Item 8. Financial Statements and Supplementary Data.

**(a)**Financial Statements

The consolidated balance sheet of Merck & Co., Inc. and subsidiaries as of December 31, 2020 and 2019, 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, 2020, the notes to consolidated financial statements, and the report dated February 25, 2021 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)

			2020						2019						2018
Sales			$	47,994					$	46,840					$	42,294
Costs, Expenses and Other
Cost of sales			15,485						14,112						13,509
Selling, general and administrative			10,468						10,615						10,102
Research and development			13,558						9,872						9,752
Restructuring costs			578						638						632
Other (income) expense, net			(886)						139						(402)
			39,203						35,376						33,593
Income Before Taxes			8,791						11,464						8,701
Taxes on Income			1,709						1,687						2,508
Net Income			7,082						9,777						6,193
Less: Net Income (Loss) Attributable to Noncontrolling Interests			15						(66)						(27)
Net Income Attributable to Merck & Co., Inc.			$	7,067					$	9,843					$	6,220
Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders			$	2.79					$	3.84					$	2.34
Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders			$	2.78					$	3.81					$	2.32

Consolidated Statement of Comprehensive Income

Merck & Co., Inc. and Subsidiaries

Years Ended December 31

($ in millions)

			2020						2019						2018
Net Income Attributable to Merck & Co., Inc.			$	7,067					$	9,843					$	6,220
Other Comprehensive Loss Net of Taxes:
Net unrealized (loss) gain on derivatives, net of reclassifications			(297)						(135)						297
Net unrealized (loss) gain on investments, net of reclassifications			(18)						96						(10)
Benefit plan net (loss) gain and prior service (cost) credit, net of amortization			(279)						(705)						(425)
Cumulative translation adjustment			153						96						(223)
			(441)						(648)						(361)
Comprehensive Income Attributable to Merck & Co., Inc.			$	6,626					$	9,195					$	5,859

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

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Consolidated Balance Sheet

Merck & Co., Inc. and Subsidiaries

December 31

($ in millions except per share amounts)

			2020						2019
Assets
Current Assets
Cash and cash equivalents			$	8,062					$	9,676
Short-term investments			—						774
Accounts receivable (net of allowance for doubtful accounts of $85 in 2020 and $86 in 2019)			7,851						6,778
Inventories (excludes inventories of $2,197 in 2020 and $1,480 in 2019 classified in Other assets - see Note 7)			6,310						5,978
Other current assets			5,541						4,277
Total current assets			27,764						27,483
Investments			785						1,469
Property, Plant and Equipment (at cost)
Land			350						343
Buildings			12,645						11,989
Machinery, equipment and office furnishings			16,649						15,394
Construction in progress			7,324						5,013
			36,968						32,739
Less: accumulated depreciation			18,982						17,686
			17,986						15,053
Goodwill			20,238						19,425
Other Intangibles, Net			14,604						14,196
Other Assets			10,211						6,771
			$	91,588					$	84,397
Liabilities and Equity
Current Liabilities
Loans payable and current portion of long-term debt			$	6,431					$	3,610
Trade accounts payable			4,594						3,738
Accrued and other current liabilities			13,053						12,549
Income taxes payable			1,575						736
Dividends payable			1,674						1,587
Total current liabilities			27,327						22,220
Long-Term Debt			25,360						22,736
Deferred Income Taxes			1,015						1,470
Other Noncurrent Liabilities			12,482						11,970
Merck & Co., Inc. Stockholders’ Equity
Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2020 and 2019			1,788						1,788
Other paid-in capital			39,588						39,660
Retained earnings			47,362						46,602
Accumulated other comprehensive loss			(6,634)						(6,193)
			82,104						81,857
Less treasury stock, at cost: 1,046,877,695 shares in 2020 and 1,038,087,496 shares in 2019			56,787						55,950
Total Merck & Co., Inc. stockholders’ equity			25,317						25,907
Noncontrolling Interests			87						94
Total equity			25,404						26,001
			$	91,588					$	84,397

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

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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, 2018			$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			—						—						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
Net income attributable to Merck & Co., Inc.			—						—						9,843						—						—						—						9,843
Other comprehensive loss, net of taxes			—						—						—						(648)						—						—						(648)
Cash dividends declared on common stock ($2.26 per share)			—						—						(5,820)						—						—						—						(5,820)
Treasury stock shares purchased			—						1,000						—						—						(5,780)						—						(4,780)
Net loss attributable to noncontrolling interests			—						—						—						—						—						(66)						(66)
Distributions attributable to noncontrolling interests			—						—						—						—						—						(21)						(21)
Share-based compensation plans and other			—						(148)						—						—						759						—						611
Balance December 31, 2019			1,788						39,660						46,602						(6,193)						(55,950)						94						26,001
Net income attributable to Merck & Co., Inc.			—						—						7,067						—						—						—						7,067
Other comprehensive loss, net of taxes			—						—						—						(441)						—						—						(441)
Cash dividends declared on common stock ($2.48 per share)			—						—						(6,307)						—						—						—						(6,307)
Treasury stock shares purchased			—						—						—						—						(1,281)						—						(1,281)
Net income attributable to noncontrolling interests			—						—						—						—						—						15						15
Distributions attributable to noncontrolling interests			—						—						—						—						—						(22)						(22)
Share-based compensation plans and other			—						(72)						—						—						444						—						372
Balance December 31, 2020			$	1,788					$	39,588					$	47,362					$	(6,634)					$	(56,787)					$	87					$	25,404

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

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Consolidated Statement of Cash Flows

Merck & Co., Inc. and Subsidiaries

Years Ended December 31

($ in millions)

			2020						2019						2018
Cash Flows from Operating Activities
Net income			$	7,082					$	9,777					$	6,193
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization			1,899						1,973						3,103
Depreciation			1,726						1,679						1,416
Intangible asset impairment charges			1,718						1,040						296
Charge for the acquisition of VelosBio Inc.			2,660						—						—
Charge for the acquisition of Peloton Therapeutics, Inc.			—						993						—
Charge for future payments related to collaboration license options			—						—						650
Deferred income taxes			(668)						(556)						(509)
Share-based compensation			475						417						348
Other			(49)						184						978
Net changes in assets and liabilities:
Accounts receivable			(1,002)						294						(418)
Inventories			(855)						(508)						(911)
Trade accounts payable			724						399						230
Accrued and other current liabilities			(1,138)						376						(341)
Income taxes payable			560						(2,359)						827
Noncurrent liabilities			(453)						(237)						(266)
Other			(2,426)						(32)						(674)
Net Cash Provided by Operating Activities			10,253						13,440						10,922
Cash Flows from Investing Activities
Capital expenditures			(4,684)						(3,473)						(2,615)
Purchase of Seagen Inc. common stock			(1,000)						—						—
Purchases of securities and other investments			(95)						(3,202)						(7,994)
Proceeds from sales of securities and other investments			2,812						8,622						15,252
Acquisition of VelosBio Inc., net of cash acquired			(2,696)						—						—
Acquisition of ArQule, Inc., net of cash acquired			(2,545)						—						—
Acquisition of Antelliq Corporation, net of cash acquired			—						(3,620)						—
Acquisition of Peloton Therapeutics, Inc., net of cash acquired			—						(1,040)						—
Other acquisitions, net of cash acquired			(1,365)						(294)						(431)
Other			130						378						102
Net Cash (Used in) Provided by Investing Activities			(9,443)						(2,629)						4,314
Cash Flows from Financing Activities
Net change in short-term borrowings			2,549						(3,710)						5,124
Payments on debt			(1,957)						—						(4,287)
Proceeds from issuance of debt			4,419						4,958						—
Purchases of treasury stock			(1,281)						(4,780)						(9,091)
Dividends paid to stockholders			(6,215)						(5,695)						(5,172)
Proceeds from exercise of stock options			89						361						591
Other			(436)						5						(325)
Net Cash Used in Financing Activities			(2,832)						(8,861)						(13,160)
Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash			253						17						(205)
Net (Decrease) Increase in Cash, Cash Equivalents and Restricted Cash			(1,769)						1,967						1,871
Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $258 of restricted cash at January 1, 2020 included in Other Assets - see Note 6)			9,934						7,967						6,096
Cash, Cash Equivalents and Restricted Cash at End of Year (includes $103 of restricted cash at December 31, 2020 included in Other Assets - see Note 6)			$	8,165					$	9,934					$	7,967

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

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Notes to Consolidated Financial Statements

Merck & Co., Inc. and Subsidiaries

($ in millions except per share amounts)

1. 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 two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are 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.

The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers.

The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020.

The Company previously had an Alliances segment that primarily included activity from the Company’s relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018.

Planned Spin-Off of Women’s Health, Biosimilars and Established Brands into a New Company

In February 2020, Merck announced its intention to spin-off products from its women’s health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon & Co. (Organon) through a distribution of Organon’s publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consist of dermatology, non-opioid pain management, respiratory, and select cardiovascular products including Zetia and Vytorin, as well as the rest of Merck’s diversified brands franchise. Merck’s existing research pipeline programs will continue to be owned and developed within Merck as planned. Organon will have development capabilities initially focused on late-stage development and life-cycle management and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed late in the second quarter of 2021, subject to market and certain other conditions. Subsequent to the spin-off, the historical results of the women’s health, biosimilars and established brands businesses will be reflected as discontinued operations in the Company’s consolidated financial statements.

2. 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

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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

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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 — 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. 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 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 $13.1 billion in 2020, $11.8 billion in 2019 and $10.7 billion in 2018. 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 $249

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million and $2.9 billion, respectively, at December 31, 2020 and were $233 million and $2.2 billion, respectively, at December 31, 2019.

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 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda, have longer payment terms, some of which are 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.

See Note 18 for disaggregated revenue disclosures.

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 $1.7 billion in 2020, $1.7 billion in 2019 and $1.4 billion in 2018.

Advertising and Promotion Costs — Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $2.0 billion in 2020, $2.1 billion in 2019 and $2.1 billion in 2018.

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. These costs are included in Property, plant and equipment. In addition, the Company capitalizes certain costs incurred to implement a cloud computing arrangement that is considered a service agreement, which are included in Other Assets. Capitalized software costs are being amortized over periods ranging from 3 to 10 years, with the longer lives generally associated with enterprise-wide projects implemented over multiple 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, licenses, trade names 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 24 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

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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 — IPR&D that the Company acquires in conjunction with the acquisition of a business 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 evaluates IPR&D for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPR&D intangible asset with its carrying value. 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 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. If the transaction is accounted for as an acquisition of a business, 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 until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Significant events that increase or decrease the probability of achieving development and regulatory milestones or that increase or decrease projected cash flows will result in corresponding increases or decreases in the fair values of the related contingent consideration obligations. If the transaction is accounted for as an acquisition of an asset rather than a business, contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved.

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.

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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 and capitalized, subject to cumulative amortization catch-up, when probable of being achieved. 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. The Company accounts for the tax effects of the tax on global intangible low-taxed income (GILTI) of certain foreign subsidiaries in the income tax provision in the period the tax arises.

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.

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Recently Adopted Accounting Standards — In June 2016, the Financial Accounting Standards Board (FASB) issued new guidance on the accounting for credit losses on financial instruments. The new 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 Company adopted the new guidance effective January 1, 2020. There was no impact to the Company’s consolidated financial statements upon adoption.

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 revenue recognition guidance (ASC 606). The Company retrospectively adopted the new guidance effective January 1, 2020, which resulted in minor changes to the presentation of information related to the Company’s collaborative arrangements (see Note 4 and Note 18).

In December 2019, the FASB issued amended guidance on the accounting and reporting of income taxes. The guidance is intended to simplify the accounting for income taxes by removing exceptions related to certain intraperiod tax allocations and deferred tax liabilities; clarifying guidance primarily related to evaluating the step-up tax basis for goodwill in a business combination; and reflecting enacted changes in tax laws or rates in the annual effective tax rate. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Company’s consolidated financial statements upon adoption.

In January 2020, the FASB issued new guidance intended to clarify certain interactions between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance addresses accounting for the transition into and out of the equity method of accounting and measuring certain purchased options and forward contracts to acquire investments. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Company’s consolidated financial statements upon adoption.

Recently Issued Accounting Standard Not Yet Adopted — In March 2020, the FASB issued optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting and subsequently issued clarifying amendments. The guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. The optional guidance is effective upon issuance and can be applied on a prospective basis at any time between January 1, 2020 through December 31, 2022. The Company is currently evaluating the impact of adoption on its consolidated financial statements.

3. Acquisitions, Divestitures, Research Collaborations and License Agreements

The Company continues to pursue acquisitions and the 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.

2020 Transactions

In December 2020, Merck acquired OncoImmune, a privately held, clinical-stage biopharmaceutical company, for an upfront payment of $423 million. In addition, OncoImmune shareholders will be eligible to receive up to $255 million of future contingent regulatory approval milestone payments and tiered royalties ranging from 10% to 20%. OncoImmune’s lead therapeutic candidate MK-7110 (also known as CD24Fc) is being evaluated for the treatment of patients hospitalized with coronavirus disease 2019 (COVID-19). The transaction was accounted for as an acquisition of an asset. Under the agreement, prior to the completion of the acquisition, OncoImmune spun-out certain rights and assets unrelated to the MK-7110 program to a new entity owned by the existing shareholders of OncoImmune. In connection with the closing of the acquisition, Merck invested $50 million for a 20% ownership interest in the new entity, which was valued at $33 million resulting in a $17 million premium. Merck also

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recognized other net liabilities of $22 million. The Company recorded Research and development expenses of $462 million in 2020 related to this transaction.

Also in December 2020, Merck acquired VelosBio Inc. (VelosBio), a privately held, clinical-stage biopharmaceutical company, for $2.8 billion. VelosBio’s lead investigational candidate is MK-2140 (formerly known as VLS-101), an antibody-drug conjugate targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) that is currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $180 million (primarily cash) and Research and development expenses of $2.7 billion in 2020 related to the transaction.

In September 2020, Merck and Seagen Inc. (Seagen, formerly known as Seattle Genetics, Inc.) announced an oncology collaboration to globally develop and commercialize Seagen’s ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials for breast cancer and other solid tumors. The collaboration will pursue a broad joint development program evaluating ladiratuzumab vedotin as monotherapy and in combination with Keytruda (pembrolizumab) in triple-negative breast cancer, hormone receptor-positive breast cancer and other LIV-1-expressing solid tumors. The companies will equally share profits worldwide. Under the terms of the agreement, Merck made an upfront payment of $600 million and a $1.0 billion equity investment in 5 million shares of Seagen common stock at a price of $200 per share. Merck recorded $616 million in Research and development expenses in 2020 related to this transaction reflecting the upfront payment as well as a $16 million premium relating to the equity shares based on the price of Seagen common stock on the closing date. Seagen is also eligible to receive future contingent milestone payments of up to $2.6 billion, including $850 million in development milestones and $1.75 billion in sales-based milestones.

Concurrent with the above transaction, Seagen granted Merck an exclusive license to commercialize Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers, in Asia, the Middle East and Latin America and other regions outside of the United States, Canada and Europe. Merck will be responsible for marketing applications seeking approval in its territories, supported by the positive results from the HER2CLIMB clinical trial. Merck will also co-fund a portion of the Tukysa global development plan, which encompasses several ongoing and planned trials across HER2-positive cancers, including breast, colorectal, gastric and other cancers set forth in a global product development plan. Merck will solely fund and conduct country-specific clinical trials necessary to support anticipated regulatory applications in its territories. Under the terms of the agreement, Merck made upfront payments aggregating $210 million, which were recorded as Research and development expenses in 2020. Seagen is also eligible to receive future contingent regulatory approval milestones of up to $65 million and will receive tiered royalties ranging from 20% to 33% based on annual sales levels of Tukysa in Merck’s territories.

Additionally in September 2020, Merck acquired a biologics manufacturing facility located in Dunboyne, Ireland from Takeda Pharmaceutical Company Limited for €256 million ($302 million). The transaction was accounted for as an acquisition of an asset. Merck recorded property, plant and equipment of $289 million and other net assets of $13 million. There are no future contingent payments associated with the acquisition.

In July 2020, Merck acquired the U.S. rights to Sentinel Flavor Tabs and Sentinel Spectrum Chews from Virbac Corporation for $410 million. Sentinel products provide protection against common parasites in dogs. The transaction was accounted for as an acquisition of an asset. Merck recognized intangible assets of $401 million related to currently marketed products and inventory of $9 million at the acquisition date. The estimated fair values of the identifiable intangible assets related to currently marketed products were determined using an income approach. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products will be amortized over their estimated useful lives of 15 years. There are no future contingent payments associated with the acquisition.

Also in July 2020, Merck and Ridgeback Biotherapeutics LP (Ridgeback Bio), a closely held biotechnology company, closed a collaboration agreement to develop molnupiravir (MK-4482, also known as EIDD-2801), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. Merck gained exclusive worldwide rights to develop and commercialize molnupiravir and related molecules. Under the terms of the agreement, Ridgeback Bio received an upfront payment and also is eligible to receive future contingent payments dependent upon the achievement of certain developmental and regulatory approval milestones, as well as a share of the net profits of molnupiravir and related molecules, if approved. Merck

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and Ridgeback are committed to ensure that any medicines developed for SARS-CoV-2 (the causative agent of COVID-19) will be accessible and affordable globally.

In June 2020, Merck acquired privately held Themis Bioscience GmbH (Themis), a company focused on vaccines (including a COVID-19 vaccine candidate, V591) and immune-modulation therapies for infectious diseases and cancer for $366 million. The acquisition originally provided for Merck to make additional contingent payments of up to $740 million. The transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $97 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 payments. Merck recognized intangible assets for IPR&D of $136 million, cash of $59 million, deferred tax assets of $70 million and other net liabilities of $32 million. The excess of the consideration transferred over the fair value of net assets acquired of $230 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. Actual cash flows are likely to be different than those assumed. In January 2021, the Company announced it was discontinuing development of V591 as discussed below. As a result, in 2020, the Company recorded an IPR&D impairment charge of $90 million within Research and development expenses. The Company also recorded a reduction in Research and development expenses resulting from a decrease in the related liability for contingent consideration of $45 million since future contingent milestone payments have been reduced to $450 million in the aggregate, including up to $60 million for development milestones, up to $196 million for regulatory approval milestones, and up to $194 million for commercial milestones.

In May 2020, Merck and the International AIDS Vaccine Initiative, Inc. (IAVI), a nonprofit scientific research organization dedicated to addressing urgent, unmet global health challenges, announced a collaboration to develop V590, an investigational vaccine against SARS-CoV-2 being studied for the prevention of COVID-19. The agreement provided for an upfront payment by Merck of $6.5 million and also provided for future contingent payments based on sales. Merck also signed an agreement with the Biomedical Advanced Research and Development Authority (BARDA), part of the office of the Assistant Secretary for Preparedness and Response within an agency of the United States Department of Health and Human Services, to provide initial funding support to Merck for this effort. In January 2021, the Company announced it was discontinuing development of V590 as discussed below.

In January 2021, the Company announced the discontinuation of the development programs for its COVID-19 vaccine candidates, V590 and V591, following Merck’s review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. Due to the discontinuation, the Company recorded a charge of $305 million in 2020, of which $260 million was reflected in Cost of sales and related to fixed-asset and materials write-offs, as well as the recognition of liabilities for purchase commitments*.* The remaining $45 million of costs were reflected in Research and development expenses and represent amounts related to the Themis acquisition noted above (an IPR&D impairment charge, partially offset by a reduction in the related liability for contingent consideration).

In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases. Total consideration paid of $2.7 billion included $138 million of share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of ArQule. The Company incurred $95 million of transaction costs directly related to the acquisition of ArQule, consisting almost entirely of share-based compensation payments to settle non-vested equity awards attributable to postcombination service. These costs were included in Selling, general and administrative expenses in 2020. ArQule’s lead investigational candidate, MK-1026 (formerly known as ARQ 531), is a novel, oral Bruton’s tyrosine kinase (BTK) inhibitor currently being evaluated for the treatment of B-cell malignancies. The transaction was accounted for as an acquisition of a business.

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The estimated fair value of assets acquired and liabilities assumed from ArQule is as follows:

($ in millions)			January 16, 2020
Cash and cash equivalents			$	145
IPR&D MK-1026 (formerly ARQ 531) (1)			2,280
Licensing arrangement for ARQ 087			80
Deferred income tax liabilities			(361)
Other assets and liabilities, net			34
Total identifiable net assets			2,178
Goodwill (2)			512
Consideration transferred			$	2,690

(1) The estimated fair value of the identifiable intangible asset related to IPR&D was determined using an income approach. The future net cash flows were discounted to present value utilizing a discount rate of 12.5%. Actual cash flows are likely to be different than those assumed.

(2) The goodwill was allocated to the Pharmaceutical segment and is not deductible for tax purposes.

2019 Transactions

In July 2019, Merck acquired Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2α (HIF-2α) for the treatment of patients with cancer and other non-oncology diseases. Peloton’s lead candidate, MK-6482 (formerly known as PT2977), is a novel investigational oral HIF-2α inhibitor in late-stage development for renal cell carcinoma. Merck made an upfront payment of $1.2 billion; additionally, former Peloton shareholders will be eligible to receive $50 million upon U.S. regulatory approval, $50 million upon first commercial sale in the United States, and up to $1.05 billion of sales-based milestones. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $157 million, deferred tax liabilities of $52 million, and other net liabilities of $4 million at the acquisition date, as well as Research and development expenses of $993 million in 2019 related to the transaction.

On April 1, 2019, Merck acquired Antelliq Corporation (Antelliq), 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 paid $2.3 billion to acquire all outstanding shares of Antelliq and spent $1.3 billion to repay Antelliq’s debt. The transaction was accounted for as an acquisition of a business.

The estimated fair value of assets acquired and liabilities assumed from Antelliq is as follows:

($ in millions)			April 1, 2019
Cash and cash equivalents			$	31
Accounts receivable			73
Inventories			93
Property, plant and equipment			60
Identifiable intangible assets (useful lives ranging from 18-24 years) (1)			2,689
Deferred income tax liabilities			(589)
Other assets and liabilities, net			(82)
Total identifiable net assets			2,275
Goodwill (2)			1,376
Consideration transferred			$	3,651

(1) The estimated fair values of identifiable intangible assets relate primarily to trade names and were determined using an income approach. The future net cash flows were discounted to present value utilizing a discount rate of 11.5%. Actual cash flows are likely to be different than those assumed.

(2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Animal Health segment. The goodwill is not deductible for tax purposes.

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The Company’s results for 2019 include eight months of activity for Antelliq, while the Company’s results in 2020 include 13 months of activity. The Company incurred $47 million of transaction costs directly related to the acquisition of Antelliq, consisting largely of advisory fees, which are reflected in Selling, general and administrative expenses in 2019.

Also in April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the body’s immune system to fight disease, for $301 million in cash. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $156 million, cash of $83 million and other net assets of $42 million. The excess of the consideration transferred over the fair value of net assets acquired of $20 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. Actual cash flows are likely to be different than those assumed.

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 had 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 V937 (formerly known as CVA21), an investigational oncolytic immunotherapy. 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).

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. The Company’s marketing rights with respect to these products will revert to Janssen Pharmaceuticals, Inc. in the second half of 2024.

4. 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 PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZeneca’s Lynparza (olaparib) for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of

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advanced ovarian, breast, pancreatic and prostate cancers. 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 are also jointly developing and commercializing AstraZeneca’s Koselugo (selumetinib), an oral, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, for multiple indications. In April 2020, Koselugo was approved by the U.S. Food and Drug Administration (FDA) for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 who have symptomatic, inoperable plexiform neurofibromas. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and Koselugo monotherapy and non-PD-L1/PD-1 combination therapy opportunities.

Profits from Lynparza and Koselugo 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 Koselugo. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or Koselugo. AstraZeneca is the principal on Lynparza and Koselugo sales transactions. Merck records its share of Lynparza and Koselugo product sales, net of cost of sales and commercialization costs, as alliance revenue 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 in 2017 and made payments of $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 was paid in December 2019). The upfront payment and license option payments were reflected in Research and development expenses in 2017. In addition, the agreement provides for additional contingent payments from Merck to AstraZeneca related to the successful achievement of sales-based and regulatory milestones.

In 2020, Merck determined it was probable that sales of Lynparza in the future would trigger $400 million of sales-based milestone payments from Merck to AstraZeneca. Accordingly, Merck recorded $400 million of liabilities and corresponding increases to the intangible asset related to Lynparza. Prior to 2020, Merck accrued sales-based milestone payments aggregating $1.0 billion related to Lynparza, of which $550 million, $200 million and $250 million was paid to AstraZeneca in 2020, 2019 and 2018, respectively. Potential future sales-based milestone payments of $2.7 billion have not yet been accrued as they are not deemed by the Company to be probable at this time.

In 2020, 2019 and 2018, Lynparza received regulatory approvals triggering capitalized milestone payments of $160 million, $60 million and $140 million, respectively, in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $1.4 billion remain under the agreement.

The intangible asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $1.3 billion at December 31, 2020 and is included in Other Intangibles, Net. The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing.

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Summarized financial information related to this collaboration is as follows:

Years Ended December 31			2020						2019						2018
Alliance revenue - Lynparza			$	725					$	444					$	187
Alliance revenue - Koselugo			8						—						—
Total alliance revenue			$	733					$	444					$	187
Cost of sales (1)			247						148						93
Selling, general and administrative			160						138						48
Research and development			133						168						152
December 31			2020						2019
Receivables from AstraZeneca included in Other current assets			$	215					$	128
Payables to AstraZeneca included in Accrued and other current liabilities (2)			423						577

(1) Represents amortization of capitalized milestone payments.

(2) Includes accrued milestone payments.

Eisai

In March 2018, Merck and Eisai Co., Ltd. (Eisai) announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima (lenvatinib), an orally available tyrosine kinase inhibitor discovered by Eisai. Lenvima is currently approved for the treatment of certain types of thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with renal cell carcinoma, and in combination with Keytruda for the treatment of certain patients with endometrial carcinoma. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda. Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions), and Merck and Eisai share applicable 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 are shared by the two companies in accordance with the collaboration agreement and reflected in Research and development expenses. Certain expenses incurred solely by Merck or Eisai are not shareable under the collaboration agreement, including costs incurred in excess of agreed upon caps and costs related to certain combination studies of Keytruda and Lenvima.

Under the agreement, Merck made an upfront payment to Eisai of $750 million in 2018 and agreed to make payments of up to $650 million for certain option rights through 2021 (of which $325 million was paid in March 2019, $200 million was paid in March 2020 and $125 million is expected to be paid in March 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 additional contingent payments from Merck to Eisai related to the successful achievement of sales-based and regulatory milestones.

In 2020, Merck determined it was probable that sales of Lenvima in the future would trigger sales-based milestone payments aggregating $400 million from Merck to Eisai. Accordingly, Merck recorded liabilities of $400 million and corresponding increases to the intangible asset related to Lenvima. Prior to 2020, Merck accrued sales-based milestone payments aggregating $950 million related to Lenvima, of which $500 million and $50 million was paid to Eisai in 2020 and 2019, respectively. Potential future sales-based milestone payments of $2.6 billion have not yet been accrued as they are not deemed by the Company to be probable at this time.

In 2020 and 2018, Lenvima received regulatory approvals triggering capitalized milestone payments of $10 million and $250 million, respectively, from Merck to Eisai. Potential future regulatory milestone payments of $125 million remain under the agreement.

The intangible asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $1.1 billion at December 31, 2020 and is included in Other Intangibles, Net. The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing.

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Summarized financial information related to this collaboration is as follows:

Years Ended December 31			2020						2019						2018
Alliance revenue - Lenvima			$	580					$	404					$	149
Cost of sales (1)			271						206						39
Selling, general and administrative			73						80						13
Research and development (2)			185						189						1,489
December 31			2020						2019
Receivables from Eisai included in Other current assets			$	157					$	150
Payables to Eisai included in Accrued and other current liabilities (3)			335						700
Payables to Eisai included in Other Noncurrent Liabilities (4)			600						525

(1) Represents amortization of capitalized milestone payments.

(2) Amount for 2018 includes $1.4 billion related to the upfront payment and option payments.

(3) Includes accrued milestone and future option payments.

(4) Includes accrued milestone 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 (riociguat), 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 Verquvo (vericiguat), which was approved by the FDA in January 2021 to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults. Verquvo is under review by regulatory authorities in other territories including the EU and Japan. Under the agreement, Bayer commercializes Adempas in the Americas, while Merck commercializes in the rest of the world. For Verquvo, Merck will commercialize in the United States and Bayer will commercialize in the rest of the world. Both companies share in development costs and profits on sales. Merck records sales of Adempas (and will record sales of Verquvo) in its marketing territories, as well as alliance revenue. Alliance revenue represents Merck’s share of profits from sales in Bayer’s marketing territories, which are product sales net of cost of sales and commercialization costs. In addition, the agreement provides for contingent payments from Merck to Bayer related to the successful achievement of sales-based milestones.

Prior to 2020, Merck accrued $725 million of sales-based milestone payments for this collaboration, of which $375 million and $350 million was paid to Bayer in 2020 and 2018, respectively. Following the 2021 FDA approval of Verquvo noted above, Merck determined it was probable that sales of Adempas and Verquvo in the future would trigger the remaining $400 million sales-based milestone payment. Accordingly, Merck will record a liability of $400 million and a corresponding increase in intangible assets related to this collaboration in the first quarter of 2021.

The intangible asset balance related to this collaboration (which includes the acquired intangible asset balance, as well as capitalized sales-based milestone payments) was $849 million at December 31, 2020 and is included in Other Intangibles, Net. The amount is being amortized over its estimated useful life through 2027 as supported by projected future cash flows, subject to impairment testing.

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Summarized financial information related to this collaboration is as follows:

Years Ended December 31			2020						2019						2018
Alliance revenue - Adempas			$	281					$	204					$	139
Net sales of Adempas recorded by Merck			220						215						190
Total sales			$	501					$	419					$	329
Cost of sales (1)			115						113						216
Selling, general and administrative			61						41						35
Research and development			63						126						127
December 31			2020						2019
Receivables from Bayer included in Other current assets			$	65					$	49
Payables to Bayer included in Other Noncurrent Liabilities (2)			—						375

(1) Includes amortization of intangible assets.

(2) Represents accrued milestone payment.

5. Restructuring

In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Company’s manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Company’s plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of Organon. As the Company continues to evaluate its global footprint and overall operating model, it subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $3.0 billion. The Company estimates that approximately 70% of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs. Approximately 30% of the cumulative pretax costs will be non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company expects to record charges of approximately $700 million in 2021 related to the Restructuring Program. Actions under previous global restructuring programs have been substantially completed.

The Company recorded total pretax costs of $883 million in 2020, $927 million in 2019 and $658 million in 2018 related to restructuring program activities. Since inception of the Restructuring Program through December 31, 2020, Merck has recorded total pretax accumulated costs of approximately $1.8 billion. For segment reporting, restructuring charges are unallocated expenses.

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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, 2020
Cost of sales			$	—					$	143					$	32					$	175
Selling, general and administrative			—						44						3						47
Research and development			—						81						2						83
Restructuring costs			385						—						193						578
			$	385					$	268					$	230					$	883
Year Ended December 31, 2019
Cost of sales			$	—					$	198					$	53					$	251
Selling, general and administrative			—						33						1						34
Research and development			—						2						2						4
Restructuring costs			572						—						66						638
			$	572					$	233					$	122					$	927
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

Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated.

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 are 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 2020, 2019 and 2018 includes asset abandonment, facility shut-down and other related costs, as well as pretax gains and losses resulting from the sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 13) and share-based compensation.

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

			Separation Costs						Accelerated Depreciation						Other						Total
Restructuring reserves January 1, 2019			$	443					$	—					$	91					$	534
Expenses			572						233						122						927
(Payments) receipts, net			(325)						—						(136)						(461)
Non-cash activity			—						(233)						(8)						(241)
Restructuring reserves December 31, 2019			690						—						69						759
Expenses			385						268						230						883
(Payments) receipts, net			(508)						—						(301)						(809)
Non-cash activity			—						(268)						38						(230)
Restructuring reserves December 31, 2020 (1)			$	567					$	—					$	36					$	603

(1) The remaining cash outlays are expected to be substantially completed by the end of 2023.

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6. 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 changes 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, Japanese yen and Chinese renminbi. 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 are 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.

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The Company also uses forward exchange contracts to hedge a portion of 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 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 components). Changes in fair value of the excluded components are recognized in OCI. The Company recognizes in earnings the initial value of the excluded components 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			2020						2019						2018						2020						2019						2018
Net Investment Hedging Relationships
Foreign exchange contracts			$	26					$	(10)					$	(18)					$	(19)					$	(31)					$	(11)
Euro-denominated notes			385						(75)						(183)						—						—						—

(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 February 2020, five interest rate swaps with notional amounts of $250 million each matured. These swaps effectively converted the Company’s $1.25 billion, 1.85% fixed-rate notes due 2020 to variable rate debt. At December 31, 2020, the Company was a party to 14 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:

			2020
Debt Instrument			Par Value of Debt						Number of Interest Rate Swaps Held						Total Swap Notional Amount
3.875% notes due 2021 (1)			$	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

(1) These interest rate swaps matured in January 2021.

The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark 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.

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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
			2020						2019						2020						2019
Balance Sheet Line Item in which Hedged Item is Included
Loans payable and current portion of long-term debt			$	1,150					$	1,249					$	—					$	(1)
Long-Term Debt			2,301						3,409						53						14

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:

									2020																		2019
									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 current assets						$	1					$	—					$	1,150					$	—					$	—					$	—
Interest rate swap contracts			Other Assets						54						—						2,250						15						—						3,400
Interest rate swap contracts			Accrued and other current liabilities						—						—						—						—						1						1,250
Foreign exchange contracts			Other current assets						12						—						3,183						152						—						6,117
Foreign exchange contracts			Other Assets						45						—						2,030						55						—						2,160
Foreign exchange contracts			Accrued and other current liabilities						—						217						5,049						—						22						1,748
Foreign exchange contracts			Other Noncurrent Liabilities						—						1						52						—						1						53
									$	112					$	218					$	13,714					$	222					$	24					$	14,728
Derivatives Not Designated as Hedging Instruments
Foreign exchange contracts			Other current assets						$	70					$	—					$	7,260					$	66					$	—					$	7,245
Foreign exchange contracts			Accrued and other current liabilities						—						307						11,810						—						73						8,693
									$	70					$	307					$	19,070					$	66					$	73					$	15,938
									$	182					$	525					$	32,784					$	288					$	97					$	30,666

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:

			2020												2019
			Asset						Liability						Asset						Liability
Gross amounts recognized in the consolidated balance sheet			$	182					$	525					$	288					$	97
Gross amounts subject to offset in master netting arrangements not offset in the consolidated balance sheet			(156)						(156)						(84)						(84)
Cash collateral posted/received			—						(36)						(34)						—
Net amounts			$	26					$	333					$	170					$	13

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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			2020						2019						2018						2020						2019						2018						2020						2019						2018
Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded			$	47,994					$	46,840					$	42,294					$	(886)					139						(402)						$	(441)					$	(648)					$	(361)
(Gain) loss on fair value hedging relationships
Interest rate swap contracts
Hedged items			—						—						—						40						95						(27)						—						—						—
Derivatives designated as hedging instruments			—						—						—						(76)						(65)						50						—						—						—
Impact of cash flow hedging relationships
Foreign exchange contracts
Amount of (loss) gain recognized in OCI on derivatives			—						—						—						—						—						—						(383)						87						228
(Decrease) increase in Sales as a result of AOCI reclassifications			(6)						255						(160)						—						—						—						6						(255)						160
Interest rate contracts
Amount of gain recognized in Other (income) expense, net on derivatives			—						—						—						(4)						(4)						(4)						—						—						—
Amount of loss recognized in OCI on derivatives			—						—						—						—						—						—						(4)						(6)						(4)

(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									2020						2019						2018
Derivatives Not Designated as Hedging Instruments			Income Statement Caption
Foreign exchange contracts (1)			Other (income) expense, net						$	(12)					$	174					$	(260)
Foreign exchange contracts (2)			Sales						13						1						(8)
Interest rate contracts (3)			Other (income) expense, net						9						—						—
Forward contract related to Seagen common stock			Research and development expenses						15						—						—

(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.

(3) These derivatives serve as economic hedges against rising treasury rates.

At December 31, 2020, the Company estimates $331 million of pretax net unrealized losses 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.

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Investments in Debt and Equity Securities

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

			2020																								2019
			Amortized Cost						Gross Unrealized												Fair Value						Amortized Cost						Gross Unrealized												Fair Value
			Gains						Losses						Gains						Losses
U.S. government and agency securities			$	84					$	—					$	—					$	84					$	266					$	3					$	—					$	269
Foreign government bonds			5						—						—						5						—						—						—						—
Commercial paper			—						—						—						—						668						—						—						668
Corporate notes and bonds			—						—						—						—						608						13						—						621
Asset-backed securities			—						—						—						—						226						1						—						227
Total debt securities			89						—						—						89						1,768						17						—						1,785
Publicly traded equity securities (1)																					1,787																								838
Total debt and publicly traded equity securities																					$	1,876																							$	2,623

(1) Unrealized net gains recognized in Other (income) expense, net on equity securities still held at December 31, 2020 were $163 million during 2020. Unrealized net gains recognized in Other (income) expense, net on equity securities still held at December 31, 2019 were $160 million during 2019.

At December 31, 2020 and 2019, the Company also had $586 million and $420 million, respectively, of equity investments without readily determinable fair values included in Other Assets. During 2020 and 2019, the Company recognized unrealized gains of $62 million and $20 million, respectively, 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 2020 and 2019, the Company recognized unrealized losses of $3 million and $13 million, respectively, in Other (income) expense, net, related to certain of these investments based on unfavorable observable price changes. Cumulative unrealized gains and cumulative unrealized losses based on observable prices changes for investments in equity investments without readily determinable fair values were $169 million and $24 million, respectively.

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.

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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
			Level 1						Level 2						Level 3						Total						Level 1						Level 2						Level 3						Total
			2020																								2019
Assets
Investments
Foreign government bonds			$	—					$	5					$	—					$	5					$	—					$	—					$	—					$	—
Commercial paper			—						—						—						—						—						668						—						668
Corporate notes and bonds			—						—						—						—						—						621						—						621
Asset-backed securities			—						—						—						—						—						227						—						227
U.S. government and agency securities			—						—						—						—						—						209						—						209
Publicly traded equity securities			780						—						—						780						518						—						—						518
			780						5						—						785						518						1,725						—						2,243
Other assets (1)
U.S. government and agency securities			84						—						—						84						60						—						—						60
Publicly traded equity securities			1,007						—						—						1,007						320						—						—						320
			1,091						—						—						1,091						380						—						—						380
Derivative assets (2)
Forward exchange contracts			—						90						—						90						—						169						—						169
Interest rate swaps			—						55						—						55						—						15						—						15
Purchased currency options			—						37						—						37						—						104						—						104
			—						182						—						182						—						288						—						288
Total assets			$	1,871					$	187					$	—					$	2,058					$	898					$	2,013					$	—					$	2,911
Liabilities
Other liabilities
Contingent consideration			$	—					$	—					$	841					$	841					$	—					$	—					$	767					$	767
Derivative liabilities (2)
Forward exchange contracts			—						505						—						505						—						95						—						95
Written currency options			—						20						—						20						—						1						—						1
Interest rate swaps			—						—						—						—						—						1						—						1
			—						525						—						525						—						97						—						97
Total liabilities			$	—					$	525					$	841					$	1,366					$	—					$	97					$	767					$	864

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

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

As of December 31, 2020 and 2019, Cash and cash equivalents include $6.8 billion and $8.9 billion, respectively, of cash equivalents (which would be considered Level 2 in the fair value hierarchy).

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Contingent Consideration

Summarized information about the changes in liabilities for contingent consideration associated with business acquisitions is as follows:

			2020						2019
Fair value January 1			$	767					$	788
Additions			97						—
Changes in estimated fair value (1)			83						64
Payments			(106)						(85)
Fair value December 31 (2)(3)			$	841					$	767

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

(2) Balance at December 31, 2020 includes $148 million recorded as a current liability for amounts expected to be paid within the next 12 months.

(3) At December 31, 2020 and 2019, $711 million and $625 million, respectively, of the liabilities relate to the termination of the Sanofi Pasteur MSD joint venture in 2016. As part of the termination, Merck recorded a liability for contingent future royalty payments of 11.5% on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024. The fair value of this liability is determined utilizing the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8% to present value the cash flows.

The additions to contingent consideration in 2020 relate to the acquisition of Themis. The changes in the estimated fair value of liabilities for contingent consideration in 2020 and 2019 were largely attributable to increases in the liabilities recorded in connection with the termination of the Sanofi Pasteur MSD (SPMSD) joint venture in 2016. In 2020, the increase was partially offset by a decline related to the discontinuation of a COVID-19 vaccine program obtained through the acquisition of Themis. The payments of contingent consideration in both years relate to the SPMSD liabilities described above.

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, 2020, was $36.0 billion compared with a carrying value of $31.8 billion and at December 31, 2019, was $28.8 billion compared with a carrying value of $26.3 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, Europe and China 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 45% of total accounts receivable at December 31, 2020. 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.

The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable. The Company factored $2.3 billion and $2.7 billion of accounts receivable in the fourth quarter of 2020 and 2019, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the

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Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2020 and 2019, the Company had collected $102 million and $256 million, respectively, on behalf of the financial institutions, which is reflected as restricted cash in Other current assets and the related obligation to remit the cash within Accrued and other current liabilities. The Company remitted the cash to the financial institutions in January 2021 and 2020, respectively. The net cash flows relating to these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The cost of factoring such accounts receivable was de minimis.

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 advanced by the Company to counterparties was $36 million at December 31, 2020. Cash collateral received by the Company from various counterparties was $34 million at December 31, 2019. The obligation to return such collateral is recorded in Accrued and other current liabilities.

7. Inventories

Inventories at December 31 consisted of:

			2020						2019
Finished goods			$	1,963					$	1,772
Raw materials and work in process			6,420						5,650
Supplies			206						207
Total (approximates current cost)			8,589						7,629
Decrease to LIFO cost			(82)						(171)
			$	8,507					$	7,458
Recognized as:
Inventories			$	6,310					$	5,978
Other assets			2,197						1,480

Inventories valued under the LIFO method comprised approximately $2.9 billion and $2.6 billion at December 31, 2020 and 2019, respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2020 and 2019, these amounts included $1.9 billion and $1.3 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $279 million and $168 million at December 31, 2020 and 2019, respectively, of inventories produced in preparation for product launches.

8. Goodwill and Other Intangibles

The following table summarizes goodwill activity by segment:

			Pharmaceutical						Animal Health						All Other						Total
Balance January 1, 2019			$	16,162					$	1,870					$	221					$	18,253
Acquisitions			19						1,322						—						1,341
Impairments			—						—						(162)						(162)
Other (1)			—						—						(7)						(7)
Balance December 31, 2019 (2)			16,181						3,192						52						19,425
Acquisitions			742						105						—						847
Divestitures			—						—						(54)						(54)
Other (1)			47						(29)						2						20
Balance December 31, 2020 (2)			$	16,970					$	3,268					$	—					$	20,238

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

(2) Accumulated goodwill impairment losses were $531 million at both December 31, 2020 and 2019.

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The additions to goodwill in the Pharmaceutical segment in 2020 were primarily related to the acquisitions of ArQule and Themis (see Note 3). The additions to goodwill within the Animal Health segment in 2019 primarily relate to the acquisition of Antelliq (see Note 3). The impairments of goodwill within other non-reportable segments in 2019 relate to certain businesses within the Healthcare Services segment. The Healthcare Services segment was fully divested in the first quarter of 2020.

Other intangibles at December 31 consisted of:

			2020																		2019
			Gross Carrying Amount						Accumulated Amortization						Net						Gross Carrying Amount						Accumulated Amortization						Net
Products and product rights			$	45,087					$	39,925					$	5,162					$	45,947					$	38,852					$	7,095
Licenses			4,177						1,387						2,790						3,185						824						2,361
IPR&D			3,228						—						3,228						1,032						—						1,032
Trade names			2,882						352						2,530						2,899						217						2,682
Other			2,223						1,329						894						2,261						1,235						1,026
			$	57,597					$	42,993					$	14,604					$	55,324					$	41,128					$	14,196

Acquired intangibles include products and product rights, licenses, trade names 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, on a net basis, related to human health marketed products (included in products and product rights above) at December 31, 2020 include Zerbaxa, $551 million; Implanon/Nexplanon, $354 million; Gardasil/Gardasil 9, $276 million; Dificid, $228 million; Bridion, $185 million; Sivextro, $154 million; and Simponi, $132 million. Additionally, the Company had $5.4 billion of net acquired intangibles related to animal health marketed products at December 31, 2020, of which $2.5 billion relate primarily to trade names obtained through the 2019 acquisition of Antelliq (see Note 3). Some of the Company’s more significant net intangible assets included in licenses above at December 31, 2020 include Lynparza, $1.3 billion and Lenvima, $1.1 billion as a result of collaborations with AstraZeneca and Eisai (see Note 4). At December 31, 2020, IPR&D primarily relates to MK-1026 obtained through the acquisition of ArQule in 2020 (see Note 3) and MK-7264 (gefapixant) obtained through the acquisition of Afferent Pharmaceuticals in 2016. The Company has an intangible asset related to a collaboration with Bayer (see Note 4) that had a carrying value of $849 million at December 31, 2020 reflected in “Other” in the table above.

In 2020, the Company recorded an impairment charge of $1.6 billion within Cost of sales related to Zerbaxa for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. In December 2020, the Company temporarily suspended sales of Zerbaxa, and subsequently issued a product recall, following the identification of product sterility issues. The recall constituted a triggering event requiring the evaluation of the Zerbaxa intangible asset for impairment. The Company revised its cash flow forecasts for Zerbaxa utilizing certain assumptions around the return to market timeline and anticipated uptake in sales thereafter. These revised cash flow forecasts indicated that the Zerbaxa 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 Zerbaxa that, when compared with its related carrying value, resulted in the impairment charge noted above. The Company also wrote-off inventory of $120 million to Cost of sales in 2020 related to the Zerbaxa recall. The remaining intangible asset balance related to Zerbaxa was $551 million at December 31, 2020.

In 2019, the Company recorded impairment charges related to marketed products and other intangibles of $705 million. Of this amount, $612 million related to Sivextro, a product for the treatment of acute bacterial skin and skin structure infections caused by designated susceptible Gram-positive organisms. As part of a reorganization and reprioritization of its internal sales force, the Company made the decision to cease promotion of Sivextro in the U.S. market by the end of 2019. This decision resulted in reduced cash flow projections for Sivextro, which indicated that the Sivextro 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 Sivextro that, when compared with its related carrying value, resulted in the impairment charge noted above.

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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 2020, the Company recorded a $90 million IPR&D impairment charge within Research and development expenses related to a decision to discontinue the development program for COVID-19 vaccine candidate V591 following Merck’s review of findings from a Phase 1 clinical study for the vaccine. In the study, V591 was generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. The discontinuation of this development program also resulted in a reversal of the related liability for contingent consideration of $45 million (see Note 6).

In 2019, the Company recorded $172 million of IPR&D impairment charges. Of this amount, $155 million relates to the write-off of the intangible asset balance for programs obtained in connection with the acquisition of IOmet Pharma Ltd following a review of clinical trial results conducted by Merck, along with external clinical trial results for similar compounds. The discontinuation of this clinical development program also resulted in a reversal of the related liability for contingent consideration of $11 million.

In 2018, the Company recorded $152 million of IPR&D impairment charges. 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 discontinuation of this clinical development program also resulted in a reversal of the related liability for contingent consideration of $60 million.

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 $1.9 billion in 2020, $2.0 billion in 2019 and $3.1 billion in 2018. The estimated aggregate amortization expense for each of the next five years is as follows: 2021, $1.5 billion; 2022, $1.5 billion; 2023, $1.4 billion; 2024, $1.3 billion; 2025, $1.2 billion.

9. Loans Payable, Long-Term Debt and Leases

Loans Payable

Loans payable at December 31, 2020 included $2.3 billion of notes due in 2021, $4.0 billion of commercial paper and $73 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2019 included $1.9 billion of notes due in 2020, $1.4 billion of commercial paper and $226 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 0.79% and 2.23% for the years ended December 31, 2020 and 2019, respectively.

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Long-Term Debt

Long-term debt at December 31 consisted of:

			2020						2019
2.75% notes due 2025			$	2,493					$	2,492
3.70% notes due 2045			1,976						1,975
2.80% notes due 2023			1,748						1,747
3.40% notes due 2029			1,734						1,732
4.00% notes due 2049			1,469						1,468
2.35% notes due 2022			1,269						1,248
4.15% notes due 2043			1,238						1,238
1.45% notes due 2030			1,233						—
1.875% euro-denominated notes due 2026			1,218						1,107
2.45% notes due 2050			1,211						—
2.40% notes due 2022			1,032						1,010
0.75% notes due 2026			991						—
3.90% notes due 2039			983						982
2.35% notes due 2040			982						—
2.90% notes due 2024			746						745
6.50% notes due 2033			719						722
0.50% euro-denominated notes due 2024			611						555
1.375% euro-denominated notes due 2036			606						551
2.50% euro-denominated notes due 2034			605						550
3.60% notes due 2042			491						490
6.55% notes due 2037			411						412
5.75% notes due 2036			338						338
5.95% debentures due 2028			306						306
5.85% notes due 2039			271						271
6.40% debentures due 2028			250						250
6.30% debentures due 2026			135						135
3.875% notes due 2021			—						1,151
1.125% euro-denominated notes due 2021			—						1,113
Other			294						148
			$	25,360					$	22,736

Other (as presented in the table above) includes $294 million and $147 million at December 31, 2020 and 2019, respectively, of borrowings at variable rates that resulted in effective interest rates of 0.45% and 2.54% for 2020 and 2019, 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 June 2020, the Company issued $4.5 billion principal amount of senior unsecured notes consisting of $1.0 billion of 0.75% notes due 2026, $1.25 billion of 1.45% notes due 2030, $1.0 billion of 2.35% notes due 2040 and $1.25 billion of 2.45% notes due 2050. Merck used the net proceeds from the offering for general corporate purposes, including without limitation the repayment of outstanding commercial paper borrowings and other indebtedness with upcoming maturities.

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, 2020, the Company was in compliance with these covenants.

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The aggregate maturities of long-term debt for each of the next five years are as follows: 2021, $2.3 billion; 2022, $2.3 billion; 2023, $1.7 billion; 2024, $1.4 billion; 2025, $2.5 billion.

The Company has a $6.0 billion credit facility that matures in June 2024. 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.

Leases

The Company has operating leases primarily for manufacturing facilities, research and development facilities, corporate offices, employee housing, vehicles and certain equipment. The Company determines if an arrangement is a lease at inception. When evaluating contracts for embedded leases, the Company exercises judgment to determine if there is an explicit or implicit identified asset in the contract and if Merck controls the use of that asset. Embedded leases, primarily associated with contract manufacturing organizations, are immaterial. The lease term includes options to extend or terminate the lease when it is reasonably certain that Merck will exercise that option. Real estate leases for facilities have an average remaining lease term of eight years, which include options to extend the leases for up to four years where applicable. Vehicle leases are generally in effect for four years. The Company does not record short-term leases (leases with an initial term of 12 months or less) on the balance sheet; however, Merck currently has no short-term leases.

Lease expense for operating lease payments is recognized on a straight-line basis over the term of the lease. Operating lease assets and liabilities are recognized based on the present value of lease payments over the lease term. Since the Company’s leases do not have a readily determinable implicit discount rate, the Company uses its incremental borrowing rate to calculate the present value of lease payments by asset class. On a quarterly basis, an updated incremental borrowing rate is determined based on the average remaining lease term of each asset class and the Company’s pretax cost of debt for that same term. The updated rates for each asset class are applied prospectively to new leases. The Company does not separate lease components (e.g. payments for rent, real estate taxes and insurance costs) from non-lease components (e.g. common-area maintenance costs) in the event that the agreement contains both. Merck includes both the lease and non-lease components for purposes of calculating the right-of-use asset and related lease liability (if the non-lease components are fixed). For vehicle leases and employee housing, the Company applies a portfolio approach to effectively account for the operating lease assets and liabilities.

Certain of the Company’s lease agreements contain variable lease payments that are adjusted periodically for inflation or for actual operating expense true-ups compared with estimated amounts; however, these amounts are immaterial. Sublease income and activity related to sale and leaseback transactions are immaterial. Merck’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

Operating lease cost was $346 million in 2020 and $339 million in 2019. Rental expense under operating leases, net of sublease income, was $322 million in 2018. Cash paid for amounts included in the measurement of operating lease liabilities was $340 million in 2020 and $281 million in 2019. Operating lease assets obtained in exchange for lease obligations was $495 million in 2020 and $129 million in 2019.

Supplemental balance sheet information related to operating leases is as follows:

December 31			2020						2019
Assets
Other Assets (1)			$	1,725					$	1,073
Liabilities
Accrued and other current liabilities			300						236
Other Noncurrent Liabilities			1,362						768
			$	1,662					$	1,004
Weighted-average remaining lease term (years)			8.0						7.4
Weighted-average discount rate			2.8		%				3.2		%

(1) Includes prepaid leases that have no related lease liability.

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Maturities of operating leases liabilities are as follows:

2021			$	336
2022			277
2023			252
2024			187
2025			162
Thereafter			665
Total lease payments			1,879
Less: Imputed interest			217
			$	1,662

At December 31, 2020, the Company had entered into additional real estate operating leases that had not yet commenced; the obligations associated with these leases total $475 million.

10. 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 condition, 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.

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, 2020, approximately 3,520 cases are pending 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.

All federal cases involving allegations of Femur Fractures 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.

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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. In May 2019, the U.S. Supreme Court decided that the Third Circuit had incorrectly concluded that the issue of preemption should be resolved by a jury, and accordingly vacated the judgment of the Third Circuit and remanded the proceedings back to the Third Circuit to address the issue in a manner consistent with the Supreme Court’s opinion. In November 2019, the Third Circuit remanded the cases back to the District Court in order to allow that court to determine in the first instance whether the plaintiffs’ state law claims are preempted by federal law under the standards described by the Supreme Court in its opinion. Briefing on the issue is closed, and the parties await the decision of the District Court.

Accordingly, as of December 31, 2020, approximately 970 cases were actively pending in the Femur Fracture MDL.

As of December 31, 2020, approximately 2,270 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 cases to be reviewed through fact discovery, and Merck has continued to select additional cases to be reviewed.

As of December 31, 2020, 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.

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

Discovery is presently stayed in the Femur Fracture MDL and in the state court in California. Merck 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, 2020, Merck is aware of approximately 1,480 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. In November 2018, the California state appellate court reversed and remanded on similar grounds. In March 2019, the parties in the MDL and the California coordinated proceedings agreed to coordinate and adopt a schedule for completing discovery on general causation and preemption issues and for renewing summary judgment and expert motions. Briefing of those motions is complete and hearings before both the MDL and California State Court judges took place on October 20 and December 8, 2020, respectively.

As of December 31, 2020, six 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 filed a petition for leave to appeal to the Illinois Supreme Court in February 2019. In April 2019, the Illinois Supreme Court stayed consideration of the pending petition to appeal until the U.S. Supreme Court issued its opinion in Merck Sharp & Dohme Corp. v. Albrecht (relating to the Fosamax matter discussed above). Merck filed

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the opinion in Albrecht with the Illinois Supreme Court in June 2019. The petition for leave to appeal was decided in September 2019, in which the Illinois Supreme Court directed the intermediate appellate court to reconsider its earlier ruling. The Illinois Appellate Court issued a favorable decision concluding, consistent with Albrecht, that preemption presents a legal question to be resolved by the court. In May 2020, the Illinois Appellate Court issued a mandate to the state trial court, which, as of December 31, 2020, had not scheduled a case management conference.

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

Merck reached a settlement with the Attorney General of Utah to fully resolve the state’s previously disclosed civil lawsuit alleging that Merck misrepresented the safety of Vioxx. As part of the resolution, Merck paid the state $25 million. The settlement does not constitute an admission by Merck of any liability or wrongdoing. This agreement marks the final resolution of litigation involving Vioxx in the United States. There is ongoing Vioxx litigation in certain countries outside the United States.

Governmental Proceedings

As previously disclosed, in the fall of 2018, the Company received a records subpoena from the U.S. Attorney’s Office for the District of Vermont (VT USAO) pursuant to Section 248 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) relating to an investigation of potential health care offenses. The subpoena sought information relating to any actual or potential business relationship or arrangement Merck has had with Practice Fusion, Inc. (PFI), a cloud-based, electronic health records (EHR) company that was acquired by Allscripts in January 2018. The Company cooperated with the government and responded to that subpoena. Subsequently, in May 2019, Merck received a second records subpoena from the VT USAO that broadened the government’s information request by seeking information relating to Merck’s relationship with any EHR company. Shortly thereafter, the VT USAO served a Civil Investigation Demand (CID) upon Merck similarly seeking information on the Company’s relationships with EHR vendors. The CID explains that the government is conducting a False Claims Act investigation concerning whether Merck and/or PFI submitted claims to federal health care programs that violate the Federal Anti-Kickback Statute. Merck is cooperating with the government’s investigation.

As previously disclosed, in April 2019, Merck received a set of investigative interrogatories from the California Attorney General’s Office pursuant to its investigation of conduct and agreements that allegedly affected or delayed competition to Lantus in the insulin market. The interrogatories seek information concerning Merck’s development of an insulin glargine product, and its subsequent termination, as well as Merck’s patent litigation against Sanofi S.A. concerning Lantus and the resolution of that litigation. Merck is cooperating with the California Attorney General’s investigation.

As previously disclosed, in June 2020, Merck received a CID from the U.S. Department of Justice. The CID requests answers to interrogatories, as well as various documents, regarding temperature excursions at a third-party storage facility containing certain Merck products. Merck is cooperating with the government’s investigation and intends to produce information and/or documents as necessary in response to the CID.

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.

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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. In December 2018, the court denied the Merck Defendants’ motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. In August 2019, the district court adopted in full the report and recommendation of the magistrate judge with respect to the Merck Defendants’ motions to dismiss on non-arbitration issues, thereby granting in part and denying in part Merck Defendants’ motions to dismiss. In addition, in June 2019, the representatives of the putative direct purchaser class filed an amended complaint and, in August 2019, retailer opt-out plaintiffs filed an amended complaint. In December 2019, the district court granted the Merck Defendants’ motion to dismiss to the extent the motion sought dismissal of claims for overcharges paid by entities that purchased generic ezetimibe from Par Pharmaceutical, Inc. (Par Pharmaceutical) and dismissed any claims for such overcharges. In November 2019, the direct purchaser plaintiffs and the indirect purchaser plaintiffs filed motions for class certification. On August 21, 2020, the district court granted in part the direct purchasers’ motion for class certification and certified a class of 35 direct purchasers, and on November 2, 2020, the U.S. Court of Appeals for the Fourth Circuit granted the Merck Defendants’ motion for permission to appeal the district court’s order. Also, on August 14, 2020, the magistrate judge recommended that the court grant the motion for class certification filed by the putative indirect purchaser class. The Merck Defendants objected to this report and recommendation and are awaiting a decision from the district court.

On August 10, 2020, the Merck Defendants filed a motion for summary judgment and other motions, and plaintiffs filed a motion for partial summary judgment, and other motions. Those motions are now fully briefed, and the court will likely hold a hearing on the competing motions. Trial in this matter has been adjourned.

On September 4, 2020, United Healthcare Services, Inc. filed a lawsuit in the United States District Court for the District of Minnesota against Merck and others (the UHC Action). The UHC Action makes similar allegations as those made in the Zetia class action. On September 23, 2020, the United States Judicial Panel on Multidistrict Litigation transferred the case to the Eastern District of Virginia to proceed with the multidistrict Zetia litigation already in progress.

On December 11, 2020, Humana Inc. filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against Merck and others, alleging defendants violated state antitrust laws in multiple states. Also, on December 11, 2020, Centene Corporation and others filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against the same defendants as Humana. Both lawsuits allege similar anticompetitive acts to those alleged in the Zetia class action.

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. In January 2019, the court denied MSD’s motions to compel arbitration and to dismiss the consolidated complaint. In February 2019, MSD appealed the court’s order on arbitration to the Third Circuit. In October 2019, the Third Circuit vacated the district court’s order and remanded for limited discovery on the issue of arbitrability. On July 6, 2020, MSD filed a renewed motion to compel arbitration, and plaintiffs filed a cross motion for summary judgment as to arbitrability. On November 20, 2020, the district court denied MSD’s motion and granted plaintiffs’ motion. On December 4, 2020, MSD filed a notice of appeal to the Third Circuit.

Bravecto Litigation

As previously disclosed, in January 2020, the Company was served with a complaint in the United States District Court for the District of New Jersey, seeking to certify a nationwide class action of purchasers or users of Bravecto (fluralaner) products in the United States or its territories between May 1, 2014 and December 27, 2019. The complaint contends Bravecto causes neurological events and alleges violations of the New Jersey Consumer

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Fraud Act, Breach of Warranty, Product Liability, and related theories. A similar case was filed in Quebec, Canada in May 2019.

Qui Tam Litigation

As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that had 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 now complete, and the parties have filed and briefed cross-motions for summary judgment, which are currently pending before the Court. 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. The litigation is ongoing in the United States with no trial date set, and also ongoing in numerous jurisdictions outside of the United States; the Company is defending those suits in each jurisdiction.

Patent Litigation

From time to time, generic manufacturers of pharmaceutical products file abbreviated New Drug Applications (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.

Bridion — Between January and November 2020, the Company received multiple Paragraph IV Certification Letters under the Hatch-Waxman Act notifying the Company that generic drug companies have filed applications to the FDA seeking pre-patent expiry approval to sell generic versions of Bridion (sugammadex) Injection. In March, April and December 2020, the Company filed patent infringement lawsuits in the U.S. District Courts for the District of New Jersey and the Northern District of West Virginia against those generic companies. All actions in the District of New Jersey have been consolidated. These lawsuits, which assert one or more patents covering sugammadex and methods of using sugammadex, automatically stay FDA approval of the generic applications until June 2023 or until adverse court decisions, if any, whichever may occur earlier.

Mylan Pharmaceuticals Inc., Mylan API US LLC, and Mylan Inc. (Mylan) have filed motions to dismiss in the District of New Jersey for lack of venue and failure to state a claim against certain defendants, and in the Northern District of West Virginia for failure to state a claim against certain defendants. The New Jersey motion has not yet been decided, and the West Virginia action is stayed pending resolution of the New Jersey motion.

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Januvia, Janumet, Janumet XR — The FDA has granted pediatric exclusivity with respect to Januvia, Janumet, and Janumet XR, which provides a further six months of exclusivity in the United States beyond the expiration of all patents listed in the FDA’s Orange Book. Including this exclusivity, key patent protection extends to January 2023. The Company anticipates that sales of Januvia and Janumet in the United States will decline significantly after this loss of market exclusivity. However, Januvia, Janumet, and Janumet XR contain sitagliptin phosphate monohydrate and the Company has another patent covering certain phosphate salt and polymorphic forms of sitagliptin, which, if determined to be valid, would preclude generic manufacturers from making sitagliptin phosphate salt and polymorphic forms before that patent, inclusive of pediatric exclusivity, expires in 2027 (2027 salt/polymorph patent). In 2019, 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 the 2027 salt/polymorph patent. 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, but prior to the expiration of the 2027 salt/polymorph patent, and a later granted patent owned by the Company covering the Janumet formulation which, inclusive of pediatric exclusivity, expires in 2029. The Company also filed a patent infringement lawsuit against Mylan in the Northern District of West Virginia. The Judicial Panel of Multidistrict Litigation entered an order transferring the Company’s lawsuit against Mylan to the U.S. District Court for the District of Delaware for coordinated and consolidated pretrial proceedings with the other cases pending in that district. The U.S. District Court for the District of Delaware has scheduled the lawsuits for a single three-day trial on invalidity issues in October 2021. The Court has scheduled separate one-day trials on infringement issues in November 2021 through January 2022, to the extent such trials are necessary. In the Company’s case against Mylan, the U.S. District Court for the Northern District of West Virginia has conditionally scheduled a three-day trial in December 2021 on all issues.

The Company has settled with nine generic companies providing that these generic companies can bring their products to the market in May 2027 or earlier under certain circumstances.

Additionally, in 2019, Mylan filed a petition for Inter Partes Review (IPR) at the United States Patent and Trademark Office (USPTO) seeking invalidity of some, but not all, of the claims of the 2027 salt/polymorph patent, which other manufacturers joined. The USPTO instituted IPR proceedings in May 2020, finding a reasonable likelihood that the challenged claims are not valid. A trial was held in February 2021 and a final decision is expected in May 2021. If the challenges are successful, the unchallenged claims of the 2027 salt/polymorph patent will remain valid, subject to the court proceedings described above.

In Germany, two generic companies have sought the revocation of the Supplementary Protection Certificate (SPC) for Janumet. If the generic companies are successful, Janumet could lose market exclusivity in Germany as early as July 2022. Challenges to the Janumet SPC have also occurred in Portugal and Finland, and could occur in other European countries.

Nexplanon — In June 2017, Microspherix LLC (Microspherix) sued the Company in the U.S District Court for the District of New Jersey asserting that the manufacturing, use, sale and importation of Nexplanon infringed several of Microspherix’s patents that claim radio-opaque, implantable drug delivery devices. Microspherix is claiming damages from September 2014 until those patents expire in May 2021. The Company brought IPR proceedings in the USPTO and successfully stayed the district court action. The USPTO invalidated some, but not all, of the claims asserted against the Company. The Company appealed the decisions finding claims valid, and the Court of Appeals for the Federal Circuit affirmed the USPTO’s decisions. The matter is no longer stayed in the district court, and the Company is currently litigating the invalidity and non-infringement of the remaining asserted claims.

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 condition, results of operations or cash flows either individually or in the aggregate.

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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, 2020 and 2019 of approximately $250 million and $240 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

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 condition, results of operations or liquidity 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 $67 million at both December 31, 2020 and 2019. 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 approximately $65 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Company’s financial condition, results of operations or liquidity for any year.

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11. 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:

			2020												2019												2018
			Common Stock						Treasury Stock						Common Stock						Treasury Stock						Common Stock						Treasury Stock
Balance January 1			3,577						1,038						3,577						985						3,577						880
Purchases of treasury stock			—						16						—						66						—						122
Issuances (1)			—						(7)						—						(13)						—						(17)
Balance December 31			3,577						1,047						3,577						1,038						3,577						985

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

In 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (the 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, which were funded with existing cash and investments, as well as short-term borrowings. Upon settlement of the ASR agreements in 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Merck’s common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million.

12. 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, 2020, 100 million shares collectively were authorized for future grants under the Company’s share-based compensation plans. These awards are settled 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. RSU awards generally vest one-third each year over a three-year period.

Total pretax share-based compensation cost recorded in 2020, 2019 and 2018 was $475 million, $417 million and $348 million, respectively, with related income tax benefits of $65 million, $57 million and $55 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-

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free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free interest 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 2020, 2019 and 2018 was $77.67, $80.05 and $58.15 per option, respectively. The weighted average fair value of options granted in 2020, 2019 and 2018 was $9.93, $10.63 and $8.26 per option, respectively, and were determined using the following assumptions:

Years Ended December 31			2020						2019						2018
Expected dividend yield			3.1		%				3.2		%				3.4		%
Risk-free interest rate			0.4		%				2.4		%				2.9		%
Expected volatility			22.1		%				18.7		%				19.1		%
Expected life (years)			5.8						5.9						6.1

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, 2020			17,868						$	59.88
Granted			3,564						77.67
Exercised			(1,685)						52.73
Forfeited			(301)						67.73
Outstanding December 31, 2020			19,446						$	63.64					6.27						$	353
Exercisable December 31, 2020			13,141						$	58.30					5.13						$	309

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

Years Ended December 31			2020						2019						2018
Total intrinsic value of stock options exercised			$	51					$	295					$	348
Fair value of stock options vested			25						27						29
Cash received from the exercise of stock options			89						361						591

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, 2020						13,527						$	67.58					1,972						$	69.18
Granted						6,627						77.79						996						77.82
Vested						(7,511)						65.70						(824)						64.01
Forfeited						(728)						72.06						(44)						80.06
Nonvested December 31, 2020						11,915						$	74.17					2,100						$	75.08

At December 31, 2020, there was $678 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.

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13. 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			2020						2019						2018						2020						2019						2018						2020						2019						2018
Service cost			$	360					$	293					$	326					$	301					$	238					$	238					$	52					$	48					$	57
Interest cost			431						458						432						137						177						178						57						69						69
Expected return on plan assets			(774)						(817)						(851)						(415)						(426)						(431)						(75)						(72)						(83)
Amortization of unrecognized prior service cost			(49)						(49)						(50)						(18)						(12)						(13)						(73)						(78)						(84)
Net loss (gain) amortization			303						151						232						127						64						84						(18)						(10)						1
Termination benefits			10						31						19						3						8						2						2						5						3
Curtailments			10						14						10						—						6						1						(4)						(11)						(8)
Settlements			13						—						5						15						1						13						—						—						—
Net periodic benefit cost (credit)			$	304					$	81					$	123					$	150					$	56					$	72					$	(59)					$	(49)					$	(45)

The changes in net periodic benefit cost 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 2020, 2019 and 2018 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 14), 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.

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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
			2020						2019						2020						2019						2020						2019
Fair value of plan assets January 1			$	11,361					$	9,648					$	10,163					$	8,580					$	1,102					$	968
Actual return on plan assets			1,908						2,165						1,026						1,505						175						203
Company contributions			199						130						387						262						19						14
Effects of exchange rate changes			—						—						746						31						—						—
Benefits paid			(751)						(582)						(215)						(230)						(93)						(104)
Settlements			(45)						—						(117)						(12)						—						—
Other			—						—						59						27						18						21
Fair value of plan assets December 31			$	12,672					$	11,361					$	12,049					$	10,163					$	1,221					$	1,102
Benefit obligation January 1			$	13,003					$	10,620					$	10,612					$	9,083					$	1,673					$	1,615
Service cost			360						293						301						238						52						48
Interest cost			431						458						137						177						57						69
Actuarial losses (gains) (1)			1,594						2,165						1,036						1,313						(98)						21
Benefits paid			(751)						(582)						(215)						(230)						(93)						(104)
Effects of exchange rate changes			—						—						794						4						(3)						1
Plan amendments			—						—						(64)						1						—						—
Curtailments			11						18						(8)						3						(1)						—
Termination benefits			10						31						3						8						2						5
Settlements			(45)						—						(117)						(12)						—						—
Other			—						—						55						27						18						18
Benefit obligation December 31			$	14,613					$	13,003					$	12,534					$	10,612					$	1,607					$	1,673
Funded status December 31			$	(1,941)					$	(1,642)					$	(485)					$	(449)					$	(386)					$	(571)
Recognized as:
Other Assets			$	—					$	—					$	941					$	837					$	—					$	—
Accrued and other current liabilities			(82)						(92)						(13)						(18)						(9)						(10)
Other Noncurrent Liabilities			(1,859)						(1,550)						(1,413)						(1,268)						(377)						(561)

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

At December 31, 2020 and 2019, the accumulated benefit obligation was $26.4 billion and $22.8 billion, respectively, for all pension plans, of which $14.4 billion and $12.8 billion, respectively, related to U.S. pension plans.

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

			U.S.												International
			2020						2019						2020						2019
Pension plans with a projected benefit obligation in excess of plan assets
Projected benefit obligation			$	14,613					$	13,003					$	8,951					$	7,421
Fair value of plan assets			12,672						11,361						7,526						6,135
Pension plans with an accumulated benefit obligation in excess of plan assets
Accumulated benefit obligation			$	13,489					$	12,009					$	4,288					$	2,476
Fair value of plan assets			11,685						10,484						3,033						1,501

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 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. 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, 2020 and 2019, $942 million and $860 million, respectively, or approximately 4% 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.

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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
			Level 1						Level 2						Level 3						NAV (1)						Total						Level 1						Level 2						Level 3						NAV (1)						Total
			2020																														2019
U.S. Pension Plans
Cash and cash equivalents			$	5					$	—					$	—					$	303					$	308					$	3					$	—					$	—					$	236					$	239
Investment funds
Developed markets equities			206						—						—						3,884						4,090						205						—						—						3,542						3,747
Emerging markets equities			169						—						—						927						1,096						165						—						—						723						888
Mortgage and asset-backed securities			—						89						—						—						89						—						—						—						—						—
Government and agency obligations			—						—						—						—						—						—						—						—						173						173
Equity securities
Developed markets			2,819						—						—						—						2,819						2,451						—						—						—						2,451
Fixed income securities																																																									—
Government and agency obligations			—						2,236						—						—						2,236						—						2,094						—						—						2,094
Corporate obligations			—						1,994						—						—						1,994						—						1,582						—						—						1,582
Mortgage and asset-backed securities			—						33						—						—						33						—						178						—						—						178
Other investments			—						—						7						—						7						—						—						9						—						9
Plan assets at fair value			$	3,199					$	4,352					$	7					$	5,114					$	12,672					$	2,824					$	3,854					$	9					$	4,674					$	11,361
International Pension Plans
Cash and cash equivalents			$	110					$	1					$	—					$	20					$	131					$	70					$	1					$	—					$	15					$	86
Investment funds
Developed markets equities			475						4,286						—						118						4,879						546						3,761						—						96						4,403
Government and agency obligations			1,516						2,614						—						172						4,302						462						2,534						—						207						3,203
Emerging markets equities			154						—						—						92						246						66						96						—						90						252
Corporate obligations			5						12						—						172						189						5						11						—						109						125
Other fixed income obligations			9						11						—						4						24						9						6						—						—						15
Real estate			—						1						—						15						16						—						1						—						—						1
Equity securities
Developed markets			505						—						—						—						505						565						—						—						—						565
Fixed income securities
Government and agency obligations			3						486						—						3						492						3						376						—						—						379
Corporate obligations			1						174						—						2						177						1						135						—						—						136
Mortgage and asset-backed securities			—						70						—						—						70						—						61						—						—						61
Other investments
Insurance contracts (2)			—						76						935						1						1,012						—						65						851						—						916
Other			1						5						—						—						6						—						5						—						16						21
Plan assets at fair value			$	2,779					$	7,736					$	935					$	599					$	12,049					$	1,727					$	7,052					$	851					$	533					$	10,163

(1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV 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, 2020 and 2019.

(2) 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.

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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:

			2020																								2019
			Insurance Contracts						Real Estate						Other						Total						Insurance Contracts						Real Estate						Other						Total
U.S. Pension Plans
Balance January 1			$	—					$	—					$	9					$	9					$	—					$	—					$	13					$	13
Actual return on plan assets:
Relating to assets still held at December 31			—						—						(5)						(5)						—						—						(8)						(8)
Relating to assets sold during the year			—						—						5						5						—						—						8						8
Purchases and sales, net			—						—						(2)						(2)						—						—						(4)						(4)
Balance December 31			$	—					$	—					$	7					$	7					$	—					$	—					$	9					$	9
International Pension Plans
Balance January 1			$	851					$	—					$	—					$	851					$	811					$	1					$	1					$	813
Actual return on plan assets:
Relating to assets still held at December 31			103						—						—						103						54						—						—						54
Purchases and sales, net			(17)						—						—						(17)						(14)						(1)						(1)						(16)
Transfers out of Level 3			(2)						—						—						(2)						—						—						—						—
Balance December 31			$	935					$	—					$	—					$	935					$	851					$	—					$	—					$	851

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
			Level 1						Level 2						Level 3						NAV (1)						Total						Level 1						Level 2						Level 3						NAV (1)						Total
			2020																														2019
Cash and cash equivalents			$	31					$	—					$	—					$	28					$	59					$	52					$	—					$	—					$	22					$	74
Investment funds
Developed markets equities			19						—						—						355						374						19						—						—						324						343
Emerging markets equities			16						—						—						85						101						15						—						—						66						81
Government and agency obligations			1						—						—						—						1						1						—						—						16						17
Mortgage and asset-backed securities			—						8						—						—						8						—						—						—						—						—
Equity securities																																																									—
Developed markets			258						—						—						—						258						225						—						—						—						225
Fixed income securities
Government and agency obligations			—						221						—						—						221						—						196						—						—						196
Corporate obligations			—						196						—						—						196						—						149						—						—						149
Mortgage and asset-backed securities			—						3						—						—						3						—						17						—						—						17
Plan assets at fair value			$	325					$	428					$	—					$	468					$	1,221					$	312					$	362					$	—					$	428					$	1,102

(1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV 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, 2020 and 2019.

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 45% in U.S. equities, 15% to 30% in international equities, 35% 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

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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 2021 are approximately $300 million for U.S. pension plans, approximately $170 million for international pension plans and approximately $35 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
2021			$	816					$	274					$	85
2022			786						277						86
2023			781						284						87
2024			772						285						89
2025			782						287						91
2026 — 2030			4,271						1,688						474

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 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			2020						2019						2018						2020						2019						2018						2020						2019						2018
Net (loss) gain arising during the period			$	(448)					$	(816)					$	(397)					$	(407)					$	(227)					$	(505)					$	198					$	112					$	186
Prior service (cost) credit arising during the period			(1)						(4)						(4)						62						(1)						(10)						(3)						(11)						2
			$	(449)					$	(820)					$	(401)					$	(345)					$	(228)					$	(515)					$	195					$	101					$	188
Net loss (gain) amortization included in benefit cost			$	303					$	151					$	232					$	127					$	64					$	84					$	(18)					$	(10)					$	1
Prior service credit amortization included in benefit cost			(49)						(49)						(50)						(18)						(12)						(13)						(73)						(78)						(84)
			$	254					$	102					$	182					$	109					$	52					$	71					$	(91)					$	(88)					$	(83)

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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			2020						2019						2018						2020						2019						2018
Net periodic benefit cost
Discount rate			3.40		%				4.40		%				3.70		%				1.50		%				2.20		%				2.10		%
Expected rate of return on plan assets			7.30		%				8.10		%				8.20		%				4.40		%				4.90		%				5.10		%
Salary growth rate			4.20		%				4.30		%				4.30		%				2.80		%				2.80		%				2.90		%
Interest crediting rate			4.90		%				3.40		%				3.30		%				2.80		%				2.90		%				2.80		%
Benefit obligation
Discount rate			2.70		%				3.40		%				4.40		%				1.10		%				1.50		%				2.20		%
Salary growth rate			4.60		%				4.20		%				4.30		%				2.80		%				2.80		%				2.80		%
Interest crediting rate			4.70		%				4.90		%				3.40		%				3.00		%				2.80		%				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 for 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 2021, the expected rate of return for the Company’s U.S. pension and other postretirement benefit plans will range from 6.50% to 6.70%, as compared to a range of 7.00% to 7.30% in 2020.

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

December 31			2020						2019
Health care cost trend rate assumed for next year			6.6		%				6.8		%
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

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 2020, 2019 and 2018 were $166 million, $149 million and $136 million, respectively.

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14. Other (Income) Expense, Net

Other (income) expense, net, consisted of:

Years Ended December 31			2020						2019						2018
Interest income			$	(59)					$	(274)					$	(343)
Interest expense			831						893						772
Exchange losses			145						187						145
Income from investments in equity securities, net (1)			(1,338)						(170)						(324)
Net periodic defined benefit plan (credit) cost other than service cost			(339)						(545)						(512)
Other, net			(126)						48						(140)
			$	(886)					$	139					$	(402)

(1) Includes net realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Unrealized gains and losses from investments that are directly owned are determined at the end of the reporting period, while ownership interests in investment funds are accounted for on a one quarter lag.

Other, net (as presented in the table above) in 2019 includes $162 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8).

Other, net in 2018 includes a gain of $115 million related to the settlement of certain patent litigation, income of $99 million related to AstraZeneca’s option exercise in 2014 in connection with the termination of the Company’s relationship with AstraZeneca LP (AZLP), 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.

Interest paid was $822 million in 2020, $841 million in 2019 and $777 million in 2018.

15. Taxes on Income

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

			2020												2019												2018
			Amount						Tax Rate						Amount						Tax Rate						Amount						Tax Rate
U.S. statutory rate applied to income before taxes			$	1,846					21.0		%				$	2,408					21.0		%				$	1,827					21.0		%
Differential arising from:
Foreign earnings			(1,242)						(14.1)						(1,020)						(8.9)						(245)						(2.8)
GILTI and the foreign-derived intangible income deduction			364						4.1						336						2.9						(25)						(0.3)
R&D tax credit			(110)						(1.3)						(118)						(1.0)						(96)						(1.1)
Tax settlements			(13)						(0.2)						(403)						(3.5)						(22)						(0.3)
Acquisition of VelosBio			559						6.3						—						—						—						—
Restructuring			105						1.2						39						0.3						56						0.6
Acquisition of OncoImmune			97						1.1						—						—						—						—
State taxes			67						0.8						(2)						—						201						2.3
Acquisition-related costs, including amortization			46						0.5						95						0.8						267						3.1
Valuation allowances			42						0.5						113						1.0						269						3.1
Acquisition of Peloton			—						—						209						1.8						—						—
Tax Cuts and Jobs Act of 2017			—						—						117						1.0						289						3.3
Other			(52)						(0.5)						(87)						(0.7)						(13)						(0.1)
			$	1,709					19.4		%				$	1,687					14.7		%				$	2,508					28.8		%

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The Tax Cuts and Jobs Act (TCJA) was enacted in December 2017 and 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, which were since finalized and resulted in additional income tax expense in 2018 and 2019. The Company’s remaining transition tax liability under the TCJA, which has been reduced by payments and the utilization of foreign tax credits, was $3.0 billion at December 31, 2020, of which $390 million is included in Income taxes payable and the remainder of $2.6 billion is included in Other Noncurrent Liabilities. As a result of the transition tax under the TCJA, the Company is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for foreign withholding taxes that would apply. The Company remains indefinitely reinvested with respect to its financial statement basis in excess of tax basis of its foreign subsidiaries. A determination of the deferred tax liability with respect to this basis difference is not practicable.

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), thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 21%. Towards the end of 2020, a new reduced tax rate arrangement was agreed to in Switzerland for certain newly active legal entities.

Income before taxes consisted of:

Years Ended December 31			2020						2019						2018
Domestic			$	(3,492)					$	439					$	3,717
Foreign			12,283						11,025						4,984
			$	8,791					$	11,464					$	8,701

Taxes on income consisted of:

Years Ended December 31			2020						2019						2018
Current provision
Federal			$	962					$	514					$	536
Foreign			1,362						1,806						2,281
State			53						(77)						200
			2,377						2,243						3,017
Deferred provision
Federal			(605)						(330)						(402)
Foreign			(40)						(240)						(64)
State			(23)						14						(43)
			(668)						(556)						(509)
			$	1,709					$	1,687					$	2,508

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Deferred income taxes at December 31 consisted of:

			2020												2019
			Assets						Liabilities						Assets						Liabilities
Product intangibles and licenses			$	141					$	1,250					$	442					$	1,778
Inventory related			43						335						32						354
Accelerated depreciation			—						588						—						594
Equity investments			—						175						—						—
Pensions and other postretirement benefits			834						248						785						191
Compensation related			252						—						322						—
Unrecognized tax benefits			117						—						109						—
Net operating losses and other tax credit carryforwards			794						—						897						—
Other			808						81						764						84
Subtotal			2,989						2,677						3,351						3,001
Valuation allowance			(433)												(1,100)
Total deferred taxes			$	2,556					$	2,677					$	2,251					$	3,001
Net deferred income taxes									$	121											$	750
Recognized as:
Other Assets			$	894											$	719
Deferred Income Taxes									$	1,015											$	1,470

The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2020, $464 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $433 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $330 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry.

Income taxes paid in 2020, 2019 and 2018 were $2.7 billion, $4.5 billion and $1.5 billion, respectively. Tax benefits relating to stock option exercises were $55 million in 2020, $65 million in 2019 and $77 million in 2018.

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

			2020						2019						2018
Balance January 1			$	1,225					$	1,893					$	1,723
Additions related to current year positions			298						199						221
Additions related to prior year positions			110						46						142
Reductions for tax positions of prior years (1)			(4)						(454)						(73)
Settlements (1)			(70)						(356)						(91)
Lapse of statute of limitations (2)			(22)						(103)						(29)
Balance December 31			$	1,537					$	1,225					$	1,893

(1) Amounts in 2019 reflects the settlement with the IRS discussed below.

(2) Amount in 2019 includes $78 million related to the divestiture of Merck’s Consumer Care business in 2014.

If the Company were to recognize the unrecognized tax benefits of $1.5 billion at December 31, 2020, the income tax provision would reflect a favorable net impact of $1.5 billion.

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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, 2020 could decrease by up to approximately $160 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.

Interest and penalties associated with uncertain tax positions amounted to an expense (benefit) of $27 million in 2020, $(101) million in 2019 and $51 million in 2018. These amounts reflect the beneficial impacts of various tax settlements, including the settlement discussed below. Liabilities for accrued interest and penalties were $268 million and $243 million as of December 31, 2020 and 2019, respectively.

In 2019, the Internal Revenue Service (IRS) concluded its examinations of Merck’s 2012-2014 U.S. federal income tax returns. As a result, the Company was required to make a payment of $107 million. 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 $364 million net tax benefit in 2019. 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.

The IRS is currently conducting examinations of the Company’s tax returns for the years 2015 and 2016. 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 2020.

16. Earnings per Share

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

Years Ended December 31			2020						2019						2018
Net income attributable to Merck & Co., Inc.			$	7,067					$	9,843					$	6,220
Average common shares outstanding			2,530						2,565						2,664
Common shares issuable (1)			11						15						15
Average common shares outstanding assuming dilution			2,541						2,580						2,679
Basic earnings per common share attributable to Merck & Co., Inc. common shareholders			$	2.79					$	3.84					$	2.34
Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders			$	2.78					$	3.81					$	2.32

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

In 2020, 2019 and 2018, 5 million, 2 million and 6 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.

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17. 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, 2018, net of taxes			$	(108)					$	(61)					$	(2,787)					$	(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			(23)						1						(344)						100						(266)
Adoption of ASU 2016-01			—						(8)						—						—						(8)
Balance at December 31, 2018, net of taxes			166						(78)						(3,556)						(2,077)						(5,545)
Other comprehensive income (loss) before reclassification adjustments, pretax			86						140						(948)						112						(610)
Tax			(15)						—						192						(16)						161
Other comprehensive income (loss) before reclassification adjustments, net of taxes			71						140						(756)						96						(449)
Reclassification adjustments, pretax			(261)			(1)			(44)			(2)			66			(3)			—						(239)
Tax			55						—						(15)						—						40
Reclassification adjustments, net of taxes			(206)						(44)						51						—						(199)
Other comprehensive income (loss), net of taxes			(135)						96						(705)						96						(648)
Balance at December 31, 2019, net of taxes			31						18						(4,261)			(4)			(1,981)						(6,193)
Other comprehensive income (loss) before reclassification adjustments, pretax			(383)						3						(599)						64						(915)
Tax			84						—						111						89						284
Other comprehensive income (loss) before reclassification adjustments, net of taxes			(299)						3						(488)						153						(631)
Reclassification adjustments, pretax			2			(1)			(21)			(2)			272			(3)			—						253
Tax			—						—						(63)						—						(63)
Reclassification adjustments, net of taxes			2						(21)						209						—						190
Other comprehensive income (loss), net of taxes			(297)						(18)						(279)						153						(441)
Balance at December 31, 2020, net of taxes			$	(266)					$	—					$	(4,540)		(4)			$	(1,828)					$	(6,634)

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

(2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net*.*

(3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 13).

(4) Includes pension plan net loss of $5.4 billion and $5.1 billion at December 31, 2020 and 2019, respectively, and other postretirement benefit plan net gain of $391 million and $247 million at December 31, 2020 and 2019, respectively, as well as pension plan prior service credit of $255 million and $263 million at December 31, 2020 and 2019, respectively, and other postretirement benefit plan prior service credit of $244 million and $305 million at December 31, 2020 and 2019, respectively.

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18. Segment Reporting

The Company’s operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are 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. 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.

The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers.

The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020.

The Company previously had an Alliances segment that primarily included activity from the Company’s relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018.

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Sales of the Company’s products were as follows:

Years Ended December 31			2020																		2019																		2018
			U.S.						Int’l						Total						U.S.						Int’l						Total						U.S.						Int’l						Total
Pharmaceutical:
Oncology
Keytruda			$	8,352					$	6,028					$	14,380					$	6,305					$	4,779					$	11,084					$	4,150					$	3,021					$	7,171
Alliance revenue - Lynparza (1)			417						308						725						269						176						444						127						61						187
Alliance revenue - Lenvima (1)			359						220						580						239						165						404						95						54						149
Emend			18						127						145						183						205						388						312						210						522
Vaccines
Gardasil/Gardasil 9			1,755						2,184						3,938						1,831						1,905						3,737						1,873						1,279						3,151
ProQuad/M-M-R II/Varivax			1,378						500						1,878						1,683						592						2,275						1,430						368						1,798
Pneumovax 23			727						359						1,087						679						247						926						627						281						907
RotaTeq			486						311						797						506						284						791						496						232						728
Vaqta			103						67						170						130						108						238						127						112						239
Hospital Acute Care
Bridion			583						615						1,198						533						598						1,131						386						531						917
Noxafil			42						287						329						282						380						662						353						389						742
Prevymis			119						162						281						84						81						165						46						27						72
Primaxin			2						248						251						2						271						273						7						258						265
Cancidas			7						207						213						6						242						249						12						314						326
Invanz			9						202						211						30						233						263						253						243						496
Cubicin			46						106						152						92						165						257						191						176						367
Zerbaxa			74						56						130						63						58						121						42						45						87
Immunology
Simponi			—						838						838						—						830						830						—						893						893
Remicade			—						330						330						—						411						411						—						582						582
Neuroscience
Belsomra			81						247						327						92						214						306						96						164						260
Virology
Isentress/Isentress HD			326						531						857						398						576						975						513						627						1,140
Zepatier			60						107						167						118						252						370						8						447						455
Cardiovascular
Zetia			(1)						483						482						14						575						590						45						813						857
Vytorin			12						171						182						16						269						285						10						487						497
Atozet			—						453						453						—						391						391						—						347						347
Alliance revenue - Adempas (2)			259						22						281						194						10						204						134						5						139
Adempas			—						220						220						—						215						215						—						190						190
Diabetes
Januvia			1,470						1,836						3,306						1,724						1,758						3,482						1,969						1,718						3,686
Janumet			477						1,494						1,971						589						1,452						2,041						811						1,417						2,228
Women’s Health
Implanon/Nexplanon			488						192						680						568						219						787						495						208						703
NuvaRing			110						127						236						742						136						879						722						180						902
Diversified Brands
Singulair			18						444						462						29						669						698						20						688						708
Cozaar/Hyzaar			21						365						386						24						418						442						23						431						453
Arcoxia			—						258						258						—						288						288						—						335						335
Nasonex			12						206						218						9						284						293						23						353						376
Follistim AQ			84						109						193						103						138						241						115						153						268
Other pharmaceutical (3)			1,555						3,152						4,709						1,416						3,204						4,615						1,231						3,308						4,546
Total Pharmaceutical segment sales			19,449						23,572						43,021						18,953						22,798						41,751						16,742						20,947						37,689
Animal Health:
Livestock			612						2,327						2,939						582						2,201						2,784						528						2,102						2,630
Companion Animals			872						892						1,764						724						885						1,609						710						872						1,582
Total Animal Health segment sales			1,484						3,219						4,703						1,306						3,086						4,393						1,238						2,974						4,212
Other segment sales (4)			23						—						23						174						1						175						248						2						250
Total segment sales			20,956						26,791						47,747						20,433						25,885						46,319						18,228						23,923						42,151
Other (5)			71						176						247						86						436						521						118						26						143
			$	21,027					$	26,967					$	47,994					$	20,519					$	26,321					$	46,840					$	18,346					$	23,949					$	42,294

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

(1) Alliance revenue represents Merck’s share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4).

(2) Alliance revenue represents Merck’s share of profits from sales in Bayer’s marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 4).

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

(4) Represents sales for the non-reportable segments of Healthcare Services (fully divested in the first quarter of 2020) and Alliances (which concluded in 2018).

(5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales.

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Consolidated sales by geographic area where derived are as follows:

Years Ended December 31			2020						2019						2018
United States			$	21,027					$	20,519					$	18,346
Europe, Middle East and Africa			13,600						12,707						12,213
China			3,624						3,207						2,184
Japan			3,376						3,583						3,212
Asia Pacific (other than China and Japan)			2,864						2,943						2,909
Latin America			2,274						2,469						2,415
Other			1,229						1,412						1,015
			$	47,994					$	46,840					$	42,294

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

Years Ended December 31			2020						2019						2018
Segment profits:
Pharmaceutical segment			$	29,722					$	28,324					$	24,871
Animal Health segment			1,650						1,609						1,659
Other segments			1						(7)						103
Total segment profits			31,373						29,926						26,633
Other profits			140						363						6
Unallocated:
Interest income			59						274						343
Interest expense			(831)						(893)						(772)
Depreciation and amortization			(1,602)						(1,593)						(1,352)
Research and development			(13,072)						(9,499)						(9,432)
Amortization of purchase accounting adjustments			(1,168)						(1,406)						(2,664)
Restructuring costs			(578)						(638)						(632)
Charge related to the termination of a collaboration with Samsung			—						—						(423)
Other unallocated, net			(5,530)						(5,070)						(3,006)
Income Before Taxes			$	8,791					$	11,464					$	8,701

Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses 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.

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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, 2020
Included in segment profits:
Equity (income) loss from affiliates			$	6					$	—					$	—					$	6
Depreciation and amortization			690						164						1						855
Year Ended December 31, 2019
Included in segment profits:
Equity (income) loss from affiliates			$	—					$	—					$	—					$	—
Depreciation and amortization			534						109						10						653
Year Ended December 31, 2018
Included in segment profits:
Equity (income) loss from affiliates			$	4					$	—					$	—					$	4
Depreciation and amortization			411						82						10						503

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

December 31			2020						2019						2018
United States			$	10,526					$	8,974					$	8,306
Europe, Middle East and Africa			6,059						4,767						3,706
Asia Pacific (other than China and Japan)			761						714						684
Latin America			252						266						264
China			217						174						167
Japan			166						152						159
Other			5						6						5
			$	17,986					$	15,053					$	13,291

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

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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 sheet of Merck & Co., Inc. and its subsidiaries (the “Company”) as of December 31, 2020 and 2019, 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, 2020, 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, 2020, 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, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 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, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

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.

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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.

Critical Audit Matters

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Customer Discount Accruals in the U.S. - Medicaid, Managed Care and Medicare Part D Rebates

As described in Note 2 to the consolidated financial statements, the Company records certain variable consideration including discounts, which are estimated at the time of sale generally using the expected value method. Amounts accrued for aggregate customer discounts as of December 31, 2020 in the U.S. are $3.1 billion and 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. Certain of these discounts take the form of rebates, which are amounts owed based upon definitive contractual agreements or legal requirements with private sector (Managed Care) 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. Management 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.

The principal considerations for our determination that performing procedures relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates is a critical audit matter are the significant judgment by management due to the significant measurement uncertainty involved in developing the provisions, as the provisions include assumptions related to changes to price and historical customer segment utilization mix, pertaining to forecasted customer claims that may not be fully paid until a subsequent period. This in turn led to a high degree of auditor judgment, subjectivity and effort in applying the procedures related to those assumptions and in evaluating the evidence obtained from these procedures.

Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates, including management’s controls over the assumptions used to estimate the corresponding rebate accruals. These procedures also included, among others, (i) developing an independent estimate of the rebate accruals by utilizing third party data on historical customer segment utilization mix in the U.S., changes to price, the terms of the specific rebate programs, and the historical trend of actual rebate claims paid, (ii) comparing the independent estimate to the rebate accruals recorded by management and (iii) testing actual rebate claims paid, including evaluating those claims for consistency with the contractual terms of the Company’s rebate agreements.

PricewaterhouseCoopers LLP

Florham Park, New Jersey

February 25, 2021

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

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