone payments of $140 million in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $1.76 billion remain under the agreement.

The asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $743 million at December 31, 2018 and is included in Other Assets on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing.

Summarized information related to this collaboration is as follows:



Years Ended December 31	2018		2017
Alliance revenue	$	187	$	20

Cost of sales (1)	93		4
Selling, general and administrative	48		1
Research and development (2)	152		2,419

December 31	2018		2017
Receivables from AstraZeneca included in Other current assets	$	52	$	12
Payables to AstraZeneca included in Accrued and other current liabilities (3)	405		543
Payables to AstraZeneca included Other Noncurrent Liabilities (3)	250		100

(1) Represents amortization of capitalized milestone payments.

(2) Amount for 2017 includes $2.35 billion related to the upfront payment and future license option payments.

(3) Includes accrued milestone and license option payments.

Eisai

In March 2018, Merck and Eisai announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Merck’s anti-PD-1 therapy, Keytruda. Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions), and Merck and Eisai share gross profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development, including for studies evaluating Lenvima as monotherapy, are shared equally by the two companies and reflected in Research and development expenses.

Under the agreement, Merck made an upfront payment to Eisai of $750 million and will make payments of up to $650 million for certain option rights through 2021 (of which $325 million will be paid in March 2019, $200 million is expected to be paid in 2020 and $125 million is expected to be paid in 2021). The Company recorded an aggregate charge of $1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for Eisai to receive up to $385 million associated with the achievement of certain clinical and regulatory milestones and up to $3.97 billion for the achievement of milestones associated with sales of Lenvima.

In 2018, Merck determined it was probable that annual sales of Lenvima in the future would trigger three sales-based milestone payments from Merck to Eisai aggregating $268 million. Accordingly, in 2018, Merck recorded $268 million of liabilities and a corresponding increase to the intangible asset related to Lenvima, and recognized $24 million of cumulative amortization expense within Cost of sales. The remaining $3.71 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time.

In 2018, Lenvima was approved for the treatment of patients with unresectable hepatocellular carcinoma in the United States, the European Union, Japan and China, triggering capitalized milestone payments to Eisai of $250 million in the aggregate. Potential future regulatory milestone payments of $135 million remain under the agreement.

The asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $479 million at December 31, 2018 and is included in Other Assets on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing.

Summarized information related to this collaboration is as follows:



Year Ended December 31	2018
Alliance revenue	$	149

Cost of sales (1)	39
Selling, general and administrative	13
Research and development (2)	1,489

December 31	2018
Receivables from Eisai included in Other current assets	$	71
Payables to Eisai included in Accrued and other current liabilities (3)	375
Payables to Eisai included in Other Noncurrent Liabilities (3)	543

(1) Represents amortization of capitalized milestone payments.

(2) Includes $1.4 billion related to the upfront payment and future option payments.

(3) Includes accrued milestone and option payments.

Bayer AG

In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayer’s Adempas, which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies have implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayer’s vericiguat, which is in Phase 3 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development by Bayer. Merck in turn made available its early-stage sGC compounds under similar terms. Under the agreement, Bayer leads commercialization of Adempas in the Americas, while Merck leads commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead commercialization in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. Revenue from Adempas includes sales in Merck’s marketing territories, as well as Merck’s share of profits from the sale of Adempas in Bayer’s marketing territories.

In 2018, Merck determined it was probable that annual worldwide sales of Adempas in the future would trigger a $375 million sales-based milestone payment from Merck to Bayer. Accordingly, Merck recorded a $375 million noncurrent liability and a corresponding increase to the intangible asset related to Adempas, and recognized $106 million of cumulative amortization expense within Cost of sales. In 2018, the Company made a $350 million milestone payment to Bayer, which was accrued for in 2016 when Merck deemed the payment to be probable. There is an additional $400 million potential future sales-based milestone payment that has not yet been accrued as it is not deemed by the Company to be probable at this time.

The intangible asset balance related to Adempas (which includes the remaining acquired intangible asset balance, as well as capitalized sales-based milestone payments) was $1.0 billion at December 31, 2018 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2027 as supported by projected future cash flows, subject to impairment testing.

Summarized information related to this collaboration is as follows:



Years Ended December 31	2018		2017		2016
Net product sales recorded by Merck	$	190	$	149	$	88
Merck’s profit share from sales in Bayer’s marketing territories	139		151		81
Total sales	329		300		169

Cost of sales (1)	216		99		133
Selling, general and administrative	35		27		26
Research and development	127		101		82

December 31			2018		2017
Receivables from Bayer included in Other current assets			$	32	$	33
Payables to Bayer included in Accrued and other current liabilities (2)			—		350
Payables to Bayer included in Other Noncurrent Liabilities (2)			375		—

(1) Includes amortization of intangible assets.

(2) Includes accrued milestone payments.

Aggregate amortization expense related to capitalized license costs recorded within Cost of sales was $186 million in 2018, $39 million in 2017 and $30 million in 2016. The estimated aggregate amortization expense for each of the next five years is as follows: 2019, $196 million; 2020, $193 million; 2021, $191 million; 2022, $187 million; 2023, $181 million.

Restructuring

In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network.

The Company recorded total pretax costs of $658 million in 2018, $927 million in 2017 and $1.1 billion in 2016 related to restructuring program activities. Since inception of the programs through December 31, 2018, Merck has recorded total pretax accumulated costs of approximately $14.1 billion and eliminated approximately 45,510 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company estimates that approximately two-thirds of the cumulative pretax costs are 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. The Company has substantially completed the actions under these programs.

For segment reporting, restructuring charges are unallocated expenses.

The following table summarizes the charges related to restructuring program activities by type of cost:



	Separation Costs		Accelerated Depreciation			Other		Total
Year Ended December 31, 2018
Cost of sales	$	—	$	10		$	11	$	21
Selling, general and administrative	—		2			1		3
Research and development	—		(13		)	15		2
Restructuring costs	473		—			159		632
	$	473	$	(1	)	$	186	$	658
Year Ended December 31, 2017
Cost of sales	$	—	$	52		$	86	$	138
Selling, general and administrative	—		2			—		2
Research and development	—		6			5		11
Restructuring costs	552		—			224		776
	$	552	$	60		$	315	$	927
Year Ended December 31, 2016
Cost of sales	$	—	$	77		$	104	$	181
Selling, general and administrative	—		8			87		95
Research and development	—		142			—		142
Restructuring costs	216		—			435		651
	$	216	$	227		$	626	$	1,069

Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Positions eliminated under restructuring program activities were approximately 2,160 in 2018, 2,450 in 2017 and 2,625 in 2016.

Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors.

Other activity in 2018, 2017 and 2016 includes $141 million, $267 million and $409 million, respectively, of 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 14) and share-based compensation. Other activity also reflects net pretax losses resulting from sales of facilities and related assets of $151 million in 2016.

The following table summarizes the charges and spending relating to restructuring program activities:



	Separation Costs			Accelerated Depreciation			Other			Total
Restructuring reserves January 1, 2017	$	395		$	—		$	146		$	541
Expenses	552			60			315			927
(Payments) receipts, net	(328		)	—			(394		)	(722		)
Non-cash activity	—			(60		)	61			1
Restructuring reserves December 31, 2017	619			—			128			747
Expenses	473			(1		)	186			658
(Payments) receipts, net	(649		)	—			(238		)	(887		)
Non-cash activity	—			1			15			16
Restructuring reserves December 31, 2018 (1)	$	443		$	—		$	91		$	534


(1)	The remaining cash outlays are expected to be substantially completed by the end of 2020.

Financial Instruments

Derivative Instruments and Hedging Activities

The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments.

A significant portion of the Company’s revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Company’s foreign currency risk management program, as well as its interest rate risk management activities are discussed below.

Foreign Currency Risk Management

The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates.

The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options.

The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or 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 unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. 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 Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiary’s functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the 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. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI, and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI. In accordance with the new guidance adopted on January 1, 2018 (see Note 2), the Company has elected to recognize in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. 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.

The effects of the Company’s net investment hedges on OCI and the Consolidated Statement of Income are shown below:



	Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1)								Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing
Years Ended December 31	2018			2017		2016			2018			2017		2016
Net Investment Hedging Relationships
Foreign exchange contracts	$	(18	)	$	—	$	2		$	(11	)	$	—	$	(1	)
Euro-denominated notes	(183		)	520		(193		)	—			—		—

(1) No amounts were reclassified from AOCI into income related to the sale of a subsidiary.

Interest Rate Risk Management

The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk.

In May 2018, four interest rate swaps with notional amounts aggregating $1.0 billion matured. These swaps effectively converted the Company’s $1.0 billion, 1.30% fixed-rate notes due 2018 to variable rate debt. In December 2018, in connection with the early repayment of debt, the Company settled three interest rate swaps with notional amounts aggregating $550 million. These swaps effectively converted a portion of the Company’s $1.25 billion, 5.00% notes due 2019 to variable rate debt. At December 31, 2018, the Company was a party to 19 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.



	2018
Debt Instrument	Par Value of Debt		Number of Interest Rate Swaps Held	Total Swap Notional Amount
1.85% notes due 2020	$	1,250	5	$	1,250
3.875% notes due 2021	1,150		5	1,150
2.40% notes due 2022	1,000		4	1,000
2.35% notes due 2022	1,250		5	1,250

The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting 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.

The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31:



	Carrying Amount of Hedged Liabilities				Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount
	2018		2017		2018			2017
Balance Sheet Line Item in which Hedged Item is Included
Loans payable and current portion of long-term debt	$	—	$	983	$	—		$	(17	)
Long-Term Debt (1)	4,560		5,146		(82		)	(41		)

(1) Amounts include hedging adjustment gains related to discontinued hedging relationships of $11 million at December 31, 2017.

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 as of December 31:



		2018						2017
		Fair Value of Derivative				U.S. Dollar Notional		Fair Value of Derivative				U.S. Dollar Notional
	Balance Sheet Caption	Asset		Liability		Asset		Liability
Derivatives Designated as Hedging Instruments
Interest rate swap contracts	Other assets	$	—	$	—	$	—	$	2	$	—	$	550
Interest rate swap contracts	Accrued and other current liabilities	—		—		—		—		3		1,000
Interest rate swap contracts	Other noncurrent liabilities	—		81		4,650		—		52		4,650
Foreign exchange contracts	Other current assets	263		—		6,222		51		—		4,216
Foreign exchange contracts	Other assets	75		—		2,655		38		—		1,936
Foreign exchange contracts	Accrued and other current liabilities	—		7		774		—		71		2,014
Foreign exchange contracts	Other noncurrent liabilities	—		1		89		—		1		20
		$	338	$	89	$	14,390	$	91	$	127	$	14,386
Derivatives Not Designated as Hedging Instruments
Foreign exchange contracts	Other current assets	$	116	$	—	$	5,430	$	39	$	—	$	3,778
Foreign exchange contracts	Accrued and other current liabilities	—		71		9,922		—		90		7,431
		$	116	$	71	$	15,352	$	39	$	90	$	11,209
		$	454	$	160	$	29,742	$	130	$	217	$	25,595

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 at December 31:



	2018						2017
	Asset			Liability			Asset			Liability
Gross amounts recognized in the consolidated balance sheet	$	454		$	160		$	130		$	217
Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet	(121		)	(121		)	(94		)	(94		)
Cash collateral received	(107		)	—			(3		)	—
Net amounts	$	226		$	39		$	33		$	123

The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships:



	Sales							Other (income) expense, net (1)							Other comprehensive income (loss)
Years Ended December 31	2018			2017		2016		2018			2017		2016		2018			2017			2016
Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded	$	42,294		$	40,122	$	39,807	$	(402	)	(500	)	189		$	(361	)	$	316		$	(1,078	)
(Gain) loss on fair value hedging relationships
Interest rate swap contracts
Hedged items	—			—		—		(27		)	(48	)	(29	)	—			—			—
Derivatives designated as hedging instruments	—			—		—		50			12		(35	)	—			—			—
Impact of cash flow hedging relationships
Foreign exchange contracts
Amount of gain (loss) recognized in OCI on derivatives	—			—		—		—			—		—		228			(562		)	210
(Decrease) increase in Sales as a result of AOCI reclassifications	(160		)	138		311		—			—		—		160			(138		)	(311		)

(1) Interest expense is a component of Other (income) expense, net.

The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments:



		Amount of Derivative Pretax (Gain) Loss Recognized in Income
Years Ended December 31	Income Statement Caption	2018			2017			2016
Derivatives Not Designated as Hedging Instruments
Foreign exchange contracts (1)	Other (income) expense, net	$	(260	)	$	110		$	132
Foreign exchange contracts (2)	Sales	(8		)	(3		)	—

(1) 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.

(2) These derivative contracts serve as economic hedges of forecasted transactions.

At December 31, 2018, the Company estimates $186 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales. The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity.

Investments in Debt and Equity Securities

Information on investments in debt and equity securities at December 31 is as follows:



	2018									2017
	Fair Value		Amortized Cost		Gross Unrealized					Fair Value		Amortized Cost		Gross Unrealized
	Gains		Losses		Gains		Losses
Corporate notes and bonds	$	4,920	$	4,985	$	3	$	(68	)	$	9,806	$	9,837	$	9	$	(40	)
Asset-backed securities	1,275		1,285		1		(11		)	1,542		1,548		1		(7		)
U.S. government and agency securities	892		895		2		(5		)	2,042		2,059		—		(17		)
Foreign government bonds	166		167		—		(1		)	733		739		—		(6		)
Mortgage-backed securities	8		8		—		—			626		634		1		(9		)
Commercial paper	—		—		—		—			159		159		—		—
Total debt securities	7,261		7,340		6		(85		)	14,908		14,976		11		(79		)
Publicly traded equity securities (1)	456									275		265		16		(6		)
Total debt and publicly traded equity securities	$	7,717								$	15,183	$	15,241	$	27	$	(85	)

(1) Pursuant to the adoption of ASU 2016-01 (see Note 2), beginning on January 1, 2018, changes in the fair value of publicly traded equity securities are recognized in net income. Unrealized net losses of $35 million were recognized in Other (income) expense, net during 2018 on equity securities still held at December 31, 2018.

At December 31, 2018, the Company also had $568 million of equity investments without readily determinable fair values included in Other Assets. During 2018, the Company recognized unrealized gains of $167 million in Other (income) expense, net on certain of these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee. In addition, during 2018, the Company recognized unrealized losses of $26 million in Other (income) expense, net related to certain of these investments based on unfavorable observable price changes.

Available-for-sale debt securities included in Short-term investments totaled $894 million at December 31, 2018. Of the remaining debt securities, $5.8 billion mature within five years. At December 31, 2018 and 2017, 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.

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis

Financial assets and liabilities measured at fair value on a recurring basis at December 31 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
	2018								2017
Assets
Investments
Corporate notes and bonds	$	—	$	4,835	$	—	$	4,835	$	—	$	9,678	$	—	$	9,678
Asset-backed securities (1)	—		1,253		—		1,253		—		1,476		—		1,476
U.S. government and agency securities	—		731		—		731		68		1,767		—		1,835
Foreign government bonds	—		166		—		166		—		732		—		732
Mortgage-backed securities	—		—		—		—		—		547		—		547
Commercial paper	—		—		—		—		—		159		—		159
Publicly traded equity securities	147		—		—		147		104		—		—		104
	147		6,985		—		7,132		172		14,359		—		14,531
Other assets (2)
U.S. government and agency securities	55		106		—		161		—		207		—		207
Corporate notes and bonds	—		85		—		85		—		128		—		128
Asset-backed securities (1)	—		22		—		22		—		66		—		66
Mortgage-backed securities	—		8		—		8		—		79		—		79
Foreign government bonds	—		—		—		—		—		1		—		1
Publicly traded equity securities	309		—		—		309		171		—		—		171
	364		221		—		585		171		481		—		652
Derivative assets (3)
Forward exchange contracts	—		241		—		241		—		48		—		48
Purchased currency options	—		213		—		213		—		80		—		80
Interest rate swaps	—		—		—		—		—		2		—		2
	—		454		—		454		—		130		—		130
Total assets	$	511	$	7,660	$	—	$	8,171	$	343	$	14,970	$	—	$	15,313
Liabilities
Other liabilities
Contingent consideration	$	—	$	—	$	788	$	788	$	—	$	—	$	935	$	935
Derivative liabilities (3)
Interest rate swaps	—		81		—		81		—		55		—		55
Forward exchange contracts	—		74		—		74		—		162		—		162
Written currency options	—		5		—		5		—		—		—		—
	—		160		—		160		—		217		—		217
Total liabilities	$	—	$	160	$	788	$	948	$	—	$	217	$	935	$	1,152


(1)	Primarily all of the asset-backed securities are highly-rated (Standard & Poor’s rating of AAA and Moody’s Investors Service rating of Aaa), secured primarily by auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less.


(2)	Investments included in other assets are restricted as to use, primarily for the payment of benefits under employee benefit plans.


(3)	The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Company’s own credit risk, the effects of which were not significant.

There were no transfers between Level 1 and Level 2 during 2018. As of December 31, 2018, Cash and cash equivalents of $8.0 billion include $7.2 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy).

Contingent Consideration

Summarized information about the changes in liabilities for contingent consideration is as follows:



	2018			2017
Fair value January 1	$	935		$	891
Changes in estimated fair value (1)	89			141
Additions	8			3
Payments	(244		)	(100		)
Fair value December 31 (2)	$	788		$	935

(1) Recorded in Research and development expenses, Cost of sales and Other (income) expense, net. Includes cumulative translation adjustments.

(2) Balance at December 31, 2018 includes $89 million recorded as a current liability for amounts expected to be paid within the next 12 months.

The changes in the estimated fair value of liabilities for contingent consideration in 2018 were largely attributable to increases in the liabilities recorded in connection with the termination of the SPMSD joint venture in 2016 (see Note 9), partially offset by the reversal of a liability related to the discontinuation of a program obtained in connection with the acquisition of SmartCells (see Note 8). The changes in the estimated fair value of liabilities for contingent consideration in 2017 primarily relate to increases in the liabilities recorded in connection with the termination of the SPMSD joint venture and the clinical progression of a program related to the Afferent acquisition. The payments of contingent consideration in 2018 include $175 million related to the achievement of a clinical milestone in connection with the acquisition of Afferent (see Note 3). The remaining payments in 2018 relate to liabilities recorded in connection with the termination of the SPMSD joint venture. The payments of contingent consideration in 2017 relate to the achievement of a clinical milestone in connection with the acquisition of IOmet (see Note 3).

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 December 31, 2018, was $25.6 billion compared with a carrying value of $25.1 billion and at December 31, 2017, was $25.6 billion compared with a carrying value of $24.4 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 global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business.

The Company’s customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented, in aggregate, approximately 40% of total accounts receivable at December 31, 2018. The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales.

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. Cash collateral received by the Company from various counterparties was $107 million and $3 million at December 31, 2018

and 2017, respectively. The obligation to return such collateral is recorded in Accrued and other current liabilities. No cash collateral was advanced by the Company to counterparties as of December 31, 2018 or 2017.

Inventories

Inventories at December 31 consisted of:



	2018		2017
Finished goods	$	1,658	$	1,334
Raw materials and work in process	5,004		4,703
Supplies	194		201
Total (approximates current cost)	6,856		6,238
Increase to LIFO costs	1		45
	$	6,857	$	6,283
Recognized as:
Inventories	$	5,440	$	5,096
Other assets	1,417		1,187

Inventories valued under the LIFO method comprised approximately $2.5 billion and $2.2 billion at December 31, 2018 and 2017, respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2018 and 2017, these amounts included $1.4 billion and $1.1 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $7 million and $80 million at December 31, 2018 and 2017, respectively, of inventories produced in preparation for product launches.

Goodwill and Other Intangibles

The following table summarizes goodwill activity by segment:



	Pharmaceutical			Animal Health			All Other			Total
Balance January 1, 2017	$	16,075		$	1,708		$	379		$	18,162
Acquisitions	—			177			—			177
Impairments	—			—			(38		)	(38		)
Other (1)	(9		)	(8		)	—			(17		)
Balance December 31, 2017 (2)	16,066			1,877			341			18,284
Acquisitions	—			17			24			41
Impairments	—			—			(144		)	(144		)
Other (1)	96			(24		)	—			72
Balance December 31, 2018 (2)	$	16,162		$	1,870		$	221		$	18,253

(1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments.

(2) Accumulated goodwill impairment losses at December 31, 2018 and 2017 were $369 million and $225 million, respectively.

The additions to goodwill within the Animal Health segment in 2017 primarily relate to the acquisition of Vallée (see Note 3). The impairments of goodwill within other non-reportable segments in 2018 and 2017 relate to certain businesses within the Healthcare Services segment.

Other intangibles at December 31 consisted of:



	2018						2017
	Gross Carrying Amount		Accumulated Amortization		Net		Gross Carrying Amount		Accumulated Amortization		Net
Products and product rights	$	46,615	$	37,585	$	9,030	$	46,693	$	34,950	$	11,743
IPR&D	1,064		—		1,064		1,194		—		1,194
Tradenames	209		107		102		209		97		112
Other	2,403		1,168		1,235		2,035		901		1,134
	$	50,291	$	38,860	$	11,431	$	50,131	$	35,948	$	14,183

Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the Company’s more significant acquired intangibles related to marketed products (included in products and product rights above) at December 31, 2018 include Zerbaxa, $2.7 billion; Sivextro, $833 million; Implanon/Nexplanon $470 million; Dificid, $395 million; Gardasil/Gardasil 9, $384 million; Bridion, $275 million; and Simponi, $194 million. The Company has an intangible asset related to Adempas as a result of a collaboration with Bayer (see Note 4) that had a carrying value of $1.0 billion at December 31, 2018 reflected in “Other” in the table above.

During 2017 and 2016, the Company recorded impairment charges related to marketed products and other intangibles of $58 million and $347 million, respectively, within Cost of sales. During 2017, the Company recorded an intangible asset impairment charge of $47 million related to Intron A, a treatment for certain types of cancers. Sales of Intron A are being adversely affected by the availability of new therapeutic options. In 2017, sales of Intron A in the United States eroded more rapidly than previously anticipated by the Company, which led to changes in the cash flow assumptions for Intron A. These revisions to cash flows indicated that the Intron A intangible asset value was not fully 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 Intron A that, when compared with its related carrying value, resulted in the impairment charge noted above. The remaining charges in 2017 relate to the impairment of customer relationship, tradename and developed technology intangibles for certain businesses in the Healthcare Services segment. In 2016, the Company lowered its cash flow projections for Zontivity, a product for the reduction of thrombotic cardiovascular events in patients with a history of myocardial infarction or with peripheral arterial disease, following several business decisions that reduced sales expectations for Zontivity in the United States and Europe. The Company utilized market participant assumptions and considered several different scenarios to determine the fair value of the intangible asset related to Zontivity that, when compared with its related carrying value, resulted in an impairment charge of $252 million. Also during 2016, the Company wrote-off $95 million that had been capitalized in connection with in-licensed products Grastek and Ragwitek, allergy immunotherapy tablets that, for business reasons, the Company returned to the licensor.

IPR&D that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPR&D are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization.

In 2018, the Company recorded $152 million of IPR&D impairment charges within Research and development expenses. Of this amount, $139 million relates to the write-off of the remaining intangible asset balance for a program obtained in connection with the SmartCells acquisition following a decision to terminate the program due to product development issues. The Company previously recorded an impairment charge in 2016 for the other programs obtained in connection with the acquisition of SmartCells as described below. The discontinuation of this clinical development program resulted in a reversal of the related liability for contingent consideration of $60 million (see Note 6).

In 2017, the Company recorded $483 million of IPR&D impairment charges. Of this amount, $240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens

MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic hepatitis C virus (HCV) infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier, which is marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPR&D impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The Company had previously recorded an impairment charge for uprifosbuvir in 2016 as described below. The IPR&D impairment charges in 2017 also include a charge of $226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimer’s disease. The decision to stop the study followed a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued.

During 2016, the Company recorded $3.6 billion of IPR&D impairment charges. Of this amount, $2.9 billion related to the clinical development program for uprifosbuvir, a nucleotide prodrug that was being evaluated for the treatment of HCV. The Company determined that changes to the product profile, as well as changes to Merck’s expectations for pricing and the market opportunity, taken together constituted a triggering event that required the Company to evaluate the uprifosbuvir intangible asset for impairment. Utilizing market participant assumptions, and considering different scenarios, the Company concluded that its best estimate of the fair value of the intangible asset related to uprifosbuvir was $240 million, resulting in the recognition of the impairment charge noted above. The IPR&D impairment charges in 2016 also included charges of $180 million and $143 million related to the discontinuation of programs obtained in connection with the acquisitions of cCAM Biotherapeutics Ltd. and OncoEthix, respectively, resulting from unfavorable efficacy data. An additional $72 million related to programs obtained in connection with the SmartCells acquisition following a decision to terminate the lead compound due to a lack of efficacy and to pursue a back-up compound which reduced projected future cash flows. The IPR&D impairment charges in 2016 also included $112 million related to an in-licensed program for house dust mite allergies that, for business reasons, was returned to the licensor. The remaining IPR&D impairment charges in 2016 primarily related to deprioritized pipeline programs that were deemed to have no alternative use during the period, including a $79 million impairment charge for an investigational candidate for contraception. The discontinuation or delay of certain of these clinical development programs resulted in a reduction of the related liabilities for contingent consideration.

The IPR&D projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPR&D programs and profitably commercialize the underlying product candidates.

The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material.

Aggregate amortization expense primarily recorded within Cost of sales was $2.9 billion in 2018, $3.2 billion in 2017 and $3.8 billion in 2016. The estimated aggregate amortization expense for each of the next five years is as follows: 2019, $1.5 billion; 2020, $1.2 billion; 2021, $1.1 billion; 2022, $1.1 billion; 2023, $1.1 billion.

Joint Ventures and Other Equity Method Affiliates

Sanofi Pasteur MSD

In 1994, Merck and Pasteur Mérieux Connaught (now Sanofi Pasteur S.A.) established an equally-owned joint venture (SPMSD) to market vaccines in Europe and to collaborate in the development of combination vaccines for distribution in Europe. Joint venture vaccine sales were $1.0 billion for 2016.

On December 31, 2016, Merck and Sanofi Pasteur (Sanofi) terminated SPMSD and ended their joint vaccines operations in Europe. Under the terms of the termination, Merck acquired Sanofi’s 50% interest in SPMSD in exchange for consideration of $657 million comprised of cash, as well as future royalties of 11.5% on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $416 million on the date of termination. The Company accounted for this transaction as a step acquisition, which required that Merck remeasure its ownership interest (previously accounted for as an equity method investment) to fair value at the acquisition date. Merck in turn sold to Sanofi its intellectual property rights held by SPMSD in exchange for consideration of $596 million comprised of cash and future royalties of 11.5% on net sales of all Sanofi products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $302 million on the date of termination. Excluded from this arrangement are sales of Vaxelis (a jointly developed pediatric hexavalent combination vaccine that was approved by the European Commission in 2016 and by the U.S. Food and Drug Administration in 2018). The European marketing rights for Vaxelis were transferred to a separate equally-owned joint venture between Sanofi and Merck.

The net impact of the termination of the SPMSD joint venture is as follows:



Products and product rights (8-year useful life)	$	936
Accounts receivable	133
Income taxes payable	(221		)
Deferred income tax liabilities	(147		)
Other, net	47
Net assets acquired	748
Consideration payable to Sanofi, net	(392		)
Derecognition of Merck’s previously held equity investment in SPMSD	(183		)
Increase in net assets	173
Merck’s share of restructuring costs related to the termination	(77		)
Net gain on termination of SPMSD joint venture (1)	$	96

(1) Recorded in Other (income) expense, net.

The estimated fair values of identifiable intangible assets related to products and product rights were determined using an income approach through which fair value is estimated based on market participant expectations of each asset’s projected net cash flows. The projected net cash flows were then discounted to present value utilizing a discount rate of 11.5%. Actual cash flows are likely to be different than those assumed. Of the amount recorded for products and product rights, $468 million related to Gardasil/Gardasil 9.

The fair value of liabilities for contingent consideration related to Merck’s future royalty payments to Sanofi of $416 million (reflected in the consideration payable to Sanofi, net, in the table above) was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8% used to present value the cash flows. Changes in the inputs could result in a different fair value measurement.

Based on an existing accounting policy election, Merck did not record the $302 million estimated fair value of contingent future royalties to be received from Sanofi on the sale of Sanofi products, but rather is recognizing such amounts as sales occur and the royalties are earned.

The Company incurred $24 million of transaction costs related to the termination of SPMSD included in Selling, general and administrative expenses in 2016.

Pro forma financial information for this transaction has not been presented as the results are not significant when compared with the Company’s financial results.

AstraZeneca LP

In 1982, Merck entered into an agreement with Astra AB (Astra) to develop and market Astra products under a royalty-bearing license. In 1993, Merck’s total sales of Astra products reached a level that triggered the first step in the establishment of a joint venture business carried on by Astra Merck Inc. (AMI), in which Merck and Astra each owned a 50% share. This joint venture, formed in 1994, developed and marketed most of Astra’s new prescription medicines in the United States. In 1998, Merck and Astra completed a restructuring of the ownership and operations of the joint venture whereby Merck acquired Astra’s interest in AMI, renamed KBI Inc. (KBI), and contributed KBI’s operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the Partnership), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AstraZeneca LP (AZLP) upon Astra’s 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights. Merck earned revenue based on sales of KBI products and earned certain Partnership returns from AZLP.

On June 30, 2014, AstraZeneca exercised its option to purchase Merck’s interest in KBI (and redeem Merck’s remaining interest in AZLP). A portion of the exercise price, which remained subject to a true-up in 2018 based on actual sales of Nexium and Prilosec from closing in 2014 to June 2018, was deferred and recognized as income as the contingency was eliminated as sales occurred. Once the deferred income amount was fully recognized, in 2016, the Company began recognizing income and a corresponding receivable for amounts that would be due to Merck from AstraZeneca based on the sales performance of Nexium and Prilosec subject to the true-up in June 2018. The Company recognized income of $99 million in 2018, $232 million in 2017, and $98 million in 2016 (including $5 million of remaining deferred income) in Other (income) expense, net related to these amounts. In January 2019, the Company received $424 million from AstraZeneca in settlement of these amounts, which concludes the transactions related to the 2014 termination of Company’s relationship with AZLP.

Loans Payable, Long-Term Debt and Other Commitments

Loans payable at December 31, 2018 included $5.1 billion of commercial paper and $149 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2017 included $3.0 billion of notes due in 2018 and $73 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 2.09% and 0.85% for the years ended December 31, 2018 and 2017, respectively.

Long-term debt at December 31 consisted of:



	2018		2017
2.75% notes due 2025	$	2,490	$	2,488
3.70% notes due 2045	1,974		1,973
2.80% notes due 2023	1,745		1,744
4.15% notes due 2043	1,237		1,237
1.85% notes due 2020	1,231		1,232
2.35% notes due 2022	1,214		1,220
1.125% euro-denominated notes due 2021	1,134		1,185
3.875% notes due 2021	1,132		1,140
1.875% euro-denominated notes due 2026	1,127		1,178
2.40% notes due 2022	983		993
6.50% notes due 2033	726		729
Floating-rate notes due 2020	699		699
0.50% euro-denominated notes due 2024	565		591
1.375% euro-denominated notes due 2036	561		587
2.50% euro-denominated notes due 2034	560		585
3.60% notes due 2042	490		489
6.55% notes due 2037	414		415
5.75% notes due 2036	338		338
5.95% debentures due 2028	306		306
5.85% notes due 2039	270		270
6.40% debentures due 2028	250		250
6.30% debentures due 2026	135		135
5.00% notes due 2019	—		1,260
Other	225		309
	$	19,806	$	21,353

Other (as presented in the table above) includes $223 million and $300 million at December 31, 2018 and 2017, respectively, of borrowings at variable rates that resulted in effective interest rates of 2.27% and 1.42% for 2018 and 2017, respectively.

With the exception of the 6.30% debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Merck’s option at any time, at varying redemption prices.

In December 2018, the Company exercised a make-whole provision on its $1.25 billion, 5.00% notes due 2019 and repaid this debt. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers and recognized a loss on extinguishment of debt of $191 million in 2017.

Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp & Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date.

Certain of the Company’s borrowings require that Merck comply with covenants and, at December 31, 2018, the Company was in compliance with these covenants.

The aggregate maturities of long-term debt for each of the next five years are as follows: 2019, no maturities; 2020, $1.9 billion; 2021, $2.3 billion; 2022, $2.2 billion; 2023, $1.7 billion.

The Company has a $6.0 billion credit facility that matures in June 2023. The facility provides backup liquidity for the Company’s commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility.

Rental expense under operating leases, net of sublease income, was $322 million in 2018, $327 million in 2017 and $292 million in 2016. The minimum aggregate rental commitments under noncancellable leases are as follows: 2019, $188 million; 2020, $198 million; 2021, $150 million; 2022, $134 million; 2023, $84 million and thereafter, $243 million. The Company has no significant capital leases.

Contingencies and Environmental Liabilities

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 governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Company’s financial position, results of operations or cash flows.

Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation.

The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable.

The Company’s decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities effective August 1, 2004.

Product Liability Litigation

Fosamax

As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax (Fosamax Litigation). As of December 31, 2018, approximately 3,900 cases have been filed and either are pending or conditionally dismissed (as noted below) against Merck in either federal or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax.

In March 2011, Merck submitted a Motion to Transfer to the Judicial Panel on Multidistrict Litigation (JPML) seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. All federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck, the jury returned a verdict in Merck’s favor. In addition, in June 2013, the Femur Fracture MDL court granted Merck’s motion for judgment as a matter of law in the Glynn case and held that the plaintiff’s failure to warn claim was preempted by federal law.

In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the court’s preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL

court’s preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. Merck filed a petition for a writ of certiorari to the U.S. Supreme Court in August 2017, seeking review of the Third Circuit’s decision. In December 2017, the Supreme Court invited the Solicitor General to file a brief in the case expressing the views of the United States, and in May 2018, the Solicitor General submitted a brief stating that the Third Circuit’s decision was wrongly decided and recommended that the Supreme Court grant Merck’s cert petition. The Supreme Court granted Merck’s petition in June 2018, and an oral argument before the Supreme Court was held on January 7, 2019. The final decision on the Femur Fracture MDL court’s preemption ruling is now pending before the Supreme Court.

Accordingly, as of December 31, 2018, nine cases were actively pending in the Femur Fracture MDL, and approximately 1,055 cases have either been dismissed without prejudice or administratively closed pending final resolution by the Supreme Court of the appeal of the Femur Fracture MDL court’s preemption order.

As of December 31, 2018, approximately 2,555 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of 30 cases to be reviewed through fact discovery. Two additional groups of 50 cases each to be reviewed through fact discovery were selected in November 2013 and March 2014, respectively. A further group of 25 cases to be reviewed through fact discovery was selected by Merck in July 2015, and Merck has continued to select additional cases to be reviewed through fact discovery from 2016 to the present.

As of December 31, 2018, approximately 275 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. In March 2014, the court directed that a group of 10 discovery pool cases be reviewed through fact discovery and subsequently scheduled the Galper v. Merck case, which plaintiffs selected, as the first trial. The Galper trial began in February 2015 and the jury returned a verdict in Merck’s favor in April 2015, and plaintiff appealed that verdict to the California appellate court. In April 2017, the California appellate court issued a decision affirming the lower court’s judgment in favor of Merck. The next Femur Fracture trial in California that was scheduled to begin in April 2016 was stayed at plaintiffs’ request and a new trial date has not been set.

Additionally, there are four Femur Fracture cases pending in other state courts.

Discovery is ongoing in the Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits.

Januvia/Janumet

As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet. As of December 31, 2018, Merck is aware of approximately 1,290 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries.

Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court).

In November 2015, the MDL and California State Court-in separate opinions-granted summary judgment to defendants on grounds of federal preemption.

Plaintiffs appealed in both forums. In November 2017, the U.S. Court of Appeals for the Ninth Circuit vacated the judgment and remanded for further discovery, which is ongoing. In November 2018, the California state appellate court reversed and remanded on similar grounds.

As of December 31, 2018, eight product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Merck’s motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck intends to appeal that ruling.

In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits.

Vioxx

As previously disclosed, Merck is a defendant in a lawsuit brought by the Attorney General of Utah alleging that Merck misrepresented the safety of Vioxx. The lawsuit is pending in Utah state court. Utah seeks damages and penalties under the Utah False Claims Act. A bench trial in this matter is currently scheduled for July 2019.

Propecia/Proscar

As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar. The lawsuits were filed in various federal courts and in state court in New Jersey. The federal lawsuits were then consolidated for pretrial purposes in a federal multidistrict litigation before Judge Brian Cogan of the Eastern District of New York. The matters pending in state court in New Jersey were consolidated before Judge Hyland in Middlesex County (NJ Coordinated Proceedings).

As previously disclosed, on April 9, 2018, Merck and the Plaintiffs’ Executive Committee in the Propecia MDL and the Plaintiffs’ Liaison Counsel in the NJ Coordinated Proceedings entered into an agreement to resolve the above mentioned Propecia/Proscar lawsuits for an aggregate amount of $4.3 million. The settlement was subject to certain contingencies, including 95% plaintiff participation and a per plaintiff clawback if the participation rate was less than 100%. The contingencies were satisfied and the settlement agreement was finalized. After the settlement, fewer than 25 cases remain pending in the United States.

The Company intends to defend against any remaining unsettled lawsuits.

Governmental Proceedings

As previously disclosed, the Company has learned that the Prosecution Office of Milan, Italy is investigating interactions between the Company’s Italian subsidiary, certain employees of the subsidiary and certain Italian health care providers. The Company understands that this is part of a larger investigation involving engagements between various health care companies and those health care providers. The Company is cooperating with the investigation.

As previously disclosed, the United Kingdom (UK) Competition and Markets Authority (CMA) issued a Statement of Objections against the Company and MSD Sharp & Dohme Limited (MSD UK) in May 2017. In the Statement of Objections, the CMA alleges that MSD UK abused a dominant position through a discount program for Remicade over the period from March 2015 to February 2016. The Company and MSD UK are contesting the CMA’s allegations.

As previously disclosed, the Company has received an investigative subpoena from the California Insurance Commissioner’s Fraud Bureau (Bureau) seeking information from January 1, 2007 to the present related to the pricing and promotion of Cubicin. The Bureau is investigating whether Cubist Pharmaceuticals, Inc., which the Company acquired in 2015, unlawfully induced the presentation of false claims for Cubicin to private insurers under the California Insurance Code False Claims Act. The Company is cooperating with the investigation.

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.

As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required.

Commercial and Other Litigation

Zetia Antitrust Litigation

As previously disclosed, Merck, MSD, Schering Corporation and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. On December 6, 2018, the court denied the Merck Defendants’ motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. On February 6, 2019, the magistrate judge issued a report and recommendation recommending that the district judge grant in part and deny in part defendants’ motions to dismiss on non-arbitration issues. On February 20, 2019, defendants and retailer opt-out plaintiffs filed objections to the report and recommendation. After responses are filed, the parties will await a decision from the district judge.

Rotavirus Vaccines Antitrust Litigation

As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq, alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. On January 23, 2019, the court denied MSD’s motions to compel arbitration and to dismiss the consolidated complaint. On February 19, 2019, MSD appealed the court’s order on arbitration to the Third Circuit, and on February 22, 2019, the court granted MSD’s motion to vacate existing deadlines in the district court in light of the appeal.

Sales Force Litigation

As previously disclosed, in May 2013, Ms. Kelli Smith filed a complaint against the Company in the U.S. District Court for the District of New Jersey on behalf of herself and a putative class of female sales representatives and a putative sub-class of female sales representatives with children, claiming (a) discriminatory policies and practices in selection, promotion and advancement, (b) disparate pay, (c) differential treatment, (d) hostile work environment and (e) retaliation under federal and state discrimination laws. In January 2014, plaintiffs filed an amended complaint adding four additional named plaintiffs. In October 2014, the court denied the Company’s motion to dismiss or strike the class claims as premature. In September 2015, plaintiffs filed additional motions, including a motion for conditional certification under the Equal Pay Act; a motion to amend the pleadings seeking to add ERISA and constructive discharge claims and a Company subsidiary as a named defendant; and a motion for equitable relief. Merck filed papers in opposition to the motions. In April 2016, the court granted plaintiff’s motion for conditional certification but denied plaintiffs’ motions to extend the liability period for their Equal Pay Act claims back to June 2009. In April 2016, the Magistrate Judge granted plaintiffs’ request to amend the complaint to add the following: (i) a Company subsidiary as a corporate defendant; (ii) an ERISA claim and (iii) an individual constructive discharge claim for one of the named plaintiffs. Approximately 700 individuals opted-in to this action; the opt-in period has closed. In August 2017, plaintiffs filed their motion for class certification. This motion sought to certify a Title VII pay discrimination class and also sought final collective action certification of plaintiffs’ Equal Pay Act claim.

On October 1, 2018, the parties entered into an agreement to fully resolve the Smith sales force litigation. As part of the settlement and in exchange for a full and general release of all individual and class claims, the Company agreed to pay $8.5 million. The settlement agreement, which contains an “opt-out” clause allowing Merck to pull out of the agreement if 30 or more individuals opt out, will be subject to court approval.

On December 18, 2018, plaintiffs filed a motion with the court seeking preliminary approval of the settlement.

Qui Tam Litigation

As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Company’s M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit, but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the M‑M‑R II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer

protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Merck’s motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is ongoing. The Company continues to defend against these lawsuits.

Merck KGaA Litigation

As previously disclosed, in January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the United States, alleging it improperly uses the name “Merck” in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, and India, KGaA also alleges breach of the parties’ coexistence agreement. In December 2015, the Paris Court of First Instance issued a judgment finding that certain activities by the Company directed towards France did not constitute trademark infringement and unfair competition while other activities were found to infringe and constitute unfair competition. The Company and KGaA appealed the decision, and the appeal was heard in May 2017. In June 2017, the French appeals court held that certain of the activities by the Company directed to France constituted unfair competition or trademark infringement and, in December 2017, the Company decided not to pursue any further appeal. In January 2016, the UK High Court issued a judgment finding that the Company had breached the co-existence agreement and infringed KGaA’s trademark rights as a result of certain activities directed towards the UK based on use of the word MERCK on promotional and information activity. As noted in the UK decision, this finding was not based on the Company’s use of the sign MERCK in connection with the sale of products or any material pharmaceutical business transacted in the UK. The Company and KGaA have both appealed this decision, and the appeal was heard in June 2017. In November 2017, the UK Court of Appeals affirmed the decision on the co-existence agreement and remitted for re-hearing issues of trademark infringement, the scope of KGaA’s UK trademarks for pharmaceutical products, and the relief to which KGaA would be entitled. The re-hearing was held, and no decision has been handed down. In November 2018, the District Court in Hamburg, Germany dismissed all of KGaA’s claims concerning KGaA’s EU trademark with respect to the territory of the EU. In accordance with the Judgment of the Court of Justice of the EU delivered in October 2017, the District Court in Hamburg further held that it had no jurisdiction over the claim by KGaA insofar as the claim related to the territory of the UK. KGaA has appealed this decision. Further decisions from the District Court in Hamburg, Germany, in connection with claims concerning KGaA’s EU trademark, German trademark and trade name rights as well as unfair competition law with respect to the territory of Germany are expected on February 28, 2019. In January 2019, the Mexican Trademark Office issued a decision on KGaA’s action. The court found no trademark infringement by the Company and dismissed all of KGaA’s claims for trademark infringement. The court ruled against the Company on KGaA’s unfair competition claim. Both KGaA and the Company have appealed this decision.

Patent Litigation

From time to time, generic manufacturers of pharmaceutical products file abbreviated NDAs with 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. Similar lawsuits defending the Company’s patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges.

Inegy — The patents protecting Inegy in Europe have expired but supplemental protection certificates (SPCs) have been granted to the Company in many European countries that will expire in April 2019. There are multiple challenges to the SPCs related to Inegy throughout Europe and generic products have been launched in Austria, France, Italy, Ireland, Spain, Portugal, Germany, and the Netherlands. The Company has filed for preliminary injunctions in many countries that are still pending decision. Preliminary injunctions are presently in force in Austria, Czech Republic, Greece, Norway, Portugal, and Slovakia. Preliminary injunctions have been denied or revoked in Germany, Ireland, the Netherlands and Spain. The Company is appealing those decisions. In France and Belgium, preliminary injunctions were granted against some companies and denied against others, and appeals are pending. The SPC was held valid in

merits proceedings in Portugal and France. The Company has filed and will continue to file actions for patent infringement seeking damages against those companies that launch generic products before April 2019.

Noxafil — In August 2015, the Company filed a lawsuit against Actavis Laboratories Fl, Inc. (Actavis) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. In October 2017, the district court held the patent valid and infringed. Actavis appealed this decision. While the appeal was pending, the parties reached a settlement, subject to certain terms of the agreement being met, whereby Actavis can launch its generic version prior to expiry of the patent and pediatric exclusivity under certain conditions. In March 2016, the Company filed a lawsuit against Roxane Laboratories, Inc. (Roxane) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. In November 2017, the parties reached a settlement whereby Roxane can launch its generic version prior to expiry of the patent under certain conditions. In February 2016, the Company filed a lawsuit against Par Sterile Products LLC, Par Pharmaceutical, Inc., Par Pharmaceutical Companies, Inc. and Par Pharmaceutical Holdings, Inc. (collectively, Par) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil injection. In October 2016, the parties reached a settlement whereby Par can launch its generic version in January 2023, or earlier under certain conditions. In February 2018, the Company filed a lawsuit against Fresenius Kabi USA, LLC (Fresenius) in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil. In November 2018, the Company reached a settlement with Fresenius, whereby Fresenius can launch its generic version of the intravenous product prior to expiry of the patent under certain conditions. In March 2018, the Company filed a lawsuit against Mylan Laboratories Limited in the United States in respect of that company’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil.

Nasonex — Nasonex lost market exclusivity in the United States in 2016. Prior to that, in April 2015, the Company filed a patent infringement lawsuit against Apotex Inc. and Apotex Corp. (Apotex) in respect of Apotex’s marketed product that the Company believed was infringing. In January 2018, the Company and Apotex settled this matter with Apotex agreeing to pay the Company $115 million plus certain other consideration.

Januvia, Janumet, Janumet XR — In February 2019, Par Pharmaceutical, Inc. (Par Pharmaceutical) filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of a patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026. A judgment in its favor may allow Par Pharmaceutical to bring to market a generic version of Janumet XR following the expiration of key patent protection in 2022, but prior to the expiration of the later-granted patent it is challenging. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia, Janumet, and Janumet XR following expiration of key patent protection in 2022, but prior to the expiration of the later-granted patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026, and a later granted patent owned by the Company covering the Janumet formulation which expires in 2028. No schedule for the cases has been set by the court.

Gilead Patent Litigation and Opposition

The Company, through its Idenix Pharmaceuticals, Inc. subsidiary, has pending litigation against Gilead in the United States, Germany, and France based on different patent estates that would be infringed by Gilead’s sales of their two products, Sovaldi and Harvoni. Gilead opposed the European patent at the European Patent Office (EPO). Trial in the United States was held in December 2016 and the jury returned a verdict for the Company, awarding damages of $2.54 billion. The Company submitted post-trial motions, including on the issues of enhanced damages and future royalties. Gilead submitted post-trial motions for judgment as a matter of law. A hearing on the motions was held in September 2017. Also, in September 2017, the court denied the Company’s motion on enhanced damages, granted its motion on prejudgment interest and deferred its motion on future royalties. In February 2018, the court granted Gilead’s motion for judgment as a matter of law and found the patent was invalid for a lack of enablement. The Company appealed this decision. The appellate briefing is completed and the Company is waiting for the oral argument to be scheduled. The EPO opposition division revoked the European patent, and the Company appealed this decision. The cases in France and Germany have been stayed pending the final decision of the EPO.

Other Litigation

There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Company’s financial position, results of operations or cash flows either individually or in the aggregate.

Legal Defense Reserves

Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Company’s legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2018 and 2017 of approximately $245 million and $160 million, respectively, represents the Company’s best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so.

Environmental Matters

As previously disclosed, Merck’s facilities in Oss, the Netherlands, were inspected in 2012 by the Province of Brabant (Province) pursuant to the Dutch Hazards of Major Accidents Decree and the sites’ environmental permits. The Province issued penalties for alleged violations of regulations governing preventing and managing accidents with hazardous substances, and the government also issued a fine for alleged environmental violations at one of the Oss facilities, which together totaled $235 thousand. The Company was subsequently advised that a criminal investigation had been initiated based upon certain of the issues that formed the basis of the administrative enforcement action by the Province. As previously disclosed, the matter was settled, without any admission of liability, for an aggregate payment of €400 thousand.

The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Company’s potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial position, results of operations, liquidity or capital resources of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties.

In management’s opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $71 million and $82 million at December 31, 2018 and 2017, respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued

should exceed $60 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Company’s financial position, results of operations, liquidity or capital resources for any year.

Equity

The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock.

Capital Stock

A summary of common stock and treasury stock transactions (shares in millions) is as follows:



	2018			2017			2016
	Common Stock	Treasury Stock		Common Stock	Treasury Stock		Common Stock	Treasury Stock
Balance January 1	3,577	880		3,577	828		3,577	796
Purchases of treasury stock	—	122		—	67		—	60
Issuances (1)	—	(17	)	—	(15	)	—	(28	)
Balance December 31	3,577	985		3,577	880		3,577	828


(1)	Issuances primarily reflect activity under share-based compensation plans.

On October 25, 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Merck’s common stock, in total, with an initial delivery of 56.7 million shares of Merck’s common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. The payments to the Dealers were recorded as reductions to shareholders’ equity, consisting of a $4 billion increase in treasury stock, which reflects the value of the initial 56.7 million shares received on October 29, 2018, and a $1 billion decrease in other-paid-in capital, which reflects the value of the stock held back by the Dealers pending final settlement. The number of shares of Merck’s common stock that Merck may receive, or may be required to remit, upon final settlement under the ASR agreements will be based upon the average daily volume weighted-average price of Merck’s common stock during the term of the ASR program, less a negotiated discount. Final settlement of the transaction under the ASR agreements is expected to occur in the first half of 2019, but may occur earlier at the option of the Dealers, or later under certain circumstances. If Merck is obligated to make adjustment payments to the Dealers under the ASR agreements, Merck may elect to satisfy such obligations in cash or in shares of Merck’s common stock.

Share-Based Compensation Plans

The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Company’s shareholders.

At December 31, 2018, 111 million shares collectively were authorized for future grants under the Company’s share-based compensation plans. These awards are settled primarily with treasury shares.

Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three-year period, with a contractual term of 7-10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Company’s stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Company’s performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Company’s stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU

distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years. Prior to 2018, RSU awards generally vested after three years; beginning with awards granted in 2018, RSU awards generally vest one-third each year over a three-year period.

Total pretax share-based compensation cost recorded in 2018, 2017 and 2016 was $348 million, $312 million and $300 million, respectively, with related income tax benefits of $55 million, $57 million and $92 million, respectively.

The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Company’s traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior.

The weighted average exercise price of options granted in 2018, 2017 and 2016 was $58.15, $63.88 and $54.63 per option, respectively. The weighted average fair value of options granted in 2018, 2017 and 2016 was $8.26, $7.04 and $5.89 per option, respectively, and were determined using the following assumptions:



Years Ended December 31	2018		2017		2016
Expected dividend yield	3.4	%	3.6	%	3.8	%
Risk-free interest rate	2.9	%	2.0	%	1.4	%
Expected volatility	19.1	%	17.8	%	19.6	%
Expected life (years)	6.1		6.1		6.2

Summarized information relative to stock option plan activity (options in thousands) is as follows:



	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Outstanding January 1, 2018	36,274		$	46.77
Granted	3,520		58.15
Exercised	(14,598	)	40.51
Forfeited	(1,389	)	53.80
Outstanding December 31, 2018	23,807		$	51.89	5.95	$	584
Exercisable December 31, 2018	16,184		$	48.85	4.82	$	446

Additional information pertaining to stock option plans is provided in the table below:



Years Ended December 31	2018		2017		2016
Total intrinsic value of stock options exercised	$	348	$	236	$	444
Fair value of stock options vested	29		30		28
Cash received from the exercise of stock options	591		499		939

A summary of nonvested RSU and PSU activity (shares in thousands) is as follows:



	RSUs				PSUs
	Number of Shares		Weighted Average Grant Date Fair Value		Number of Shares		Weighted Average Grant Date Fair Value
Nonvested January 1, 2018	13,609		$	59.32	1,868		$	60.03
Granted	7,270		58.46		1,081		57.17
Vested	(3,766	)	59.66		(758	)	57.59
Forfeited	(985	)	59.30		(152	)	60.06
Nonvested December 31, 2018	16,128		$	58.85	2,039		$	59.42

At December 31, 2018, there was $560 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 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses.

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. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans.

Net Periodic Benefit Cost

The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components:



	Pension Benefits
	U.S.									International									Other Postretirement Benefits
Years Ended December 31	2018			2017			2016			2018			2017			2016			2018			2017			2016
Service cost	$	326		$	312		$	282		$	238		$	252		$	238		$	57		$	57		$	54
Interest cost	432			454			456			178			172			204			69			81			82
Expected return on plan assets	(851		)	(862		)	(831		)	(431		)	(393		)	(382		)	(83		)	(78		)	(107		)
Amortization of unrecognized prior service cost	(50		)	(53		)	(55		)	(13		)	(11		)	(11		)	(84		)	(98		)	(106		)
Net loss amortization	232			180			119			84			98			87			1			1			3
Termination benefits	19			44			23			2			4			4			3			8			4
Curtailments	10			3			5			1			(4		)	(1		)	(8		)	(31		)	(18		)
Settlements	5			—			—			13			5			6			—			—			—
Net periodic benefit cost (credit)	$	123		$	78		$	(1	)	$	72		$	123		$	145		$	(45	)	$	(60	)	$	(88	)

The changes in net periodic benefit cost (credit) year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization.

In connection with restructuring actions (see Note 5), termination charges were recorded in 2018, 2017 and 2016 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above.

The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 15), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions as noted above.

Obligations and Funded Status

Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows:



	Pension Benefits												Other Postretirement Benefits
	U.S.						International
	2018			2017			2018			2017			2018			2017
Fair value of plan assets January 1	$	10,896		$	9,766		$	9,339		$	7,794		$	1,114		$	1,019
Actual return on plan assets	(810		)	1,723			(289		)	677			(72		)	161
Company contributions, net	378			58			167			226			6			(4		)
Effects of exchange rate changes	—			—			(352		)	843			—			—
Benefits paid	(772		)	(651		)	(202		)	(198		)	(80		)	(62		)
Settlements	(44		)	—			(106		)	(17		)	—			—
Other	—			—			23			14			—			—
Fair value of plan assets December 31	$	9,648		$	10,896		$	8,580		$	9,339		$	968		$	1,114
Benefit obligation January 1	$	11,904		$	10,849		$	9,483		$	8,372		$	1,922		$	1,922
Service cost	326			312			238			252			57			57
Interest cost	432			454			178			172			69			81
Actuarial (gains) losses (1)	(1,258		)	881			(154		)	(7		)	(341		)	(87		)
Benefits paid	(772		)	(651		)	(202		)	(198		)	(80		)	(62		)
Effects of exchange rate changes	—			—			(387		)	916			(6		)	3
Plan amendments	—			—			10			(22		)	(9		)	—
Curtailments	13			15			(2		)	(3		)	—			—
Termination benefits	19			44			2			4			3			8
Settlements	(44		)	—			(106		)	(17		)	—			—
Other	—			—			23			14			—			—
Benefit obligation December 31	$	10,620		$	11,904		$	9,083		$	9,483		$	1,615		$	1,922
Funded status December 31	$	(972	)	$	(1,008	)	$	(503	)	$	(144	)	$	(647	)	$	(808	)
Recognized as:
Other assets	$	—		$	—		$	659		$	828		$	—		$	—
Accrued and other current liabilities	(47		)	(59		)	(14		)	(17		)	(10		)	(11		)
Other noncurrent liabilities	(925		)	(949		)	(1,148		)	(955		)	(637		)	(797		)

(1) Actuarial (gains) losses in 2018 and 2017 primarily reflect changes in discount rates.

At December 31, 2018 and 2017, the accumulated benefit obligation was $19.0 billion and $20.5 billion, respectively, for all pension plans, of which $10.4 billion and $11.5 billion, respectively, related to U.S. pension plans.

Information related to the funded status of selected pension plans at December 31 is as follows:



	U.S.				International
	2018		2017		2018		2017
Pension plans with a projected benefit obligation in excess of plan assets
Projected benefit obligation	$	10,620	$	11,904	$	6,251	$	3,323
Fair value of plan assets	9,648		10,896		5,089		2,352
Pension plans with an accumulated benefit obligation in excess of plan assets
Accumulated benefit obligation	$	9,702	$	676	$	5,936	$	2,120
Fair value of plan assets	8,966		—		5,071		1,346

Plan Assets

Entities are required to use 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 3 — Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2018 and 2017, $826 million and $488 million, respectively, or approximately 5% and 2%, respectively, of the Company’s pension investments were categorized as Level 3 assets.

If the inputs used to measure the financial assets 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.

The fair values of the Company’s pension plan assets at December 31 by asset category are as follows:



	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
	2018								2017
U.S. Pension Plans
Assets
Cash and cash equivalents	$	40	$	—	$	—	$	40	$	6	$	—	$	—	$	6
Investment funds
Developed markets equities	169		—		—		169		390		—		—		390
Emerging markets equities	121		—		—		121		138		—		—		138
Equity securities
Developed markets	2,172		—		—		2,172		2,743		—		—		2,743
Fixed income securities
Government and agency obligations	—		1,509		—		1,509		—		757		—		757
Corporate obligations	—		1,246		—		1,246		—		900		—		900
Mortgage and asset-backed securities	—		262		—		262		—		240		—		240
Other investments	—		—		13		13		—		—		15		15
Net assets in fair value hierarchy	$	2,502	$	3,017	$	13	$	5,532	$	3,277	$	1,897	$	15	$	5,189
Investments measured at NAV (1)							4,116								5,707
Plan assets at fair value							$	9,648							$	10,896
International Pension Plans
Assets
Cash and cash equivalents	$	50	$	3	$	—	$	53	$	54	$	19	$	—	$	73
Investment funds
Developed markets equities	461		3,071		—		3,532		562		3,326		—		3,888
Emerging markets equities	56		112		—		168		62		176		—		238
Government and agency obligations	372		2,082		—		2,454		249		2,095		—		2,344
Corporate obligations	4		7		—		11		5		329		—		334
Fixed income obligations	7		4		—		11		7		4		—		11
Real estate (2)	—		1		1		2		—		1		2		3
Equity securities
Developed markets	544		—		—		544		660		—		—		660
Fixed income securities
Government and agency obligations	2		291		—		293		2		266		—		268
Corporate obligations	1		113		—		114		1		118		—		119
Mortgage and asset-backed securities	—		55		—		55		—		55		—		55
Other investments
Insurance contracts (3)	—		66		811		877		—		67		470		537
Other	—		4		1		5		—		6		1		7
Net assets in fair value hierarchy	$	1,497	$	5,809	$	813	$	8,119	$	1,602	$	6,462	$	473	$	8,537
Investments measured at NAV (1)							461								802
Plan assets at fair value							$	8,580							$	9,339


(1)	Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2018 and 2017.


(2)	The plans’ Level 3 investments in real estate funds are generally valued by market appraisals of the underlying investments in the funds.


(3)	The plans’ Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques.

The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Company’s pension plan assets:



	2018												2017
	Insurance Contracts			Real Estate			Other			Total			Insurance Contracts		Real Estate			Other			Total
U.S. Pension Plans
Balance January 1	$	—		$	—		$	15		$	15		$	—	$	—		$	18		$	18
Actual return on plan assets:
Relating to assets still held at December 31	—			—			(3		)	(3		)	—		—			(2		)	(2		)
Relating to assets sold during the year	—			—			4			4			—		—			4			4
Purchases and sales, net	—			—			(3		)	(3		)	—		—			(5		)	(5		)
Balance December 31	$	—		$	—		$	13		$	13		$	—	$	—		$	15		$	15
International Pension Plans
Balance January 1	$	470		$	2		$	1		$	473		$	412	$	4		$	1		$	417
Actual return on plan assets:
Relating to assets still held at December 31	(32		)	—			—			(32		)	52		—			—			52
Purchases and sales, net	380			(1		)	—			379			5		(2		)	—			3
Transfers into Level 3	(7		)	—			—			(7		)	1		—			—			1
Balance December 31	$	811		$	1		$	1		$	813		$	470	$	2		$	1		$	473

The fair values of the Company’s other postretirement benefit plan assets at December 31 by asset category are as follows:



	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
	2018								2017
Assets
Cash and cash equivalents	$	78	$	—	$	—	$	78	$	97	$	—	$	—	$	97
Investment funds
Developed markets equities	16		—		—		16		37		—		—		37
Emerging markets equities	12		—		—		12		13		—		—		13
Government and agency obligations	1		—		—		1		1		—		—		1
Equity securities
Developed markets	200		—		—		200		256		—		—		256
Fixed income securities
Government and agency obligations	—		141		—		141		—		71		—		71
Corporate obligations	—		116		—		116		—		84		—		84
Mortgage and asset-backed securities	—		24		—		24		—		23		—		23
Net assets in fair value hierarchy	$	307	$	281	$	—	$	588	$	404	$	178	$	—	$	582
Investments measured at NAV (1)							380								532
Plan assets at fair value							$	968							$	1,114


(1)	Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2018 and 2017.

The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each

plan, given an acceptable level of risk. The target investment portfolio of the Company’s U.S. pension and other postretirement benefit plans is allocated 30% to 50% in U.S. equities, 15% to 30% in international equities, 30% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolio’s equity weighting is consistent with the long-term nature of the plans’ benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines.

Expected Contributions

Expected contributions during 2019 are approximately $50 million for U.S. pension plans, approximately $150 million for international pension plans and approximately $15 million for other postretirement benefit plans.

Expected Benefit Payments

Expected benefit payments are as follows:



	U.S. Pension Benefits		International Pension Benefits		Other Postretirement Benefits
2019	$	638	$	225	$	91
2020	661		213		95
2021	680		221		98
2022	685		239		102
2023	709		249		105
2024 — 2028	3,805		1,349		577

Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service.

Amounts Recognized in Other Comprehensive Income

Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI:



	Pension Plans																		Other Postretirement Benefit Plans
	U.S.									International
Years Ended December 31	2018			2017			2016			2018			2017			2016			2018			2017			2016
Net (loss) gain arising during the period	$	(397	)	$	(19	)	$	(743	)	$	(505	)	$	309		$	(380	)	$	186		$	170		$	(45	)
Prior service (cost) credit arising during the period	(4		)	(13		)	(10		)	(10		)	22			(2		)	2			(31		)	(19		)
	$	(401	)	$	(32	)	$	(753	)	$	(515	)	$	331		$	(382	)	$	188		$	139		$	(64	)
Net loss amortization included in benefit cost	$	232		$	180		$	119		$	84		$	98		$	87		$	1		$	1		$	3
Prior service (credit) cost amortization included in benefit cost	(50		)	(53		)	(55		)	(13		)	(11		)	(11		)	(84		)	(98		)	(106		)
	$	182		$	127		$	64		$	71		$	87		$	76		$	(83	)	$	(97	)	$	(103	)

The estimated net loss (gain) and prior service cost (credit) amounts that will be amortized from AOCI into net periodic benefit cost during 2019 are $204 million and $(62) million, respectively, for pension plans (of which $141 million and $(50) million, respectively, relates to U.S. pension plans) and $(7) million and $(78) million, respectively, for other postretirement benefit plans.

Actuarial Assumptions

The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows:



	U.S. Pension and Other Postretirement Benefit Plans						International Pension Plans
December 31	2018		2017		2016		2018		2017		2016
Net periodic benefit cost
Discount rate	3.70	%	4.30	%	4.70	%	2.10	%	2.20	%	2.80	%
Expected rate of return on plan assets	8.20	%	8.70	%	8.60	%	5.10	%	5.10	%	5.60	%
Salary growth rate	4.30	%	4.30	%	4.30	%	2.90	%	2.90	%	2.90	%
Benefit obligation
Discount rate	4.40	%	3.70	%	4.30	%	2.20	%	2.10	%	2.20	%
Salary growth rate	4.30	%	4.30	%	4.30	%	2.80	%	2.90	%	2.90	%

For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return within each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted average expected return for each plan’s target portfolio is developed, according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2019, the expected rate of return for the Company’s U.S. pension and other postretirement benefit plans will range from 7.70% to 8.10%, as compared to a range of 7.70% to 8.30% in 2018. The decrease is primarily due to a modest shift in asset allocation. The change in the weighted-average expected return on U.S. pension and other postretirement benefit plan assets from 2016 to 2018 is due to the relative weighting of the referenced plans’ assets.

The health care cost trend rate assumptions for other postretirement benefit plans are as follows:



December 31	2018		2017
Health care cost trend rate assumed for next year	7.0	%	7.2	%
Rate to which the cost trend rate is assumed to decline	4.5	%	4.5	%
Year that the trend rate reaches the ultimate trend rate	2032		2032

A one percentage point change in the health care cost trend rate would have had the following effects:



	One Percentage Point
	Increase		Decrease
Effect on total service and interest cost components	$	11	$	(9	)
Effect on benefit obligation	88		(74		)

Savings Plans

The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employee’s contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2018, 2017 and 2016 were $136 million, $131 million and $126 million, respectively.

Other (Income) Expense, Net

Other (income) expense, net, consisted of:



Years Ended December 31	2018			2017			2016
Interest income	$	(343	)	$	(385	)	$	(328	)
Interest expense	772			754			693
Exchange losses (gains)	145			(11		)	174
Income on investments in equity securities, net (1)	(324		)	(352		)	(43		)
Net periodic defined benefit plan (credit) cost other than service cost	(512		)	(512		)	(531		)
Other, net	(140		)	6			224
	$	(402	)	$	(500	)	$	189

(1) Includes net realized and unrealized gains and losses on investments in equity securities either owned directly or through ownership interests in investment funds.

Income on investments in equity securities, net, in 2018 reflects the recognition of unrealized net gains pursuant to the prospective adoption of ASU 2016-01 on January 1, 2018 (see Note 2). The increase in income on investments in equity securities, net, in 2017 was driven primarily by higher realized gains on sales.

Other, net (as presented in the table above) in 2018 includes a gain of $115 million related to the settlement of certain patent litigation (see Note 11), income of $99 million related to AstraZeneca’s option exercise (see Note 9), and a gain of $85 million resulting from the receipt of a milestone payment for an out-licensed migraine clinical development program. Other, net in 2018 also includes $144 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8), as well as $41 million of charges related to the write-down of assets held for sale to fair value in anticipation of the dissolution of the Company’s joint venture with Supera Farma Laboratorios S.A. in Brazil.

Other, net in 2017 includes income of $232 million related to AstraZeneca’s option exercise and a $191 million loss on extinguishment of debt (see Note 10).

Other, net in 2016 includes a charge of $625 million related to the previously disclosed settlement of worldwide patent litigation related to Keytruda, a gain of $117 million related to the settlement of other patent litigation, gains of $100 million resulting from the receipt of milestone payments for out-licensed migraine clinical development programs, and $98 million of income related to AstraZeneca’s option exercise.

Interest paid was $777 million in 2018, $723 million in 2017 and $686 million in 2016.

Taxes on Income

A reconciliation between the effective tax rate and the U.S. statutory rate is as follows:



	2018					2017					2016
	Amount			Tax Rate		Amount			Tax Rate		Amount			Tax Rate
U.S. statutory rate applied to income before taxes	$	1,827		21.0	%	$	2,282		35.0	%	$	1,631		35.0	%
Differential arising from:
Impact of the TCJA	289			3.3		2,625			40.3		—			—
Valuation allowances	269			3.1		632			9.7		(5		)	(0.1	)
Impact of purchase accounting adjustments, including amortization	267			3.1		713			10.9		623			13.4
State taxes	201			2.3		77			1.2		173			3.7
Restructuring	56			0.6		142			2.2		145			3.1
Foreign earnings	(245		)	(2.8	)	(1,654		)	(25.4	)	(1,546		)	(33.2	)
R&D tax credit	(96		)	(1.1	)	(71		)	(1.1	)	(58		)	(1.3	)
Tax settlements	(22		)	(0.3	)	(356		)	(5.5	)	—			—
Other (1)	(38		)	(0.4	)	(287		)	(4.4	)	(245		)	(5.2	)
	$	2,508		28.8	%	$	4,103		62.9	%	$	718		15.4	%


(1)	Other includes the tax effects of losses on foreign subsidiaries and miscellaneous items.

The Company’s 2017 effective tax rate reflected a provisional impact of 40.3% for the Tax Cuts and Jobs Act (TCJA), which was enacted on December 22, 2017. Among other provisions, the TCJA reduced the U.S. federal corporate statutory tax rate from 35% to 21% effective January 1, 2018, requires companies to pay a one-time transition tax on undistributed earnings of certain foreign subsidiaries, and creates new taxes on certain foreign sourced earnings.

The Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA. In 2018, these amounts were finalized as described below.

The one-time transition tax is based on the Company’s post-1986 undistributed earnings and profits (E&P). For a substantial portion of these undistributed E&P, the Company had not previously provided deferred taxes as these earnings were deemed by Merck to be retained indefinitely by subsidiary companies for reinvestment. The Company recorded a provisional amount in 2017 for its one-time transition tax liability of $5.3 billion. This provisional amount was reduced by the reversal of $2.0 billion of deferred taxes that were previously recorded in connection with the merger of Schering-Plough Corporation in 2009 for certain undistributed foreign E&P. On the basis of revised calculations of post-1986 undistributed foreign E&P and finalization of the amounts held in cash or other specified assets, the Company recognized a measurement-period adjustment of $124 million in 2018 related to the transition tax obligation, with a corresponding adjustment to income tax expense during the period, resulting in a revised transition tax obligation of $5.5 billion. The Company anticipates that it will be able to utilize certain foreign tax credits to partially reduce the transition tax payment. As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years. After payment of the amount due in 2018, the remaining transition tax liability at December 31, 2018, is $4.9 billion, of which $275 million is included in Income Taxes Payable and the remainder of $4.6 billion is included in Other Noncurrent Liabilities. As a result of the TCJA, the Company has made a determination it is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for withholding tax that would apply.

In 2017, the Company remeasured its deferred tax assets and liabilities at the new federal statutory tax rate of 21%, which resulted in a provisional deferred tax benefit of $779 million. On the basis of clarifications to the deferred tax benefit calculation, the Company recorded measurement-period adjustments in 2018 of $32 million related to deferred income taxes.

Beginning in 2018, the TCJA includes a tax on “global intangible low-taxed income” (GILTI) as defined in the TCJA. The Company has made an accounting policy election to account for the tax effects of the GILTI tax in the income tax provision in future periods as the tax arises.

The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), where the earnings had been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 35% in 2017 and 2016 and 21% in 2018. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate compared to the U.S. statutory rate of 35% in 2017 and 2016 and 21% in 2018.

Income before taxes consisted of:



Years Ended December 31	2018		2017		2016
Domestic	$	3,717	$	3,483	$	518
Foreign	4,984		3,038		4,141
	$	8,701	$	6,521	$	4,659

Taxes on income consisted of:



Years Ended December 31	2018			2017			2016
Current provision
Federal	$	536		$	5,585		$	1,166
Foreign	2,281			1,229			916
State	200			(90		)	157
	3,017			6,724			2,239
Deferred provision
Federal	(402		)	(2,958		)	(1,255		)
Foreign	(64		)	75			(225		)
State	(43		)	262			(41		)
	(509		)	(2,621		)	(1,521		)
	$	2,508		$	4,103		$	718

Deferred income taxes at December 31 consisted of:



	2018					2017
	Assets			Liabilities		Assets			Liabilities
Product intangibles and licenses	$	720		$	1,640	$	307		$	2,256
Inventory related	32			377		29			499
Accelerated depreciation	—			582		28			642
Pensions and other postretirement benefits	565			151		498			192
Compensation related	291			—		314			—
Unrecognized tax benefits	174			—		156			—
Net operating losses and other tax credit carryforwards	715			—		654			—
Other	621			66		909			52
Subtotal	3,118			2,816		2,895			3,641
Valuation allowance	(1,348		)			(900		)
Total deferred taxes	$	1,770		$	2,816	$	1,995		$	3,641
Net deferred income taxes				$	1,046				$	1,646
Recognized as:
Other assets	$	656				$	573
Deferred income taxes				$	1,702				$	2,219

The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2018, $715 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $1.3 billion have been established on these foreign NOL carryforwards and other foreign deferred tax assets. The Company has no NOL carryforwards relating to U.S. jurisdictions.

Income taxes paid in 2018, 2017 and 2016 were $1.5 billion, $4.9 billion and $1.8 billion, respectively. Tax benefits relating to stock option exercises were $77 million in 2018, $73 million in 2017 and $147 million in 2016.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	2018			2017			2016
Balance January 1	$	1,723		$	3,494		$	3,448
Additions related to current year positions	221			146			196
Additions related to prior year positions	142			520			75
Reductions for tax positions of prior years (1)	(73		)	(1,038		)	(90		)
Settlements (1)	(91		)	(1,388		)	(92		)
Lapse of statute of limitations	(29		)	(11		)	(43		)
Balance December 31	$	1,893		$	1,723		$	3,494


(1)	Amounts reflect the settlements with the IRS as discussed below.

If the Company were to recognize the unrecognized tax benefits of $1.9 billion at December 31, 2018, the income tax provision would reflect a favorable net impact of $1.8 billion.

The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2018 could decrease by up to approximately $750 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Company’s examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures.

Expenses for interest and penalties associated with uncertain tax positions amounted to $51 million in 2018, $183 million in 2017 and $134 million in 2016. These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $372 million and $341 million as of December 31, 2018 and 2017, respectively.

In 2017, the Internal Revenue Service (IRS) concluded its examinations of Merck’s 2006-2011 U.S. federal income tax returns. As a result, the Company was required to make a payment of approximately $2.8 billion. The Company’s reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a net $234 million tax benefit in 2017. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for, as well as adjustments to reserves for unrecognized tax benefits relating to years which remain open to examination that are affected by this settlement.

The IRS is currently conducting examinations of the Company’s tax returns for the years 2012 through 2014. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Company’s income tax returns are open for examination for the period 2003 through 2018.

Earnings per Share

The calculations of earnings per share (shares in millions) are as follows:



Years Ended December 31	2018		2017		2016
Net income attributable to Merck & Co., Inc.	$	6,220	$	2,394	$	3,920
Average common shares outstanding	2,664		2,730		2,766
Common shares issuable (1)	15		18		21
Average common shares outstanding assuming dilution	2,679		2,748		2,787
Basic earnings per common share attributable to Merck & Co., Inc. common shareholders	$	2.34	$	0.88	$	1.42
Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders	$	2.32	$	0.87	$	1.41


(1)	Issuable primarily under share-based compensation plans.

In 2018, 2017 and 2016, 6 million, 5 million and 13 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.

Other Comprehensive Income (Loss)

Changes in AOCI by component are as follows:



	Derivatives				Investments				Employee Benefit Plans				Cumulative Translation Adjustment			Accumulated Other Comprehensive Income (Loss)
Balance January 1, 2016, net of taxes	$	404			$	41			$	(2,407	)		$	(2,186	)	$	(4,148	)
Other comprehensive income (loss) before reclassification adjustments, pretax	210				(38		)		(1,199		)		(150		)	(1,177		)
Tax	(72		)		16				363				(19		)	288
Other comprehensive income (loss) before reclassification adjustments, net of taxes	138				(22		)		(836		)		(169		)	(889		)
Reclassification adjustments, pretax	(314		)	(1)	(31		)	(2)	37			(3)	—			(308		)
Tax	110				9				—				—			119
Reclassification adjustments, net of taxes	(204		)		(22		)		37				—			(189		)
Other comprehensive income (loss), net of taxes	(66		)		(44		)		(799		)		(169		)	(1,078		)
Balance December 31, 2016, net of taxes	338				(3		)		(3,206		)		(2,355		)	(5,226		)
Other comprehensive income (loss) before reclassification adjustments, pretax	(561		)		212				438				235			324
Tax	207				(35		)		(106		)		166			232
Other comprehensive income (loss) before reclassification adjustments, net of taxes	(354		)		177				332				401			556
Reclassification adjustments, pretax	(141		)	(1)	(291		)	(2)	117			(3)	—			(315		)
Tax	49				56				(30		)		—			75
Reclassification adjustments, net of taxes	(92		)		(235		)		87				—			(240		)
Other comprehensive income (loss), net of taxes	(446		)		(58		)		419				401			316
Balance December 31, 2017, net of taxes	(108		)		(61		)		(2,787		)	(4)	(1,954		)	(4,910		)
Other comprehensive income (loss) before reclassification adjustments, pretax	228				(108		)		(728		)		(84		)	(692		)
Tax	(55		)		1				169				(139		)	(24		)
Other comprehensive income (loss) before reclassification adjustments, net of taxes	173				(107		)		(559		)		(223		)	(716		)
Reclassification adjustments, pretax	157			(1)	97			(2)	170			(3)	—			424
Tax	(33		)		—				(36		)		—			(69		)
Reclassification adjustments, net of taxes	124				97				134				—			355
Other comprehensive income (loss), net of taxes	297				(10		)		(425		)		(223		)	(361		)

Adoption of ASU 2018-02 (see Note 2)	(23		)		1				(344		)		100			(266		)
Adoption of ASU 2016-01 (see Note 2)	—				(8		)		—				—			(8		)

Balance December 31, 2018, net of taxes	$	166			$	(78	)		$	(3,556	)	(4)	$	(2,077	)	$	(5,545	)


(1)	Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales.


(2)	Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net. In 2017 and 2016, these amounts included both investments in debt and equity securities; however, as a result of the adoption of ASU 2016-01 (see Note 2), in 2018, these amounts relate only to investments in available-for-sale debt securities.


(3)	Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 14).

(4)

Includes pension plan net loss of $4.4 billion and $3.5 billion at December 31, 2018 and 2017, respectively, and other postretirement benefit plan net (gain) loss of $(170) million and $(16) million at December 31, 2018 and 2017, respectively, as well as pension plan prior service credit of $314 million and $326 million at December 31, 2018 and 2017, respectively, and other postretirement benefit plan prior service credit of $375 million and $383 million at December 31, 2018 and 2017, respectively.

Segment Reporting

The Company’s operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Animal Health segment met the criteria for separate reporting and became a reportable segment in 2018.

The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. Sales of vaccines in most major European markets were marketed through the Company’s SPMSD joint venture until its termination on December 31, 2016 (see Note 9).

The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients.

The Alliances segment primarily includes activity from the Company’s relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018 (see Note 9).

Sales of the Company’s products were as follows:



Years Ended December 31	2018						2017						2016
	U.S.		Int’l		Total		U.S.		Int’l		Total		U.S.		Int’l		Total
Pharmaceutical:
Oncology
Keytruda	$	4,150	$	3,021	$	7,171	$	2,309	$	1,500	$	3,809	$	792	$	610	$	1,402
Emend	312		210		522		342		213		556		356		193		549
Temodar	6		209		214		16		256		271		15		268		283
Alliance revenue - Lynparza	127		61		187		—		20		20		—		—		—
Alliance revenue - Lenvima	95		54		149		—		—		—		—		—		—
Vaccines (1)
Gardasil/Gardasil 9	1,873		1,279		3,151		1,565		743		2,308		1,780		393		2,173
ProQuad/M-M-R II/Varivax	1,430		368		1,798		1,374		303		1,676		1,362		279		1,640
Pneumovax 23	627		281		907		581		240		821		447		193		641
RotaTeq	496		232		728		481		204		686		482		169		652
Zostavax	22		195		217		422		246		668		518		168		685
Hospital Acute Care
Bridion	386		531		917		239		465		704		77		405		482
Noxafil	353		389		742		309		327		636		284		312		595
Invanz	253		243		496		361		241		602		329		233		561
Cubicin	191		176		367		189		193		382		906		181		1,087
Cancidas	12		314		326		20		402		422		25		533		558
Primaxin	7		258		265		10		270		280		4		293		297
Immunology
Simponi	—		893		893		—		819		819		—		766		766
Remicade	—		582		582		—		837		837		—		1,268		1,268
Neuroscience
Belsomra	96		164		260		98		112		210		84		70		154
Virology
Isentress/Isentress HD	513		627		1,140		565		639		1,204		721		666		1,387
Zepatier	8		447		455		771		888		1,660		488		67		555
Cardiovascular
Zetia	45		813		857		352		992		1,344		1,588		972		2,560
Vytorin	10		487		497		124		627		751		473		668		1,141
Atozet	—		347		347		—		225		225		1		146		146
Adempas	—		329		329		—		300		300		—		169		169
Diabetes
Januvia	1,969		1,718		3,686		2,153		1,584		3,737		2,286		1,622		3,908
Janumet	811		1,417		2,228		863		1,296		2,158		984		1,217		2,201
Women’s Health
NuvaRing	722		180		902		564		197		761		576		202		777
Implanon/Nexplanon	495		208		703		496		191		686		420		186		606
Diversified Brands
Singulair	20		688		708		40		692		732		40		874		915
Cozaar/Hyzaar	23		431		453		18		466		484		16		494		511
Nasonex	23		353		376		54		333		387		184		352		537
Arcoxia	—		335		335		—		363		363		—		450		450
Follistim AQ	115		153		268		123		174		298		157		197		355
Dulera	186		28		214		261		26		287		412		24		436
Fosamax	4		205		209		6		235		241		5		279		284
Other pharmaceutical (2)	1,228		2,855		4,090		1,148		2,917		4,065		1,261		3,158		4,420
Total Pharmaceutical segment sales	16,608		21,081		37,689		15,854		19,536		35,390		17,073		18,077		35,151
Animal Health:
Livestock	528		2,102		2,630		471		2,013		2,484		446		1,841		2,287
Companion Animals	710		872		1,582		619		772		1,391		543		648		1,191
Total Animal Health segment sales	1,238		2,974		4,212		1,090		2,785		3,875		989		2,489		3,478
Other segment sales (3)	248		2		250		396		1		397		385		—		385
Total segment sales	18,094		24,057		42,151		17,340		22,322		39,662		18,447		20,566		39,014
Other (4)	118		26		143		84		376		460		31		763		793
	$	18,212	$	24,083	$	42,294	$	17,424	$	22,698	$	40,122	$	18,478	$	21,329	$	39,807

U.S. plus international may not equal total due to rounding.

(1)

On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which marketed vaccines in most major European markets (see Note 9). Accordingly, vaccine sales in 2018 and 2017 include sales in the European markets that were previously part of SPMSD. Amounts for 2016 do not include sales of vaccines sold through SPMSD, the results of which are reflected in equity income from affiliates included in Other (income) expense, net. Amounts for 2016 do, however, include supply sales to SPMSD.


(2)	Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately.


(3)	Represents the non-reportable segments of Healthcare Services and Alliances.


(4)	Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2018, 2017 and 2016 also includes approximately $95 million, $85 million and $170 million, respectively, related to the sale of the marketing rights to certain products.

Consolidated revenues by geographic area where derived are as follows:



Years Ended December 31	2018		2017		2016
United States	$	18,212	$	17,424	$	18,478
Europe, Middle East and Africa	12,213		11,478		10,953
Japan	3,212		3,122		2,846
Asia Pacific (other than Japan and China)	2,909		2,751		2,483
Latin America	2,415		2,339		2,155
China	2,184		1,586		1,435
Other	1,149		1,422		1,457
	$	42,294	$	40,122	$	39,807

A reconciliation of segment profits to Income before taxes is as follows:



Years Ended December 31	2018			2017			2016
Segment profits:
Pharmaceutical segment	$	24,292		$	22,495		$	22,141
Animal Health segment	1,659			1,552			1,357
Other segments	103			275			146
Total segment profits	26,054			24,322			23,644
Other profits	6			26			481
Unallocated:
Interest income	343			385			328
Interest expense	(772		)	(754		)	(693		)
Depreciation and amortization	(1,334		)	(1,378		)	(1,585		)
Research and development	(8,853		)	(9,481		)	(9,218		)
Amortization of purchase accounting adjustments	(2,664		)	(3,056		)	(3,692		)
Restructuring costs	(632		)	(776		)	(651		)
Charge related to termination of collaboration agreement with Samsung	(423		)	—			—
Loss on extinguishment of debt	—			(191		)	—
Gain on sale of certain migraine clinical development programs	—			—			100
Charge related to the settlement of worldwide Keytruda patent litigation	—			—			(625		)
Other unallocated, net	(3,024		)	(2,576		)	(3,430		)
	$	8,701		$	6,521		$	4,659

Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Company’s research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments.

Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales.

Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of liabilities for contingent consideration, and other miscellaneous income or expense items.

In 2018, the Company adopted a new accounting standard related to the classification of certain defined benefit plan costs (see Note 2), which resulted in a change to the measurement of segment profits. Net periodic benefit cost (credit) other than service cost is no longer included as a component of segment profits. Prior period amounts have been recast to conform to the new presentation.

Equity (income) loss from affiliates and depreciation and amortization included in segment profits is as follows:



	Pharmaceutical			Animal Health		All Other		Total
Year Ended December 31, 2018
Included in segment profits:
Equity (income) loss from affiliates	$	4		$	—	$	—	$	4
Depreciation and amortization	243			82		10		335
Year Ended December 31, 2017
Included in segment profits:
Equity (income) loss from affiliates	$	7		$	—	$	—	$	7
Depreciation and amortization	125			75		12		212
Year Ended December 31, 2016
Included in segment profits:
Equity (income) loss from affiliates	$	(105	)	$	—	$	—	$	(105	)
Depreciation and amortization	160			10		13		183

Property, plant and equipment, net, by geographic area where located is as follows:



December 31	2018		2017		2016
United States	$	8,306	$	8,070	$	8,114
Europe, Middle East and Africa	3,706		3,151		2,732
Asia Pacific (other than Japan and China)	684		632		623
Latin America	264		271		234
China	167		150		152
Japan	159		158		164
Other	5		7		7
	$	13,291	$	12,439	$	12,026

The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Merck & Co., Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Merck & Co., Inc and its subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Change in Accounting Principle

As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for retirement benefits in 2018.

Basis for Opinions

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PricewaterhouseCoopers LLP

Florham Park, New Jersey

February 27, 2019

We have served as the Company’s auditor since 2002.


(b)	Supplementary Data

Selected quarterly financial data for 2018 and 2017 are contained in the Condensed Interim Financial Data table below.

Condensed Interim Financial Data (Unaudited)



($ in millions except per share amounts)	4th Q (1)			3rd Q (2)			2nd Q			1st Q (3)
2018 (4)
Sales	$	10,998		$	10,794		$	10,465		$	10,037
Cost of sales	3,289			3,619			3,417			3,184
Selling, general and administrative	2,643			2,443			2,508			2,508
Research and development	2,214			2,068			2,274			3,196
Restructuring costs	138			171			228			95
Other (income) expense, net	110			(172		)	(48		)	(291		)
Income before taxes	2,604			2,665			2,086			1,345
Net income attributable to Merck & Co., Inc.	1,827			1,950			1,707			736
Basic earnings per common share attributable to Merck & Co., Inc. common shareholders	$	0.70		$	0.73		$	0.64		$	0.27
Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders	$	0.69		$	0.73		$	0.63		$	0.27
2017 (4) (5)
Sales	$	10,433		$	10,325		$	9,930		$	9,434
Cost of sales	3,440			3,307			3,116			3,049
Selling, general and administrative	2,643			2,459			2,500			2,472
Research and development	2,314			4,413			1,782			1,830
Restructuring costs	306			153			166			151
Other (income) expense, net	(149		)	(207		)	(73		)	(71		)
Income before taxes	1,879			200			2,439			2,003
Net (loss) income attributable to Merck & Co., Inc.	(1,046		)	(56		)	1,946			1,551
Basic (loss) earnings per common share attributable to Merck & Co., Inc. common shareholders	$	(0.39	)	$	(0.02	)	$	0.71		$	0.56
(Loss) earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders	$	(0.39	)	$	(0.02	)	$	0.71		$	0.56


(1)	Amounts for 2017 include a provisional net tax charge related to the enactment of U.S. tax legislation (see Note 16).


(2)	Amounts for 2017 include a charge related to the formation of a collaboration with AstraZeneca (see Note 4).


(3)	Amounts for 2018 include a charge related to the formation of a collaboration with Eisai (see Note 4).

(4) Amounts for 2018 and 2017 reflect acquisition and divestiture-related costs (see Note 8) and the impact of restructuring actions (see Note 5).

(5) Amounts have been recast as a result of the adoption, on January 1, 2018, of a new accounting standard related to the classification of certain defined benefit plan costs. There was no impact to net income as a result of adopting the new accounting standard (see Note 2).

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