Table of Contents

As filed with the Securities and Exchange Commission on February 28, 2013

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

 

FORM 10-K

(MARK ONE)

 

  þ Annual Report Pursuant to Section 13 or 15(d)
       of the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 2012

or

  ¨ Transition Report Pursuant to Section 13 or 15(d)
       of the Securities Exchange Act of 1934

For the transition period from                  to                 

 

Commission File No. 1-6571

 

 

Merck & Co., Inc.

One Merck Drive

Whitehouse Station, N. J. 08889-0100

(908) 423-1000

 

Incorporated in New Jersey  

I.R.S. Employer

Identification No. 22-1918501

Securities Registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange

on which Registered

Common Stock ($0.50 par value)   New York Stock Exchange

Number of shares of Common Stock ($0.50 par value) outstanding as of January 31, 2013: 3,022,367,538.

Aggregate market value of Common Stock ($0.50 par value) held by non-affiliates on June 30, 2012 based on closing price on June 30, 2012: $126,837,000,000.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes    þ        No    ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes    ¨        No    þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes    þ        No    ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes    þ        No    ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer   þ            Accelerated filer         ¨      Non-accelerated filer   ¨        Smaller reporting company   ¨
    

  (Do not check if a smaller reporting company)        

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨       No   þ

Documents Incorporated by Reference:

 

Document

 

Part of Form 10-K

Proxy Statement for the Annual Meeting of

Shareholders to be held May 28, 2013, to be filed with the

Securities and Exchange Commission within 120 days after the

close of the fiscal year covered by this report

  Part III

 

 

 


Table of Contents

Table of Contents

 

              Page  
Part I   

Item 1.

  Business      1   

Item 1A.

  Risk Factors      21   
  Cautionary Factors that May Affect Future Results      31   

Item 1B.

  Unresolved Staff Comments      32   

Item 2.

  Properties      33   

Item 3.

  Legal Proceedings      33   

Item 4.

  Mine Safety Disclosures      33   
  Executive Officers of the Registrant      33   
Part II   

Item 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      37   

Item 6.

  Selected Financial Data      40   

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      41   

Item 7A.

  Quantitative and Qualitative Disclosures About Market Risk      80   

Item 8.

  Financial Statements and Supplementary Data      81   
  (a)   

Financial Statements

     81   
    

Notes to Consolidated Financial Statements

     85   
    

Report of Independent Registered Public Accounting Firm

     136   
  (b)   

Supplementary Data

     137   

Item 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      138   

Item 9A.

  Controls and Procedures      138   
  Management’s Report      138   

Item 9B.

  Other Information      139   
Part III   

Item 10.

  Directors, Executive Officers and Corporate Governance      140   

Item 11.

  Executive Compensation      140   

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
     140   

Item 13.

  Certain Relationships and Related Transactions, and Director Independence      140   

Item 14.

  Principal Accountant Fees and Services      141   
Part IV   

Item 15.

  Exhibits and Financial Statement Schedules      141   
  Signatures      147   
  Consent of Independent Registered Public Accounting Firm      148   


Table of Contents

PART I

 

Item 1. Business.

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, animal health, and consumer care products, which it markets directly and through its joint ventures. The Company’s operations are principally managed on a products basis and are comprised of four operating segments, which are the Pharmaceutical, Animal Health, Consumer Care and Alliances segments, and one reportable segment, which is the Pharmaceutical segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products marketed either directly by the Company or through joint ventures. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Company also has animal health operations that discover, develop, manufacture and market animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. Additionally, the Company has consumer care operations that develop, manufacture and market over-the-counter, foot care and sun care products, which are sold through wholesale and retail drug, food chain and mass merchandiser outlets, as well as club stores and specialty channels.

For financial information and other information about the Company’s segments, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary Data” below.

All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners.

Overview

Merck continued to execute on its strategic priorities during 2012 despite facing several business challenges, including the August U.S. patent expiration for Singulair (montelukast), a medicine indicated for the chronic treatment of asthma and the relief of symptoms of allergic rhinitis. Worldwide sales were $47.3 billion in 2012, a decline of 2% compared with 2011, including a 3% unfavorable effect from foreign exchange. Excluding the impact of foreign exchange, sales increased 1% reflecting growth of key products and within key geographic regions which offset the impact of the U.S. Singulair patent expiration. The Company also reduced operating expenses by efficiently managing costs through targeted reductions. In addition, the Company generated new clinical data and advanced certain key research and development pipeline programs.

The Company’s four-part growth strategy is focused on; one, executing on its core business, which includes its largest markets, its core brands, new launch brands, and research and development efforts targeted at therapeutic areas with the greatest future patient demand and scientific opportunity; two, expanding geographically into high-growth markets; three, extending into complementary businesses of consumer care and animal health; and four, effectively managing costs while continuing to invest for future growth.

Beginning with the Company’s sales performance in its largest markets during 2012, despite the adverse effects of the U.S. Singulair patent expiry which caused a significant and rapid decline in U.S. Singulair sales, sales in the United States were relatively flat compared to the prior year reflecting strong growth of key brands including Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCI), treatments for type 2 diabetes, Zostavax (Zoster Vaccine Live), a vaccine to help prevent shingles (herpes zoster), Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant), a vaccine to help prevent certain diseases caused by four types of human papillomavirus (“HPV”), Victrelis (boceprevir), a treatment for chronic hepatitis C, and Isentress (raltegravir), an antiretroviral therapy for use in combination therapy for the treatment of HIV-1 infection. Turning to Europe and Canada, the Company continues to experience positive volume growth trends for many of its key

 

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brands, including Victrelis, Januvia , Janumet , and Simponi (golimumab), a treatment for inflammatory diseases; however, this growth only partially offset increased generic erosion and the price declines stemming from the economic issues and related fiscal austerity measures in this region.

With respect to research and development efforts, the Company continued the advancement of drug candidates through its pipeline in 2012. The Company currently has three candidates under review with the U.S. Food and Drug Administration (the “FDA”): MK-4305, suvorexant, an investigational treatment for insomnia; MK-8616, sugammadex sodium injection, a medication for the reversal of certain muscle relaxants used during surgery; and MK-0653C, an investigational combination of ezetimibe and atorvastatin for the treatment of primary or mixed hyperlipidemia. MK-8109, vintafolide, an investigational cancer candidate, is under review in the European Union (the “EU”). In addition, the Company currently has 16 candidates in Phase III development and anticipates filing a New Drug Application (“NDA”) or a Biologics License Application (“BLA”), as applicable, with the FDA with respect to several of these candidates in 2013.

In December 2012, the Company announced the HPS2-THRIVE (Heart Protection Study 2-Treatment of HDL to Reduce the Incidence of Vascular Events) study of Tredaptive (extended-release niacin/laropipant) did not meet its primary endpoint. As a result, the Company does not plan to seek regulatory approval for the medicine in the United States. In January 2013, Merck began taking steps to suspend the availability of Tredaptive outside the United States. Also, on February 1, 2013, the Company announced that it had recently received and was reviewing safety and efficacy data from a Phase III study involving MK-0822, odanacatib, the Company’s investigational treatment for osteoporosis in post-menopausal women. As a result of its review of this data, the Company concluded that review of additional data from the previously planned, ongoing extension study was warranted and that filing an application for approval with the FDA should be delayed. As previously announced, the Company is conducting a blinded extension of the trial in approximately 8,200 women, which will provide additional safety and efficacy data. Merck now anticipates that it will file applications for approval of odanacatib in 2014 with additional data from the extension trial. The Company continues to believe that odanacatib will have the potential to address unmet medical needs in patients with osteoporosis.

Merck continues to pursue opportunities for establishing external alliances to complement its substantial internal research capabilities, including research collaborations, as well as licensing preclinical and clinical compounds and technology platforms that have the potential to drive both near- and long-term growth. During 2012, the Company completed a variety of transactions spanning different therapeutic areas and clinical stages including licensing agreements with Endocyte, Inc. (“Endocyte”) for vintafolide (MK-8109), an investigational cancer candidate, and with AiCuris for a portfolio of investigational medicines targeting human cytomegalovirus, including letermovir (MK-8228).

Consistent with the second element of the Company’s strategy to expand geographically in high-growth markets such as Japan and key emerging markets, the Company continued to invest in these markets in 2012. Emerging market sales grew 4% in 2012, including a 4% unfavorable impact of foreign exchange, despite the loss of sales from Remicade (infliximab) and Simponi , treatments for inflammatory diseases, in markets relinquished to Johnson & Johnson (“J&J”) as part of the arbitration settlement agreement in 2011 as discussed below. China continues to be an important growth driver with sales exceeding $1.0 billion in 2012, representing growth of 25% over the prior year, including a 3% favorable effect from foreign exchange. Growth in Japan was 6% during 2012, tempered by generic competition and the biennial price cuts early in the year. Merck has entered into several transactions designed to strengthen its presence in the emerging markets in the longer term. The Company’s joint venture with Simcere Pharmaceutical Group in China began preliminary operations in late-2012.

The third component of Merck’s strategy relates to the complementary businesses of Consumer Care and Animal Health. Merck’s Animal Health business continues as a solid contributor with 4% revenue growth in 2012, including a 5% unfavorable effect from foreign exchange, reflecting growth in the cattle, poultry, companion animal and swine product lines. Sales of Consumer Care products grew 6% in 2012, including a 1% unfavorable effect from foreign exchange, led by the Dr. Scholl’s franchise and higher sales of Coppertone , MiraLAX and Claritin .

As noted, the last element of the Company’s strategy is to tightly manage costs while also investing for growth. Consistent with these efforts, Merck remains committed to driving continuous productivity improvements across the enterprise and continues to realize cost savings across all areas of the Company. These savings result

 

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from various actions, including the Merger Restructuring Program discussed below, previously announced ongoing cost reduction activities, as well as from non-restructuring-related activities. As of the end of 2012, the Company had achieved its projected $3.5 billion in annual net cost savings from these activities since the merger with Schering-Plough Corporation (“Schering-Plough”) (the “Merger”).

The global restructuring program that was initiated in conjunction with the integration of the legacy Merck and legacy Schering-Plough businesses (the “Merger Restructuring Program”) is intended to optimize the cost structure of the combined company. The workforce reductions associated with this plan relate to the elimination of positions in sales, administrative and headquarters organizations, as well as from the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company recorded total pretax restructuring costs of $951 million in 2012, $1.8 billion in 2011 and $1.8 billion in 2010 related to this program. Costs associated with the Company’s restructuring actions are included in Materials and production costs, Marketing and administrative expenses, Research and development expenses and Restructuring costs . The restructuring actions under the Merger Restructuring Program are expected to be substantially completed by the end of 2013, with the exception of certain actions, principally manufacturing-related. Subsequent to the Merger, the Company has rationalized a number of manufacturing sites worldwide. The remaining actions under this program will result in additional manufacturing facility rationalizations, which are expected to be substantially completed by 2016. The Company now expects the estimated total cumulative pretax costs for this program to be approximately $7.2 billion to $7.5 billion. The Company estimates that approximately two-thirds of the cumulative pretax costs relate to cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company expects the Merger Restructuring Program to yield annual savings by the end of 2013 of approximately $3.5 billion to $4.0 billion and annual savings upon completion of the program of approximately $4.0 billion to $4.6 billion.

In November 2012, Merck’s Board of Directors raised the Company’s quarterly dividend to $0.43 per share from $0.42 per share.

In February 2013, Merck reached an agreement in principle with plaintiffs to resolve two federal securities class-action lawsuits pending in the U.S. District Court for the District of New Jersey against Merck, Schering-Plough and certain of their current and former officers and directors (the “ENHANCE Litigation”). Under the proposed agreement, Merck will pay $215 million to resolve the securities class action against all of the Merck defendants and $473 million to resolve the securities class action against all of the Schering-Plough defendants. In connection with the settlement, Merck recorded a pretax and after-tax charge of $493 million in 2012 which reflects $195 million of anticipated insurance recoveries.

Earnings per common share assuming dilution attributable to common shareholders (“EPS”) for 2012 were $2.00, which reflect a net unfavorable impact resulting from acquisition-related costs and restructuring costs, as well as the charge related to the ENHANCE Litigation noted above. Non-GAAP EPS in 2012 were $3.82 excluding these items (see “Non-GAAP Income and Non-GAAP EPS” below).

 

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Product Sales

Sales of the Company’s products were as follows:

 

($ in millions)    2012      2011      2010  

Primary Care and Women’s Health

        

Cardiovascular

        

Zetia

   $ 2,567       $ 2,428       $ 2,297   

Vytorin

     1,747         1,882         2,014   

Diabetes and Obesity

        

Januvia

     4,086         3,324         2,385   

Janumet

     1,659         1,363         954   

Respiratory

        

Singulair

     3,853         5,479         4,987   

Nasonex

     1,268         1,286         1,219   

Clarinex

     393         621         623   

Dulera

     207         96         8   

Asmanex

     185         206         208   

Women’s Health and Endocrine

        

Fosamax

     676         855         926   

NuvaRing

     623         623         559   

Follistim AQ

     468         530         528   

Implanon

     348         294         236   

Cerazette

     271         268         209   

Other

        

Maxalt

     638         639         550   

Arcoxia

     453         431         398   

Avelox

     201         322         316   

Hospital and Specialty

        

Immunology

        

Remicade

     2,076         2,667         2,714   

Simponi

     331         264         97   

Infectious Disease

        

Isentress

     1,515         1,359         1,090   

PegIntron

     653         657         737   

Cancidas

     619         640         611   

Victrelis

     502         140           

Invanz

     445         406         362   

Primaxin

     384         515         610   

Noxafil

     258         230         198   

Oncology

        

Temodar

     917         935         1,065   

Emend

     489         419         378   

Other

        

Cosopt/Trusopt

     444         477         484   

Bridion

     261         201         103   

Integrilin

     211         230         266   

Diversified Brands

        

Cozaar/Hyzaar

     1,284         1,663         2,104   

Propecia

     424         447         447   

Zocor

     383         456         468   

Claritin Rx

     244         314         296   

Remeron

     232         241         223   

Proscar

     217         223         216   

Vasotec/Vaseretic

     192         231         255   

Vaccines (1)

        

Gardasil

     1,631         1,209         988   

ProQuad/M-M-R II/Varivax

     1,273         1,202         1,378   

Zostavax

     651         332         243   

RotaTeq

     601         651         519   

Pneumovax

     580         498         376   

Other pharmaceutical (2)

     4,141         4,035         4,622   

Total Pharmaceutical segment sales

     40,601         41,289         39,267   

Other segment sales (3)

     6,412         6,428         6,159   

Total segment sales

     47,013         47,717         45,426   

Other (4)

     254         330         561   
     $ 47,267       $ 48,047       $ 45,987   

 

(1)  

These amounts do not reflect sales of vaccines sold in most major European markets through the Company’s joint venture, Sanofi Pasteur MSD, the results of which are reflected in Equity income from affiliates . These amounts do, however, reflect supply sales to Sanofi Pasteur MSD.

 

(2)  

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

 

(3)  

Reflects the non-reportable segments of Animal Health, Consumer Care and Alliances. The Alliances segment includes revenue from the Company relationship with AZLP.

 

(4)  

Other revenues are primarily comprised of miscellaneous corporate revenues, third-party manufacturing sales, sales related to divested products or businesses and other supply sales not included in segment results.

 

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Pharmaceutical

The Company’s pharmaceutical products include therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Certain of the products within the Company’s franchises are as follows:

Primary Care and Women’s Health

Cardiovascular:     Zetia (marketed as Ezetrol outside the United States); and Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States), cholesterol modifying medicines.

Diabetes and Obesity:     Januvia and Janumet for the treatment of type 2 diabetes.

Respiratory:     Singulair ; Nasonex (mometasone furoate monohydrate), an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms; Clarinex (desloratadine), a non-sedating antihistamine; Dulera Inhalation Aerosol (mometasone furoate/formoterol fumarate dihydrate), a combination medicine for the treatment of asthma; and Asmanex Twisthaler (mometasone furoate inhalation powder), an inhaled corticosteroid for first-line maintenance treatment of asthma in patients 4 years of age and older .

Women’s Health and Endocrine:     Fosamax (alendronate sodium) for the treatment and prevention of osteoporosis ; NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive ring ; Follistim AQ (follitropin beta injection), a biological fertility treatment; Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant; and Cerazette (desogestrel), a progestin only oral contraceptive.

Other:     Maxalt (rizatriptan benzoate) , a product for acute treatment of migraine; Arcoxia (etoricoxib) for the treatment of arthritis and pain; and Avelox (moxifloxacin), which the Company only markets in the United States, a broad-spectrum fluoroquinolone antibiotic for the treatment of certain respiratory and skin infections.

Hospital and Specialty

Immunology:     Remicade and Simponi for the treatment of inflammatory diseases.

Infectious Disease:     Isentress ; PegIntron (peginterferon alpha-2b), a treatment for chronic hepatitis C; Cancidas (caspofungin acetate), an anti-fungal product; Victrelis ; Invanz (ertapenem sodium) for the treatment of certain infections; Primaxin (imipenem and cilastatin sodium), an anti-bacterial product; and Noxafil (posaconazole) for the prevention of invasive fungal infections.

Oncology:     Temodar (temozolomide) (marketed as Temodal outside the United States), a treatment for certain types of brain tumors; and Emend (aprepitant) for the prevention of chemotherapy-induced and post-operative nausea and vomiting.

Other:     Cosopt (dorzolamide hydrochloride-timolol maleate ophthalmic solution) and Trusopt (dorzolamide hydrochloride ophthalmic solution), ophthalmic products; Bridion (sugammadex sodium injection), a medication for the reversal of certain muscle relaxants used during surgery; and Integrilin (eptifibatide), a treatment for patients with acute coronary syndrome.

Diversified Brands

Cozaar (losartan potassium) and Hyzaar (losartan potassium and hydrochlorothiazide), treatments for hypertension; Propecia (finasteride), a product for the treatment of male pattern hair loss; Zocor (simvastatin), a statin for modifying cholesterol; Claritin Rx (loratadine) for treatment of seasonal outdoor allergies and year-round indoor allergies ; Remeron (mirtazapine), an antidepressant; Proscar (finasteride), a urology product for the treatment of symptomatic benign prostate enlargement; and Vasotec (enalapril maleate) and Vaseretic (enalapril maleate-hydrochlorothiazide) , hypertension and/or heart failure products .

Vaccines

Gardasil;    ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; M-M-R II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Zostavax; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Pneumovax (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease .

 

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Animal Health

The Animal Health segment discovers, develops, manufactures and markets animal health products, including vaccines. Principal marketed products in this segment include:

Livestock Products:     Nuflor antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine bovine and swine anti-inflammatory; Estrumate for the treatment of fertility disorders in cattle; Regumate / Matrix fertility management for swine and horses; Resflor combination broad-spectrum antibiotic and non-steroidal anti-inflammatory drug for bovine respiratory disease; Zuprevo for bovine respiratory disease; Zilmax and Revalor to improve production efficiencies in beef cattle; M+Pac swine pneumonia vaccine; and Porcilis vaccine line for infectious diseases in swine.

Poultry Products:     Nobilis / Innovax, vaccine lines for poultry; and Paracox and Coccivac coccidiosis vaccines.

Companion Animal Products:     Nobivac / Continuum vaccine lines for flexible dog and cat vaccination; Otomax / Mometamax / Posatex ear ointments for acute and chronic otitis; Caninsulin / Vetsulin diabetes mellitus treatment for dogs and cats; Panacur / Safeguard broad-spectrum anthelmintic (de-wormer) for use in many animals; and Activyl/Scalibor/Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies.

Aquaculture Products:     Slice parasiticide for sea lice in salmon; Aquavac / Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; and Aquaflor antibiotic for farm-raised fish.

Consumer Care

The Consumer Care segment develops, manufactures and markets over-the-counter, foot care and sun care products. Principal products in this segment include:

Over-the-Counter Products:     Claritin non-drowsy antihistamines; MiraLAX for relief of occasional constipation; Coricidin HBP decongestant-free cold/flu medicine for people with high blood pressure; Afrin nasal decongestant spray; and Zegerid OTC treatment for frequent heartburn.

Foot Care:     Dr. Scholl’s foot care products; Lotrimin topical antifungal products; and Tinactin topical antifungal products and foot and sneaker odor/wetness products.

Sun Care:     Coppertone sun care lotions, sprays and dry oils.

For a further discussion of sales of the Company’s products, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.

Product Approvals

In February 2012, the FDA approved Zioptan (tafluprost), a preservative-free prostaglandin analog ophthalmic solution for reducing elevated intraocular pressure in patients with open-angle glaucoma or ocular hypertension. Merck has exclusive commercial rights to tafluprost in Western Europe (excluding Germany), North America, South America, Africa, the Middle East, India and Australia. Zioptan is marketed as Saflutan in certain markets outside the United States. Also, in February 2012, the FDA approved Janumet XR , a new treatment for type 2 diabetes that combines sitagliptin, which is the active component of Januvia , with extended-release metformin. Janumet XR provides a convenient once-daily treatment option for health care providers and patients who need help to control their blood sugar. In addition, in February 2012, the FDA approved Cosopt PF , Merck’s preservative-free formulation of Cosopt ophthalmic solution, indicated for the reduction of elevated intraocular pressure in appropriate patients with open-angle glaucoma or ocular hypertension.

Joint Ventures

AstraZeneca LP

In 1982, Merck entered into an agreement with Astra AB (“Astra”) to develop and market Astra products in the United States. In 1994, Merck and Astra formed an equally owned joint venture that developed and marketed most of Astra’s new prescription medicines in the United States including Prilosec (omeprazole), the first in a class of medications known as proton pump inhibitors, which slows the production of acid from the cells of the stomach lining.

 

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In 1998, Merck and Astra restructured the joint venture whereby Merck acquired Astra’s interest in the joint venture, renamed KBI Inc. (“KBI”), and contributed KBI’s operating assets to a new U.S. limited partnership named Astra Pharmaceuticals, L.P. (the “Partnership”), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AstraZeneca LP (“AZLP”) upon Astra’s 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights.

The Company earns certain Partnership returns as well as ongoing revenue based on sales of current and future KBI products. The Partnership returns include a priority return provided for in the Partnership Agreement, a preferential return representing the Company’s share of undistributed Partnership AZLP generally accepted accounting principles (“GAAP”) earnings, and a variable return related to the Company’s 1% limited partner interest.

In conjunction with the 1998 restructuring discussed above, Astra purchased an option (the “Asset Option”) for a payment of $443 million, which was recorded as deferred income, to buy Merck’s interest in the KBI products, excluding the gastrointestinal medicines Nexium and Prilosec (the “Non-PPI Products”). In April 2010, AstraZeneca exercised the Asset Option. Merck received $647 million from AstraZeneca representing the net present value as of March 31, 2008 of projected future pretax revenue to be received by Merck from the Non-PPI Products, which was recorded as a reduction to the Company’s investment in AZLP. The Company recognized the $443 million of deferred income in 2010 as a component of Other (income) expense, net . In addition, in 1998, Merck granted Astra an option to buy Merck’s common stock interest in KBI and, through it, Merck’s interest in Nexium and Prilosec as well as AZLP, exercisable in 2012. In June 2012, Merck and AstraZeneca amended the 1998 option agreement. The updated agreement eliminated AstraZeneca’s option to acquire Merck’s interest in KBI in 2012 and provides AstraZeneca a new option to acquire Merck’s interest in KBI in June 2014. As a result of the amended agreement, Merck continues to record supply sales and equity income from the partnership. In 2014, AstraZeneca has the option to purchase Merck’s interest in KBI based in part on the value of Merck’s interest in Nexium and Prilosec. AstraZeneca’s option is exercisable between March 1, 2014 and April 30, 2014. If AstraZeneca chooses to exercise this option, the closing date is expected to be June 30, 2014. Under the amended agreement, AstraZeneca will make a payment to Merck upon closing of $327 million, reflecting an estimate of the fair value of Merck’s interest in Nexium and Prilosec. This portion of the exercise price is subject to a true-up in 2018 based on actual sales from closing in 2014 to June 2018. The exercise price will also include an additional amount equal to a multiple of ten times Merck’s average 1% annual profit allocation in the partnership for the three years prior to exercise. The Company believes that it is likely that AstraZeneca will exercise its option in 2014. If AstraZeneca exercises its option, the Company will no longer record equity income from AZLP and supply sales to AZLP will decline substantially.

Sanofi Pasteur MSD

In 1994, Merck and Pasteur Mérieux Connaught (now Sanofi Pasteur S.A.) formed a joint venture to market human vaccines in Europe and to collaborate in the development of combination vaccines for distribution in the then-existing EU and the European Free Trade Association. Merck and Sanofi Pasteur contributed, among other things, their European vaccine businesses for equal shares in the joint venture, known as Pasteur Mérieux MSD, S.N.C. (now Sanofi Pasteur MSD, S.N.C.). The joint venture maintains a presence, directly or through affiliates or branches, in Belgium, Italy, Germany, Spain, France, Austria, Ireland, Sweden, Portugal, the Netherlands, Switzerland and the United Kingdom and through distributors in the rest of its territory.

Licenses

In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (“Centocor”), a 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 had exclusive marketing rights to both products outside the United States, Japan and certain other Asian markets. In December 2007, Schering-Plough and Centocor revised their distribution agreement regarding the development, commercialization and distribution of both Remicade and Simponi , extending the Company’s rights to exclusively market Remicade to match the duration of the Company’s exclusive marketing rights for Simponi . In addition,

 

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Schering-Plough and Centocor agreed to share certain development costs relating to Simponi ’s auto-injector delivery system. On October 6, 2009, the European Commission (“EC”) approved Simponi as a treatment for rheumatoid arthritis and other immune system disorders in two presentations — a novel auto-injector and a prefilled syringe. As a result, the Company’s marketing rights for both products extend for 15 years from the first commercial sale of Simponi in the EU following the receipt of pricing and reimbursement approval within the EU.

In April 2011, Merck and J&J reached an agreement to amend the agreement governing the distribution rights to Remicade and Simponi . Under the terms of the amended distribution agreement, Merck relinquished marketing rights for Remicade and Simponi to J&J in territories including Canada, Central and South America, the Middle East, Africa and Asia Pacific effective July 1, 2011. Merck retained exclusive marketing rights throughout Europe, Russia and Turkey (the “Retained Territories”). In addition, beginning July 1, 2011, all profits derived from Merck’s exclusive distribution of the two products in the Retained Territories are being equally divided between Merck and J&J. J&J also received a one-time payment from Merck of $500 million in April 2011.

Competition and the Health Care Environment

Competition

The markets in which the Company conducts its business and the pharmaceutical industry are highly competitive and highly regulated. The Company’s competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, and generic drug and consumer health care manufacturers. The Company’s operations may be affected by technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors’ branded products, new information from clinical trials of marketed products or post-marketing surveillance and generic competition as the Company’s products mature. In addition, patent positions are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the recognition of an impairment charge with respect to certain products. Competitive pressures have intensified as pressures in the industry have grown. The effect on operations of competitive factors and patent disputes cannot be predicted.

Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well positioned to compete in the search for technological innovations. Additional resources required to meet market challenges include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through external alliances, such as joint ventures and licenses, and has been refining its sales and marketing efforts to further address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth for the Company’s products in that therapeutic category.

The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Company’s products, effective promotional efforts and the frequent introduction of generic products by competitors.

The Company’s consumer care operations face competition from other consumer health care businesses as well as retailers who carry their own private label brands. The Company’s competitive position is affected by several factors, including regulatory and legislative issues, scientific and technological advances, the quality and price of the Company’s products, promotional efforts and the growth of lower cost private label brands.

Health Care Environment

Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, federal and state governments for many years also have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for outpatient medicines purchased by certain Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients.

 

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Against this backdrop, the United States enacted major health care reform legislation in 2010, which began to be implemented in 2010. Various insurance market reforms have advanced and will continue through full implementation in 2014. The law is expected to expand access to health care to about 32 million Americans by the end of the decade who did not previously have insurance coverage. With respect to the effect of the law on the pharmaceutical industry, the mandated Medicaid rebate increased from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called “donut hole”). Approximately $210 million and $150 million was recorded by Merck as a reduction to revenue in 2012 and 2011, respectively, related to the donut hole provision. Also, pharmaceutical manufacturers are now required to pay an annual health care reform fee. The total annual industry fee was $2.8 billion in 2012 and will be $2.8 billion in 2013. The fee is assessed on each company in proportion to its share of sales to certain government programs, such as Medicare and Medicaid. The Company recorded $190 million and $162 million of costs within Marketing and administrative expenses in 2012 and 2011, respectively, for the annual health care reform fee.

The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Company’s sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act of 2010. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures.

In addition, in the effort to contain the U.S. federal deficit, the pharmaceutical industry could be considered a potential source of savings via legislative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls in the Medicare prescription drug program (Part D). In addition, Congress may again consider proposals to allow, under certain conditions, the importation of medicines from other countries. It remains very uncertain as to what proposals, if any, may be included as part of future federal budget deficit reduction proposals that would directly or indirectly affect the Company.

Efforts toward health care cost containment remain intense in several European countries. Many countries have announced austerity measures, which include the implementation of pricing actions to reduce prices of generic and patented drugs and mandatory switches to generic drugs. While the Company is taking steps to mitigate the impact in the EU, the austerity measures continued to negatively affect the Company’s revenue performance in 2012 and the Company anticipates the austerity measures will continue to negatively affect revenue performance in 2013.

Additionally, the global economic downturn and the sovereign debt issues in certain European countries, among other factors, have adversely affected foreign receivables in certain European countries. While the Company continues to receive payment on these receivables, these conditions have resulted in an increase in the average length of time it takes to collect accounts receivable outstanding thereby adversely affecting cash flows.

Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and related measures that aim to put pressure on the price of pharmaceuticals and constrain market access. The Company anticipates that pricing pressures and market access challenges will continue in 2013 to varying degrees in the emerging markets.

The Company’s focus on and share of revenue from emerging markets has increased. Countries in these markets may be subject to conditions that can affect the Company’s efforts to continue to grow in emerging markets, including potential political instability, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Company’s risk exposure.

 

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The full impact of health care reform, as well as continuing budget pressures on governments around the world, cannot be predicted at this time.

In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to attempt to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company seeks to work with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of government health care spending, the Company encourages those governments to increase their investments in order to improve their citizens’ access to appropriate health care, including medicines.

Certain markets outside of the United States have implemented health technology assessments and other cost management strategies which require additional data, reviews and administrative processes, all of which increase the complexity and costs of obtaining product reimbursement and exert downward pressure on reimbursement available and obtained.

Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Company’s business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well positioned to respond to the evolving health care environment and market forces.

Government Regulation

The pharmaceutical industry is subject to regulation by regional, country, state and local agencies around the world. Governmental regulation and legislation tend to focus on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement, especially related to the pricing of products.

Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In many cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States.

The EU has adopted directives and other legislation concerning the classification, labeling, advertising, wholesale distribution, integrity of the supply chain, enhanced pharmacovigilance monitoring and approval for marketing of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. The Company’s policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Company’s business.

The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment.

Access to Medicines

As a global health care company, Merck’s primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its products around the world. The Company’s efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Company’s worldwide approach to expanding access to health care. For example, the Company has been recognized for pricing many of its products through a differential pricing framework, taking into consideration such factors as a country’s level of economic development and public health need. In addition, the Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Company’s assistance, cannot afford their Merck medicine and vaccines.

Building on the Company’s own efforts, Merck has undertaken collaborations with many stakeholders to improve access to medicines and enhance the quality of life for people around the world.

 

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For example, in 2011, Merck announced that it would launch “Merck for Mothers,” a long-term effort with global health partners to create a world where no woman has to die from preventable complications of pregnancy and childbirth. The launch includes a 10-year, $500 million initiative that applies Merck’s scientific and business expertise to making proven solutions more widely available, developing new technologies and improving public awareness, policy efforts and private sector engagement to reduce maternal mortality.

Merck has also in the past provided funds to the Merck Foundation, an independent organization, which has partnered with a variety of organizations dedicated to improving global health. One of these partnerships is The African Comprehensive HIV/AIDS Partnership in Botswana, a collaboration with the government of Botswana that was renewed in 2010 and supports Botswana’s response to HIV/AIDS through a comprehensive and sustainable approach to HIV prevention, care, treatment, and support.

Privacy and Data Protection

The Company is subject to a number of privacy and data protection laws and regulations globally. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Company’s business, including recently enacted laws and regulations in the United States, Europe, Asia and Latin America and increased enforcement activity in the United States and other developed markets.

Distribution

The Company sells its 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 vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Company’s professional representatives communicate the effectiveness, safety and value of the Company’s pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. The Company’s over-the-counter, foot care and sun care products are sold through wholesale and retail drug, food chain and mass merchandiser outlets, as well as club stores and specialty channels.

Raw Materials

Raw materials and supplies, which are generally available from multiple sources, are purchased worldwide and are normally available in quantities adequate to meet the needs of the Company’s business.

Patents, Trademarks and Licenses

Patent protection is considered, in the aggregate, to be of material importance in the Company’s marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for or intermediates useful in the manufacture of products or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage.

The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term under Patent Term Restoration for periods when the patented product was under regulatory review by the FDA.

 

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Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key U.S. patent protection (including Patent Term Restoration and Pediatric Exclusivity) for major marketed products:

 

Product

 

Year of Expiration (in the U.S.) (1)

Propecia (2)

  2013 (formulation/use)

Asmanex

  2014 (use)/2018 (formulation)

Avelox (3)

  2014

Dulera

  2014 (use)/2017(formulation)/2020 (combination)

Integrilin

  2014 (compound)/2015 (use/formulation)

Nasonex (4)

  2014 (use/formulation)/2018(formulation)

Temodar (5)

  2014

Emend

  2015

Follistim AQ

  2015

PegIntron

  2015 (conjugates)/2020 (Mature IFN-alpha)

Invanz

  2016 (compound)/2017 (composition)

Zostavax

  2016 (use)

Zetia (6) /Vytorin

  2017

NuvaRing

  2018 (delivery system)

Noxafil

  2019

RotaTeq

  2019

Intron A

  2020

Recombivax

  2020 (method of making/vectors)

Saphris/Sycrest

  2020 (use/formulation) (with pending Patent Term Restoration)

Januvia/Janumet/Juvisync/Janumet XR

  2022 (compound)/2026 (salt)

Zioptan

  2022 (with pending Patent Term Restoration)

Isentress

  2023

Victrelis

  2024 (with pending Patent Term Restoration)

Gardasil

  2028

 

(1)  

Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. “Financial Statements and Supplementary Data,” Note 11. “Contingencies and Environmental Liabilities” below.

 

(2)  

By agreement, a generic manufacturer entered the U.S. market in January 2013, and another has been given the right to enter in July 2013 with a generic version of Propecia .

 

(3)  

By agreement, a generic manufacturer may launch a generic version of Avelox in the United States in February 2014.

 

(4)  

By agreement, a generic manufacturer has been granted rights under Merck’s Nasonex use patent in the United States. In addition, a recent court decision found that a proposed generic product by a generic manufacturer would not infringe on Merck’s Nasonex formulation patent. Thus, if the generic manufacturer’s application is approved by the FDA, it can enter the market in the United States with a generic version of Nasonex . That decision is under appeal.

 

(5)  

By agreement, a generic manufacturer may launch a generic version of Temodar in the United States in August 2013.

 

(6)  

By agreement, a generic manufacturer may launch a generic version of Zetia in the United States in December 2016.

While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries.

The patent that provides U.S. market exclusivity for Avelox expires in March 2014; however, by agreement, a generic manufacturer may launch a generic version of Avelox in the United States in February 2014. Also, the patent that provides market exclusivity in the United States for Temodar will expire in February 2014; however, by agreement, a generic manufacturer may launch a generic version of Temodar in the United States in August 2013. The Company anticipates that sales in the United States will decline significantly after these patent expiries.

 

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Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties.

The Company has the following key U.S. patent protection for drug candidates under review in the United States by the FDA. Additional patent term may be provided for these pipeline candidates based on Patent Term Restoration and Pediatric Exclusivity.

 

Under Review

       

Currently Anticipated

Year of Expiration (in the U.S.) (1)(2)(3)(4)

MK-0653C (ezetimibe/atorvastatin)

   

2017

MK-8616 (sugammadex sodium injection)

   

2021

MK-4305 (suvorexant)

   

2029

The Company also has the following key U.S. patent protection for drug candidates in Phase III development:

 

Phase III Drug Candidate

 

Currently Anticipated

Year of Expiration (in the U.S.) (1)(2)(3)(4)

V212 (inactivated varicella zoster virus (“VZV”) vaccine)

  2016 (method of use)

MK-8175A (NOMAC/E2)

  2017 (use)

MK-8962 (corifollitropin alfa injection)

  2018 (formulation)

V419 (pediatric hexavalent combination vaccine)

  2020 (method of making/vectors)

MK-3814 (preladenant)

  2021

MK-3641 (ragweed)

  2023

MK-7243 (grass pollen)

  2023

MK-0822 (odanacatib)

  2024

MK-5348 (vorapaxar)

  2024

MK-8109 (vintafolide)

  2024

MK-0859 (anacetrapib)

  2027

MK-3222 (psoriasis)

  2028 (composition)

MK-3415A (actoxumab/bezlotoxumab)

  2028

V503 (HPV vaccine (9 valent))

  2028

MK-3102 (diabetes mellitus)

  2030

 

(1)  

Compound patent unless otherwise noted.

 

(2)  

Subject to any future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available.

 

(3)  

Depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product.

 

(4)  

Regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in many cases, may provide more efficacious or longer lasting marketing exclusivity than a compound’s patent estate. In the United States, the data protection generally runs 5 years from first marketing approval of a new chemical entity, extended to 7 years for an orphan drug indication and 12 years from first marketing approval of a biological product.

For further information with respect to the Company’s patents, see Item 1A. “Risk Factors” and Item 8. “Financial Statements and Supplementary Data,” Note 11. “Contingencies and Environmental Liabilities” below.

Worldwide, all of the Company’s important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely.

Royalty income in 2012 on patent and know-how licenses and other rights amounted to $352 million. Merck also incurred royalty expenses amounting to $1.3 billion in 2012 under patent and know-how licenses it holds.

 

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Research and Development

The Company’s business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. Approximately 13,600 people are employed in the Company’s research activities. Research and development expenses were $8.2 billion in 2012, $8.5 billion in 2011, and $11.1 billion in 2010 (which included restructuring costs in all years, as well as $200 million, $587 million and $2.4 billion of in-process research and development impairment charges in 2012, 2011 and 2010, respectively). The Company maintains its ongoing commitment to research over a broad range of therapeutic areas and clinical development in support of new products.

The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Company’s research and development model is designed to increase productivity and improve the probability of success by prioritizing the Company’s research and development resources on disease areas of unmet medical needs, scientific opportunity and commercial opportunity. Merck is managing its research and development portfolio across diverse approaches to discovery and development by balancing investments appropriately on novel, innovative targets with the potential to have a major impact on human health, on developing best-in-class approaches, and on delivering maximum value of its approved medicines and vaccines through new indications and new formulations. Another important component of the Company’s science-based diversification is based on expanding the Company’s portfolio of modalities to include not only small molecules and vaccines, but also biologics (peptides, small proteins, antibodies) and RNAi. Further, Merck has moved to diversify its portfolio through biosimilars, which have the potential to harness the market opportunity presented by biological medicine patent expiries by delivering high quality follow-on biologic products to enhance access for patients worldwide. The Company supplements its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as new technologies.

The Company’s clinical pipeline includes candidates in multiple disease areas, including atherosclerosis, cancer, cardiovascular diseases, diabetes, infectious diseases, inflammatory/autoimmune diseases, insomnia, neurodegenerative diseases, osteoporosis, respiratory diseases and women’s health.

In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through preclinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on preclinical and clinical experience are included in the NDA for a drug or the BLA for a vaccine or biologic submitted to the FDA for the required approval.

Once the Company’s scientists discover a new small molecule compound or biologics molecule that they believe has promise to treat a medical condition, the Company commences preclinical testing with that compound. Preclinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable preclinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase I studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase II studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compound’s usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase IIa/IIb trial design, a two-stage trial design consisting of a Phase IIa proof-of-concept stage and a Phase IIb dose-optimization finding stage. If data from the Phase II trials are satisfactory, the Company commences large-scale Phase III trials to confirm the compound’s efficacy and safety. Upon completion of those trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed.

Vaccine development follows the same general pathway as for drugs. Preclinical testing focuses on the vaccine’s safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase I clinical studies are conducted in normal subjects to evaluate

 

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the safety, tolerability and immunogenicity of the vaccine candidate. Phase II studies are dose-ranging studies. Finally, Phase III trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. Also during this stage, the proposed manufacturing facility undergoes a pre-approval inspection during which production of the vaccine as it is in progress is examined in detail.

In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V, the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Company’s own initiative or the FDA’s request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter, or by issuing a Complete Response Letter stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a Complete Response Letter, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission.

The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the “centralized procedure.” This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (“MAA”) with the European Medicines Agency (“EMA”). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a “mutual recognition procedure,” in which an application is made to a single member state, and if the member state approves the pharmaceutical product under a national procedure, then the applicant may submit that approval to the mutual recognition procedure of some or all other member states.

Research and Development Update

The Company currently has four candidates under regulatory review in the United States and internationally.

MK-4305, suvorexant, an investigational insomnia medicine in a new class of medicines called orexin receptor antagonists for use in patients with difficulty falling or staying asleep, is under review by the FDA. Suvorexant will be evaluated by the Controlled Substance Staff of the FDA during NDA review. If approved by the FDA, suvorexant will become available after a schedule assessment and determination has been completed by the U.S. Drug Enforcement Administration, which routinely occurs after FDA approval. The Company has also submitted a new drug application for suvorexant to the health authorities in Japan and is continuing with plans to seek approval for suvorexant in other countries around the world.

MK-8616, sugammadex sodium injection, is an investigational agent for the reversal of neuromuscular blockade induced by rocuronium or vecuronium (neuromuscular blocking agents) under review by the FDA. Neuromuscular blockade is used in anesthesiology to induce muscle relaxation during surgery. If approved, MK-8616 would be the first in a new class of medicines in the United States known as selective relaxant binding agents to be used in the surgical setting. In 2008, the FDA did not approve the original NDA for sugammadex sodium injection, requesting additional data related to hypersensitivity (allergic) reactions and coagulation (bleeding) events. Merck submitted these requested data within the NDA resubmission, which the FDA deemed complete for review. The Company expects the FDA’s review to be completed in the first half of 2013. Sugammadex sodium injection is approved and has been launched in many countries outside of the United States where it is marketed as Bridion .

 

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MK-8109, vintafolide, is an investigational cancer candidate under review by the EMA. As part of an exclusive license agreement with Endocyte, Merck is responsible for the development and worldwide commercialization of vintafolide in oncology. The EMA accepted the MAA filings for vintafolide and Endocyte’s investigational companion diagnostic imaging agent, etarfolatide, for the targeted treatment of patients with folate-receptor positive platinum-resistant ovarian cancer in combination with pegylated liposomal doxorubicin. Both vintafolide and etarfolatide have been granted orphan drug status by the EC. Vintafolide is in Phase III development in the United States.

MK-0653C is an investigational combination of ezetimibe and atorvastatin for the treatment of primary or mixed hyperlipidemia under review by the FDA. An updated NDA for MK-0653C was deemed complete for review by the FDA after Merck submitted additional data in response to the FDA’s Complete Response Letter issued in 2012. Merck expects the FDA’s review to be completed in the first half of 2013. Merck is continuing to move forward with planned filings for the ezetimibe and atorvastatin combination tablet in additional countries around the world.

In addition to the candidates under regulatory review, the Company has 16 drug candidates in Phase III development targeting a broad range of diseases. The Company anticipates filing an NDA or a BLA, as applicable, with the FDA with respect to several of these candidates in 2013.

V503 is a nine-valent HPV vaccine in development to help protect against certain HPV-related diseases. V503 incorporates antigens against five additional cancer-causing HPV types as compared with Gardasil . As previously disclosed, the 14,000-patient Phase III event-driven clinical study of V503 is ongoing. Merck anticipates filing a BLA for V503 with the FDA in 2013.

MK-8962, corifollitropin alpha injection, which is being marketed as Elonva in the EU, is an investigational fertility treatment for controlled ovarian stimulation in women participating in in vitro fertilization or intracytoplasmic sperm injection currently in Phase III development in the United States. Merck continues to anticipate filing an NDA for MK-8962 with the FDA in 2013.

MK-5348, vorapaxar, is a thrombin receptor antagonist being developed for the prevention of thrombosis, or clot formation, and the reduction of cardiovascular events. Vorapaxar has been evaluated in two major clinical outcomes studies in different patient groups: TRACER (Thrombin Receptor Antagonist for Clinical Event Reduction in Acute Coronary Syndrome), a clinical outcomes trial in patients with acute coronary syndrome, and TRA-2P (Thrombin Receptor Antagonist in Secondary Prevention of atherothrombotic ischemic events), a secondary prevention study in patients with a previous heart attack or ischemic stroke, or with documented peripheral vascular disease. In March 2012, results from the TRA-2P study of vorapaxar were presented at the American College of Cardiology Annual Scientific Session and published concurrently in the online edition of the New England Journal of Medicine. In the study, the addition of vorapaxar to standard of care (e.g. aspirin or thienopyridine or both) resulted in a significantly greater reduction in the risk of the composite of cardiovascular death, heart attack, stroke or urgent coronary revascularization. There was also a significant increase in bleeding, including intracranial hemorrhage, among patients taking vorapaxar in addition to standard of care, although the risk of intracranial hemorrhage was lower in patients without a history of stroke. In November 2011, researchers presented results from the TRACER outcomes study at the American Heart Association Scientific Sessions, and the results have been published. TRACER did not achieve its primary endpoint. In January 2011, Merck and the external study investigators announced that the combined Data Safety Monitoring Board (“DSMB”) for the two clinical trials had reviewed the available safety and efficacy data, and recommended that patients in the TRACER trial discontinue study drug and investigators close out the study. Following a review of the clinical trial data and discussions with external experts, Merck plans to file applications for vorapaxar in the United States and EU in 2013 seeking an indication for the prevention of cardiovascular events in patients with a history of heart attack and no history of transient ischemic attack or stroke.

MK-7243 is an investigational allergy immunotherapy sublingual tablet (“AIT”) in Phase III development for grass pollen allergy for which the Company has North American rights. AIT is a dissolvable oral tablet that is designed to prevent allergy symptoms by inducing a protective immune response against allergies, thereby treating the underlying cause of the disease. Merck is investigating AIT for the treatment of grass pollen allergic rhinoconjunctivitis in both children and adults. The Company has submitted a BLA for MK-7243 with the FDA.

 

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MK-3641, an AIT for ragweed allergy, is also in Phase III development for the North American market. The Company anticipates filing a BLA for MK-3641 with the FDA in 2013.

MK-8175A, NOMAC/E2, which is being marketed as Zoely in the EU, is an investigational oral contraceptive for use by women to prevent pregnancy. NOMAC/E2 is a combined oral contraceptive tablet containing a unique monophasic combination of two hormones: nomegestrol acetate, a highly selective progesterone-derived progestin, and 17-beta estradiol, an estrogen that is similar to the one naturally present in a women’s body. In November 2011, Merck received a Complete Response Letter from the FDA for NOMAC/E2. The Company is conducting an additional clinical study requested by the FDA and plans to update the application in the future.

MK-0822, odanacatib, is an oral, once-weekly investigational treatment for osteoporosis in post-menopausal women. Osteoporosis is a disease that reduces bone density and strength and results in an increased risk of bone fractures. Odanacatib is a cathepsin K inhibitor that selectively inhibits the cathepsin K enzyme. Cathepsin K is known to play a central role in the function of osteoclasts, which are cells that break down existing bone tissue, particularly the protein components of bone. Inhibition of cathepsin K is a novel approach to the treatment of osteoporosis. In July 2012, Merck announced an update on the Phase III trial assessing fracture risk reduction with odanacatib. The independent Data Monitoring Committee (the “DMC”) for the study completed its first planned interim analysis for efficacy and recommended that the study be closed early due to robust efficacy and a favorable benefit-risk profile. The DMC noted that safety issues remain in certain selected areas and made recommendations with respect to following up on them. On February 1, 2013, Merck announced that it had recently received and was reviewing safety and efficacy data from the Phase III trial. As a result of its review of this data, the Company concluded that review of additional data from the previously planned, ongoing extension study was warranted and that filing an application for approval with the FDA should be delayed. As previously announced, the Company is conducting a blinded extension of the trial in approximately 8,200 women, which will provide additional safety and efficacy data. Merck now anticipates that it will file applications for approval of odanacatib in 2014 with additional data from the extension trial. The Company continues to believe that odanacatib will have the potential to address unmet medical needs in patients with osteoporosis.

MK-3814, preladenant, is a selective adenosine 2a receptor antagonist in Phase III development for treatment of Parkinson’s disease. The Company anticipates filing an NDA for MK-3814 with the FDA in 2014.

V212 is an inactivated VZV vaccine in development for the prevention of herpes zoster. The Company is enrolling two Phase III trials, one in autologous hematopoietic cell transplant patients and the other in patients with solid tumor malignancies undergoing chemotherapy and hematological malignancies. The Company anticipates filing a BLA first with the autologous hematopoietic cell transplant data in 2014 and filing for the second indication in cancer patients at a later date.

V419 is an investigational hexavalent pediatric combination vaccine, which contains components of current vaccines, designed to help protect against six potentially serious diseases: diphtheria, tetanus, whooping cough ( Bordetella pertussis ), polio (poliovirus types 1, 2, and 3), invasive disease caused by Haemophilus influenzae type b, and hepatitis B that is being developed in collaboration with Sanofi-Pasteur. The Company anticipates filing a BLA for V419 with the FDA in 2014.

MK-7009, vaniprevir, is an investigational, oral twice-daily protease inhibitor for the treatment of chronic hepatitis C virus for development in Japan only. The Company anticipates filing a new drug application for MK-7009 in Japan in 2014.

MK-3102 is an investigational once-weekly DPP-4 inhibitor in development for the treatment of type 2 diabetes. The Company anticipates filing an NDA for MK-3102 with the FDA beyond 2014.

MK-3222 is an anti-interleukin-23 monoclonal antibody candidate being investigated for the treatment of psoriasis. The Company anticipates filing a BLA for MK-3222 with the FDA beyond 2014.

MK-3415A, actoxumab/bezlotoxumab, an investigational candidate for the treatment of Clostridium difficile infection, is a combination of two monoclonal antibodies used to treat patients with a single infusion. The Company now anticipates filing a BLA for MK-3415A with the FDA in 2015.

 

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MK-0859, anacetrapib, is an investigational inhibitor of the cholesteryl ester transfer protein (“CETP”) that is being investigated in lipid management to raise HDL-C and reduce LDL-C. Based on the results from the Phase III DEFINE (Determining the EFficacy and Tolerability of CETP INhibition with AnacEtrapib) safety study of 1,623 patients with coronary heart disease or coronary heart disease risk equivalents, the Company initiated a large, event-driven cardiovascular clinical outcomes trial REVEAL (Randomized EValuation of the Effects of Anacetrapib Through Lipid-modification) involving patients with preexisting vascular disease that is predicted to be completed in 2017. The Company continues to anticipate filing an NDA for anacetrapib with the FDA beyond 2015.

MK-8931 is Merck’s novel investigational oral ß-amyloid precursor protein site-cleaving enzyme (BACE) inhibitor for the treatment of Alzheimer’s disease. In December 2012, Merck announced the initiation of a Phase II/III clinical trial (EPOCH) designed to evaluate the safety and efficacy of MK-8931 versus placebo in patients with mild-to-moderate Alzheimer’s disease.

MK-8669, ridaforolimus, is an investigational oral mTOR (mammalian target of rapamycin) inhibitor under development for cancer indications. In June 2012, Merck announced that the FDA issued a Complete Response Letter regarding the NDA for ridaforolimus as a treatment for metastatic soft tissue or bone sarcoma. The Complete Response Letter states that the FDA cannot approve the application in its present form, and that additional clinical trial(s) would need to be conducted to further assess safety and efficacy. In November 2012, Merck formally notified the EMA of its decision to withdraw the MAA for ridaforolimus that was accepted by the EMA in 2011. The Company no longer plans to pursue the sarcoma indication in the United States or the EU, but will continue to support patients enrolled in ongoing clinical trials. Merck remains committed to pursuing ridaforolimus in other cancer indications. As part of an exclusive license agreement with ARIAD Pharmaceuticals, Inc. (“ARIAD”), Merck is responsible for the development and worldwide commercialization of ridaforolimus in oncology.

In December 2012, Merck announced the HPS2-THRIVE study of MK-0524A, Tredaptive , did not meet its primary endpoint. In the study, adding the combination of extended-release niacin and laropiprant to statin therapy did not significantly further reduce the risk of the combination of coronary deaths, non-fatal heart attacks, strokes or revascularizations compared to statin therapy. In addition, there was a statistically significant increase in the incidence of some types of non-fatal serious adverse events in the group that received extended-release niacin/laropiprant compared to statin therapy. Merck does not plan to seek regulatory approval for the medicine in the United States. In January 2013, based on the understanding of the preliminary data from the HPS2-THRIVE study and in consultation with regulatory authorities, Merck began taking steps to suspend the availability of Tredaptive , which is approved for use in certain countries outside of the United States. The clinical development program for MK-0524B, a combination product of extended-release niacin with laropiprant and simvastatin, had previously been discontinued.

In 2012, Merck announced that it will return the global marketing and development rights for both the intravenous and oral formulations for vernakalant, a treatment for atrial fibrillation, to Cardiome Pharma Corp. for business reasons. Merck also decided in 2012 to discontinue the clinical development program for MK-0431E, a combination product of sitagliptin and atorvastatin for the treatment of type 2 diabetes, for business reasons.

 

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The chart below reflects the Company’s research pipeline as of February 22, 2013. Candidates shown in Phase III include specific products and the date such candidate entered into Phase III development. Candidates shown in Phase II include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Candidates in Phase I, additional indications in the same therapeutic area and additional claims, line extensions or formulations for in-line products are not shown.

 

Phase II   Phase III (Phase III entry date)   Under Review

Allergy

MK-8237, Immunotherapy (1)

 

Alzheimer’s Disease

MK-8931 (2)

 

Asthma

MK-1029

 

Bacterial Infection

MK-7655

 

Cancer

MK-0646 (dalotuzumab)

MK-1775

MK-2206

MK-7965 (dinaciclib) (2)

MK-8669 (ridaforolimus)

 

CMV Prophylaxis in Transplant Patients

MK-8228 (letermovir)

 

Contraception, Medicated IUS

MK-8342

 

Contraception, Next Generation Ring

MK-8175A

MK-8342B

 

Hepatitis C

MK-5172

MK-8742

 

HIV

MK-1439

 

Insomnia

MK-6096

 

Melanoma

MK-3475

 

Migraine

MK-1602

 

Overactive Bladder

MK-4618

 

Pneumoconjugate Vaccine

V114

 

Rheumatoid Arthritis

MK-8457

 

Allergy

MK-7243, Grass pollen (March 2008) (1)(3)

MK-3641, Ragweed  (September 2009) (1)

 

Atherosclerosis

MK-0859 (anacetrapib) (May 2008)

 

Clostridium difficile Infection

MK-3415A (actoxumab/bezlotoxumab) (November 2011)

 

Contraception

MK-8175A (NOMAC/E2) (U.S.) (June 2006) (4)

 

Diabetes Mellitus

MK-3102 (September 2012)

 

Fertility

MK-8962 (corifollitropin alfa injection) (U.S.) (July 2006)

 

Hepatitis C

MK-7009 (vaniprevir) (June 2011) (5)

 

Herpes Zoster

V212 (inactivated VZV vaccine) (December 2010)

 

HPV-Related Cancers

V503 (HPV vaccine (9 valent)) (September 2008)

 

Osteoporosis

MK-0822 (odanacatib) (September 2007)

 

Parkinson’s Disease

MK-3814 (preladenant) (July 2010)

 

Pediatric Hexavalent Combination Vaccine

V419 (April 2011)

 

Platinum-Resistant Ovarian Cancer

 

MK-8109 (vintafolide) (U.S.) (April 2011)

 

Psoriasis

MK-3222 (December 2012)

 

Thrombosis

MK-5348 (vorapaxar) (September 2007)

 

Atherosclerosis

MK-0653C (ezetimibe/atorvastatin) (U.S.)

 

Insomnia

MK-4305 (suvorexant) (U.S.)

 

Neuromuscular Blockade Reversal

MK-8616 (sugammadex sodium injection) (U.S.)

 

Platinum-Resistant Ovarian Cancer

MK-8109 (vintafolide) (EU)

    Footnotes:
(1)    North American rights only.
(2)   Phase II/III adaptive design.
(3)   The Company has submitted a BLA for
MK-7243 and now awaits acceptance for
review by the FDA.

(4)    In November 2011, Merck received a
Complete Response Letter from the FDA
for NOMAC/E2 (MK-8175A). The
Company is conducting an additional
clinical study requested by the FDA and
plans to update the application in the future.

(5)    For development in Japan only.

Employees

As of December 31, 2012, the Company had approximately 83,000 employees worldwide, with approximately 32,500 employed in the United States, including Puerto Rico. Approximately 31% of worldwide employees of the Company are represented by various collective bargaining groups.

In 2010, the Company commenced actions under a global restructuring program (the “Merger Restructuring Program”) in conjunction with the integration of the legacy Merck and legacy Schering-Plough businesses designed to optimize the cost structure of the combined company. These initial actions, which are expected to result in workforce reductions of approximately 17%, primarily reflect the elimination of positions in sales, administrative and headquarters organizations, as well as from the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. In July 2011, the Company initiated further actions under the Merger Restructuring Program through which the Company expects to reduce its workforce measured at the time of the Merger by an additional 12% to 13% across the Company worldwide. A majority of the workforce reductions associated with these additional actions relate to manufacturing (including

 

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Animal Health), administrative and headquarters organizations. Since inception of the Merger Restructuring Program through December 31, 2012, Merck has eliminated approximately 22,400 positions comprised of employee separations, as well as the elimination of contractors and vacant positions.

In October 2008, Merck announced a global restructuring program (the “2008 Restructuring Program”) to reduce its cost structure, increase efficiency, and enhance competitiveness. As part of the 2008 Restructuring Program, the Company expects to eliminate approximately 7,200 positions — 6,800 active employees and 400 vacancies — across the Company worldwide. Since inception of the 2008 Restructuring Program through December 31, 2012, Merck has eliminated approximately 6,400 positions comprised of employee separations and the elimination of contractors and vacant positions.

Environmental Matters

The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $14 million in 2012, $25 million in 2011 and $16 million in 2010, and are estimated at $84 million in the aggregate for the years 2013 through 2017. These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and providing for these costs and, in management’s opinion, the liabilities for all environmental matters, which are probable and reasonably estimable, have been accrued and totaled $145 million at December 31, 2012. Although it is not possible to predict with certainty the outcome of these environmental 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 $112 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Company’s financial position, results of operations, liquidity or capital resources for any year.

Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Company’s facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Company’s business planning including investment in reducing energy, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time.

Geographic Area Information

The Company’s operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States were 57% of sales in 2012, 57% of sales in 2011 and 56% of sales in 2010.

The Company’s worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions.

Merck has expanded its operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time.

Financial information about geographic areas of the Company’s business is discussed in Item 8. “Financial Statements and Supplementary Data” below.

Available Information

The Company’s Internet website address is www.merck.com . The Company will make available, free of charge at the “Investors” portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or

 

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15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).

The Company’s corporate governance guidelines and the charters of the Board of Directors’ four standing committees are available on the Company’s website at www.merck.com/about/leadership and all such information is available in print to any stockholder who requests it from the Company.

 

Item 1A. Risk Factors.

Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Company’s securities. The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Company’s business, financial condition, results of operations or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Company’s results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See “Cautionary Factors that May Affect Future Results” below.

Singulair and Maxalt lost market exclusivity in the United States in 2012, and the Company is experiencing a significant decline in sales of those products. In addition, Singulair and Maxalt will each lose market exclusivity in the EU in 2013 and the Company expects a significant decline in sales of those products in these markets.

The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. As product patents for several of the Company’s products have recently expired in the United States and in other countries, the Company faces strong competition from lower priced generic drugs. Loss of patent protection for one of the Company’s products typically leads to a rapid loss of sales for that product, as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Company’s sales, the loss of patent protection can have a material adverse effect on the Company’s business, cash flow, results of operations, financial position and prospects. The patent that provided U.S. market exclusivity for Singulair, which in 2012 was the Company’s second largest selling product globally, and which had U.S. sales of $2.2 billion, expired in August 2012. Accordingly, the Company experienced a significant and rapid decline in U.S. Singulair sales, which declined 97% in the fourth quarter of 2012 to $25 million as compared to the fourth quarter of 2011. The patent that provided market exclusivity for Singulair expired in a number of major European markets in February 2013 and the Company expects a significant and rapid decline in sales of Singulair in those markets. The patent that provided U.S. market exclusivity for Maxalt expired in December 2012. Also, the patent that provides market exclusivity for Maxalt will expire in a number of major European markets in August 2013. The Company anticipates that sales in the United States, which were approximately $491 million in 2012, and in these European markets will decline significantly as a result of these patent expiries. Also, two additional Company products, Temodar and Propecia , will lose market exclusivity in the United States in 2013 and the Company anticipates that sales will decline significantly.

A chart listing the U.S. patent protection for the Company’s major marketed products is set forth above in Item 1. “Business — Patents, Trademarks and Licenses.”

The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business would be adversely affected.

Patent protection is considered, in the aggregate, to be of material importance in the Company’s marketing of human health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available.

Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for

 

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the Company’s business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or infringement and similar claims against the Company. The Company aggressively defends its important patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. “Financial Statements and Supplementary Data,” Note 11. “Contingencies and Environmental Liabilities” below. In particular, manufacturers of generic pharmaceutical products from time to time file Abbreviated New Drug Applications with the FDA seeking to market generic forms of the Company’s products prior to the expiration of relevant patents owned by the Company. The Company normally responds by vigorously defending its patent, including by filing lawsuits alleging patent infringement. As discussed above, in 2012, a court decision found that a proposed generic product by a generic manufacturer would not infringe on the Company’s Nasonex formulation patent. If the generic manufacturer’s application is approved by the FDA, it can enter the market in the United States with a generic version of Nasonex which would adversely affect sales of Nasonex . Patent litigation and other challenges to the Company’s patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area.

Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Company’s results of operations. Further, recent court decisions relating to other companies’ U.S. patents, potential U.S. legislation relating to patent reform, as well as regulatory initiatives may result in further erosion of intellectual property protection.

If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available and, in the case of certain products, such a loss could result in a material non-cash impairment charge. The Company’s results of operations may be adversely affected by the lost sales unless and until the Company has successfully launched commercially successful replacement products.

Key Company products generate a significant amount of the Company’s profits and cash flows, and any events that adversely affect the markets for its leading products could have a material and negative impact on results of operations and cash flows.

The Company’s ability to generate profits and operating cash flow depends largely upon the continued profitability of the Company’s key products, such as Januvia , Remicade , Zetia, Vytorin, Janumet, Isentress, Nasonex and Gardasil . As a result of the Company’s dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Company’s product or a competitive product, the discovery of previously unknown side effects, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. If any of these events had a material adverse effect on the sales of certain products, such an event could result in a material non-cash impairment charge.

The Company’s research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that have lost patent protection.

Like other major pharmaceutical companies, in order to remain competitive, the Company must continue to launch new products each year. Expected declines in sales of products, such as Singulair and Maxalt, after the loss of market exclusivity mean that the Company’s future success is dependent on its pipeline of new products, including new products which it may develop through joint ventures and products which it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research to develop new drugs to treat diseases. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns.

 

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This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested.

For a description of the research and development process, see Item 1. “Business — Research and Development” above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals, therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the FDA for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing.

The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products, such as Singulair and Maxalt in 2012 and Temodar and Propecia in 2013, lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Company’s business, results of operations, cash flow, financial position and prospects.

The Company’s success is dependent on the successful development and marketing of new products, which are subject to substantial risks.

Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following:

 

   

findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing;

 

   

failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, and increasing uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals;

 

   

failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product;

 

   

lack of economic feasibility due to manufacturing costs or other factors; and

 

   

preclusion from commercialization by the proprietary rights of others.

In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with mergers and acquisitions.

The Company’s products, including products in development, can not be marketed unless the Company obtains and maintains regulatory approval.

The Company’s activities, including research, preclinical testing, clinical trials and manufacturing and marketing its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU. In the United States, the FDA is of particular importance to the Company, as it administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new

 

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products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, cost reduction. The FDA and foreign regulatory authorities have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product.

Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Company’s failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the new products in that jurisdiction until approval is obtained, if ever. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval.

Developments following regulatory approval may adversely affect sales of the Company’s products.

Even after a product reaches market, certain developments following regulatory approval, including results in post-marketing Phase IV trials or other studies, may decrease demand for the Company’s products, including the following:

 

   

the re-review of products that are already marketed;

 

   

new scientific information and evolution of scientific theories;

 

   

the recall or loss of marketing approval of products that are already marketed;

 

   

changing government standards or public expectations regarding safety, efficacy or labeling changes; and

 

   

greater scrutiny in advertising and promotion.

In the past several years, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond.

In addition, following the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA and Japan’s Pharmaceutical and Medical Device Agency have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications and are re-reviewing select products that are already marketed, adding further to the uncertainties in the regulatory processes. There is also greater regulatory scrutiny, especially in the United States, on advertising and promotion and, in particular, direct-to-consumer advertising.

If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Company’s products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities.

The Company faces intense competition from lower cost-generic products.

In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent

 

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protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures which encourages the use of generic products. Although it is the Company’s policy to actively protect its patent rights, generic challenges to the Company’s products can arise at any time, and the Company’s patents may not prevent the emergence of generic competition for its products.

Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Company’s sales of that product. Availability of generic substitutes for the Company’s drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Company’s sales and, potentially, its business, cash flow, results of operations, financial position and prospects.

The Company faces intense competition from competitors’ products which, in addition to other factors, could in certain circumstances lead to non-cash impairment charges.

The Company’s products face intense competition from competitors’ products. This competition may increase as new products enter the market. In such an event, the competitors’ products may be safer or more effective, more convenient to use or more effectively marketed and sold than the Company’s products. Alternatively, in the case of generic competition, including the generic availability of competitors’ branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Company’s products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial position and prospects. In addition, if products that were measured at fair value and capitalized in connection with mergers and acquisitions, such as Saphris, or former Merck/Schering Plough Partnership products, Vytorin or Zetia , experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products.

The Company faces pricing pressure with respect to its products.

The Company faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Company’s sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act of 2010. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, the Company faces the risk of litigation with the government over its pricing calculations.

Outside the United States, numerous major markets, including the EU, have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products.

The Company expects pricing pressures to increase in the future.

The health care industry in the United States will continue to be subject to increasing regulation and political action.

The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by Congress and state legislatures. In 2010, major health care reform was adopted into law in the United States.

Important market reforms have begun and will continue through full implementation in 2014. The new law is expected to expand access to health care to more than 32 million Americans by the end of the decade. In 2012, Merck incurred additional costs as a result of the law, including increased Medicaid rebates and other impacts

 

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that reduced revenues. In 2010, the minimum rebate to states participating in the Medicaid program increased from 15.1% to 23.1% on the Company’s branded prescription drugs; the Medicaid rebate was extended to Medicaid Managed Care Organizations; and eligibility for the federal 340B drug discount program was extended to rural referral centers, sole community hospitals, critical access hospitals, certain free standing cancer hospitals, and certain additional children’s hospitals.

In addition, the law requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called “donut hole”). Approximately $210 million and $150 million was recorded by Merck as a reduction to revenue in 2012 and 2011, respectively, related to the donut hole provision. Also, the Company is required to pay an annual health care reform fee, which is assessed on all branded prescription drug manufacturers and importers. The fee is calculated based on the industry’s total sales of branded prescription drugs to specified government programs. The percentage of a manufacturer’s sales that are included is determined by a tiered scale based on the manufacturer’s individual revenues. Each manufacturer’s portion of the total annual fee is based on the manufacturer’s proportion of the total includable sales in the prior year. The annual industry fee for 2012 was $2.8 billion and will be $2.8 billion in 2013. The Company recorded $190 million and $162 million of costs within Marketing and administrative expenses in 2012 and 2011, respectively, for the annual health care reform fee.

The Company cannot predict the likelihood of future changes in the health care industry in general, or the pharmaceutical industry in particular, or what impact they may have on the Company’s results of operations, financial condition or business.

The current uncertainty in global economic conditions together with austerity measures being taken by certain governments could negatively affect the Company’s operating results.

The current uncertainty in global economic conditions may result in a further slowdown to the global economy that could affect the Company’s business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Company’s products or by reducing the demand for the Company’s products, which could in turn negatively impact the Company’s sales and result in a material adverse effect on the Company’s business, cash flow, results of operations, financial position and prospects.

Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. In many international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, other austerity measures negatively affected the Company’s revenue performance in 2012. The Company anticipates these pricing actions and other austerity measures will continue to negatively affect revenue performance in 2013.

The Company continues to monitor the credit and economic conditions within Greece, Spain, Italy and Portugal, among other members of the EU. These economic conditions, as well as inherent variability of timing of cash receipts, have resulted in, and may continue to result in, an increase in the average length of time that it takes to collect on the accounts receivable outstanding in these countries and may also impact the likelihood of collecting 100% of outstanding accounts receivable. As of December 31, 2012, the Company’s accounts receivable in Greece, Italy, Spain and Portugal totaled approximately $1.1 billion. Of this amount, hospital and public sector receivables were approximately $800 million in the aggregate, of which approximately 18%, 37%, 36% and 9% related to Greece, Italy, Spain and Portugal, respectively. As of December 31, 2012, the Company’s total accounts receivable outstanding for more than one year were approximately $200 million, of which approximately 70% related to accounts receivable in Greece, Italy, Spain and Portugal, mostly comprised of hospital and public sector receivables.

If the conditions in Europe worsen and one or more countries in the euro zone exits the euro zone and reintroduces its legacy currency, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Company’s results.

 

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The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material negative impact on the Company’s results of operations.

The extent of the Company’s operations outside the United States are significant. Risks inherent in conducting a global business include:

 

   

changes in medical reimbursement policies and programs and pricing restrictions in key markets;

 

   

multiple regulatory requirements that could restrict the Company’s ability to manufacture and sell its products in key markets;

 

   

trade protection measures and import or export licensing requirements;

 

   

foreign exchange fluctuations;

 

   

diminished protection of intellectual property in some countries; and

 

   

possible nationalization and expropriation.

In addition, there may be changes to the Company’s business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease.

The Company has experienced difficulties and delays in manufacturing of certain of its products.

As previously disclosed, Merck has, in the past, experienced difficulties in manufacturing certain of its vaccines and other products. Similarly, the Company has, in the past, experienced difficulties manufacturing certain of its animal health products and is currently experiencing difficulty manufacturing certain women’s health products. The Company is working on its manufacturing issues, but there can be no assurance of when or if these issues will be finally resolved.

In addition to the difficulties that the Company is experiencing currently, the Company may experience difficulties and delays inherent in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) construction delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Company’s products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. Manufacturing difficulties can result in product shortages, leading to lost sales.

The Company faces significant litigation related to Vioxx.

On September 30, 2004, Merck voluntarily withdrew Vioxx , its arthritis and acute pain medication, from the market worldwide. Although Merck has settled the major portion of the U.S. Product Liability litigation, the Company still faces material litigation arising from the voluntary withdrawal of Vioxx .

In addition to the Vioxx Product Liability Lawsuits and lawsuits from certain states that did not participate in a previously-disclosed settlement, various purported class actions and individual lawsuits have been brought against Merck and several current and former officers and directors of Merck alleging that Merck made false and misleading statements regarding Vioxx in violation of the federal securities laws and state laws (all of these suits are referred to as the “ Vioxx Securities Lawsuits”). The Vioxx Securities Lawsuits have been transferred by the Judicial Panel on Multidistrict Litigation (the “JPML”) to the U.S. District Court for the District of New Jersey before District Judge Stanley R. Chesler for inclusion in a nationwide MDL (the “Shareholder MDL”), and have been consolidated for all purposes. Merck has also been named as a defendant in actions in various countries outside the United States. (All of these suits are referred to as the “ Vioxx International Lawsuits”.)

 

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The Vioxx litigation is discussed more fully in Item 8. “Financial Statements and Supplementary Data,” Note 11. “Contingencies and Environmental Liabilities” below. The Company believes that it has meritorious defenses to the Vioxx Product Liability Lawsuits, Vioxx Securities Lawsuits and Vioxx International Lawsuits (collectively, the “ Vioxx Lawsuits”) and will vigorously defend against them. The Company’s insurance coverage with respect to the Vioxx Lawsuits will not be adequate to cover its defense costs and any losses.

The Company is not currently able to estimate any additional amounts that it may be required to pay in connection with the Vioxx Lawsuits. These proceedings are still expected to continue for years and the Company cannot predict the course the proceedings will take. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek unspecified damages, the Company is unable to predict the outcome of these matters, and at this time cannot reasonably estimate the possible loss or range of loss with respect to the remaining Vioxx Lawsuits. The Company has not established any material reserves for any potential liability relating to the remaining Vioxx Lawsuits although it has established reserves related to the settlement of the Canadian Vioxx litigation and with respect to certain other Vioxx Product Liability Lawsuits, including a previously-disclosed settlement relating to a lawsuit brought by a class of Missouri plaintiffs, all of which are discussed in Item 8. “Financial Statements and Supplementary Data,” Note 11. “Contingencies and Environmental Liabilities” below.

A series of unfavorable outcomes in the Vioxx Lawsuits resulting in the payment of substantial damages could have a material adverse effect on the Company’s business, cash flow, results of operations, financial position and prospects.

Issues concerning Vytorin and the ENHANCE clinical trial have had an adverse effect on sales of Vytorin and Zetia in the United States and results from the IMPROVE-IT trial could have a material adverse effect on such sales.

The Company sells Vytorin and Zetia. As previously disclosed, in January 2008, the Company announced the results of the ENHANCE clinical trial, an imaging trial in 720 patients with heterozygous familial hypercholesterolemia, a rare genetic condition that causes very high levels of LDL “bad” cholesterol and greatly increases the risk for premature coronary artery disease. As previously reported, despite the fact that ezetimibe/simvastatin 10/80 mg ( Vytorin ) significantly lowered LDL “bad” cholesterol more than simvastatin 80 mg alone, there was no significant difference between treatment with ezetimibe/simvastatin and simvastatin alone on the pre-specified primary endpoint, a change in the thickness of carotid artery walls over two years as measured by ultrasound. The IMPROVE-IT trial is underway and is designed to provide cardiovascular outcomes data for ezetimibe/simvastatin in patients presenting with acute coronary syndrome. No incremental benefit of ezetimibe/simvastatin on cardiovascular morbidity and mortality over and above that demonstrated for simvastatin has been established. In January 2009, the FDA announced that it had completed its review of the final clinical study report of ENHANCE. The FDA stated that the results from ENHANCE did not change its position that elevated LDL cholesterol is a risk factor for cardiovascular disease and that lowering LDL cholesterol reduces the risk for cardiovascular disease.

The IMPROVE-IT trial is scheduled for completion in 2014. In the IMPROVE-IT trial, blinded interim efficacy analyses were conducted by the DSMB for the trial when approximately 50% and 75% of the endpoints were accrued, respectively. In each case, the DSMB recommended continuing the trial without change in design. At the time of the second interim efficacy analysis, the DSMB stated it planned to review the data again in approximately nine months; that review has been scheduled for March 2013, at which point nine months of additional data will have been adjudicated. If, based on the results of that review, the trial were to be halted because of concerns related to Vytorin , that could have a material adverse effect on sales of Vytorin and Zetia .

These issues concerning the ENHANCE clinical trial have had an adverse effect on sales of Vytorin and Zetia and could continue to have an adverse effect on such sales. If the results of the IMPROVE-IT trial fail to demonstrate an incremental benefit of ezetimibe/simvastatin on cardiovascular morbidity and mortality over and above that demonstrated for simvastatin, sales of Zetia and Vytorin could be materially adversely affected. If sales of such products are materially adversely affected, the Company’s business, cash flow, results of operations, financial position and prospects could also be materially adversely affected and the Company could be required to record a material non-cash impairment charge.

 

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The Company may not be able to realize the expected benefits of its investments in emerging markets.

The Company has been taking steps to increase its presence in emerging markets. However, there is no guarantee that the Company’s efforts to expand sales in emerging markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and if such currencies devalue and the Company cannot offset the devaluations, the Company’s financial performance within such countries could be adversely affected.

For instance, in February 2013, the Venezuelan government devalued its currency. As a result of that devaluation, the Company will recognize losses due to exchange.

For all these reasons, sales within emerging markets carry significant risks. However, a failure to continue to expand the Company’s business in emerging markets could have a material adverse effect on the business, financial condition or results of the Company’s operations.

The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates.

The Company operates in multiple jurisdictions and, as such, virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into acquisition, licensing, borrowings or other financial transactions that may give rise to currency and interest rate exposure.

Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates and interest rates could negatively affect the Company’s results of operations, financial position and cash flows.

In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful.

The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations.

The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Company’s tax liabilities, and the Company’s tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued.

In February 2012, President Obama’s administration re-proposed significant changes to the U.S. international tax laws, including changes that would tax companies on “excess returns” attributable to certain offshore intangible assets, limit U.S. tax deductions for expenses related to un-repatriated foreign-source income and modify the U.S. foreign tax credit rules. Other potentially significant changes to the U.S. international laws, including a move toward a territorial tax system, have been set out by various Congressional committees. The Company cannot determine whether these proposals will be enacted into law or what, if any, changes may be made to such proposals prior to their being enacted into law. If these or other changes to the U.S. international tax laws are enacted, they could have a significant impact on the financial results of the Company.

In addition, the Company may be affected by changes in tax laws, including tax rate changes, changes to the laws related to the remittance of foreign earnings (deferral), or other limitations impacting the U.S. tax treatment of foreign earnings, new tax laws, and revised tax law interpretations in domestic and foreign jurisdictions.

 

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Pharmaceutical products can develop unexpected safety or efficacy concerns.

Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions.

Changes in laws and regulations could adversely affect the Company’s business.

All aspects of the Company’s business, including research and development, manufacturing, marketing, pricing, sales, litigation and intellectual property rights, are subject to extensive legislation and regulation. Changes in applicable federal and state laws and agency regulations could have a material adverse effect on the Company’s business.

Reliance on third party relationships and outsourcing arrangements could adversely affect the Company’s business.

The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Company’s business.

The Company is increasingly dependent on sophisticated information technology and infrastructure.

The Company is increasingly dependent on sophisticated information technology and infrastructure. The size and complexity of the Company’s computer systems makes them potentially vulnerable to service interruption, malicious intrusion and random attacks. In addition, data privacy or security breaches by employees or others may pose a risk that data, including intellectual property or personal information, may be exposed to unauthorized individuals or to the public. There can be no assurance that the Company’s efforts to protect its data and systems will prevent service interruption or the loss of critical or sensitive information which could result in financial, legal, business or reputational harm to the Company.

Negative events in the animal health industry could have a negative impact on future results of operations.

Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as Bovine Spongiform Encephalopathy or mad cow disease, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely impact the Company’s results of operations. Also, the outbreak of any highly contagious diseases near the Company’s main production sites could require the Company to immediately halt production of vaccines at such sites or force the Company to incur substantial expenses in procuring raw materials or vaccines elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Company’s business becomes more significant, the impact of any such events on future results of operations would also become more significant.

Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations.

The successful development, testing, manufacturing and commercialization of biologics, particularly human and animal health vaccines, is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics, including:

 

   

There may be limited access to and supply of normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in

 

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multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs.

 

   

The development, manufacturing and marketing of biologics are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both preclinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates and FDA approval is required for the release of each manufactured commercial lot.

 

   

Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes.

 

   

Biologics are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines.

 

   

The use of biologically derived ingredients can lead to allegations of harm, including infections or allergic reactions, or closure of product facilities due to possible contamination. Any of these events could result in substantial costs.

Product liability insurance for products may be limited, cost prohibitive or unavailable.

As a result of a number of factors, product liability insurance has become less available while the cost has increased significantly. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for certain product liabilities effective August 1, 2004, including liability for legacy Merck products first sold after that date. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise.

Cautionary Factors that May Affect Future Results

(Cautionary Statements Under the Private Securities Litigation Reform Act of 1995)

This report and other written reports and oral statements made from time to time by the Company may contain so-called “forward-looking statements,” all of which are based on management’s current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as “anticipates,” “expects,” “plans,” “will,” “estimates,” “forecasts,” “projects” and other words of similar meaning. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Company’s growth strategy, financial results, product development, product approvals, product potential, and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Company’s forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are

 

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known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following:

 

   

Competition from generic products as the Company’s products, such as Singulair and Maxalt , lose patent protection.

 

   

Increased “brand” competition in therapeutic areas important to the Company’s long-term business performance.

 

   

The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels.

 

   

Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general.

 

   

Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Company’s business.

 

   

Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales.

 

   

Significant litigation related to Vioxx and Fosamax.

 

   

Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products.

 

   

Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities.

 

   

Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Company’s business, including recently enacted laws in a majority of states in the United States requiring security breach notification.

 

   

Changes in tax laws including changes related to the taxation of foreign earnings.

 

   

Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company.

 

   

Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates.

This list should not be considered an exhaustive statement of all potential risks and uncertainties. See “Risk Factors” above.

 

Item 1B. Unresolved Staff Comments.

None

 

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Item 2. Properties.

The Company’s corporate headquarters is currently located in Whitehouse Station, New Jersey, although the Company has announced that it intends to move its headquarters to Summit, New Jersey in 2015. The Company’s U.S. commercial operations are headquartered in Upper Gwynedd, Pennsylvania. The Company’s U.S. pharmaceutical business is conducted through divisional headquarters located in Upper Gwynedd and Whitehouse Station. The Company’s vaccines business is conducted through divisional headquarters located in West Point, Pennsylvania. Merck’s Animal Health global headquarters functions are located in Summit, New Jersey. Principal U.S. research facilities are located in Rahway, Kenilworth and Summit, New Jersey, West Point, Pennsylvania, Palo Alto, California, Boston, Massachusetts, and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the U.S. are located in the Netherlands, Switzerland and China. The Company also has production facilities for human health products at 15 locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Australia, Canada, Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia.

Capital expenditures were $2.0 billion in 2012, $1.7 billion in 2011 and $1.7 billion in 2010. In the United States, these amounted to $1.3 billion for 2012, $1.2 billion for 2011 and $990 million in 2010. Abroad, such expenditures amounted to $662 million for 2012, $516 million for 2011 and $687 million for 2010.

The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company considers that its properties are in good operating condition and that its machinery and equipment have been well maintained. Plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products.

 

Item 3. Legal Proceedings.

The information called for by this Item is incorporated herein by reference to Note 11. “Contingencies and Environmental Liabilities” included in Part II, Item 8. “Financial Statements and Supplementary Data.”

 

Item 4. Mine Safety Disclosures.

Not Applicable

Executive Officers of the Registrant (ages as of February 1, 2013)

At the time of the Merger, November 3, 2009, certain executive officers assumed their position in the newly merged company as noted below.

KENNETH C. FRAZIER — Age 58

December 2011 — Chairman, President and Chief Executive Officer, Merck & Co., Inc.

January 2011 — President and Chief Executive Officer, Merck & Co., Inc.

May 2010 — President, Merck & Co., Inc. — responsible for the Company’s three largest worldwide divisions — Global Human Health, Merck Manufacturing Division and Merck Research Laboratories

November 2009 — Executive Vice President and President, Global Human Health, Merck & Co., Inc. — responsible for the Company’s marketing and sales organizations worldwide, including the global pharmaceutical and vaccine franchises

August 2007 — Executive Vice President and President, Global Human Health, Merck & Co., Inc. — responsible for the Company’s marketing and sales organizations worldwide, including the global pharmaceutical and vaccine franchises

 

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ADELE D. AMBROSE — Age 56

November 2009 — Senior Vice President and Chief Communications Officer, Merck & Co., Inc. — responsible for the Global Communications organization

December 2007 — Vice President and Chief Communications Officer, Merck & Co., Inc. — responsible for the Global Communications organization

JOHN CANAN — Age 56

November 2009 — Senior Vice President Finance-Global Controller, Merck & Co., Inc. — responsible for the Company’s global controller’s organization including all accounting, controls, external reporting and financial standards and policies

January 2008 — Senior Vice President and Controller, Merck & Co., Inc. — responsible for the Corporate Controller’s Group

WILLIE A. DEESE — Age 57

November 2009 — Executive Vice President and President, Merck Manufacturing Division, Merck & Co., Inc. — responsible for the Company’s global manufacturing, procurement, and distribution and logistics functions

January 2008 — Executive Vice President and President, Merck Manufacturing Division, Merck & Co., Inc. — responsible for the Company’s global manufacturing, procurement, and distribution and logistics functions

RICHARD R. DELUCA, JR. — Age 50

September 2011 — Executive Vice President and President, Merck Animal Health, Merck & Co., Inc. — responsible for the Merck Animal Health organization

Prior to September 2011, Mr. DeLuca was Chief Financial Officer, Becton Dickinson Biosciences (a medical technology company) since 2010 and President, Wyeth’s Fort Dodge Animal Health division from 2007 to 2010. He also served as Chief Operating Officer, Fort Dodge from 2006 to 2007 and Executive Vice President and Chief Financial Officer from 2002 to 2006.

CUONG VIET DO — Age 46

October 2011 — Executive Vice President and Chief Strategy Officer, Merck & Co., Inc. — responsible for leading the formulation and execution of the Company’s long term strategic plan

Prior to October 2011, Mr. Do was Senior Vice President, Corporate Strategy and Business Development, TE Connectivity (a global company that designs, manufactures and markets products for customers in a variety of industries) from 2009 to 2011 and Senior Vice President and Chief Strategy Officer, Lenovo (a personal technology company) from 2006 to 2009.

CLARK GOLESTANI — Age 46

December 2012 — Executive Vice President and Chief Information Officer, Merck & Co., Inc. — responsible for Merck’s global information technology (IT)

August 2008 — Vice President, Merck Research Laboratories Information Technology, Merck & Co., Inc. — responsible for global IT for Merck’s Research & Development division, including Basic Research, PreClinical, Clinical and Regulatory

November 2006 — Vice President, Corporate Information Technology, Merck & Co., Inc. — responsible for global IT supporting Finance, Human Resources, Procurement, Legal, Public Affairs, Site Services, Real Estate, and Shared Business Services operations

 

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MIRIAN M. GRADDICK-WEIR — Age 58

November 2009 — Executive Vice President, Human Resources, Merck & Co., Inc. — responsible for the Global Human Resources organization

January 2008 — Executive Vice President, Human Resources, Merck & Co., Inc. — responsible for the Global Human Resources organization

BRIDGETTE P. HELLER — Age 51

March 2010 — Executive Vice President and President, Merck Consumer Care, Merck & Co., Inc. — responsible for the Merck Consumer Care organization

Prior to March 2010, Ms. Heller was President, Johnson & Johnson’s Global Baby Business Unit from 2007 to 2010.

MICHAEL J. HOLSTON — Age 50

June 2012 — Executive Vice President and Chief Ethics and Compliance Officer, Merck & Co., Inc. — responsible for the Company’s compliance function, including Global Safety & Environment, Systems Assurance, Ethics and Privacy

Prior to June 2012, Mr. Holston was Executive Vice President, General Counsel and Board Secretary for Hewlett-Packard Company (a technology company) since 2007, where he oversaw the legal, compliance, government affairs, privacy and ethics operations.

PETER N. KELLOGG — Age 56

November 2009 — Executive Vice President and Chief Financial Officer, Merck & Co., Inc. — responsible for the Company’s worldwide financial organization, investor relations, corporate development and licensing, and the Company’s joint venture relationships

August 2007 — Executive Vice President and Chief Financial Officer, Merck & Co., Inc. — responsible for the Company’s worldwide financial organization, investor relations, corporate development and licensing, and the Company’s joint venture relationships

PETER S. KIM — Age 54

November 2009 — Executive Vice President and President, Merck Research Laboratories, Merck & Co., Inc. — responsible for the Company’s research and development efforts worldwide

January 2008 — Executive Vice President and President, Merck Research Laboratories, Merck & Co., Inc. — responsible for the Company’s research and development efforts worldwide

BRUCE N. KUHLIK — Age 56

November 2009 — Executive Vice President and General Counsel, Merck & Co., Inc. — responsible for legal, communications, and public policy functions

January 2008 — Executive Vice President and General Counsel, Merck & Co., Inc. — responsible for legal, communications, and public policy functions

MICHAEL ROSENBLATT, M.D. — Age 65

December 2009 — Executive Vice President and Chief Medical Officer, Merck & Co., Inc. — the Company’s primary voice to the global medical community on critical issues such as patient safety and oversight for the Company’s Global Center for Scientific Affairs

Prior to December 2009, Dr. Rosenblatt was the Dean of Tufts University School of Medicine since 2003.

 

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ADAM H. SCHECHTER — Age 48

May 2010 — Executive Vice President and President, Global Human Health, Merck & Co., Inc. — responsible for the Company’s pharmaceutical and vaccine worldwide business

November 2009 — President, Global Human Health, U.S. Market-Integration Leader, Merck & Co., Inc. — commercial responsibility in the United States for the Company’s portfolio of prescription medicines. Leader for the integration efforts for the Merck/Schering-Plough merger across all divisions and functions.

August 2007 — President, Global Pharmaceuticals, Global Human Health, Merck & Co., Inc. — global responsibilities for the Company’s atherosclerosis/cardiovascular, diabetes/obesity, oncology, specialty/neuroscience, respiratory, bone, arthritis and analgesia franchises as well as commercial responsibility in the United States for the Company’s portfolio of prescription medicines

All officers listed above serve at the pleasure of the Board of Directors. None of these officers was elected pursuant to any arrangement or understanding between the officer and the Board.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The principal market for trading of the Company’s Common Stock is the New York Stock Exchange (“NYSE”) under the symbol MRK. The Common Stock market price information set forth in the table below is based on historical NYSE market prices.

The following table also sets forth, for the calendar periods indicated, the dividend per share information.

Cash Dividends Paid per Common Share

 

       Year      4th Q      3rd Q      2nd Q      1st Q  

2012

   $ 1.68       $ 0.42       $ 0.42       $ 0.42       $ 0.42   

2011

   $ 1.52       $ 0.38       $ 0.38       $ 0.38       $ 0.38   

 

Common Stock Market Prices

 

              

2012

              4th Q         3rd Q         2nd Q         1st Q   

High

      $ 48.00       $ 45.70       $ 41.75       $ 39.43   

Low

            $ 40.02       $ 41.06       $ 37.02       $ 36.91   

2011

                                            

High

      $ 37.90       $ 36.56       $ 37.65       $ 37.62   

Low

            $ 30.54       $ 29.47       $ 33.00       $ 31.06   

As of January 31, 2013, there were approximately 156,850 shareholders of record.

 

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Equity Compensation Plan Information

The following table summarizes information about the options, warrants and rights and other equity compensation under the Company’s equity compensation plans as of the close of business on December 31, 2012. The table does not include information about tax qualified plans such as the MSD Employee Savings and Security Plan and the Schering-Plough Employees’ Savings Plan.

 

Plan Category

   Number of
securities to be
issued upon
exercise of
outstanding
options, warrants
and rights
(a)
    Weighted-average
exercise price of
outstanding
options, warrants
and rights
(b)
     Number of
securities remaining
available for future
issuance under equity
compensation plans
(excluding
securities
reflected in column (a))
(c)
 

Equity compensation plans approved by security holders (1)

     165,756,073 (2)     $ 39.47         179,527,854   

Equity compensation plans not approved by security holders

                      

Total

     165,756,073      $ 39.47         179,527,854   

 

(1)  

Includes options to purchase shares of Company Common Stock and other rights under the following shareholder-approved plans: the Merck Sharp & Dohme 2001, 2004, 2007 and 2010 Incentive Stock Plans, the Merck & Co., Inc. 2001, 2006 and 2010 Non-Employee Directors Stock Option Plans, and the Merck & Co., Inc. Schering-Plough 1997, 2002 and 2006 Stock Incentive Plans.

 

(2)  

Excludes approximately 18,216,551 shares of restricted stock units and 2,255,251 performance share units (assuming maximum payouts) under the Merck Sharp & Dohme 2004, 2007 and 2010 Incentive Stock Plans and 4,526,616 shares of restricted stock units and 247,410 performance share units (excluding accrued dividends) under the Merck & Co., Inc. Schering-Plough 2006 Stock Incentive Plan. Also excludes 318,476 shares of phantom stock deferred under the MSD Employee Deferral Program and 473,582 shares of phantom stock deferred under the MSD Directors Deferral Program.

 

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Performance Graph

The following graph assumes a $100 investment on December 31, 2007, and reinvestment of all dividends, in each of the Company’s Common Shares, the S&P 500 Index, and a composite peer group of the major U.S.-based pharmaceutical companies, which are: Abbott Laboratories, Bristol-Myers Squibb Company, Johnson & Johnson, Eli Lilly and Company, and Pfizer Inc.

Comparison of Five-Year Cumulative Total Return*

Merck & Co., Inc., Composite Peer Group and S&P 500 Index

 

     End of
Period Value
     2012/2007
CAGR**
 

MERCK

   $ 165         11

PEER GRP.***

     134         6   

S&P 500

     109         2   

 

LOGO

 

      2007     2008     2009     2010     2011     2012  

MERCK

    100.00        64.90        129.31        132.97        145.66        164.78   

PEER GRP.

    100.00        89.16        96.19        95.77        116.41        133.75   

S&P 500

    100.00        63.01        79.69        91.71        93.62        108.60   

 

      * The Performance Graph reflects Schering-Plough’s stock performance from December 31, 2007 through the close of the Merger and Merck’s stock performance from November 3, 2009 through December 31, 2012. Assumes the cash component of the merger consideration was reinvested in Merck stock at the closing price on November 3, 2009.

 

   ** Compound Annual Growth Rate

 

  *** On October 15, 2009, Wyeth and Pfizer Inc. completed their previously announced merger (the “Pfizer/Wyeth Merger”) where Wyeth became a wholly-owned subsidiary of Pfizer Inc. As discussed, on November 3, 2009, Merck and Schering-Plough completed the Merger (together with the Pfizer/Wyeth Merger, the “Transactions”) in which Merck (subsequently renamed Merck Sharp & Dohme Corp. (“MSD”)) became a wholly-owned subsidiary of Schering-Plough (subsequently renamed Merck & Co., Inc.). As a result of the Transactions, Wyeth and MSD no longer exist as publicly traded entities and ceased all trading of their common stock as of the close of business on their respective merger dates. Wyeth and MSD have been permanently removed from the peer group index.

 

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Item 6. Selected Financial Data.

The following selected financial data should be read in conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and consolidated financial statements and notes thereto contained in Item 8. “Financial Statements and Supplementary Data” of this report.

Merck & Co., Inc. and Subsidiaries

($ in millions except per share amounts)

       2012 (1)     2011 (2)     2010 (3)     2009 (4)     2008 (5)  

Results for Year:

          

Sales

   $ 47,267      $ 48,047      $ 45,987      $ 27,428      $ 23,850   

Materials and production

     16,446        16,871        18,396        9,019        5,583   

Marketing and administrative

     12,776        13,733        13,125        8,543        7,377   

Research and development

     8,168        8,467        11,111        5,845        4,805   

Restructuring costs

     664        1,306        985        1,634        1,033   

Equity income from affiliates

     (642     (610     (587     (2,235     (2,561

Other (income) expense, net

     1,116        946        1,304        (10,668     (2,318

Income before taxes

     8,739        7,334        1,653        15,290        9,931   

Taxes on income

     2,440        942        671        2,268        1,999   

Net income

     6,299        6,392        982        13,022        7,932   

Less: Net income attributable to noncontrolling interests

     131        120        121        123        124   

Net income attributable to Merck & Co., Inc.

     6,168        6,272        861        12,899        7,808   

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

     $2.03        $2.04        $0.28        $5.67        $3.65   

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

     $2.00        $2.02        $0.28        $5.65        $3.63   

Cash dividends declared

     5,173        4,818        4,730        3,598        3,250   

Cash dividends paid per common share

     $1.68        $1.52        $1.52        $1.52 (6)       $1.52   

Capital expenditures

     1,954        1,723        1,678        1,461        1,298   

Depreciation

     1,999        2,351        2,638        1,654        1,445   

Average common shares outstanding (millions)

     3,041        3,071        3,095        2,268        2,136   

Average common shares outstanding assuming dilution (millions)

     3,076        3,094        3,120        2,273        2,143   

Year-End Position:

          

Working capital

   $ 16,509      $ 16,936      $ 13,423      $ 12,791      $ 4,794   

Property, plant and equipment, net

     16,030        16,297        17,082        18,279        12,000   

Total assets

     106,132        105,128        105,781        112,314        47,196   

Long-term debt

     16,254        15,525        15,482        16,095        3,943   

Total equity

     55,463        56,943        56,805        61,485        21,167   

Year-End Statistics:

          

Number of stockholders of record

     157,400        166,100        171,000        175,600        165,700   

Number of employees

     83,000        86,000        94,000        100,000        55,200   
(1)  

Amounts for 2012 include the amortization of purchase accounting adjustments, a net charge recorded in connection with a litigation settlement, in-process research and development impairment charges reflected in research and development expenses, the impact of restructuring actions and the favorable impact of certain tax items.

 

(2)  

Amounts for 2011 include the amortization of purchase accounting adjustments, in-process research and development impairment charges reflected in research and development expenses, the impact of restructuring actions, an arbitration settlement charge, and the favorable impact of certain tax items, including a net favorable impact of approximately $700 million relating to the settlement of a federal income tax audit.

 

(3)  

Amounts for 2010 include the amortization of purchase accounting adjustments, in-process research and development impairment charges of $2.4 billion reflected in research and development expenses, the impact of restructuring actions, a reserve related to Vioxx litigation, a gain recognized on AstraZeneca LP’s exercise of its option to acquire certain assets from the Company and the favorable impact of certain tax items.

 

(4)  

Amounts for 2009 include the impact of the merger with Schering-Plough Corporation on November 3, 2009, including the recognition of a gain representing the fair value step-up of Merck’s previously held interest in the Merck/Schering-Plough partnership as a result of obtaining a controlling interest and the amortization of purchase accounting adjustments recorded in the post-merger period. Also included in 2009, is a gain on the sale of Merck’s interest in Merial Limited, the favorable impact of certain tax items and the impact of restructuring actions.

 

(5)  

Amounts for 2008 include a gain on distribution from AstraZeneca LP, a gain related to the sale of the remaining worldwide rights to Aggrastat , the favorable impact of certain tax items, the impact of restructuring actions and an expense for a contribution to the Merck Foundation.

 

(6)

Amount reflects dividends paid to common shareholders of Merck. In addition, approximately $144 million of dividends were paid subsequent to the merger with Schering-Plough, and $431 million were paid prior to the merger, relating to common stock and preferred stock dividends declared by Schering-Plough in 2009.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Description of Merck’s Business

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, animal health, and consumer care products, which it markets directly and through its joint ventures. The Company’s operations are principally managed on a products basis and are comprised of four operating segments, which are the Pharmaceutical, Animal Health, Consumer Care and Alliances segments, and one reportable segment, which is the Pharmaceutical segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products marketed either directly by the Company or through joint ventures. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Company also has animal health operations that discover, develop, manufacture and market animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. Additionally, the Company has consumer care operations that develop, manufacture and market over-the-counter, foot care and sun care products, which are sold through wholesale and retail drug, food chain and mass merchandiser outlets, as well as club stores and specialty channels.

Overview

Merck continued to execute on its strategic priorities during 2012 despite facing several business challenges, including the August U.S. patent expiration for Singulair , a medicine indicated for the chronic treatment of asthma and the relief of symptoms of allergic rhinitis. Worldwide sales were $47.3 billion in 2012, a decline of 2% compared with 2011, including a 3% unfavorable effect from foreign exchange. Excluding the impact of foreign exchange, sales increased 1% reflecting growth of key products and within key geographic regions which offset the impact of the U.S. Singulair patent expiration. The Company also reduced operating expenses by efficiently managing costs through targeted reductions. In addition, the Company generated new clinical data and advanced certain key research and development pipeline programs.

The Company’s four-part growth strategy is focused on; one, executing on its core business, which includes its largest markets, its core brands, new launch brands, and research and development efforts targeted at therapeutic areas with the greatest future patient demand and scientific opportunity; two, expanding geographically into high-growth markets; three, extending into complementary businesses of consumer care and animal health; and four, effectively managing costs while continuing to invest for future growth.

Beginning with the Company’s sales performance in its largest markets during 2012, despite the adverse effects of the U.S. Singulair patent expiry which caused a significant and rapid decline in U.S. Singulair sales, sales in the United States were relatively flat compared to the prior year reflecting strong growth of key brands including Januvia and Janumet , treatments for type 2 diabetes, Zostavax , a vaccine to help prevent shingles (herpes zoster), Gardasil , a vaccine to help prevent certain diseases caused by four types of human papillomavirus (“HPV”), Victrelis , a treatment for chronic hepatitis C, and Isentress , an antiretroviral therapy for use in combination therapy for the treatment of HIV-1 infection. Turning to Europe and Canada, the Company continues to experience positive volume growth trends for many of its key brands, including Victrelis, Januvia , Janumet , and Simponi , a treatment for inflammatory diseases; however, this growth only partially offset increased generic erosion and the price declines stemming from the economic issues and related fiscal austerity measures in this region.

With respect to research and development efforts, the Company continued the advancement of drug candidates through its pipeline in 2012. The Company currently has three candidates under review with the U.S. Food and Drug Administration (the “FDA”): MK-4305, suvorexant, an investigational treatment for insomnia; MK-8616, sugammadex sodium injection, a medication for the reversal of certain muscle relaxants used during surgery; and MK-0653C, an investigational combination of ezetimibe and atorvastatin for the treatment of primary or mixed hyperlipidemia. MK-8109, vintafolide, an investigational cancer candidate, is under review in the European Union

 

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(the “EU”). In addition, the Company currently has 16 candidates in Phase III development and anticipates filing a New Drug Application (“NDA”) or a Biologics License Application (“BLA”), as applicable, with the FDA with respect to several of these candidates in 2013.

In December 2012, the Company announced the HPS2-THRIVE (Heart Protection Study 2-Treatment of HDL to Reduce the Incidence of Vascular Events) study of Tredaptive (extended-release niacin/laropiprant) did not meet its primary endpoint. As a result, the Company does not plan to seek regulatory approval for the medicine in the United States. In January 2013, Merck began taking steps to suspend the availability of Tredaptive outside the United States. Also, on February 1, 2013, the Company announced that it had recently received and was reviewing safety and efficacy data from a Phase III study involving MK-0822, odanacatib, the Company’s investigational treatment for osteoporosis in post-menopausal women. As a result of its review of this data, the Company concluded that review of additional data from the previously planned, ongoing extension study was warranted and that filing an application for approval with the FDA should be delayed. As previously announced, the Company is conducting a blinded extension of the trial in approximately 8,200 women, which will provide additional safety and efficacy data. Merck now anticipates that it will file applications for approval of odanacatib in 2014 with additional data from the extension trial. The Company continues to believe that odanacatib will have the potential to address unmet medical needs in patients with osteoporosis.

Merck continues to pursue opportunities for establishing external alliances to complement its substantial internal research capabilities, including research collaborations, as well as licensing preclinical and clinical compounds and technology platforms that have the potential to drive both near- and long-term growth. During 2012, the Company completed a variety of transactions spanning different therapeutic areas and clinical stages including licensing agreements with Endocyte, Inc. (“Endocyte”) for vintafolide (MK-8109), an investigational cancer candidate, and with AiCuris for a portfolio of investigational medicines targeting human cytomegalovirus, including letermovir (MK-8228).

Consistent with the second element of the Company’s strategy to expand geographically in high-growth markets such as Japan and key emerging markets, the Company continued to invest in these markets in 2012. Emerging market sales grew 4% in 2012, including a 4% unfavorable impact of foreign exchange, despite the loss of sales from Remicade and Simponi , treatments for inflammatory diseases, in markets relinquished to Johnson & Johnson (“J&J”) as part of the arbitration settlement agreement in 2011 as discussed below. China continues to be an important growth driver with sales exceeding $1.0 billion in 2012, representing growth of 25% over the prior year, including a 3% favorable effect from foreign exchange. Growth in Japan was 6% during 2012, tempered by generic competition and the biennial price cuts early in the year. Merck has entered into several transactions designed to strengthen its presence in the emerging markets in the longer term. The Company’s joint venture with Simcere Pharmaceutical Group in China began preliminary operations in late-2012.

The third component of Merck’s strategy relates to the complementary businesses of Consumer Care and Animal Health. Merck’s Animal Health business continues as a solid contributor with 4% revenue growth in 2012, including a 5% unfavorable effect from foreign exchange, reflecting growth in the cattle, poultry, companion animal and swine product lines. Sales of Consumer Care products grew 6% in 2012, including a 1% unfavorable effect from foreign exchange, led by the Dr. Scholl’s franchise and higher sales of Coppertone , MiraLAX and Claritin .

As noted, the last element of the Company’s strategy is to tightly manage costs while also investing for growth. Consistent with these efforts, Merck remains committed to driving continuous productivity improvements across the enterprise and continues to realize cost savings across all areas of the Company. These savings result from various actions, including the Merger Restructuring Program discussed below, previously announced ongoing cost reduction activities, as well as from non-restructuring-related activities. As of the end of 2012, the Company had achieved its projected $3.5 billion in annual net cost savings from these activities since the merger with Schering-Plough Corporation (“Schering-Plough”) (the “Merger”).

The global restructuring program that was initiated in conjunction with the integration of the legacy Merck and legacy Schering-Plough businesses (the “Merger Restructuring Program”) is intended to optimize the cost structure of the combined company. The workforce reductions associated with this plan relate to the elimination of positions in sales, administrative and headquarters organizations, as well as from the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company recorded total pretax restructuring costs of $951 million in 2012, $1.8 billion in 2011 and $1.8 billion in

 

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2010 related to this program. Costs associated with the Company’s restructuring actions are included in Materials and production costs, Marketing and administrative expenses, Research and development expenses and Restructuring costs . The restructuring actions under the Merger Restructuring Program are expected to be substantially completed by the end of 2013, with the exception of certain actions, principally manufacturing-related. Subsequent to the Merger, the Company has rationalized a number of manufacturing sites worldwide. The remaining actions under this program will result in additional manufacturing facility rationalizations, which are expected to be substantially completed by 2016. The Company now expects the estimated total cumulative pretax costs for this program to be approximately $7.2 billion to $7.5 billion. The Company estimates that approximately two-thirds of the cumulative pretax costs relate to cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company expects the Merger Restructuring Program to yield annual savings by the end of 2013 of approximately $3.5 billion to $4.0 billion and annual savings upon completion of the program of approximately $4.0 billion to $4.6 billion.

In November 2012, Merck’s Board of Directors raised the Company’s quarterly dividend to $0.43 per share from $0.42 per share.

In February 2013, Merck reached an agreement in principle with plaintiffs to resolve two federal securities class-action lawsuits pending in the U.S. District Court for the District of New Jersey against Merck, Schering-Plough and certain of their current and former officers and directors (the “ENHANCE Litigation”). Under the proposed agreement, Merck will pay $215 million to resolve the securities class action against all of the Merck defendants and $473 million to resolve the securities class action against all of the Schering-Plough defendants. In connection with the settlement, Merck recorded a pretax and after-tax charge of $493 million in 2012 which reflects $195 million of anticipated insurance recoveries.

Earnings per common share assuming dilution attributable to common shareholders (“EPS”) for 2012 were $2.00, which reflect a net unfavorable impact resulting from acquisition-related costs and restructuring costs, as well as the charge related to the ENHANCE Litigation noted above. Non-GAAP EPS in 2012 were $3.82 excluding these items (see “Non-GAAP Income and Non-GAAP EPS” below).

Competition and the Health Care Environment

Competition

The markets in which the Company conducts its business and the pharmaceutical industry are highly competitive and highly regulated. The Company’s competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, and generic drug and consumer health care manufacturers. The Company’s operations may be affected by technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors’ branded products, new information from clinical trials of marketed products or post-marketing surveillance and generic competition as the Company’s products mature. In addition, patent positions are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the recognition of an impairment charge with respect to certain products. Competitive pressures have intensified as pressures in the industry have grown. The effect on operations of competitive factors and patent disputes cannot be predicted.

Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well positioned to compete in the search for technological innovations. Additional resources required to meet market challenges include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through external alliances, such as joint ventures and licenses, and has been refining its sales and marketing efforts to further address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth for the Company’s products in that therapeutic category.

 

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The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Company’s products, effective promotional efforts and the frequent introduction of generic products by competitors.

The Company’s consumer care operations face competition from other consumer health care businesses as well as retailers who carry their own private label brands. The Company’s competitive position is affected by several factors, including regulatory and legislative issues, scientific and technological advances, the quality and price of the Company’s products, promotional efforts and the growth of lower cost private label brands.

Health Care Environment

Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, federal and state governments for many years also have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for outpatient medicines purchased by certain Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients.

Against this backdrop, the United States enacted major health care reform legislation in 2010, which began to be implemented in 2010. Various insurance market reforms have advanced and will continue through full implementation in 2014. The law is expected to expand access to health care to about 32 million Americans by the end of the decade who did not previously have insurance coverage. With respect to the effect of the law on the pharmaceutical industry, the mandated Medicaid rebate increased from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called “donut hole”). Approximately $210 million and $150 million was recorded by Merck as a reduction to revenue in 2012 and 2011, respectively, related to the donut hole provision. Also, pharmaceutical manufacturers are now required to pay an annual health care reform fee. The total annual industry fee was $2.8 billion in 2012 and will be $2.8 billion in 2013. The fee is assessed on each company in proportion to its share of sales to certain government programs, such as Medicare and Medicaid. The Company recorded $190 million and $162 million of costs within Marketing and administrative expenses in 2012 and 2011, respectively, for the annual health care reform fee.

The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Company’s sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act of 2010. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures.

In addition, in the effort to contain the U.S. federal deficit, the pharmaceutical industry could be considered a potential source of savings via legislative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls in the Medicare prescription drug program (Part D). In addition, Congress may again consider proposals to allow, under certain conditions, the importation of medicines from other countries. It remains very uncertain as to what proposals, if any, may be included as part of future federal budget deficit reduction proposals that would directly or indirectly affect the Company.

Efforts toward health care cost containment remain intense in several European countries. Many countries have announced austerity measures, which include the implementation of pricing actions to reduce prices of generic and patented drugs and mandatory switches to generic drugs. While the Company is taking steps to mitigate the impact in the EU, the austerity measures continued to negatively affect the Company’s revenue performance in 2012 and the Company anticipates the austerity measures will continue to negatively affect revenue performance in 2013.

 

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Additionally, the global economic downturn and the sovereign debt issues in certain European countries, among other factors, have adversely affected foreign receivables in certain European countries. While the Company continues to receive payment on these receivables, these conditions have resulted in an increase in the average length of time it takes to collect accounts receivable outstanding thereby adversely affecting cash flows.

Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and related measures that aim to put pressure on the price of pharmaceuticals and constrain market access. The Company anticipates that pricing pressures and market access challenges will continue in 2013 to varying degrees in the emerging markets.

The Company’s focus on and share of revenue from emerging markets has increased. Countries in these markets may be subject to conditions that can affect the Company’s efforts to continue to grow in emerging markets, including potential political instability, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Company’s risk exposure.

The full impact of health care reform, as well as continuing budget pressures on governments around the world, cannot be predicted at this time.

In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to attempt to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company seeks to work with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of government health care spending, the Company encourages those governments to increase their investments in order to improve their citizens’ access to appropriate health care, including medicines.

Certain markets outside of the United States have implemented health technology assessments and other cost management strategies which require additional data, reviews and administrative processes, all of which increase the complexity and costs of obtaining product reimbursement and exert downward pressure on reimbursement available and obtained.

Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Company’s business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well positioned to respond to the evolving health care environment and market forces.

Government Regulation

The pharmaceutical industry is subject to regulation by regional, country, state and local agencies around the world. Governmental regulation and legislation tend to focus on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement, especially related to the pricing of products.

Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In many cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States.

The EU has adopted directives and other legislation concerning the classification, labeling, advertising, wholesale distribution, integrity of the supply chain, enhanced pharmacovigilance monitoring and approval for marketing of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. The Company’s policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Company’s business.

 

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The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment.

Access to Medicines

As a global health care company, Merck’s primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its products around the world. The Company’s efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Company’s worldwide approach to expanding access to health care. For example, the Company has been recognized for pricing many of its products through a differential pricing framework, taking into consideration such factors as a country’s level of economic development and public health need. In addition, the Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Company’s assistance, cannot afford their Merck medicine and vaccines.

Building on the Company’s own efforts, Merck has undertaken collaborations with many stakeholders to improve access to medicines and enhance the quality of life for people around the world.

For example, in 2011, Merck announced that it would launch “Merck for Mothers,” a long-term effort with global health partners to create a world where no woman has to die from preventable complications of pregnancy and childbirth. The launch includes a 10-year, $500 million initiative that applies Merck’s scientific and business expertise to making proven solutions more widely available, developing new technologies and improving public awareness, policy efforts and private sector engagement to reduce maternal mortality.

Merck has also in the past provided funds to the Merck Foundation, an independent organization, which has partnered with a variety of organizations dedicated to improving global health. One of these partnerships is The African Comprehensive HIV/AIDS Partnership in Botswana, a collaboration with the government of Botswana that was renewed in 2010 and supports Botswana’s response to HIV/AIDS through a comprehensive and sustainable approach to HIV prevention, care, treatment, and support.

Privacy and Data Protection

The Company is subject to a number of privacy and data protection laws and regulations globally. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Company’s business, including recently enacted laws and regulations in the United States, Europe, Asia and Latin America and increased enforcement activity in the United States and other developed markets.

Operating Results

Sales

Worldwide sales totaled $47.3 billion in 2012, a decline of 2% compared with $48.0 billion in 2011. Foreign exchange unfavorably affected global sales performance by 3%. The sales decrease was driven primarily by Singulair , which lost market exclusivity in the United States in August 2012 resulting in a significant and rapid decline in U.S. Singulair sales. The sales decline was also driven by lower sales of Remicade , a treatment for inflammatory diseases, largely as a result of the arbitration settlement agreement with J&J in 2011 as discussed below. In addition, lower sales of Cozaar and Hyzaar , treatments for hypertension, Clarinex , a non-sedating antihistamine, Fosamax , for the treatment of osteoporosis, Vytorin , a cholesterol modifying medicine, Primaxin , an anti-bacterial product, and Avelox , a broad-spectrum fluoroquinolone antibiotic for the treatment of certain respiratory and skin infections, as well as lower revenue from the Company’s relationship with AstraZeneca LP (“AZLP”) also contributed to the sales decline in 2012. These declines were largely offset by higher sales of Januvia , Gardasil , Victrelis , Zostavax , Janumet , Isentress , Zetia , a cholesterol modifying medicine, Dulera , a combination medicine for the treatment of asthma, as well as by higher sales of the Company’s animal health and consumer care products.

Sales in the United States were $20.4 billion in 2012, a decline of 1% compared with $20.5 billion in 2011. The sales decrease was driven by lower sales of Singulair , Vytorin , Avelox , Cozaar and Hyzaar , as well as lower revenue from the Company’s relationship with AZLP. These declines were largely offset by higher sales of

 

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Januvia , Zostavax , Gardasil , Victrelis , Janumet , Isentress , Pneumovax , a vaccine to help prevent pneumococcal disease, Zetia and Dulera , as well as higher sales of animal health and consumer care products.

International sales were $26.9 billion in 2012, a decline of 2% compared with $27.6 billion in 2011. Foreign exchange unfavorably affected international sales performance by 4% in 2012. Declines in Europe and Canada were partially offset by growth in Japan and certain of the emerging markets, particularly in China. Lower sales of Remicade led the decline, along with lower sales of Cozaar , Hyzaar , Singulair , Fosamax and Clarinex , partially offset by growth in Januvia , Victrelis , Gardasil and Janumet . International sales represented 57% of total sales in both 2012 and 2011.

Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. In many international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, other austerity measures negatively affected the Company’s revenue performance in 2012. The Company anticipates these pricing actions and other austerity measures will continue to negatively affect revenue performance in 2013.

Worldwide sales totaled $48.0 billion in 2011, an increase of 4% compared with $46.0 billion in 2010. Foreign exchange favorably affected global sales performance by 2%. The revenue increase was driven largely by growth in Januvia and Janumet, Singulair , Isentress, Gardasil, Simponi, RotaTeq , a vaccine to help protect against rotavirus gastroenteritis in infants and children, Zetia , Pneumovax and Bridion , for the reversal of certain muscle relaxants used during surgery. In addition, revenue in 2011 benefited from higher sales of the Company’s animal health products and from the launch of Victrelis . These increases were partially offset by lower sales of Cozaar , Hyzaar , Vytorin , Temodar , a treatment for certain types of brain tumors, ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, and Varivax , a vaccine to help prevent chickenpox (varicella). Revenue was also negatively affected by lower sales of Caelyx, Subutex and Suboxone as the Company no longer has marketing rights to these products. In addition, the ongoing implementation of certain provisions of U.S. health care reform legislation during 2011 resulted in further increases in Medicaid rebates and other impacts that reduced revenues as compared with 2010.

 

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Sales of the Company’s products were as follows:

 

($ in millions)    2012      2011      2010  

Primary Care and Women’s Health

        

Cardiovascular

        

Zetia

   $ 2,567       $ 2,428       $ 2,297   

Vytorin

     1,747         1,882         2,014   

Diabetes and Obesity

        

Januvia

     4,086         3,324         2,385   

Janumet

     1,659         1,363         954   

Respiratory

        

Singulair

     3,853         5,479         4,987   

Nasonex

     1,268         1,286         1,219   

Clarinex

     393         621         623   

Dulera

     207         96         8   

Asmanex

     185         206         208   

Women’s Health and Endocrine

        

Fosamax

     676         855         926   

NuvaRing

     623         623         559   

Follistim AQ

     468         530         528   

Implanon

     348         294         236   

Cerazette

     271         268         209   

Other

        

Maxalt

     638         639         550   

Arcoxia

     453         431         398   

Avelox

     201         322         316   

Hospital and Specialty

        

Immunology

        

Remicade

     2,076         2,667         2,714   

Simponi

     331         264         97   

Infectious Disease

        

Isentress

     1,515         1,359         1,090   

PegIntron

     653         657         737   

Cancidas

     619         640         611   

Victrelis

     502         140           

Invanz

     445         406         362   

Primaxin

     384         515         610   

Noxafil

     258         230         198   

Oncology

        

Temodar

     917         935         1,065   

Emend

     489         419         378   

Other

        

Cosopt/Trusopt

     444         477         484   

Bridion

     261         201         103   

Integrilin

     211         230         266   

Diversified Brands

        

Cozaar/Hyzaar

     1,284         1,663         2,104   

Propecia

     424         447         447   

Zocor

     383         456         468   

Claritin Rx

     244         314         296   

Remeron

     232         241         223   

Proscar

     217         223         216   

Vasotec/Vaseretic

     192         231         255   

Vaccines (1)

        

Gardasil

     1,631         1,209         988   

ProQuad/M-M-R II/Varivax

     1,273         1,202         1,378   

Zostavax

     651         332         243   

RotaTeq

     601         651         519   

Pneumovax

     580         498         376   

Other pharmaceutical (2)

     4,141         4,035         4,622   

Total Pharmaceutical segment sales

     40,601         41,289         39,267   

Other segment sales (3)

     6,412         6,428         6,159   

Total segment sales

     47,013         47,717         45,426   

Other (4)

     254         330         561   
     $ 47,267       $ 48,047       $ 45,987   
(1)  

These amounts do not reflect sales of vaccines sold in most major European markets through the Company’s joint venture, Sanofi Pasteur MSD, the results of which are reflected in Equity income from affiliates . These amounts do, however, reflect supply sales to Sanofi Pasteur MSD.

 

(2)  

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

 

(3)  

Represents the non-reportable segments of Animal Health, Consumer Care and Alliances. The Alliances segment includes revenue from the Company’s relationship with AZLP .

 

(4)

Other revenues are primarily comprised of miscellaneous corporate revenues, third-party manufacturing sales, sales related to divested products or businesses and other supply sales not included in segment results.

 

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Pharmaceutical Segment

Primary Care and Women’s Health

Cardiovascular

Worldwide sales of Zetia (also marketed as Ezetrol outside the United States), a cholesterol absorption inhibitor, increased 6% in 2012 to $2.6 billion, including a 2% unfavorable effect from foreign exchange. The sales increase reflects positive performance in the United States due to pricing, as well as volume growth in Japan, partially offset by volume declines in the United States. Sales of Zetia increased 6% in 2011 to $2.4 billion, including a 3% favorable effect from foreign exchange. The increase reflects higher sales in international markets, particularly in Japan, partially offset by volume declines in the United States.

Global sales of Vytorin (marketed outside the United States as Inegy ), a combination product containing the active ingredients of both Zetia and Zocor , declined 7% in 2012 to $1.7 billion, including a 3% unfavorable effect from foreign exchange. The sales decline reflects volume declines in the United States, partially offset by pricing in the United States and volume growth in certain international markets. Worldwide sales of Vytorin declined 7% in 2011 to $1.9 billion reflecting volume declines in the United States, partially offset by increases in international markets.

In March 2012, the Data Safety Monitoring Board (the “DSMB”) of the IMPROVE-IT trial, a large cardiovascular outcomes study evaluating ezetimibe/simvastatin against simvastatin alone in patients presenting with acute coronary syndrome, completed the second pre-specified interim efficacy analysis of the study. The DSMB conducted the planned interim efficacy analysis after the trial had reached approximately 75% of the targeted 5,250 clinical endpoints called for in the study design. The DSMB recommended that the study continue without change in design and stated it planned to review the data again in approximately nine months. That review has been scheduled for March 2013, at which point nine months of additional data will have been adjudicated. Merck remains blinded to IMPROVE-IT safety and efficacy data. IMPROVE-IT is an 18,000 patient event-driven trial and, based on the current rate at which events are being reported, the Company now anticipates the targeted 5,250 clinical endpoints for study completion will be reached in 2014.

In December 2012, Merck announced the HPS2-THRIVE study of Tredaptive did not meet its primary endpoint (see “Research and Development” below). Subsequently, based on the understanding of the preliminary data from the HPS2-THRIVE study and in consultation with regulatory authorities, Merck began taking steps to suspend the availability of Tredaptive , which is approved for use in certain countries outside of the United States. The Company recognized approximately $40 million of costs in 2012 associated with suspending the availability of Tredaptive . Sales of Tredaptive were $17 million in 2012.

Diabetes and Obesity

Global sales of Januvia , Merck’s dipeptidyl peptidase-4 (“DPP-4”) inhibitor for the treatment of type 2 diabetes, rose 23% in 2012 to $4.1 billion and grew 39% in 2011 to $3.3 billion reflecting volume growth in the United States, as well as in international markets, particularly in Japan. Foreign exchange unfavorably affected sales performance by 2% in 2012 and favorably affected sales performance by 3% in 2011.

Worldwide sales of Janumet , Merck’s oral antihyperglycemic agent that combines sitagliptin ( Januvia) with metformin in a single tablet to target all three key defects of type 2 diabetes, were $1.7 billion in 2012, an increase of 22% compared with 2011, reflecting volume growth in the United States, the emerging markets and Europe. Global sales of Janumet were $1.4 billion in 2011 compared with $954 million in 2010 reflecting growth internationally due in part to ongoing launches in certain markets, as well as growth in the United States. Foreign exchange unfavorably affected sales performance by 4% in 2012 and favorably affected sales performance by 2% in 2011.

In February 2012, the FDA approved Janumet XR , a new treatment for type 2 diabetes that combines sitagliptin with extended-release metformin. Janumet XR provides a convenient once-daily treatment option for health care providers and patients who need help to control their blood sugar.

As previously disclosed, on February 17, 2012, the FDA sent a Warning Letter to the Company relating to Januvia and Janumet stating that the Company did not fulfill a post-marketing requirement for a 3-month pancreatic safety study in a diabetic rodent model treated with sitagliptin. The Company completed the study and

 

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submitted the study report to the FDA in December 2012. The FDA has recently reviewed the submission and concluded that the post-marketing requirement has been fulfilled.

Respiratory

Worldwide sales of Singulair, a once-a-day oral medicine for the chronic treatment of asthma and for the relief of symptoms of allergic rhinitis, declined 30% to $3.9 billion in 2012 driven primarily by lower sales in the United States. Revenue declines in Europe, Canada and Latin America also contributed to the Singulair sales decline. The patent that provided U.S. market exclusivity for Singulair expired on August 3, 2012 and the Company experienced a significant and rapid decline in U.S. Singulair sales thereafter. U.S. sales of Singulair declined 97% in the fourth quarter to $25 million. U.S. sales of Singulair decreased 39% to $2.2 billion for the full year of 2012 driven by lower sales after the U.S. patent expiry in August. In addition, the patent that provided market exclusivity for Singulair expired in a number of major European markets in February 2013 and the Company expects a significant and rapid reduction in sales of Singulair in those markets. The patent that provides market exclusivity for Singulair in Japan will expire in 2016. In 2012, sales of Singulair were $602 million in Europe and $668 million in Japan. Global sales of Singulair grew 10% in 2011 to $5.5 billion, including a 2% favorable impact of foreign exchange, driven primarily by favorable pricing in the United States, as well as volume growth in Japan and in the emerging markets.

Global sales of Nasonex , an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms, declined 1% in 2012 to $1.3 billion, including a 1% unfavorable impact from foreign exchange. Sales performance reflects price declines in Europe and lower volumes in the United States, largely offset by higher prices in the United States. In 2009, Apotex Inc. and Apotex Corp. (collectively, “Apotex”) filed an Abbreviated New Drug Application with the FDA seeking approval to sell its generic version of Nasonex . In June 2012, the U.S. District Court for the District of New Jersey ruled against the Company in a patent infringement suit against Apotex holding that Apotex’s generic version of Nasonex does not infringe on the Company’s formulation patent (see Note 11 to the consolidated financial statements). The Company has appealed the U.S. District Court decision. If generic versions become available, significant losses of Nasonex sales could occur and the Company may take a non-cash impairment charge with respect to the value of the Nasonex intangible asset, which had a carrying value of approximately $1.9 billion at December 31, 2012. If the Nasonex intangible asset is determined to be impaired, the impairment charge could be material. As a result of the unfavorable U.S. District Court decision, the Company evaluated the Nasonex intangible asset for impairment and concluded that it was not impaired. U.S. sales of Nasonex were $597 million in 2012. Worldwide sales of Nasonex increased 5% in 2011 to $1.3 billion, including a 1% favorable effect from foreign exchange. The sales increase was driven largely by volume growth in Japan and Latin America, partially offset by volume declines in the United States.

Global sales of Clarinex (marketed as Aerius in many countries outside the United States), a non-sedating antihistamine, declined 37% in 2012 to $393 million driven by lower volumes in Europe and the United States as a result of generic competition. As previously disclosed, by virtue of litigation settlements, certain generic manufacturers were given the right to enter the U.S. market in 2012 and several generic versions have been launched. The Company anticipates that sales of Clarinex will continue to decline. Worldwide sales of Clarinex were $621 million in 2011 compared with $623 million in 2010.

Global sales of Dulera Inhalation Aerosol, a combination medicine for the treatment of asthma, were $207 million in 2012 compared with $96 million in 2011 reflecting volume growth in the United States. Dulera Inhalation Aerosol was approved by the FDA in June 2010. In January 2012, Merck received a Complete Response Letter from the FDA on the Company’s supplemental New Drug Application for Dulera , for the treatment of chronic obstructive pulmonary disease. The Company is planning to conduct an additional clinical study and update the application in the future.

Women’s Health and Endocrine

Worldwide sales of Fosamax and Fosamax Plus D (marketed as Fosavance throughout the EU and as Fosamac in Japan) for the treatment and, in the case of Fosamax , prevention of osteoporosis, declined 21% in 2012 to $676 million and decreased 8% in 2011 to $855 million. These medicines have lost market exclusivity in the United States and in most major European markets. During 2012, declines in Japan and the emerging markets also contributed to the sales decrease. The Company expects the declines within the Fosamax product franchise to continue.

 

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Worldwide sales of NuvaRing , a vaginal contraceptive product, were $623 million in 2012, comparable with sales in 2011. Foreign exchange unfavorably affected sales performance by 3% in 2012. Excluding the unfavorable impact of foreign exchange, sales performance in 2012 reflects volume growth in the emerging markets and positive performance in Europe. Global sales of NuvaRing grew 12% to $623 million in 2011, including a 3% beneficial effect from foreign exchange, driven by positive performance in the United States and internationally.

Global sales of Follistim AQ (marketed in most countries outside the United States as Puregon ), a biological fertility treatment, declined 12% in 2012 to $468 million, including a 3% unfavorable effect from foreign exchange, driven largely by declines in Europe resulting from supply issues and pricing. Sales of Follistim AQ were $530 million in 2011 compared with $528 million in 2010 reflecting growth in emerging markets offset by declines in Europe due primarily to supply constraints. Puregon lost market exclusivity in the EU in August 2009.

The Company is currently experiencing difficulty manufacturing certain women’s health products. The Company is working to resolve these issues, which were not material to the Company’s results of operations.

Other

Global sales of Maxalt , a product for the acute treatment of migraine, were $638 million in 2012, comparable with sales in 2011. Sales performance in 2012 reflects higher sales in the United States driven by favorable pricing, offset by volume declines in Europe and Canada due to generic erosion. Sales of Maxalt increased 16% in 2011 to $639 million reflecting a higher inventory level and favorable pricing in the United States. The patent that provided U.S. market exclusivity for Maxalt expired in December 2012 and the Company is experiencing a decline in U.S. Maxalt sales and expects the decline to continue. In addition, the patent that provides market exclusivity for Maxalt will expire in a number of major European markets in August 2013 and the Company anticipates that sales in those European markets will decline significantly after these patent expiries. In 2012, sales of Maxalt were $491 million in the United States and $92 million in Europe.

Sales of Avelox , a broad-spectrum fluoroquinolone antibiotic for the treatment of certain respiratory and skin infections marketed by the Company in the United States, declined 37% in 2012 to $201 million due primarily to a competitor’s product becoming available in generic form. Sales of Avelox grew 2% in 2011 to $322 million. The patent that provides U.S. market exclusivity for Avelox expires in March 2014; however, by agreement, a generic manufacturer may launch a generic version of Avelox in February 2014.

Other products included in Primary Care and Women’s Health include among others, Asmanex Twisthaler , an inhaled corticosteroid for asthma; Implanon , a single-rod subdermal contraceptive implant; Cerazette , a progestin only oral contraceptive; and Arcoxia , for the treatment of arthritis and pain.

Hospital and Specialty

Immunology

Sales of Remicade , a treatment for inflammatory diseases, were $2.1 billion in 2012, a decline of 22% compared with 2011, and were $2.7 billion in 2011, a decline of 2% compared with 2010. Foreign exchange unfavorably affected global sales performance by 6% in 2012 and favorably affected sales performance by 5% in 2011. Prior to July 1, 2011, Remicade was marketed by the Company outside of the United States (except in Japan and certain other Asian markets). As a result of the agreement reached in April 2011 to amend the agreement governing the distribution rights to Remicade and Simponi , effective July 1, 2011, Merck relinquished marketing rights for these products in certain territories including Canada, Central and South America, the Middle East, Africa and Asia Pacific. Merck retained exclusive marketing rights throughout Europe, Russia and Turkey (the “Retained Territories”). In the Retained Territories, Remicade sales declined 2% in 2012, which reflects an 8% unfavorable effect from foreign exchange and volume growth in Europe. Sales of Remicade in the Retained Territories grew 13% in 2011, which reflects a 6% favorable impact from foreign exchange. Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases was approved by the European Commission (the “EC”) in October 2009. Sales of Simponi were $331 million in 2012, $264 million in 2011 and $97 million in 2010. The revenue increases were driven by growth in the Retained Territories due in part to ongoing launches. In July 2012, a submission was made to the European Medicines Agency (the “EMA”) requesting approval of Simponi for the treatment of adult patients with moderately to severely active ulcerative colitis who have had an inadequate response to conventional therapy.

 

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Infectious Disease

Worldwide sales of Isentress, an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, grew 11% in 2012 to $1.5 billion driven primarily by volume growth in the United States, Latin America and the Asia Pacific region. Global sales of Isentress rose 25% in 2011 to $1.4 billion reflecting volume growth in the United States and internationally, partially offset by unfavorable pricing in European markets. Foreign exchange unfavorably affected global sales performance by 4% in 2012 and favorably affected sales performance by 3% in 2011.

Worldwide sales of PegIntron , a treatment for chronic hepatitis C, declined 1% in 2012 to $653 million, including an unfavorable effect from foreign exchange of 4%. Excluding the unfavorable impact of foreign exchange, sales performance reflects volume growth and favorable pricing in the United States and volume growth in certain of the emerging markets. Sales of PegIntron declined 11% in 2011 to $657 million, including a 4% favorable effect from foreign exchange, reflecting competitive pressures.

Global sales of Cancidas , an anti-fungal product, declined 3% in 2012 to $619 million, including a 5% unfavorable effect from foreign exchange. Excluding the unfavorable impact of foreign exchange, sales performance in 2012 reflects growth in the emerging markets. Sales of Cancidas grew 5% in 2011 to $640 million, including a 4% favorable effect from foreign exchange, reflecting higher sales in Europe and Canada, partially offset by declines in the United States.

Global sales of Victrelis , the Company’s innovative oral medicine for the treatment of chronic hepatitis C, were $502 million in 2012 compared with $140 million in 2011, driven by post-launch growth in the United States and internationally, particularly in Europe. Victrelis was approved by the FDA in May 2011 and by the EC in July 2011. Victrelis is approved in 70 countries and has launched in 45 of those markets.

Sales of Primaxin , an anti-bacterial product, declined 25% in 2012 to $384 million and decreased 16% in 2011 to $515 million. Patents on Primaxin have expired worldwide and multiple generics have been launched.

Oncology

Sales of Temodar (marketed as Temodal outside the United States), a treatment for certain types of brain tumors, declined 2% in 2012 to $917 million, including a 2% unfavorable effect from foreign exchange. Sales declines in Europe from generic competition were offset by price increases in the United States. Sales of Temodar decreased 12% in 2011 to $935 million, including a 3% favorable effect from foreign exchange, primarily reflecting generic competition in Europe. Temodar lost patent exclusivity in the EU in 2009. As previously disclosed, by agreement, a generic manufacturer may launch a generic version of Temodar in the United States in August 2013. Accordingly, the Company anticipates U.S. sales of Temodar , which were $423 million in 2012, will decline significantly in 2013. The U.S. patent and exclusivity periods will otherwise expire in February 2014.

Global sales of Emend , for the prevention of chemotherapy-induced and post-operative nausea and vomiting, increased 17% in 2012 to $489 million, including a 2% unfavorable effect from foreign exchange. The sales increase reflects volume growth in the United States and Japan. Sales of Emend increased 11% in 2011 to $419 million primarily reflecting growth in international markets.

Other

Worldwide sales of ophthalmic products Cosopt and Trusopt declined 7% in 2012 to $444 million, including a 4% unfavorable effect from foreign exchange. The sales decline primarily reflects lower sales in Europe due to generic erosion and price reductions, mitigated in part by higher Cosopt sales in Japan. Sales of Cosopt and Trusopt declined 1% in 2011 to $477 million, including a 5% favorable impact of foreign exchange, reflecting unfavorable pricing and volume declines in Europe, partially offset by higher Cosopt sales in Japan. The patent that provided U.S. market exclusivity for Cosopt and Trusopt has expired. Trusopt has also lost market exclusivity in a number of major European markets. The patent for Cosopt will expire in a number of major European markets in March 2013 and the Company expects sales in those markets to decline significantly thereafter.

Bridion (sugammadex sodium injection), for the reversal of certain muscle relaxants used during surgery, is approved and has been launched in many countries outside of the United States. Sales of Bridion were $261 million in 2012, $201 million in 2011 and $103 million in 2010. Sugammadex sodium injection is currently under review by the FDA.

 

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In 2009, the FDA approved Saphris (asenapine), an antipsychotic indicated for the treatment of schizophrenia and bipolar I disorder in adults. In 2010, asenapine, sold under the brand name Sycrest , received marketing approval in the EU for the treatment of bipolar I disorder in adults. In 2010, Merck and H. Lundbeck A/S (“Lundbeck”) announced a worldwide commercialization agreement for Sycrest sublingual tablets (5 mg, 10 mg). Under the terms of the agreement, Lundbeck paid a fee and makes product supply payments in exchange for exclusive commercial rights to Sycrest in all markets outside the United States, China and Japan. Merck’s sales of Saphris were $166 million in 2012 and $120 million in 2011. Merck continues to focus on building and maintaining the brand awareness of Saphris in the United States. If these efforts in the United States or Lundbeck’s on-going launch of the product in the EU are not successful, the Company may take a non-cash impairment charge with respect to the value of the Saphris/Sycrest intangible asset, which had a carrying value of approximately $550 million at December 31, 2012. If the Saphris/Sycrest intangible asset is determined to be impaired, the impairment charge could be material.

Other products contained in Hospital and Specialty include among others, Invanz , for the treatment of certain infections; Noxafil , for the prevention of certain invasive fungal infections; and Integrilin, a treatment for patients with acute coronary syndrome, which is sold by the Company in the United States and Canada.

Diversified Brands

Merck’s diversified brands include human health pharmaceutical products that are approaching the expiration of their marketing exclusivity or are no longer protected by patents in developed markets, but continue to be a core part of the Company’s offering in other markets around the world.

Global sales of Cozaar and its companion agent Hyzaar (a combination of Cozaar and hydrochlorothiazide), treatments for hypertension, declined 23% in 2012 to $1.3 billion and decreased 21% in 2011 to $1.7 billion. The patents that provided market exclusivity for Cozaar and Hyzaar in the United States and in a number of major international markets have expired. Accordingly, the Company is experiencing significant declines in Cozaar and Hyzaar sales and the Company expects the declines to continue.

Other products contained in Diversified Brands include among others, Propecia , a product for the treatment of male pattern hair loss; Zocor , a statin for modifying cholesterol; prescription Claritin , a treatment for seasonal outdoor allergies and year-round indoor allergies; Remeron , an antidepressant; Proscar, a urology product for the treatment of symptomatic benign prostate enlargement; and Vasotec and Vaseretic , hypertension and/or heart failure products. The formulation/use patent that provides U.S. market exclusivity for Propecia expires in October 2013; however, as previously disclosed, by agreement, one generic manufacturer entered the U.S. market in January 2013 and another has been given the right to enter in July 2013. Accordingly, the Company anticipates U.S. sales of Propecia , which were $124 million in 2012, will decline significantly in 2013.

Vaccines

The following discussion of vaccines does not include sales of vaccines sold in most major European markets through Sanofi Pasteur MSD (“SPMSD”), the Company’s joint venture with Sanofi Pasteur, the results of which are reflected in Equity income from affiliates (see “Selected Joint Venture and Affiliate Information” below). Supply sales to SPMSD, however, are included.

Worldwide sales of Gardasil recorded by Merck grew 35% in 2012 to $1.6 billion driven primarily by growth in the United States, reflecting continued uptake in males and approximately $45 million of government purchases for the U.S. Centers for Disease Control and Prevention (the “CDC”) Pediatric Vaccine Stockpile, as well as growth in the emerging markets, particularly in Latin America and the Asia Pacific region, and in Japan. Sales of Gardasil rose 22% in 2011 to $1.2 billion driven by greater uptake in males in the United States, higher sales in conjunction with the launch in Japan and growth in emerging markets, partially offset by lower government orders in Canada. Gardasil, the world’s top-selling HPV vaccine, is indicated for girls and women 9 through 26 years of age for the prevention of cervical, vulvar, vaginal and anal cancer caused by HPV types 16 and 18, certain precancerous or dysplastic lesions caused by HPV types 6, 11, 16 and 18, and genital warts caused by HPV types 6 and 11. Gardasil is also approved in the United States for use in boys and men 9 through 26 years of age for the prevention of anal cancer caused by HPV types 16 and 18, anal dysplasias and precancerous lesions caused by HPV

 

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types 6, 11, 16 and 18, and genital warts caused by HPV types 6 and 11. The Company is a party to certain third-party license agreements with respect to Gardasil (including a cross-license and settlement agreement with GlaxoSmithKline). As a result of these agreements, the Company pays royalties on worldwide Gardasil sales of 21% to 27% which vary by country and are included in Materials and production costs.

In recent years, the Company has experienced difficulties in producing its varicella zoster virus (“VZV”)-containing vaccines. These difficulties have resulted in supply constraints for ProQuad , Varivax and Zostavax . The Company has resolved the supply constraints in the United States and anticipates limited launches in international markets for Zostavax in 2013 as noted below.

ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, one of the VZV-containing vaccines, became available again in the United States for ordering in October 2012. Merck’s sales of ProQuad were $61 million in 2012, $34 million in 2011 and $134 million in 2010. Sales in all of these years were affected by supply constraints.

Merck’s sales of Varivax, a vaccine to help prevent chickenpox (varicella), were $846 million in 2012, $831 million in 2011 and $929 million in 2010. Sales for 2010 reflect $48 million of government purchases for the CDC’s Pediatric Vaccine Stockpile. Merck’s sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, were $365 million in 2012, $337 million in 2011 and $315 million in 2010. Sales growth in 2012 was driven primarily by higher volumes in the United States. Sales of Varivax and M-M-R II were affected by ProQuad supply constraints discussed above.

Merck’s sales of Zostavax, a vaccine to help prevent shingles (herpes zoster) in adults 50 years of age and older, were $651 million in 2012, $332 million in 2011 and $243 million in 2010. Sales performance in 2012 reflects supply availability and increased promotional efforts in the United States. Sales in 2011 and 2010 were affected by supply issues. The Company anticipates limited launches outside of the United States later in 2013.

Merck’s sales of RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, declined 8% in 2012 to $601 million reflecting favorable public sector inventory fluctuations in 2011, partially offset by volume growth in the emerging markets and Japan in 2012. Merck’s sales of RotaTeq grew 25% in 2011 to $651 million reflecting favorable public sector inventory fluctuations and growth in emerging markets.

Merck’s sales of Pneumovax , a vaccine to help prevent pneumococcal disease, grew 17% in 2012 to $580 million due primarily to growth in the United States as a result of price increases and higher volumes, partially offset by declines in Japan. Sales of Pneumovax increased 33% in 2011 to $498 million due to positive performance in the United States, due in part to favorable pricing, and growth in Japan.

Merck’s adult formulation of Vaqta , a vaccine against hepatitis A which was experiencing supply issues, became available in the third quarter of 2012.

Other Segments

Animal Health

Animal Health includes pharmaceutical and vaccine products for the prevention, treatment and control of disease in all major farm and companion animal species. Animal Health sales are affected by intense competition and the frequent introduction of generic products. Global sales of Animal Health products grew 4% in 2012 to $3.4 billion and increased 11% in 2011 to $3.3 billion. Foreign exchange unfavorably affected global sales performance by 5% in 2012 and favorably affected global sales performance by 4% in 2011. The increase in sales in both periods was driven by positive performance among cattle, poultry, companion animal and swine products.

Consumer Care

Consumer Care products include over-the-counter, foot care and sun care products such as Claritin non-drowsy antihistamines; MiraLAX , for the relief of occasional constipation; Dr. Scholl’s foot care products; and Coppertone sun care products. Global sales of Consumer Care products grew 6% in 2012, including a 1% unfavorable effect from foreign exchange, to $2.0 billion reflecting higher sales of Dr. Scholl’s , Coppertone , MiraLAX and Claritin , partially offset by lower sales of Marvelon , an oral contraceptive, which is an over-the-

 

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counter product in China. Sales increased 1% in 2011 to $1.8 billion reflecting strong performance of Coppertone , offset by declines in Dr. Scholl’s and Claritin . Consumer Care product sales are affected by competition and consumer spending patterns. In January 2013, the FDA approved Oxytrol for Women , the first and only over-the-counter treatment for overactive bladder in women, which the Company anticipates will be available to customers in fall 2013.

Alliances

The alliances segment includes results from the Company’s relationship with AZLP. Revenue from AZLP, primarily relating to sales of Nexium and Prilosec, was $915 million in 2012, $1.2 billion in 2011 and $1.3 billion in 2010. AstraZeneca has an option to buy Merck’s interest in a subsidiary, and through it, Merck’s interest in Nexium and Prilosec, exercisable in 2014, and the Company believes that it is likely that AstraZeneca will exercise that option (see “Selected Joint Venture and Affiliate Information” below). If AstraZeneca exercises its option, the Company will no longer record equity income from AZLP and supply sales to AZLP will decline substantially.

Costs, Expenses and Other

 

($ in millions)    2012     Change     2011     Change     2010  

Materials and production

   $ 16,446        -3   $ 16,871        -8   $ 18,396   

Marketing and administrative

     12,776        -7     13,733        5     13,125   

Research and development (1)

     8,168        -4     8,467        -24     11,111   

Restructuring costs

     664        -49     1,306        33     985   

Equity income from affiliates

     (642     5     (610     4     (587

Other (income) expense, net

     1,116        18     946        -27     1,304   
     $ 38,528        -5   $ 40,713        -8   $ 44,334   

 

(1)

Includes $200 million, $587 million and $2.4 billion of IPR&D impairment charges in 2012, 2011 and 2010, respectively.

Materials and Production

Materials and production costs were $16.4 billion in 2012, $16.9 billion in 2011 and $18.4 billion in 2010. Costs include expenses for the amortization of intangible assets recorded in connection with mergers and acquisitions which totaled $4.9 billion in each of 2012 and 2011 and $4.6 billion in 2010. Additionally, expenses in 2011 and 2010 include $89 million and $2.0 billion, respectively, of amortization of purchase accounting adjustments to Schering-Plough’s inventories recognized as a result of the Merger. Costs in 2011 include an intangible asset impairment charge of $118 million. The Company may recognize additional non-cash impairment charges in the future related to product intangibles that were measured at fair value and capitalized in connection with mergers and acquisitions and such charges could be material. Also included in materials and production were costs associated with restructuring activities which amounted to $188 million, $348 million and $429 million in 2012, 2011 and 2010, respectively, including accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below.

Gross margin was 65.2% in 2012 compared with 64.9% in 2011 and 60.0% in 2010. The amortization of intangible assets and purchase accounting adjustments to inventories, as well as the restructuring and impairment charges noted above reduced gross margin by 10.7 percentage points in 2012, 11.4 percentage points in 2011 and 15.2 percentage points in 2010. Excluding these impacts, the gross margin decline in 2012 as compared with 2011 reflects the significant decline in Singulair sales as a result of the loss of U.S. market exclusivity, partially offset by improvements resulting from other changes in product mix. The Company anticipates that gross margin will continue to be negatively affected by the Singulair U.S. patent expiry which occurred in August 2012 and by the Singulair patent expiries in major European markets which occurred in February 2013. In addition, anticipated generic competition in the United States for Maxalt and Propecia will also negatively impact gross margin in 2013. The gross margin improvement in 2011 as compared with 2010 reflects changes in product mix and manufacturing efficiencies, as well as a benefit from foreign exchange.

 

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Marketing and Administrative

Marketing and administrative expenses declined 7% in 2012 to $12.8 billion due to the favorable effect of foreign exchange, a decline in promotion costs and lower selling costs resulting from restructuring activities. Marketing and administrative expenses grew 5% to $13.7 billion in 2011 due in part to the unfavorable effect of foreign exchange and strategic investments made in emerging markets. Marketing and administrative expenses in 2012 and 2011 include $190 million and $162 million, respectively, of expenses for the annual health care reform fee required as part of U.S. health care reform legislation. Expenses for 2012, 2011 and 2010 include restructuring costs of $90 million, $119 million and $144 million, respectively, related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. Expenses also include $272 million, $278 million and $379 million of acquisition-related costs in 2012, 2011 and 2010, respectively, consisting of incremental, third-party integration costs related to the Merger, including costs related to legal entity and system integration. Acquisition- related costs for 2011 also consist of severance costs associated with the acquisition of Inspire Pharmaceuticals, Inc., which are not part of the Company’s formal restructuring programs.

Research and Development

Research and development expenses were $8.2 billion in 2012, $8.5 billion in 2011 and $11.1 billion in 2010. Research and development expenses are comprised of the costs directly incurred by Merck Research Laboratories (“MRL”), the Company’s research and development division that focuses on human health-related activities, which were approximately $4.5 billion in each of 2012 and 2011 and were $4.9 billion in 2010. Also included in research and development expenses are costs incurred by other divisions in support of research and development activities, including depreciation, production and general and administrative, as well as certain costs from operating segments, including the Pharmaceutical, Animal Health and Consumer Care segments, which in the aggregate were $3.4 billion, $3.2 billion and $3.4 billion for 2012, 2011 and 2010, respectively. Research and development expenses in 2012 and 2011 were favorably affected by cost savings resulting from restructuring activities. Included in research and development expenses in 2012 were upfront payments of approximately $260 million related to agreements with Endocyte and AiCuris. (See “Research and Development” below.)

Research and development expenses also include in-process research and development (“IPR&D”) impairment charges and research and development-related restructuring charges. During 2012, the Company recorded $200 million of IPR&D impairment charges primarily for pipeline programs that had previously been deprioritized and were subsequently deemed to have no alternative use during the period. During 2011, the Company recorded IPR&D impairment charges of $587 million primarily for pipeline programs that were abandoned and determined to have no alternative use, as well as for expected delays in the launch timing or changes in the cash flow assumptions for certain compounds. In addition, the impairment charges related to pipeline programs that had previously been deprioritized and were either deemed to have no alternative use during the period or were out-licensed to a third party for consideration that was less than the related asset’s carrying value. During 2010, the Company recorded $2.4 billion of IPR&D impairment charges. Of this amount, $1.7 billion related to the write-down of the intangible asset for vorapaxar resulting from developments in the clinical program for this compound. The remaining $763 million of IPR&D impairment charges recorded in 2010 were attributable to compounds that were abandoned and determined to have either no alternative use or were returned to the respective licensor, as well as from expected delays in the launch timing or changes in the cash flow assumptions for certain compounds. The Company may recognize additional non-cash impairment charges in the future for the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with mergers and acquisitions and such charges could be material. Research and development expenses in 2012, 2011 and 2010 reflect $57 million, $138 million and $428 million, respectively, of accelerated depreciation and asset abandonment costs associated with restructuring activities. In 2012, the Company recorded an adjustment to accelerated depreciation costs included in research and development expenses revising previously recorded amounts for certain facilities.

Share-Based Compensation

Total pretax share-based compensation expense was $335 million in 2012, $369 million in 2011 and $509 million in 2010. At December 31, 2012, there was $370 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be

 

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recognized over a weighted average period of 1.8 years. For segment reporting, share-based compensation costs are unallocated expenses.

Restructuring Costs

Restructuring costs were $664 million, $1.3 billion and $985 million in 2012, 2011 and 2010, respectively. Nearly all of the costs recorded in 2012 and 2011 relate to the Merger Restructuring Program. Of the restructuring costs recorded in 2010, $915 million related to the Merger Restructuring Program, $77 million related to the global restructuring program initiated in 2008 (the “2008 Restructuring Program”) and the remaining activity related to the legacy Schering-Plough program, which included a gain on the sale of a manufacturing facility. In 2012, 2011 and 2010, separation costs of $489 million, $1.1 billion and $768 million, respectively, were incurred associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Merck eliminated approximately 4,255 positions in 2012 (of which 3,975 related to the Merger Restructuring Program, 155 related to the 2008 Restructuring Program and 125 related to the legacy Schering-Plough program), approximately 7,590 positions in 2011 (of which 6,880 related to the Merger Restructuring Program, 450 related to the 2008 Restructuring Program and 260 related to the legacy Schering-Plough program) and approximately 12,465 positions in 2010 (of which 11,410 related to the Merger Restructuring Program, 890 related to the 2008 Restructuring Program and 165 to the legacy Schering-Plough program). These position eliminations are comprised of actual headcount reductions, and the elimination of contractors and vacant positions. Also included in restructuring costs are curtailment, settlement and termination charges associated with pension and other postretirement benefit plans, share-based compensation plan costs, as well as contract termination and shutdown costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Company’s restructuring activities are included in Materials and production , Marketing and administrative and Research and development as discussed above.

Equity Income from Affiliates

Equity income from affiliates, which reflects the performance of the Company’s joint ventures and other equity method affiliates, increased 5% in 2012 to $642 million and grew 4% in 2011 to $610 million due primarily to higher partnership returns from AZLP. During 2011, the Company divested its interest in the Johnson & Johnson°Merck Consumer Pharmaceuticals Company (“JJMCP”) joint venture. (See “Selected Joint Venture and Affiliate Information” below.)

Other (Income) Expense, Net

Other (income) expense, net was $1.1 billion of expense in 2012 compared with $946 million of expense in 2011 driven primarily by a $493 million net charge in 2012 relating to the settlement of the ENHANCE Litigation (see Note 11 to the consolidated financial statements) and gains recognized in 2011 of $136 million on the disposition of the Company’s interest in the JJMCP joint venture (see Note 9 to the consolidated financial statements) and $127 million on the sale of certain manufacturing facilities and related assets (see Note 4 to the consolidated financial statements), partially offset by a $500 million charge in 2011 related to the resolution of the arbitration proceeding involving the Company’s rights to market Remicade and Simponi (see Note 5 to the consolidated financial statements) and higher interest income in 2012. Other (income) expense, net in 2010 was $1.3 billion of expense reflecting a $950 million charge to settle certain litigation related to Vioxx (the “ Vioxx Liability Reserve”), charges related to the settlement of certain pending AWP litigation, and $200 million of exchange losses due to two Venezuelan currency devaluations as discussed below, partially offset by $443 million of income recognized upon AstraZeneca’s asset option exercise (see Note 9 to the consolidated financial statements) and $102 million of income recognized on the settlement of certain disputed royalties.

In February 2013, the Venezuelan government devalued its currency (Bolívar Fuertes) from 4.30 VEF per U.S. dollar to 6.30 VEF per U.S. dollar. The Company anticipates that it will recognize losses due to exchange of approximately $150 million in the first quarter of 2013 resulting from the remeasurement of the local monetary assets and liabilities at the new rate. Since January 2010, Venezuela has been designated hyperinflationary and, as a result, local foreign operations are remeasured in U.S. dollars with the impact recorded in results of operations. As noted above, exchange losses for 2010 reflect losses relating to Venezuelan currency devaluations. Effective January 11, 2010, the Venezuelan government devalued its currency to a two-tiered official exchange rate with an “essentials rate” and a “non-essentials rate.” In December 2010, the Venezuelan government announced it would

 

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eliminate the essentials rate effective January 1, 2011. As a result of this announcement, the Company remeasured its December 31, 2010 monetary assets and liabilities at the new official rate.

Segment Profits

 

($ in millions)    2012     2011     2010  

Pharmaceutical segment profits

   $ 25,852      $ 25,617      $ 23,864   

Other non-reportable segment profits

     3,163        2,995        2,849   

Other

     (20,276     (21,278     (25,060

Income before income taxes

   $ 8,739      $ 7,334      $ 1,653   

Segment profits are comprised of segment sales less standard costs, certain operating expenses directly incurred by the segment, components of equity income or loss from affiliates and depreciation and amortization expenses. For internal management reporting presented to the chief operating decision maker, Merck does not allocate materials and production costs, other than standard costs, the majority of research and development expenses 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. Also excluded from the determination of segment profits is the charge related to the settlement of the ENHANCE Litigation recorded in 2012, the arbitration settlement charge, the gain on the divestiture of the Company’s interest in the JJMCP joint venture and a gain on the sale of certain manufacturing facilities and related assets recorded in 2011, and the charge for the Vioxx Liability Reserve and the income recognized on AstraZeneca’s asset option exercise both recognized in 2010. In addition, the amortization of purchase accounting adjustments and other acquisition-related costs, intangible asset impairment charges, restructuring costs, taxes paid at the joint venture level and a portion of equity income are also excluded from the determination of segment profits. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items are reflected in “Other” in the above table. Also included in “Other” are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales, divested products or businesses, and other supply sales.

Pharmaceutical segment profits increased 1% in 2012 driven primarily by lower operating expenses mostly offset by the effects of the loss of U.S. market exclusivity for Singulair . Pharmaceutical segment profits rose 7% in 2011 driven largely by the increase in sales and the gross margin improvement discussed above.

Taxes on Income

The effective income tax rates of 27.9% in 2012, 12.8% in 2011 and 40.6% in 2010 reflect the impacts of acquisition-related costs and restructuring costs, partially offset by the beneficial impact of foreign earnings. The effective tax rate for 2012 also reflects the favorable impacts of a tax settlement with the Canada Revenue Agency (the “CRA”), the realization of foreign tax credits and the impact of a favorable ruling on a state tax matter. In addition, the 2012 effective tax rate reflects the unfavorable impact of the net charge recorded in connection with the settlement of the ENHANCE Litigation for which no tax benefit was recorded and does not reflect any impacts for the R&D tax credit, which expired on December 31, 2011. As a result of legislation passed in 2013 that extended the R&D tax credit, both the 2012 and 2013 R&D tax credits will be recognized in 2013; however, the entire 2012 R&D tax credit will be recognized in the first quarter of 2013. The effective tax rate for 2011 reflects a net favorable impact of approximately $700 million relating to the settlement of Merck’s 2002-2005 federal income tax audit, the favorable impact of certain foreign and state tax rate changes that resulted in a net $270 million reduction of deferred tax liabilities on intangibles established in purchase accounting, and the unfavorable impact of the $500 million charge related to the resolution of the arbitration proceeding with J&J. The 2010 effective tax rate reflects the impact of the Vioxx Liability Reserve for which no tax impact was recorded, a $147 million charge associated with a change in tax law that requires taxation of the prescription drug subsidy of the Company’s retiree health benefit plans which was enacted in the first quarter of 2010 as part of U.S. health care reform legislation, and the impact of AstraZeneca’s asset option exercise. These unfavorable impacts were partially offset by a $391 million tax benefit from changes in a foreign entity’s tax rate, which resulted in a reduction in deferred tax liabilities on product intangibles recorded in conjunction with the Merger, and the favorable impact of foreign earnings and dividends from the Company’s foreign subsidiaries.

 

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Net Income and Earnings per Common Share

Net income attributable to Merck & Co., Inc. was $6.2 billion in 2012, $6.3 billion in 2011 and $861 million in 2010. EPS was $2.00 in 2012, $2.02 in 2011 and $0.28 in 2010. The decreases in net income and EPS in 2012 as compared with 2011 were due primarily to the net charge recorded in connection with the settlement of the ENHANCE Litigation, the effects of the loss of U.S. market exclusivity for Singulair in 2012 and the favorable impact of tax items in 2011, partially offset by lower marketing and administrative expenses, lower restructuring costs and lower intangible asset impairment charges in 2012 and the arbitration settlement charge recorded in 2011. The increases in net income and EPS in 2011 as compared with 2010 were primarily due to lower IPR&D impairment charges and amortization of inventory step-up, lower legal reserves and the favorable impact of tax settlements, partially offset by the arbitration settlement charge recorded in 2011 and the income recognized in 2010 on AstraZeneca’s asset option exercise.

Non-GAAP Income and Non-GAAP EPS

Non-GAAP income and non-GAAP EPS are alternative views of the Company’s performance used by management that Merck is providing because management believes this information enhances investors’ understanding of the Company’s results. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items consist of acquisition-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Therefore, the information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not in lieu of, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). Additionally, since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies.

Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP income and non-GAAP EPS and the performance of the Company is measured on this basis along with other performance metrics. Senior management’s annual compensation is derived in part using non-GAAP income and non-GAAP EPS.

 

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A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows:

 

($ in millions except per share amounts)    2012      2011     2010  

Pretax income as reported under GAAP

   $ 8,739       $ 7,334      $ 1,653   

Increase (decrease) for excluded items:

       

Acquisition-related costs

     5,344         5,939        9,403   

Restructuring costs

     999         1,911        1,986   

Other items:

       

Net charge related to settlement of ENHANCE Litigation

     493                  

Arbitration settlement charge

             500          

Gain on disposition of interest in JJMCP joint venture

             (136       

Gain on sale of manufacturing facilities and related assets

             (127       

Vioxx Liability Reserve

                    950   

Income recognized on AstraZeneca’s asset option exercise

                    (443

Other

             5          
       15,575         15,426        13,549   

Taxes on income as reported under GAAP

     2,440         942        671   

Estimated tax benefit (expense) on excluded items

     1,261         1,697        1,798   

Tax benefit from settlement of federal income tax audit

             700          

Tax benefit from foreign and state tax rate changes

             270        391   

Tax charge related to U.S. health care reform legislation

                    (147
       3,701         3,609        2,713   

Non-GAAP net income

     11,874         11,817        10,836   

Less: Net income attributable to noncontrolling interests

     131         120        121   

Non-GAAP net income attributable to Merck & Co., Inc.

   $ 11,743       $ 11,697      $ 10,715   

EPS assuming dilution as reported under GAAP

   $ 2.00       $ 2.02      $ 0.28   

EPS difference (1)

     1.82         1.75        3.14   

Non-GAAP EPS assuming dilution

   $ 3.82       $ 3.77      $ 3.42   
(1)  

Represents the difference between calculated GAAP EPS and calculated non-GAAP EPS, which may be different than the amount calculated by dividing the impact of the excluded items by the weighted-average shares for the applicable year .

Acquisition-Related Costs

Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with mergers and acquisitions. These amounts include the amortization of intangible assets and inventory step-up, as well as intangible asset impairment charges. Also excluded are incremental, third-party integration costs associated with the Merger, such as costs related to legal entity and system integration, as well as other costs associated with mergers and acquisitions, such as severance costs which are not part of the Company’s formal restructuring programs. These costs are excluded because management believes that these costs are not representative of ongoing normal business activities.

Restructuring Costs

Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions, including restructuring activities related to the Merger (see Note 3 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the site, based upon the anticipated date the site will be closed or divested, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. The Company has undertaken

 

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restructurings of different types during the covered periods and therefore these charges should not be considered non-recurring; however, management excludes these amounts from non-GAAP income and non-GAAP EPS because it believes it is helpful for understanding the performance of the continuing business.

Certain Other Items

Non-GAAP income and non-GAAP EPS exclude certain other items. These items represent substantive, unusual items that are evaluated on an individual basis. Such evaluation considers both the quantitative and the qualitative aspect of their unusual nature and generally represent items that, either as a result of their nature or magnitude, management would not anticipate that they would occur as part of the Company’s normal business on a regular basis. Certain other items are comprised of the net charge recorded in connection with the settlement of the ENHANCE Litigation, the arbitration settlement charge, the gain on the disposition of the Company’s interest in the JJMCP joint venture, the gain associated with the sale of certain manufacturing facilities and related assets, the charge to establish the Vioxx Liability Reserve and the income recognized upon AstraZeneca’s asset option exercise. Also excluded from non-GAAP income and non-GAAP EPS are the tax benefits from the settlement of a federal income tax audit, the favorable impact of certain foreign and state tax rate changes that resulted in a net reduction of deferred tax liabilities on intangibles established in purchase accounting, and the tax charge related to U.S. health care reform legislation.

Research and Development

A chart reflecting the Company’s current research pipeline as of February 22, 2013 is set forth in Item 1. “Business  — Research and Development” above.

Research and Development Update

The Company currently has four candidates under regulatory review in the United States and internationally.

MK-4305, suvorexant, an investigational insomnia medicine in a new class of medicines called orexin receptor antagonists for use in patients with difficulty falling or staying asleep, is under review by the FDA. Suvorexant will be evaluated by the Controlled Substance Staff of the FDA during NDA review. If approved by the FDA, suvorexant will become available after a schedule assessment and determination has been completed by the U.S. Drug Enforcement Administration, which routinely occurs after FDA approval. The Company has also submitted a new drug application for suvorexant to the health authorities in Japan and is continuing with plans to seek approval for suvorexant in other countries around the world.

MK-8616, sugammadex sodium injection, is an investigational agent for the reversal of neuromuscular blockade induced by rocuronium or vecuronium (neuromuscular blocking agents) under review by the FDA. Neuromuscular blockade is used in anesthesiology to induce muscle relaxation during surgery. If approved, MK-8616 would be the first in a new class of medicines in the United States known as selective relaxant binding agents to be used in the surgical setting. In 2008, the FDA did not approve the original NDA for sugammadex sodium injection, requesting additional data related to hypersensitivity (allergic) reactions and coagulation (bleeding) events. Merck submitted these requested data within the NDA resubmission, which the FDA deemed complete for review. The Company expects the FDA’s review to be completed in the first half of 2013. Sugammadex sodium injection is approved and has been launched in many countries outside of the United States where it is marketed as Bridion .

MK-8109, vintafolide, is an investigational cancer candidate under review by the EMA. As part of an exclusive license agreement with Endocyte, Merck is responsible for the development and worldwide commercialization of vintafolide in oncology. The EMA accepted the marketing authorization application filings for vintafolide and Endocyte’s investigational companion diagnostic imaging agent, etarfolatide, for the targeted treatment of patients with folate-receptor positive platinum-resistant ovarian cancer in combination with pegylated liposomal doxorubicin. Both vintafolide and etarfolatide have been granted orphan drug status by the EC. Vintafolide is in Phase III development in the United States.

MK-0653C is an investigational combination of ezetimibe and atorvastatin for the treatment of primary or mixed hyperlipidemia under review by the FDA. An updated NDA for MK-0653C was deemed complete for

 

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review by the FDA after Merck submitted additional data in response to the FDA’s Complete Response Letter issued in 2012. Merck expects the FDA’s review to be completed in the first half of 2013. Merck is continuing to move forward with planned filings for the ezetimibe and atorvastatin combination tablet in additional countries around the world.

In addition to the candidates under regulatory review, the Company has 16 drug candidates in Phase III development targeting a broad range of diseases. The Company anticipates filing an NDA or a BLA, as applicable, with the FDA with respect to several of these candidates in 2013.

V503 is a nine-valent HPV vaccine in development to help protect against certain HPV-related diseases. V503 incorporates antigens against five additional cancer-causing HPV types as compared with Gardasil . As previously disclosed, the 14,000-patient Phase III event-driven clinical study of V503 is ongoing. Merck anticipates filing a BLA for V503 with the FDA in 2013.

MK-8962, corifollitropin alpha injection, which is being marketed as Elonva in the EU, is an investigational fertility treatment for controlled ovarian stimulation in women participating in in vitro fertilization or intracytoplasmic sperm injection currently in Phase III development in the United States. Merck continues to anticipate filing an NDA for MK-8962 with the FDA in 2013.

MK-5348, vorapaxar, is a thrombin receptor antagonist being developed for the prevention of thrombosis, or clot formation, and the reduction of cardiovascular events. Vorapaxar has been evaluated in two major clinical outcomes studies in different patient groups: TRACER (Thrombin Receptor Antagonist for Clinical Event Reduction in Acute Coronary Syndrome), a clinical outcomes trial in patients with acute coronary syndrome, and TRA-2P (Thrombin Receptor Antagonist in Secondary Prevention of atherothrombotic ischemic events), a secondary prevention study in patients with a previous heart attack or ischemic stroke, or with documented peripheral vascular disease. In March 2012, results from the TRA-2P study of vorapaxar were presented at the American College of Cardiology Annual Scientific Session and published concurrently in the online edition of the New England Journal of Medicine. In the study, the addition of vorapaxar to standard of care (e.g. aspirin or thienopyridine or both) resulted in a significantly greater reduction in the risk of the composite of cardiovascular death, heart attack, stroke or urgent coronary revascularization. There was also a significant increase in bleeding, including intracranial hemorrhage, among patients taking vorapaxar in addition to standard of care, although the risk of intracranial hemorrhage was lower in patients without a history of stroke. In November 2011, researchers presented results from the TRACER outcomes study at the American Heart Association Scientific Sessions, and the results have been published. TRACER did not achieve its primary endpoint. In January 2011, Merck and the external study investigators announced that the combined DSMB for the two clinical trials had reviewed the available safety and efficacy data, and recommended that patients in the TRACER trial discontinue study drug and investigators close out the study. Following a review of the clinical trial data and discussions with external experts, Merck plans to file applications for vorapaxar in the United States and EU in 2013 seeking an indication for the prevention of cardiovascular events in patients with a history of heart attack and no history of transient ischemic attack or stroke.

MK-7243 is an investigational allergy immunotherapy sublingual tablet (“AIT”) in Phase III development for grass pollen allergy for which the Company has North American rights. AIT is a dissolvable oral tablet that is designed to prevent allergy symptoms by inducing a protective immune response against allergies, thereby treating the underlying cause of the disease. Merck is investigating AIT for the treatment of grass pollen allergic rhinoconjunctivitis in both children and adults. The Company has submitted a BLA for MK-7243 with the FDA.

MK-3641, an AIT for ragweed allergy, is also in Phase III development for the North American market. The Company anticipates filing a BLA for MK-3641 with the FDA in 2013.

MK-8175A, NOMAC/E2, which is being marketed as Zoely in the EU, is an investigational oral contraceptive for use by women to prevent pregnancy. NOMAC/E2 is a combined oral contraceptive tablet containing a unique monophasic combination of two hormones: nomegestrol acetate, a highly selective progesterone-derived progestin, and 17-beta estradiol, an estrogen that is similar to the one naturally present in a women’s body. In November 2011, Merck received a Complete Response Letter from the FDA for NOMAC/E2. The Company is conducting an additional clinical study requested by the FDA and plans to update the application in the future.

 

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MK-0822, odanacatib, is an oral, once-weekly investigational treatment for osteoporosis in post-menopausal women. Osteoporosis is a disease that reduces bone density and strength and results in an increased risk of bone fractures. Odanacatib is a cathepsin K inhibitor that selectively inhibits the cathepsin K enzyme. Cathepsin K is known to play a central role in the function of osteoclasts, which are cells that break down existing bone tissue, particularly the protein components of bone. Inhibition of cathepsin K is a novel approach to the treatment of osteoporosis. In July 2012, Merck announced an update on the Phase III trial assessing fracture risk reduction with odanacatib. The independent Data Monitoring Committee (the “DMC”) for the study completed its first planned interim analysis for efficacy and recommended that the study be closed early due to robust efficacy and a favorable benefit-risk profile. The DMC noted that safety issues remain in certain selected areas and made recommendations with respect to following up on them. On February 1, 2013, Merck announced that it had recently received and was reviewing safety and efficacy data from the Phase III trial. As a result of its review of this data, the Company concluded that review of additional data from the previously planned, ongoing extension study was warranted and that filing an application for approval with the FDA should be delayed. As previously announced, the Company is conducting a blinded extension of the trial in approximately 8,200 women, which will provide additional safety and efficacy data. Merck now anticipates that it will file applications for approval of odanacatib in 2014 with additional data from the extension trial. The Company continues to believe that odanacatib will have the potential to address unmet medical needs in patients with osteoporosis.

MK-3814, preladenant, is a selective adenosine 2a receptor antagonist in Phase III development for treatment of Parkinson’s disease. The Company anticipates filing an NDA for MK-3814 with the FDA in 2014.

V212 is an inactivated VZV vaccine in development for the prevention of herpes zoster. The Company is enrolling two Phase III trials, one in autologous hematopoietic cell transplant patients and the other in patients with solid tumor malignancies undergoing chemotherapy and hematological malignancies. The Company anticipates filing a BLA first with the autologous hematopoietic cell transplant data in 2014 and filing for the second indication in cancer patients at a later date.

V419 is an investigational hexavalent pediatric combination vaccine, which contains components of current vaccines, designed to help protect against six potentially serious diseases: diphtheria, tetanus, whooping cough ( Bordetella pertussis ), polio (poliovirus types 1, 2, and 3), invasive disease caused by Haemophilus influenzae type b, and hepatitis B that is being developed in collaboration with Sanofi-Pasteur. The Company anticipates filing a BLA for V419 with the FDA in 2014.

MK-7009, vaniprevir, is an investigational, oral twice-daily protease inhibitor for the treatment of chronic hepatitis C virus for development in Japan only. The Company anticipates filing a new drug application for MK-7009 in Japan in 2014.

MK-3102 is an investigational once-weekly DPP-4 inhibitor in development for the treatment of type 2 diabetes. The Company anticipates filing an NDA for MK-3102 with the FDA beyond 2014.

MK-3222 is an anti-interleukin-23 monoclonal antibody candidate being investigated for the treatment of psoriasis. The Company anticipates filing a BLA for MK-3222 with the FDA beyond 2014.

MK-3415A, actoxumab/bezlotoxumab, an investigational candidate for the treatment of Clostridium difficile infection, is a combination of two monoclonal antibodies used to treat patients with a single infusion. The Company now anticipates filing a BLA for MK-3415A with the FDA in 2015.

MK-0859, anacetrapib, is an investigational inhibitor of the cholesteryl ester transfer protein (“CETP”) that is being investigated in lipid management to raise HDL-C and reduce LDL-C. Based on the results from the Phase III DEFINE (Determining the EFficacy and Tolerability of CETP INhibition with AnacEtrapib) safety study of 1,623 patients with coronary heart disease or coronary heart disease risk equivalents, the Company initiated a large, event-driven cardiovascular clinical outcomes trial REVEAL (Randomized EValuation of the Effects of Anacetrapib Through Lipid-modification) involving patients with preexisting vascular disease that is predicted to be completed in 2017. The Company continues to anticipate filing an NDA for anacetrapib with the FDA beyond 2015.

MK-8931 is Merck’s novel investigational oral ß-amyloid precursor protein site-cleaving enzyme (BACE) inhibitor for the treatment of Alzheimer’s disease. In December 2012, Merck announced the initiation of a Phase II/III clinical trial (EPOCH) designed to evaluate the safety and efficacy of MK-8931 versus placebo in patients with mild-to-moderate Alzheimer’s disease.

 

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MK-8669, ridaforolimus, is an investigational oral mTOR (mammalian target of rapamycin) inhibitor under development for cancer indications. In June 2012, Merck announced that the FDA issued a Complete Response Letter regarding the NDA for ridaforolimus as a treatment for metastatic soft tissue or bone sarcoma. The Complete Response Letter states that the FDA cannot approve the application in its present form, and that additional clinical trial(s) would need to be conducted to further assess safety and efficacy. In November 2012, Merck formally notified the EMA of its decision to withdraw the marketing authorization application for ridaforolimus that was accepted by the EMA in 2011. The Company no longer plans to pursue the sarcoma indication in the United States or the EU, but will continue to support patients enrolled in ongoing clinical trials. Merck remains committed to pursuing ridaforolimus in other cancer indications. As part of an exclusive license agreement with ARIAD Pharmaceuticals, Inc. (“ARIAD”), Merck is responsible for the development and worldwide commercialization of ridaforolimus in oncology.

In December 2012, Merck announced the HPS2-THRIVE study of MK-0524A, Tredaptive , did not meet its primary endpoint. In the study, adding the combination of extended-release niacin and laropiprant to statin therapy did not significantly further reduce the risk of the combination of coronary deaths, non-fatal heart attacks, strokes or revascularizations compared to statin therapy. In addition, there was a statistically significant increase in the incidence of some types of non-fatal serious adverse events in the group that received extended-release niacin/laropiprant compared to statin therapy. Merck does not plan to seek regulatory approval for the medicine in the United States. In January 2013, based on the understanding of the preliminary data from the HPS2-THRIVE study and in consultation with regulatory authorities, Merck began taking steps to suspend the availability of Tredaptive , which is approved for use in certain countries outside of the United States. The clinical development program for MK-0524B, a combination product of extended-release niacin with laropiprant and simvastatin, had previously been discontinued.

In 2012, Merck announced that it will return the global marketing and development rights for both the intravenous and oral formulations for vernakalant, a treatment for atrial fibrillation, to Cardiome Pharma Corp. for business reasons. Merck also decided in 2012 to discontinue the clinical development program for MK-0431E, a combination product of sitagliptin and atorvastatin for the treatment of type 2 diabetes, for business reasons.

The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Company’s research and development model is designed to increase productivity and improve the probability of success by prioritizing the Company’s research and development resources on disease areas of unmet medical needs, scientific opportunity and commercial opportunity. Merck is managing its research and development portfolio across diverse approaches to discovery and development by balancing investments appropriately on novel, innovative targets with the potential to have a major impact on human health, on developing best-in-class approaches, and on delivering maximum value of its approved medicines and vaccines through new indications and new formulations. Another important component of the Company’s science-based diversification is based on expanding the Company’s portfolio of modalities to include not only small molecules and vaccines, but also biologics (peptides, small proteins, antibodies) and RNAi. Further, Merck has moved to diversify its portfolio through biosimilars, which have the potential to harness the market opportunity presented by biological medicine patent expiries by delivering high quality follow-on biologic products to enhance access for patients worldwide. The Company supplements its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as new technologies.

The Company’s clinical pipeline includes candidates in multiple disease areas, including atherosclerosis, cancer, cardiovascular diseases, diabetes, infectious diseases, inflammatory/autoimmune diseases, insomnia, neurodegenerative diseases, osteoporosis, respiratory diseases and women’s health.

In-Process Research and Development

In connection with mergers and acquisitions, the Company has recorded the fair value of incomplete research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2012, the balance of IPR&D was $2.4 billion.

Some of the more significant projects in late-stage development include sugammadex sodium injection and an ezetimibe/atorvastatin combination product, both of which are currently under review by the FDA as noted above, as well as vorapaxar, which remains in Phase III clinical development.

 

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During 2012, 2011 and 2010, approximately $78 million, $666 million and $378 million, respectively, of IPR&D projects received marketing approval in a major market and the Company began amortizing these assets based on their estimated useful lives.

All of 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 time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Company’s failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPR&D programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPR&D as of the acquisition date, and the Company may also not recover the research and development expenditures made since the acquisition to further develop such program. If such circumstances were to occur, the Company’s future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material.

During 2012, the Company recorded $200 million of IPR&D impairment charges within Research and development expenses primarily for pipeline programs that had previously been deprioritized and were subsequently deemed to have no alternative use during the period. During 2011, the Company recorded $587 million of IPR&D impairment charges primarily for pipeline programs that were abandoned and determined to have no alternative use, as well as for expected delays in the launch timing or changes in the cash flow assumptions for certain compounds. In addition, the impairment charges related to pipeline programs that had previously been deprioritized and were either deemed to have no alternative use during the period or were out-licensed to a third party for consideration that was less than the related asset’s carrying value.

During 2010, the Company recorded $2.4 billion of IPR&D impairment charges. The Company determined that the developments in the clinical research program for vorapaxar constituted a triggering event that required the Company to evaluate the vorapaxar intangible asset for impairment. Utilizing market participant assumptions, and considering several different scenarios, the Company concluded that its best estimate of the current fair value of the intangible asset related to vorapaxar was $350 million, which resulted in the recognition of an impairment charge of $1.7 billion during 2010. The remaining $763 million of IPR&D impairment charges recorded in 2010 were attributable to compounds that were abandoned and determined to have either no alternative use or were returned to the respective licensor, as well as from expected delays in the launch timing or changes in the cash flow assumptions for certain compounds.

Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. As of December 31, 2012, the estimated costs to complete projects acquired in connection with mergers and acquisitions in Phase III development for human health and the analogous stage of development for animal health were approximately $1.2 billion.

Acquisitions, Research Collaborations and License Agreements

Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. During 2012, the Company completed transactions across a broad range of therapeutic categories, including early-stage technology transactions. Merck is actively monitoring the landscape for growth opportunities that meet the Company’s strategic criteria.

In October 2012, Merck and AiCuris entered into an exclusive licensing agreement which provides Merck with worldwide rights to develop and commercialize candidates in AiCuris’ novel portfolio of investigational medicines targeting human cytomegalovirus (“HCMV”), including letermovir (MK-8228), an oral, late-stage antiviral candidate being investigated for the treatment and prevention of HCMV infection in transplant recipients. AiCuris received an upfront payment of €110 million (approximately $140 million), which the Company recorded as research and development expense, and is eligible for milestone payments of up to €332.5 million based on successful achievement of development, regulatory and commercialization goals for HCMV candidates, including letermovir, an additional back-up candidate as well as other Phase I candidates designed to act via an

 

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alternate mechanism. In addition, AiCuris will be entitled to receive royalty payments reflecting the advanced stage of the clinical program on any potential products that result from the agreement. Merck will be responsible for all development activities and costs. The agreement may be terminated by either party in the event of a material uncured breach or insolvency. The agreement may be terminated by Merck at any time in the event that any of the compounds licensed from AiCuris develop an adverse safety profile or any material adverse issue arises related to the development, efficacy or dosing regimen of any of the compounds, and/or in the event that certain patents are invalid and/or unenforceable in certain jurisdictions. Merck (i) may terminate the agreement with respect to certain compounds after successful completion of the first proof of concept clinical trial or (ii) must terminate the agreement with respect to certain compounds if Merck fails to minimally invest in such compounds. In addition, Merck may terminate the agreement as a whole at any time upon six months prior written notice at any time after completion of the first Phase III clinical trial for a compound. AiCuris may terminate the agreement in the event that Merck challenges any AiCuris patent covering the compounds licensed from AiCuris. Upon termination of the agreement, depending upon the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of compounds and, in the case of termination for cause by Merck, certain royalty obligations.

In April 2012, the Company entered into an agreement with Endocyte to develop and commercialize Endocyte’s novel investigational therapeutic candidate vintafolide (MK-8109). Vintafolide is currently being evaluated in a Phase III clinical trial for folate-receptor positive platinum-resistant ovarian cancer (PROCEED) and a Phase II trial for non-small cell lung cancer. Under the agreement, Merck gained worldwide rights to develop and commercialize vintafolide. Endocyte received a $120 million upfront payment, which the Company recorded as research and development expense, and is eligible for milestone payments of up to $880 million based on the successful achievement of development, regulatory and commercialization goals for vintafolide for a total of six cancer indications. In addition, if vintafolide receives regulatory approval, Merck and Endocyte will share equally profit and losses in the United States. Endocyte will receive a royalty on sales of the product in the rest of the world. Endocyte has retained the right to co-promote vintafolide with Merck in the United States and Merck has the exclusive right to promote vintafolide in the rest of world. Endocyte will be responsible for the majority of funding and completion of the PROCEED trial. Merck will be responsible for all other development activities and development costs and have all decision rights for vintafolide. Merck has the right to terminate the agreement on 90 days notice. Merck and Endocyte both have the right to terminate the agreement due to the material breach or insolvency of the other party. Endocyte has the right to terminate the agreement in the event that Merck challenges an Endocyte patent right relating to vintafolide. Upon termination of the agreement, depending upon the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of vintafolide and, in the case of termination for cause by Merck, certain royalty obligations and U.S. profit and loss sharing. Endocyte is responsible for the development, manufacture and commercialization worldwide of etarfolatide, a non-invasive companion diagnostic imaging agent that is used to identify folate receptor positive tumor cells. As discussed above, in 2012, the EMA accepted the marketing authorization application filings for vintafolide and etarfolatide for platinum resistant ovarian cancer.

Selected Joint Venture and Affiliate Information

To expand its research base and realize synergies from combining capabilities, opportunities and assets, in previous years Merck has formed a number of joint ventures.

AstraZeneca LP

In 1982, Merck entered into an agreement with Astra AB (“Astra”) to develop and market Astra products under a royalty-bearing license. In 1993, Merck’s total sales of Astra products reached a level that triggered the first step in the establishment of a joint venture business carried on by Astra Merck Inc. (“AMI”), in which Merck and Astra each owned a 50% share. This joint venture, formed in 1994, developed and marketed most of Astra’s new prescription medicines in the United States including Prilosec, the first of a class of medications known as proton pump inhibitors, which slows the production of acid from the cells of the stomach lining.

In 1998, Merck and Astra completed the restructuring of the ownership and operations of the joint venture whereby Merck acquired Astra’s interest in AMI, renamed KBI Inc. (“KBI”), and contributed KBI’s operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the “Partnership”), in exchange for a

 

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1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AstraZeneca LP (“AZLP”) upon Astra’s 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights.

While maintaining a 1% limited partner interest in AZLP, Merck has consent and protective rights intended to preserve its business and economic interests, including restrictions on the power of the general partner to make certain distributions or dispositions. Furthermore, in limited events of default, additional rights will be granted to the Company, including powers to direct the actions of, or remove and replace, the Partnership’s chief executive officer and chief financial officer. Merck earns ongoing revenue based on sales of KBI products and such revenue was $915 million, $1.2 billion and $1.3 billion in 2012, 2011 and 2010, respectively, primarily relating to sales of Nexium, as well as Prilosec. In addition, Merck earns certain Partnership returns which are recorded in Equity income from affiliates. Such returns include a priority return provided for in the Partnership Agreement, a preferential return representing Merck’s share of undistributed AZLP GAAP earnings, and a variable return related to the Company’s 1% limited partner interest. These returns aggregated $621 million, $574 million and $546 million in 2012, 2011 and 2010, respectively.

In conjunction with the 1998 restructuring discussed above, Astra purchased an option (the “Asset Option”) for a payment of $443 million, which was recorded as deferred income, to buy Merck’s interest in the KBI products, excluding the gastrointestinal medicines Nexium and Prilosec (the “Non-PPI Products”). In April 2010, AstraZeneca exercised the Asset Option. Merck received $647 million from AstraZeneca representing the net present value as of March 31, 2008 of projected future pretax revenue to be received by Merck from the Non-PPI Products, which was recorded as a reduction to the Company’s investment in AZLP. The Company recognized the $443 million of deferred income in 2010 as a component of Other (income) expense, net . In addition, in 1998, Merck granted Astra an option to buy Merck’s common stock interest in KBI and, through it, Merck’s interest in Nexium and Prilosec as well as AZLP, exercisable in 2012. In June 2012, Merck and AstraZeneca amended the 1998 option agreement. The updated agreement eliminated AstraZeneca’s option to acquire Merck’s interest in KBI in 2012 and provides AstraZeneca a new option to acquire Merck’s interest in KBI in June 2014. As a result of the amended agreement, Merck continues to record supply sales and equity income from the partnership. In 2014, AstraZeneca has the option to purchase Merck’s interest in KBI based in part on the value of Merck’s interest in Nexium and Prilosec. AstraZeneca’s option is exercisable between March 1, 2014 and April 30, 2014. If AstraZeneca chooses to exercise this option, the closing date is expected to be June 30, 2014. Under the amended agreement, AstraZeneca will make a payment to Merck upon closing of $327 million, reflecting an estimate of the fair value of Merck’s interest in Nexium and Prilosec. This portion of the exercise price is subject to a true-up in 2018 based on actual sales from closing in 2014 to June 2018. The exercise price will also include an additional amount equal to a multiple of ten times Merck’s average 1% annual profit allocation in the partnership for the three years prior to exercise. The Company believes that it is likely that AstraZeneca will exercise its option in 2014. If AstraZeneca exercises its option, the Company will no longer record equity income from AZLP and supply sales to AZLP will decline substantially.

Sanofi Pasteur MSD

In 1994, Merck and Pasteur Mérieux Connaught (now Sanofi Pasteur S.A.) established an equally-owned joint venture to market vaccines in Europe and to collaborate in the development of combination vaccines for distribution in Europe.

Sales of joint venture products were as follows:

 

($ in millions)    2012      2011      2010  

Gardasil

   $ 264       $ 253       $ 350   

Influenza vaccines

     161         183         220   

Other viral vaccines

     107         105         93   

RotaTeq

     47         44         42   

Hepatitis vaccines

     31         39         25   

Other vaccines

     474         486         487   
     $ 1,084       $ 1,110       $ 1,217   

 

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Johnson & Johnson°Merck Consumer Pharmaceuticals Company

In September 2011, Merck sold its 50% interest in the JJMCP joint venture to J&J. The venture between Merck and J&J was formed in 1989 to develop, manufacture, market and distribute certain over-the-counter consumer products in the United States and Canada. Merck received a one-time payment of $175 million and recognized a pretax gain of $136 million in 2011 reflected in Other (income) expense, net . The partnership assets also included a manufacturing facility. Sales of products marketed by the joint venture were $62 million for the period from January 1, 2011 until the September 29, 2011 divestiture date and $129 million for 2010.

Capital Expenditures

Capital expenditures were $2.0 billion in 2012, $1.7 billion in 2011 and $1.7 billion in 2010. Expenditures in the United States were $1.3 billion in 2012, $1.2 billion in 2011 and $990 million in 2010.

Depreciation expense was $2.0 billion in 2012, $2.4 billion in 2011 and $2.6 billion in 2010 of which $1.3 billion, $1.4 billion and $1.7 billion, respectively, applied to locations in the United States. Total depreciation expense in 2012, 2011 and 2010 included accelerated depreciation of $235 million, $589 million and $849 million, respectively, associated with restructuring activities (see Note 3 to the consolidated financial statements).

Analysis of Liquidity and Capital Resources

Merck’s strong financial profile enables it to fully fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders.

Selected Data

 

($ in millions)    2012     2011     2010  

Working capital

   $ 16,509      $ 16,936      $ 13,423   

Total debt to total liabilities and equity

     19.4     16.7     16.9

Cash provided by operations to total debt

     0.5:1        0.7:1        0.6:1   

Cash provided by operating activities was $10.0 billion in 2012, $12.4 billion in 2011 and $10.8 billion in 2010. Cash provided by operating activities in 2012 reflects higher contributions of $1.3 billion to its defined benefit plans as compared with 2011. Cash provided by operating activities in 2012 also reflects the payment of $960 million (including interest) related to the resolution of certain litigation related to Vioxx . The increase in cash provided by operating activities in 2011 as compared with 2010 reflects increased results of operations, partially offset by a $500 million payment made to J&J as a result of the arbitration settlement, as well as net payments of approximately $465 million to the Internal Revenue Service (the “IRS”) as a result of the conclusion of its examination of certain of Merck’s federal income tax returns as discussed below. Cash provided by operating activities continues to be the Company’s primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. The global economic downturn and the sovereign debt issues, among other factors, have adversely affected foreign receivables in certain European countries (see Note 6 to the consolidated financial statements). The Company continues to receive payment on these receivables, including significant collections during 2012 in connection with the Spanish government’s debt stabilization/stimulus plan. Additionally, the Company continues to expand in the emerging markets where payment terms tend to be longer. The conditions in the EU and the emerging markets have resulted in an increase in the average length of time it takes to collect accounts receivable outstanding thereby adversely affecting cash provided by operating activities.

 

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Cash used in investing activities was $6.8 billion in 2012 compared with $2.9 billion in 2011 primarily reflecting higher purchases of securities and other investments, partially offset by higher proceeds from the sales of securities and other investments. Cash used in investing activities was $2.9 billion in 2011 compared with $3.5 billion in 2010 primarily reflecting higher proceeds from the sales of securities and other investments and proceeds from the disposition of certain businesses, partially offset by higher purchases of securities and other investments. In addition, in 2010, proceeds from AstraZeneca’s asset option exercise and a decrease in restricted assets contributed to cash flows from investing activities.

Cash used in financing activities in 2012 was $3.3 billion compared with $6.9 billion in 2011. The lower use of cash in financing activities was primarily driven by proceeds from the issuance of debt, lower payments on debt and higher proceeds from the exercise of stock options, partially offset by increased purchases of treasury stock, a decrease in short-term borrowings and higher dividends paid to stockholders. Cash used in financing activities was $6.9 billion in 2011 compared with $5.4 billion in 2010. The higher use of cash in financing activities was primarily driven by lower proceeds from the issuance of debt, higher purchases of treasury stock and higher payments on debt, partially offset by an increase in short-term borrowings.

In an effort to implement Merck’s strategy to expand product offerings and capabilities in the emerging markets, the Company has and, anticipates in the future, will allocate capital and resources across those regions.

At December 31, 2012, the total of worldwide cash and investments was $23.4 billion, including $16.1 billion of cash, cash equivalents and short-term investments, and $7.3 billion of long-term investments. Generally 80%-90% of these cash and investments are held by foreign subsidiaries and would be subject to significant tax payments if such cash and investments were repatriated in the form of dividends. The Company records U.S. deferred tax liabilities for certain unremitted earnings, but when amounts earned overseas are expected to be indefinitely reinvested outside of the United States, no accrual for U.S. taxes is provided. The amount of cash and investments held by U.S. and foreign subsidiaries fluctuates due to a variety of factors including the timing and receipt of payments in the normal course of business. Cash provided by operating activities in the United States continues to be the Company’s primary source of funds to finance domestic operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders.

As previously disclosed, the Canada Revenue Agency (the “CRA”) had proposed adjustments for 1999 and 2000 relating to intercompany pricing matters and, in July 2011, the CRA issued assessments for other miscellaneous audit issues for tax years 2001-2004. In 2012, Merck and the CRA reached a settlement for these years that calls for Merck to pay additional Canadian tax of approximately $65 million. The Company’s unrecognized tax benefits related to these matters exceeded the settlement amount and therefore the Company recorded a net $112 million tax provision benefit in 2012. A portion of the taxes paid is expected to be creditable for U.S. tax purposes. The Company had previously established reserves for these matters. The resolution of these matters did not have a material effect on the Company’s results of operations, financial position or liquidity.

In April 2011, the IRS concluded its examination of Merck’s 2002-2005 federal income tax returns and as a result the Company was required to make net payments of approximately $465 million. The Company’s unrecognized tax benefits for the years under examination exceeded the adjustments related to this examination period and therefore the Company recorded a net $700 million tax provision benefit in 2011. This net benefit reflects the decrease of unrecognized tax benefits for the years under examination partially offset by increases to unrecognized tax benefits for years subsequent to the examination period as a result of this settlement. The Company disagrees with the IRS treatment of one issue raised during this examination and is appealing the matter through the IRS administrative process.

 

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The Company’s contractual obligations as of December 31, 2012 are as follows:

Payments Due by Period

 

($ in millions)    Total      2013      2014—2015      2016—2017      Thereafter  

Purchase obligations (1)

   $ 1,241       $ 551       $ 505       $ 176       $ 9   

Loans payable and current portion of long-term debt

     4,288         4,288                           

Long-term debt

     15,803                 4,129         1,936         9,738   

Interest related to debt obligations

     8,758         800         1,277         1,022         5,659   

ENHANCE Litigation settlement (2)

     688         688                           

Unrecognized tax benefits (3)

     739         739                           

Operating leases

     835         203         318         169         145   
     $ 32,352       $ 7,269       $ 6,229       $ 3,303       $ 15,551   
(1)

During 2011, Merck entered into a transaction which will require the Company to make future bulk supply purchases of $150 million over a maximum four-year period commencing upon the occurrence of certain predetermined events. This amount is not reflected in the table because the predetermined events have not yet occurred and therefore the timing of the resulting payments in any given year cannot yet be determined.

 

(2)

As discussed in Note 11 to the consolidated financial statements, the Company settled the ENHANCE Litigation. Assuming the settlement is approved by the court, the Company anticipates it will pay $688 million in 2013 in connection with the settlement; however, the Company expects that $195 million of this amount will be recovered through insurance.

 

(3)

As of December 31, 2012, the Company’s Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, interest and penalties of $5.6 billion, including $739 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2013 cannot be made.

Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts reflected for research and development obligations do not include contingent milestone payments. Also excluded from research and development obligations are potential future funding commitments of up to approximately $130 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $328 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2013 relating to the Company’s pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $340 million and $40 million, respectively, to its pension plans and other postretirement benefit plans during 2013.

In May 2012, the Company terminated its existing credit facilities and entered into a new $4.0 billion, five-year credit facility maturing in May 2017. 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.

In September 2012, the Company closed an underwritten public offering of $2.5 billion senior unsecured notes consisting of $1.0 billion aggregate principal amount of 1.1% notes due 2018, $1.0 billion aggregate principal amount of 2.4% notes due 2022 and $500 million aggregate principal amount of 3.6% notes due 2042. Interest on the notes is payable semi-annually. The notes of each series are redeemable in whole or in part at any time at the Company’s option at varying redemption prices. Proceeds from the notes were used for general corporate purposes, including contributions to the Company’s pension plans and the repayment of outstanding commercial paper and certain debt maturities.

In December 2012, the Company filed a securities registration statement with the Securities and Exchange Commission (“SEC”) under the automatic shelf registration process available to “well-known seasoned issuers” which is effective for three years.

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.

 

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The Company’s long-term credit ratings assigned by Moody’s Investors Service and Standard & Poor’s are Aa3 with a stable outlook and AA with a stable outlook, respectively. These ratings continue to allow access to the capital markets and flexibility in obtaining funds on competitive terms. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. Despite this strong financial profile, certain contingent events, if realized, which are discussed in Note 11 to the consolidated financial statements, could have a material adverse impact on the Company’s liquidity and capital resources. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations.

In November 2012, the Board of Directors declared a quarterly dividend of $0.43 per share on the Company’s common stock payable in January 2013.

In April 2011, Merck’s Board of Directors approved additional purchases of up to $5.0 billion of Merck’s common stock for its treasury. The Company purchased $2.6 billion of its common stock (62 million shares) for its treasury during 2012. The Company has approximately $1.9 billion remaining under this program. The treasury stock purchases have no time limit and will be made over time on the open market, in block transactions or in privately negotiated transactions. The Company purchased $1.9 billion and $1.6 billion of its common stock during 2011 and 2010, respectively.

Financial Instruments Market Risk Disclosures

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

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

Foreign Currency Risk Management

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

The objective of the revenue hedging program is to reduce the potential for longer-term unfavorable changes in foreign exchange rates to decrease the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales that are expected to occur over its planning cycle, typically no more than three years into the future. The Company will layer in hedges over time, increasing the portion of third-party and intercompany distributor entity sales hedged as it gets closer to the expected date of the forecasted foreign currency denominated sales. The portion of sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The hedged anticipated sales are a specified component of a portfolio of similarly denominated foreign currency-based sales transactions, each of which responds to the hedged currency risk in the same manner. The Company manages its anticipated transaction exposure principally with purchased local currency put options, which provide the Company with a right, but not an obligation, to sell foreign currencies in the future at a predetermined price. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, total changes in the options’ cash flows offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the options’ value reduces to zero, but the Company benefits from the increase in the U.S. dollar equivalent value of the anticipated foreign currency cash flows.

In connection with the Company’s revenue hedging program, a purchased collar option strategy may be utilized. With a purchased collar option strategy, the Company writes a local currency call option and purchases a local currency put option. As compared to a purchased put option strategy alone, a purchased collar strategy reduces

 

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the upfront costs associated with purchasing puts through the collection of premium by writing call options. If the U.S. dollar weakens relative to the currency of the hedged anticipated sales, the purchased put option value of the collar strategy reduces to zero and the Company benefits from the increase in the U.S. dollar equivalent value of its anticipated foreign currency cash flows, however this benefit would be capped at the strike level of the written call. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the written call option value of the collar strategy reduces to zero and the changes in the purchased put cash flows of the collar strategy would offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales.

The Company may also utilize forward contracts in its revenue hedging program. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the increase in the fair value of the forward contracts offsets the decrease in the expected future U.S. dollar cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the decrease in the fair value of the forward contracts offsets the increase in the value of the anticipated foreign currency cash flows. While a weaker U.S. dollar would result in a net benefit, the market value of Merck’s hedges would have declined by an estimated $453 million and $330 million, respectively, from a uniform 10% weakening of the U.S. dollar at December 31, 2012 and 2011. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Because Merck principally uses purchased local currency put options, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these options. The sensitivity measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Merck’s major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.

The primary objective of the balance sheet risk management program is to mitigate the exposure of foreign currency denominated net monetary assets of foreign subsidiaries where the U.S. dollar is the functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts, which enable the Company to buy and sell foreign currencies in the future at fixed exchange rates and economically offset the consequences of changes in foreign exchange from the monetary assets. Merck routinely enters into contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The Company will also minimize the effect of exchange on monetary assets and liabilities by managing operating activities and net asset positions at the local level.

A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2012, Income before taxes would have declined by approximately $20 million in 2012. Because the Company was in a net short position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. At December 31, 2011, the Company was in a net long position relative to its major foreign currencies after consideration of forward contracts, therefore a uniform 10% strengthening of the U.S. dollar would have reduced Income before taxes by approximately $165 million. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Merck’s major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.

In February 2013, the Venezuelan government devalued its currency (Bolívar Fuertes) from 4.30 VEF per U.S. dollar to 6.30 VEF per U.S. dollar. The Company anticipates that it will recognize losses due to exchange of approximately $150 million in the first quarter of 2013 resulting from the remeasurement of the local monetary assets and liabilities at the new rate. Since January 2010, Venezuela has been designated hyperinflationary and, as a

 

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result, local foreign operations are remeasured in U.S. dollars with the impact recorded in results of operations. In addition, effective January 11, 2010, the Venezuelan government devalued its currency to a two-tiered official exchange rate with an “essentials rate” and a “non-essentials rate.” In December 2010, the Venezuelan government announced it would eliminate the essentials rate effective January 1, 2011. As a result of this announcement, the Company remeasured its December 31, 2010 monetary assets and liabilities at the new official rate.

The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates. The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within Other Comprehensive Income (“ OCI ”), and remains in Accumulated Other Comprehensive Income (“ AOCI”) until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows.

Foreign exchange risk is also managed through the use of foreign currency debt. The Company’s senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI .

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.

During 2011, the Company terminated 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. These swaps effectively converted certain of its fixed-rate notes to floating-rate instruments. The interest rate swap contracts were designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (“LIBOR”) swap rate. As a result of the swap terminations, the Company received $288 million in cash, which included $43 million in accrued interest. The corresponding $245 million basis adjustment of the debt associated with the terminated interest rate swap contracts was deferred and is being amortized as a reduction of interest expense over the respective term of the notes. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.

The Company’s investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Company’s medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Company’s fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Merck’s investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2012 and 2011 would have positively affected the net aggregate market value of these instruments by $1.2 billion each year. A one percentage point decrease at December 31, 2012 and 2011 would have negatively affected the net aggregate market value by $1.4 billion each year. The fair value of Merck’s debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Merck’s investments were determined using a combination of pricing and duration models.

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in conformity with 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 mergers and acquisitions, including initial fair value determinations of assets and liabilities, primarily IPR&D and other intangible assets, as well as subsequent fair

 

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value measurement. 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 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. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements.

Mergers and 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 merger or acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are recognized at fair value if fair value can reasonably be estimated. If the acquisition date fair value of an asset acquired or liability assumed that arises from a contingency 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 merger or 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. The fair values of intangible assets, including acquired IPR&D, are determined utilizing information available near the merger or acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPR&D are capitalized and 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 separate determination as to the then useful life of the asset and begin amortization. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Company’s results of operations.

The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an “income approach” through which fair value is estimated based on each asset’s discounted projected net cash flows. The Company’s estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Company’s competitors; and the life of each asset’s underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate.

The fair values of identifiable intangible assets related to IPR&D are determined using an income approach, through which fair value is estimated based on each asset’s probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate.

 

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Revenue Recognition

Revenues from sales of products are recognized at the time of delivery when title and risk of loss passes to the customer. Recognition of revenue also requires reasonable assurance of collection of sales proceeds and completion of all performance obligations. Domestically, sales discounts are issued to customers as direct discounts at the point-of-sale or indirectly through an intermediary wholesaler, known as chargebacks, or indirectly 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 for customers for which collection of accounts receivable is expected to be in excess of one year.

The provision for aggregate indirect customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases directly through an intermediary wholesaler. The contracted customer generally purchases product at its contracted price plus a mark-up from the wholesaler. 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 is based on expected payments, which are driven by patient usage and contract performance by the benefit provider customers.

The Company uses historical customer segment mix, adjusted for other known events, in order to estimate the expected provision. Amounts accrued for aggregate indirect customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers and other customers to the amounts accrued. Adjustments are recorded when trends or significant events indicate that a change in the estimated provision is appropriate.

The Company continually monitors its provision for aggregate indirect customer discounts. There were no material adjustments to estimates associated with the aggregate indirect customer discount provision in 2012, 2011 or 2010.

Summarized information about changes in the aggregate indirect customer discount accrual is as follows:

 

($ in millions)    2012     2011  

Balance January 1

   $ 1,824      $ 1,307   

Current provision

     5,694        5,392   

Adjustments to prior years

     89        81   

Payments

     (5,734     (4,956

Balance December 31

   $ 1,873      $ 1,824   

Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $120 million and $1.8 billion, respectively, at December 31, 2012 and were $87 million and $1.7 billion, respectively, at December 31, 2011.

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 additional generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales was approximately 1.0% of U.S. net pharmaceutical sales in 2012, 2011 and 2010.

Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs

 

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allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns.

Wholesalers generally provide only the above mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns.

Inventories Produced in Preparation for Product Launches

The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase III clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2012 and 2011 were $196 million and $127 million, respectively.

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 additional matters such as antitrust actions. (See Note 11 to the consolidated financial statements.) 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. 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, 2012 and 2011 of approximately $260 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.

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. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which

 

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other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined.

The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and providing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually.

The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $14 million in 2012, and are estimated at $84 million in the aggregate for the years 2013 through 2017. In management’s opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $145 million and $171 million at December 31, 2012 and 2011, respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $112 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Company’s financial position, results of operations, liquidity or capital resources for any year.

Share-Based Compensation

The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options.

Pensions and Other Postretirement Benefit Plans

Net periodic benefit cost for pension and other postretirement benefit plans totaled $509 million in 2012, $665 million in 2011 and $696 million in 2010. The decline in net periodic benefit cost for pension and other postretirement benefit plans in 2012 as compared with 2011 and 2010 is largely attributable to the benefit plan design changes approved in December 2011 (see Note 14 to the consolidated financial statements). Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets.

The Company reassesses its benefit plan assumptions on a regular basis. 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. At December 31, 2012, the discount rates for the Company’s U.S. pension and other postretirement benefit plans ranged from 3.00% to 4.20% compared with a range of 4.00% to 5.00% at December 31, 2011.

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. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data as well as actual returns on the Company’s plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. As a result of this analysis, for 2013, the Company’s expected rate of return will range from 6.00% to 8.75% compared to a range of 5.75% to 8.75% in 2012 for its U.S. pension and other postretirement benefit plans.

 

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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 45% to 60% in U.S. equities, 20% to 30% in international equities, 15% to 25% in fixed-income investments, and up to 8% 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 13%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines.

Actuarial assumptions are based upon management’s best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have an estimated $67 million favorable (unfavorable) impact on its net periodic benefit cost. A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have an estimated $34 million favorable (unfavorable) impact on its net periodic benefit cost. Required funding obligations for 2013 relating to the Company’s pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Company’s funding requirements.

Net loss amounts, which reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCI . Expected returns for pension plans are based on a calculated market-related value of assets. Under this methodology, asset gains/losses resulting from actual returns that differ from the Company’s expected returns are recognized in the market-related value of assets ratably over a five-year period. Also, net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Amortization of net losses for the Company’s U.S. plans at December 31, 2012 is expected to increase net periodic benefit cost by approximately $7 million annually from 2013 through 2017.

Restructuring Costs

Restructuring costs have been recorded in connection with restructuring programs designed to reduce the cost structure, increase efficiency and enhance competitiveness. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. 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. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Materials and production costs, Marketing and administrative expenses and Research and development expenses depending upon the nature of the asset.

Impairments of Long-Lived Assets

The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Company’s property, plant and equipment, goodwill and other intangible assets.

The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the asset’s fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach.

 

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Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses purchased and is assigned to reporting units. The Company tests its goodwill 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. Some of the factors considered in the assessment include general macro economic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Company’s share price. Additionally, the Company evaluates the extent to which the fair value exceeded the carrying value of the reporting unit at the last date a valuation was performed. 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.

Other acquired intangibles (excluding IPR&D) are recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows.

IPR&D represents the fair value assigned to incomplete research projects that the Company acquires through business combinations which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the project. The Company tests IPR&D for impairment at least annually, or more frequently if impairment indicators exist, through a one-step test that compares the fair value of the IPR&D intangible asset with its carrying value. For impairment testing purposes, the Company may combine separately recorded IPR&D intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPR&D intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized within the Company’s operating results.

Impairments of Investments

The Company reviews its investments for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments, including the duration and extent to which fair value is less than cost and, for equity securities, the Company’s ability and intent to hold the investments. For debt securities, an other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the 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 is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI .

Taxes on Income

The Company’s effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Company’s quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Company’s quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Company’s tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on management’s best judgment given the facts, circumstances and information available at the reporting date. 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

 

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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. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period. (See Note 16 to the consolidated financial statements.)

Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. At December 31, 2012, foreign earnings of $53.4 billion have been retained indefinitely by subsidiary companies for reinvestment; therefore, no provision has been made for income taxes that would be payable upon the distribution of such earnings and it would not be practicable to determine the amount of the related unrecognized deferred income tax liability.

Recently Issued Accounting Standards

In July 2012, the FASB issued amended guidance that simplifies how an entity tests indefinite-lived intangibles for impairment. The amended guidance will allow companies to first assess qualitative factors to determine whether it is more-likely-than-not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. The updated guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The effect of adoption on the Company’s financial position and results of operations is not expected to be material.

Cautionary Factors That May Affect Future Results

This report and other written reports and oral statements made from time to time by the Company may contain so-called “forward-looking statements,” all of which are based on management’s current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as “anticipates,” “expects,” “plans,” “will,” “estimates,” “forecasts,” “projects” and other words of similar meaning. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Company’s growth strategy, financial results, product development, product approvals, product potential and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Company’s forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially.

The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Company’s filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. “Risk Factors” of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties.

 

Item 7A.     Quantitative and Qualitative Disclosures about Market Risk.

The information required by this Item is incorporated by reference to the discussion under “Financial Instruments Market Risk Disclosures” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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Item 8. Financial Statements and Supplementary Data.

 

  (a) Financial Statements

The consolidated balance sheet of Merck & Co., Inc. and subsidiaries as of December 31, 2012 and 2011, 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, 2012, the notes to consolidated financial statements, and the report dated February 26, 2013 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)

 

       2012     2011     2010  

Sales

   $ 47,267      $ 48,047      $ 45,987   

Costs, Expenses and Other

      

Materials and production

     16,446        16,871        18,396   

Marketing and administrative

     12,776        13,733        13,125   

Research and development

     8,168        8,467        11,111   

Restructuring costs

     664        1,306        985   

Equity income from affiliates

     (642     (610     (587

Other (income) expense, net

     1,116        946        1,304   
       38,528        40,713        44,334   

Income Before Taxes

     8,739        7,334        1,653   

Taxes on Income

     2,440        942        671   

Net Income

     6,299        6,392        982   

Less: Net Income Attributable to Noncontrolling Interests

     131        120        121   

Net Income Attributable to Merck & Co., Inc.

   $ 6,168      $ 6,272      $ 861   

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

   $ 2.03      $ 2.04      $ 0.28   

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

   $ 2.00      $ 2.02      $ 0.28   

Consolidated Statement of Comprehensive Income

Merck & Co., Inc. and Subsidiaries

Years Ended December 31

($ in millions)

 

       2012     2011     2010  

Net Income Attributable to Merck & Co., Inc.

   $ 6,168      $ 6,272      $ 861   

Other Comprehensive (Loss) Income Net of Taxes:

      

Net unrealized (loss) gain on derivatives, net of reclassifications

     (101     (37     83   

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

     52        (10     (2

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

     (1,321     (303     426   

Cumulative translation adjustment

     (180     434        (956
       (1,550     84        (449

Comprehensive Income Attributable to Merck & Co., Inc.

   $ 4,618      $ 6,356      $ 412   

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)

 

       2012     2011  

Assets

    

Current Assets

    

Cash and cash equivalents

   $ 13,451      $ 13,531   

Short-term investments

     2,690        1,441   

Accounts receivable (net of allowance for doubtful accounts of $163 in
2012 and $131 in 2011)

     7,672        8,261   

Inventories (excludes inventories of $1,606 in 2012 and $1,379 in
2011 classified in Other assets — see Note 7)

     6,535        6,254   

Deferred income taxes and other current assets

     4,509        3,694   

Total current assets

     34,857        33,181   

Investments

     7,305        3,458   

Property, Plant and Equipment (at cost)

    

Land

     591        623   

Buildings

     13,196        12,733   

Machinery, equipment and office furnishings

     17,188        16,919   

Construction in progress

     2,440        2,198   
     33,415        32,473   

Less: accumulated depreciation

     17,385        16,176   
       16,030        16,297   

Goodwill

     12,134        12,155   

Other Intangibles, Net

     29,083        34,302   

Other Assets

     6,723        5,735   
     $ 106,132      $ 105,128   

Liabilities and Equity

    

Current Liabilities

    

Loans payable and current portion of long-term debt

     4,315        1,990   

Trade accounts payable

     1,753        2,023   

Accrued and other current liabilities

     9,737        10,170   

Income taxes payable

     1,200        781   

Dividends payable

     1,343        1,281   

Total current liabilities

     18,348        16,245   

Long-Term Debt

     16,254        15,525   

Deferred Income Taxes and Noncurrent Liabilities

     16,067        16,415   

Merck & Co., Inc. Stockholders’ Equity

    

Common stock, $0.50 par value
Authorized — 6,500,000,000 shares

    

Issued — 3,577,103,522 shares in 2012 and 2011

     1,788        1,788   

Other paid-in capital

     40,646        40,663   

Retained earnings

     39,985        38,990   

Accumulated other comprehensive loss

     (4,682     (3,132
     77,737        78,309   

Less treasury stock, at cost:

    

550,468,221 shares in 2012;

    

536,109,713 shares in 2011

     24,717        23,792   

Total Merck & Co., Inc. stockholders’ equity

     53,020        54,517   

Noncontrolling Interests

     2,443        2,426   

Total equity

     55,463        56,943   
     $ 106,132      $ 105,128   

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, 2010

  $ 1,781      $ 39,683      $ 41,405      $ (2,767   $ (21,044   $ 2,427      $ 61,485   

Net income attributable to Merck & Co., Inc.

                  861                             861   

Other comprehensive loss, net of tax

                         (449                   (449

Cash dividends declared on common stock ($1.52 per share)

                  (4,730                          (4,730

Mandatory conversion of 6% convertible preferred stock

    2        132                                    134   

Treasury stock shares purchased

                                (1,593            (1,593

Net income attributable to noncontrolling interests

                                       121        121   

Distributions attributable to noncontrolling interests

                                       (119     (119

Share-based compensation plans and other

    5        886                      204               1,095   

Balance December 31, 2010

    1,788        40,701        37,536        (3,216     (22,433     2,429        56,805   

Net income attributable to Merck & Co., Inc.

                  6,272                             6,272   

Other comprehensive income, net of tax

                         84                      84   

Cash dividends declared on common stock ($1.56 per share)

                  (4,818                          (4,818

Treasury stock shares purchased

                                (1,921            (1,921

Net income attributable to noncontrolling interests

                                       120        120   

Distributions attributable to noncontrolling interests

                                       (120     (120

Share-based compensation plans and other

           (38                   562        (3     521   

Balance December 31, 2011

    1,788        40,663        38,990        (3,132     (23,792     2,426        56,943   

Net income attributable to Merck & Co., Inc.

                  6,168                             6,168   

Other comprehensive loss, net of tax

                         (1,550                   (1,550

Cash dividends declared on common stock ($1.69 per share)

                  (5,173                          (5,173

Treasury stock shares purchased

                                (2,591            (2,591

Net income attributable to noncontrolling interests

                                       131        131   

Distributions attributable to noncontrolling interests

                                       (120     (120

Share-based compensation plans and other

           (17                   1,666        6        1,655   

Balance December 31, 2012

  $ 1,788      $ 40,646      $ 39,985      $ (4,682   $ (24,717   $ 2,443      $ 55,463   

 

 

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)

 

       2012     2011     2010  

Cash Flows from Operating Activities

      

Net income

   $ 6,299      $ 6,392      $ 982   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     6,978        7,427        7,381   

Intangible asset impairment charges

     200        705        2,441   

Gain on disposition of interest in equity method investment

            (136       

Gain on AstraZeneca LP asset option exercise

                   (443

Equity income from affiliates

     (642     (610     (587

Dividends and distributions from equity affiliates

     291        216        324   

Deferred income taxes

     669        (1,537     (1,092

Share-based compensation

     335        369        509   

Other

     28        323        377   

Net changes in assets and liabilities:

      

Accounts receivable

     349        (1,168     (1,089

Inventories

     (482     (678     1,990   

Trade accounts payable

     (302     182        124   

Accrued and other current liabilities

     (717     1,444        35   

Income taxes payable

     (34     (277     128   

Noncurrent liabilities

     (1,747     (7     (98

Other

     (1,203     (262     (160

Net Cash Provided by Operating Activities

     10,022        12,383        10,822   

Cash Flows from Investing Activities

      

Capital expenditures

     (1,954     (1,723     (1,678

Purchases of securities and other investments

     (12,841     (7,325     (7,197

Proceeds from sales of securities and other investments

     7,783        6,149        4,561   

Proceeds from sale of interest in equity method investment

            175          

Acquisitions of businesses, net of cash acquired

            (373     (256

Dispositions of businesses, net of cash divested

            323          

Proceeds from AstraZeneca LP asset option exercise

                   647   

Decrease in restricted assets

     34               276   

Other

     173        (116     150   

Net Cash Used in Investing Activities

     (6,805     (2,890     (3,497

Cash Flows from Financing Activities

      

Net change in short-term borrowings

     624        1,076        90   

Payments on debt

     (22     (1,547     (1,341

Proceeds from issuance of debt

     2,562               1,999   

Purchases of treasury stock

     (2,591     (1,921     (1,593

Dividends paid to stockholders

     (5,116     (4,691     (4,734

Other dividends paid

     (120     (120     (119

Proceeds from exercise of stock options

     1,310        321        363   

Other

     86        (22     (106

Net Cash Used in Financing Activities

     (3,267     (6,904     (5,441

Effect of Exchange Rate Changes on Cash and Cash Equivalents

     (30     42        (295

Net (Decrease) Increase in Cash and Cash Equivalents

     (80     2,631        1,589   

Cash and Cash Equivalents at Beginning of Year

     13,531        10,900        9,311   

Cash and Cash Equivalents at End of Year

   $ 13,451      $ 13,531      $ 10,900   

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, animal health, and consumer care products, which it markets directly and through its joint ventures. The Company’s operations are principally managed on a products basis and are comprised of four operating segments, which are the Pharmaceutical, Animal Health, Consumer Care and Alliances segments, and one reportable segment, which is the Pharmaceutical segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products marketed either directly by the Company or through joint ventures. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Company also has animal health operations that discover, develop, manufacture and market animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. Additionally, the Company has consumer care operations that develop, manufacture and market over-the-counter, foot care and sun care products, which are sold through wholesale and retail drug, food chain and mass merchandiser outlets, as well as club stores and specialty channels.

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 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.

Mergers and 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 merger or acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are recognized at fair value if fair value can reasonably be estimated. If the acquisition date fair value of an asset acquired or liability assumed that arises from a contingency 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 merger or 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.

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

 

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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 market. The cost of a substantial majority of domestic 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 and certain products awaiting 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 and equity securities classified as available-for-sale are reported at fair value. Fair values of the Company’s investments 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 ”). For declines in the fair value of equity securities that are considered other-than-temporary, impairment losses are charged to Other (income) expense, net . The Company considers available evidence in evaluating potential impairments of its investments, including the duration and extent to which fair value is less than cost and, for equity securities, the Company’s ability and intent to hold the investments. For debt securities, an other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Realized gains and losses for both debt and equity securities are included in Other (income) expense, net .

Revenue Recognition —  Revenues from sales of products are recognized at the time of delivery when title and risk of loss passes to the customer. Recognition of revenue also requires reasonable assurance of collection of sales proceeds and completion of all performance obligations. Domestically, sales discounts are issued to customers as direct discounts at the point-of-sale or indirectly through an intermediary wholesaler, known as chargebacks, or indirectly 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. Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates are recorded as current liabilities. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $120 million and $1.8 billion, respectively, at December 31, 2012 and $87 million and $1.7 billion, respectively, at December 31, 2011.

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 .

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 10 to 50 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings .

 

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Software Capitalization —  The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. Capitalized software costs are included in Property, plant and equipment and amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with the Company’s multi-year implementation of an enterprise-wide resource planning system are being amortized over 6 to 10 years. At December 31, 2012 and 2011, there was approximately $385 million and $390 million, respectively, of remaining unamortized capitalized software costs associated with this initiative. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred.

Goodwill —  Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses purchased. 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. Based upon the Company’s most recent annual impairment test completed as of October 1, 2012, the Company concluded goodwill was not impaired.

Acquired Intangibles —  Acquired intangibles include products and product rights, tradenames and patents, which are recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives ranging from 3 to 40 years (see Note 8). When events or circumstances warrant a review, the Company will assess recoverability of acquired intangibles from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows.

In-Process Research and Development —  In-process research and development (“IPR&D”) represents the fair value assigned to incomplete research projects that the Company acquires through business combinations 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 substantially all of the cash flows are expected to be generated, and begin amortization. The Company tests IPR&D for impairment at least annually, or more frequently if impairment indicators exist, through a one-step 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.

Research and Development —  Research and development is expensed as incurred. Upfront and milestone payments due to third parties in connection with research and development collaborations prior to regulatory approval are expensed as incurred. Payments due to third parties upon or subsequent to regulatory approval are capitalized and amortized over the shorter of the remaining license or product patent life. 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 in all periods and IPR&D impairment charges of $200 million, $587 million and $2.4 billion in 2012, 2011 and 2010, respectively.

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.

 

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

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

Use of Estimates —  The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (“GAAP”) and, accordingly, include certain amounts that are based on management’s best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with mergers and acquisitions, including initial fair value determinations of assets and liabilities, primarily IPR&D and other intangible assets, 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 and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates.

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

Recently Adopted Accounting Standards —  During 2012, the Company retrospectively adopted amended guidance from the Financial Accounting Standards Board (the “FASB”) on the presentation of comprehensive income in financial statements. As a result of adopting this guidance, the Company has presented a separate Statement of Comprehensive Income. The adoption of this new guidance did not impact the Company’s financial position, results of operations or cash flows.

Recently Issued Accounting Standards —  In July 2012, the FASB issued amended guidance that simplifies how an entity tests indefinite-lived intangibles for impairment. The amended guidance will allow companies to first assess qualitative factors to determine whether it is more-likely-than-not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. The updated guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The effect of adoption on the Company’s financial position and results of operations is not expected to be material.

3.    Restructuring

Merger Restructuring Program

In 2010, subsequent to the Merck and Schering-Plough Corporation (“Schering-Plough”) merger (the “Merger”), the Company commenced actions under a global restructuring program (the “Merger Restructuring Program”) in conjunction with the integration of the legacy Merck and legacy Schering-Plough businesses designed to optimize the cost structure of the combined company. These initial actions, which are expected to result in workforce reductions of approximately 17%, primarily reflect the elimination of positions in sales, administrative and headquarters organizations, as well as from the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. In July 2011, the Company initiated further actions under the Merger Restructuring Program through which the Company expects to reduce its workforce measured at the time of the Merger by an additional 12% to 13% across the Company worldwide. A majority of the workforce reductions associated with these additional actions relate to manufacturing (including Animal Health),

 

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administrative and headquarters organizations. The Company will continue to hire employees in strategic growth areas of the business as necessary.

The Company recorded total pretax restructuring costs of $951 million in 2012, $1.8 billion in 2011 and $1.8 billion in 2010 related to this program. Since inception of the Merger Restructuring Program through December 31, 2012, Merck has recorded total pretax accumulated costs of approximately $6.1 billion and eliminated approximately 22,400 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The restructuring actions under the Merger Restructuring Program are expected to be substantially completed by the end of 2013, with the exception of certain actions, principally manufacturing-related. Subsequent to the Merger, the Company has rationalized a number of manufacturing sites worldwide. The remaining actions under this program will result in additional manufacturing facility rationalizations, which are expected to be substantially completed by 2016. The Company now expects the estimated total cumulative pretax costs for this program to be approximately $7.2 billion to $7.5 billion. The increase from original estimates primarily reflects accelerated depreciation related to additional facility closures identified during the Company’s ongoing assessment of worldwide capacity requirements for its manufacturing, research and administrative facilities subsequent to the Merger, including the recently announced move of the Company’s worldwide headquarters to Summit, New Jersey. The Company estimates that approximately two-thirds of the cumulative pretax costs relate to cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.

2008 Global Restructuring Program

In October 2008, Merck announced a global restructuring program (the “2008 Restructuring Program”) to reduce its cost structure, increase efficiency, and enhance competitiveness. As part of the 2008 Restructuring Program, the Company expects to eliminate approximately 7,200 positions — 6,800 active employees and 400 vacancies — across the Company worldwide. Pretax restructuring costs of $48 million, $45 million and $176 million were recorded in 2012, 2011 and 2010, respectively, related to the 2008 Restructuring Program. Since inception of the 2008 Restructuring Program through December 31, 2012, Merck has recorded total pretax accumulated costs of $1.7 billion and eliminated approximately 6,400 positions comprised of employee separations and the elimination of contractors and vacant positions. The 2008 Restructuring Program was substantially completed in 2011, with the exception of certain manufacturing-related actions, which are expected to be completed by 2015, with the total cumulative pretax costs estimated to be up to $2.0 billion. The Company estimates that two-thirds of the cumulative pretax costs relate to cash outlays, primarily from employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested.

For segment reporting, restructuring charges are unallocated expenses.

 

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The following table summarizes the charges related to Merger Restructuring Program and 2008 Restructuring Program activities by type of cost:

 

Year Ended December 31, 2012    Separation
Costs
    Accelerated
Depreciation
     Other     Total  

Merger Restructuring Program

                                 

Materials and production

   $      $ 92       $ 70      $ 162   

Marketing and administrative

            75         6        81   

Research and development

            53         4        57   

Restructuring costs

     497                154        651   
       497        220         234        951   

2008 Restructuring Program

                                 

Materials and production

            7         19        26   

Marketing and administrative

            8         1        9   

Restructuring costs

     (8             21        13   
       (8     15         41        48   
     $ 489      $ 235       $ 275      $ 999   

Year Ended December 31, 2011

                                 

Merger Restructuring Program

                                 

Materials and production

   $      $ 282       $ 17      $ 299   

Marketing and administrative

            108         11        119   

Research and development

            151         (17     134   

Restructuring costs

     1,117                177        1,294   
       1,117        541         188        1,846   

2008 Restructuring Program

                                 

Materials and production

            24         5        29   

Research and development

            4                4   

Restructuring costs

     (6             18        12   
       (6     28         23        45   
     $ 1,111      $ 569       $ 211      $ 1,891   

Year Ended December 31, 2010

                                 

Merger Restructuring Program

                                 

Materials and production

   $      $ 241       $ 74      $ 315   

Marketing and administrative

            145         2        147   

Research and development

            364         54        418   

Restructuring costs

     708                207        915   
       708        750         337        1,795   

2008 Restructuring Program

                                 

Materials and production

            67         25        92   

Marketing and administrative

                    (3     (3

Research and development

            10                10   

Restructuring costs

     60                17        77   
       60        77         39        176   
     $ 768      $ 827       $ 376      $ 1,971   

 

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Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. In 2012, 2011 and 2010 approximately 3,975, 6,880 and 11,410 positions, respectively, were eliminated under the Merger Restructuring Program and approximately 155, 450 and 890 positions, respectively, were eliminated under the 2008 Restructuring Program. These position eliminations were comprised of actual headcount reductions and the elimination of contractors and vacant positions.

Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the site, based upon the anticipated date the site will be closed or divested, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All of the sites have and will continue to operate up through the respective closure dates and, since future cash flows were sufficient to recover the respective book values, Merck was required to accelerate depreciation of the site assets rather than write them off immediately. 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 2012, 2011 and 2010 includes $155 million, $72 million and $152 million, respectively, of asset abandonment, shut-down and other related costs and, in 2010, also includes approximately $65 million of contract termination costs. Additionally, other activity includes $35 million, $53 million and $88 million in 2012, 2011 and 2010, respectively, for other employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans (see Note 14) and share-based compensation costs. Other activity also reflects net pretax gains resulting from sales of facilities and related assets in 2012, 2011 and 2010 of $28 million, $10 million and $49 million, respectively.

Adjustments to the recorded amounts were not material in any period.

The following table summarizes the charges and spending relating to Merger Restructuring Program and 2008 Restructuring Program activities:

 

       Separation
Costs
    Accelerated
Depreciation
    Other     Total  

Merger Restructuring Program

                                

Restructuring reserves January 1, 2011

   $ 859      $      $ 64      $ 923   

Expenses

     1,117        541        188        1,846   

(Payments) receipts, net

     (832            (245     (1,077

Non-cash activity

            (541     44        (497

Restructuring reserves December 31, 2011

     1,144               51        1,195   

Expenses

     497        220        234        951   

(Payments) receipts, net

     (942            (170     (1,112

Non-cash activity

            (220     (96     (316

Restructuring reserves December 31, 2012 (1)

   $ 699      $      $ 19      $ 718   

2008 Restructuring Program

                                

Restructuring reserves January 1, 2011

   $ 196      $      $      $ 196   

Expenses

     (6     28        23        45   

(Payments) receipts, net

     (64            (21     (85

Non-cash activity

            (28     (2     (30

Restructuring reserves December 31, 2011

     126                      126   

Expenses

     (8     15        41        48   

(Payments) receipts, net

     (41            (21     (62

Non-cash activity

            (15     (20     (35

Restructuring reserves December 31, 2012 (1)

   $ 77      $      $      $ 77   

 

(1)  

The cash outlays associated with the Merger Restructuring Program are expected to be substantially completed by the end of 2013 with the exception of certain actions, principally manufacturing-related, which are expected to be substantially completed by 2016. The cash outlays associated with the remaining restructuring reserves for the 2008 Restructuring Program are primarily manufacturing-related and are expected to be completed by the end of 2015.

 

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Legacy Schering-Plough Program

Prior to the Merger, Schering-Plough commenced a Productivity Transformation Program which was designed to reduce and avoid costs and increase productivity. During 2011 and 2010, the Company recorded $20 million and $22 million, respectively, of accelerated depreciation costs included in Materials and production costs. In addition, Restructuring costs reflect a $7 million net gain in 2010 primarily related to the sale of a manufacturing facility. This program was substantially complete at the end of 2011.

4.    Acquisitions, Divestitures, Research Collaborations and License Agreements

In October 2012, Merck and AiCuris entered into an exclusive licensing agreement which provides Merck with worldwide rights to develop and commercialize candidates in AiCuris’ novel portfolio of investigational medicines targeting human cytomegalovirus (“HCMV”), including letermovir (MK-8228), an oral, late-stage antiviral candidate being investigated for the treatment and prevention of HCMV infection in transplant recipients. AiCuris received an upfront payment of €110 million (approximately $140 million), which the Company recorded as research and development expense, and is eligible for milestone payments of up to €332.5 million based on successful achievement of development, regulatory and commercialization goals for HCMV candidates, including letermovir, an additional back-up candidate as well as other Phase I candidates designed to act via an alternate mechanism. In addition, AiCuris will be entitled to receive royalty payments reflecting the advanced stage of the clinical program on any potential products that result from the agreement. Merck will be responsible for all development activities and costs. The agreement may be terminated by either party in the event of a material uncured breach or insolvency. The agreement may be terminated by Merck at any time in the event that any of the compounds licensed from AiCuris develop an adverse safety profile or any material adverse issue arises related to the development, efficacy or dosing regimen of any of the compounds, and/or in the event that certain patents are invalid and/or unenforceable in certain jurisdictions. Merck (i) may terminate the agreement with respect to certain compounds after successful completion of the first proof of concept clinical trial or (ii) must terminate the agreement with respect to certain compounds if Merck fails to minimally invest in such compounds. In addition, Merck may terminate the agreement as a whole at any time upon six months prior written notice at any time after completion of the first Phase III clinical trial for a compound. AiCuris may terminate the agreement in the event that Merck challenges any AiCuris patent covering the compounds licensed from AiCuris. Upon termination of the agreement, depending upon the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of compounds and, in the case of termination for cause by Merck, certain royalty obligations.

In April 2012, the Company entered into an agreement with Endocyte, Inc. (“Endocyte”) to develop and commercialize Endocyte’s novel investigational therapeutic candidate vintafolide (MK-8109). Vintafolide is currently being evaluated in a Phase III clinical trial for folate-receptor positive platinum-resistant ovarian cancer (PROCEED) and a Phase II trial for non-small cell lung cancer. Under the agreement, Merck gained worldwide rights to develop and commercialize vintafolide. Endocyte received a $120 million upfront payment, which the Company recorded as research and development expense, and is eligible for milestone payments of up to $880 million based on the successful achievement of development, regulatory and commercialization goals for vintafolide for a total of six cancer indications. In addition, if vintafolide receives regulatory approval, Merck and Endocyte will share equally profits and losses in the United States. Endocyte will receive a royalty on sales of the product in the rest of the world. Endocyte has retained the right to co-promote vintafolide with Merck in the United States and Merck has the exclusive right to promote vintafolide in the rest of world. Endocyte will be responsible for the majority of funding and completion of the PROCEED trial. Merck will be responsible for all other development activities and development costs and have all decision rights for vintafolide. Merck has the right to terminate the agreement on 90 days notice. Merck and Endocyte both have the right to terminate the agreement due to the material breach or insolvency of the other party. Endocyte has the right to terminate the agreement in the event that Merck challenges an Endocyte patent right relating to vintafolide. Upon termination of the agreement, depending upon the circumstances, the parties have varying rights and obligations with respect to the continued development and commercialization of vintafolide and, in the case of termination for cause by Merck, certain royalty obligations and U.S. profit and loss sharing.

In May 2011, Merck completed the acquisition of Inspire Pharmaceuticals, Inc. (“Inspire”), a specialty pharmaceutical company focused on developing and commercializing ophthalmic products. Under the terms of the merger agreement, Merck acquired all outstanding shares of common stock of Inspire at a price of $5.00 per share

 

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in cash for a total of approximately $420 million. The transaction was accounted for as an acquisition of a business; accordingly, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date. The determination of fair value requires management to make significant estimates and assumptions. In connection with the acquisition, substantially all of the purchase price was allocated to Inspire’s product and product right intangible assets and related deferred tax liabilities, a deferred tax asset relating to Inspire’s net operating loss carryforwards, and goodwill. This transaction closed on May 16, 2011, and accordingly, the results of operations of the acquired business have been included in the Company’s results of operations since the acquisition date. Pro forma financial information has not been included because Inspire’s historical financial results are not significant when compared with the Company’s financial results.

In March 2011, the Company sold the Merck BioManufacturing Network, a provider of contract manufacturing and development services for the biopharmaceutical industry and wholly owned by Merck, to Fujifilm Corporation (“Fujifilm”). Under the terms of the agreement, Fujifilm purchased all of the equity interests in two Merck subsidiaries which together owned all of the assets of the Merck BioManufacturing Network comprising facilities located in Research Triangle Park, North Carolina and Billingham, United Kingdom. As part of the agreement with Fujifilm, Merck has committed to purchase certain development and manufacturing services at fair value from Fujifilm over a three-year period following the closing of the transaction. The transaction resulted in a gain of $127 million in 2011 reflected in Other (income) expense, net .

5.    Collaborative Arrangements

The Company continues its strategy of establishing external alliances to complement its substantial internal research capabilities, including research collaborations, as well as licensing preclinical and clinical compounds and technology platforms to drive both near- and long-term growth. The Company supplements its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as new technologies across a broad range of therapeutic areas. These arrangements often include upfront payments and royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development, as well as expense reimbursements or payments to the third party.

Cozaar/Hyzaar

In 1989, Merck and E.I. duPont de Nemours and Company (“DuPont”) agreed to form a long-term research and marketing collaboration to develop a class of therapeutic agents for high blood pressure and heart disease, discovered by DuPont, called angiotensin II receptor antagonists, which include Cozaar and Hyzaar . In return, Merck provided DuPont marketing rights in the United States and Canada to its prescription medicines, Sinemet and Sinemet CR (the Company has since regained global marketing rights to Sinemet and Sinemet CR ). Pursuant to a 1994 agreement with DuPont, the Company had an exclusive licensing agreement to market Cozaar and Hyzaar in return for royalties and profit share payments to DuPont. This agreement terminated on December 31, 2012 in accordance with its terms. As a result of the termination of the agreement, Merck no longer shares profits from, or marketing costs related to, the sale of Cozaar and Hyzaar with DuPont. However, under a separate agreement, the trademarks for Cozaar and Hyzaar were permanently transferred to Merck in exchange for Merck paying a trademark royalty to DuPont based on sales of Cozaar and Hyzaar for a period of 10 years.

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 had exclusive marketing rights to both products outside the United States, Japan and certain other Asian markets. In December 2007, Schering-Plough and Centocor revised their distribution agreement regarding the development, commercialization and distribution of both Remicade and Simponi , extending the Company’s rights to exclusively market Remicade to match the duration of the Company’s exclusive marketing rights for Simponi . In addition, Schering-Plough and Centocor agreed to share certain development costs relating to Simponi ’s auto-injector delivery system. On October 6, 2009, the European Commission approved Simponi as a treatment for rheumatoid arthritis and other immune system disorders in two presentations — a novel auto-injector and a prefilled

 

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syringe. As a result, the Company’s marketing rights for both products extend for 15 years from the first commercial sale of Simponi in the European Union (the “EU”) following the receipt of pricing and reimbursement approval within the EU.

In April 2011, Merck and J&J reached an agreement to amend the agreement governing the distribution rights to Remicade and Simponi . Under the terms of the amended distribution agreement, Merck relinquished marketing rights for Remicade and Simponi to J&J in territories including Canada, Central and South America, the Middle East, Africa and Asia Pacific effective July 1, 2011. Merck retained exclusive marketing rights throughout Europe, Russia and Turkey (the “Retained Territories”). In addition, beginning July 1, 2011, all profits derived from Merck’s exclusive distribution of the two products in the Retained Territories are being equally divided between Merck and J&J. J&J also received a one-time payment from Merck of $500 million in April 2011, which the Company recorded as a charge to Other (income) expense, net in 2011.

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 volatility in foreign exchange rates.

The objective of the revenue hedging program is to reduce the potential for longer-term unfavorable changes in foreign exchange rates to decrease the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales that are expected to occur over its planning cycle, typically no more than three years into the future. The Company will layer in hedges over time, increasing the portion of third-party and intercompany distributor entity sales hedged as it gets closer to the expected date of the forecasted foreign currency denominated sales. The portion of sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The hedged anticipated sales are a specified component of a portfolio of similarly denominated foreign currency-based sales transactions, each of which responds to the hedged currency risk in the same manner. The Company manages its anticipated transaction exposure principally with purchased local currency put options, which provide the Company with a right, but not an obligation, to sell foreign currencies in the future at a predetermined price. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, total changes in the options’ cash flows offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the options’ value reduces to zero, but the Company benefits from the increase in the U.S. dollar equivalent value of the anticipated foreign currency cash flows.

In connection with the Company’s revenue hedging program, a purchased collar option strategy may be utilized. With a purchased collar option strategy, the Company writes a local currency call option and purchases a local currency put option. As compared to a purchased put option strategy alone, a purchased collar strategy reduces the upfront costs associated with purchasing puts through the collection of premium by writing call options. If the U.S. dollar weakens relative to the currency of the hedged anticipated sales, the purchased put option value of the collar strategy reduces to zero and the Company benefits from the increase in the U.S. dollar equivalent value of its anticipated foreign currency cash flows, however this benefit would be capped at the strike level of the written call. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the written call option

 

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value of the collar strategy reduces to zero and the changes in the purchased put cash flows of the collar strategy would offset the decline in the expected future U.S. dollar equivalent cash flows of the hedged foreign currency sales.

The Company may also utilize forward contracts in its revenue hedging program. If the U.S. dollar strengthens relative to the currency of the hedged anticipated sales, the increase in the fair value of the forward contracts offsets the decrease in the expected future U.S. dollar cash flows of the hedged foreign currency sales. Conversely, if the U.S. dollar weakens, the decrease in the fair value of the forward contracts offsets the increase in the value of the anticipated foreign currency cash flows.

The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the effective portion of the unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. The hedge relationship is highly effective and hedge ineffectiveness has been de minimis . For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes.

The primary objective of the balance sheet risk management program is to mitigate the exposure of foreign currency denominated net monetary assets of foreign subsidiaries where the U.S. dollar is the functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts, which enable the Company to buy and sell foreign currencies in the future at fixed exchange rates and economically offset the consequences of changes in foreign exchange from the monetary assets. Merck routinely enters into contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The Company will also minimize the effect of exchange on monetary assets and liabilities by managing operating activities and net asset positions at the local level.

Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year.

The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates. The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within OCI , and remains in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows.

Foreign exchange risk is also managed through the use of foreign currency debt. The Company’s senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Included in the cumulative translation adjustment are pretax losses of $31 million in 2012 and pretax gains of $6 million in 2011 and $277 million in 2010 from the euro-denominated notes.

 

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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.

During 2011, the Company terminated 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. These swaps effectively converted certain of its fixed-rate notes to floating-rate instruments. The interest rate swap contracts were designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (“LIBOR”) swap rate. As a result of the swap terminations, the Company received $288 million in cash, which included $43 million in accrued interest. The corresponding $245 million basis adjustment of the debt associated with the terminated interest rate swap contracts was deferred and is being amortized as a reduction of interest expense over the respective term of the notes. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.

Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31:

 

         2012     2011  
         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

                                                    

Foreign exchange contracts (current)

   Deferred income taxes and
other current assets
  $ 281      $      $ 6,646      $ 196      $      $ 3,727   

Foreign exchange contracts
(non-current)

   Other assets     387               5,989        420               4,956   

Foreign exchange contracts (current)

   Accrued and other current liabilities            13        938               53        1,718   

Foreign exchange contracts
(non-current)

   Deferred income taxes and noncurrent liabilities                                 1        104   
         $ 668      $ 13      $ 13,573      $ 616      $ 54      $ 10,505   

Derivatives Not Designated as Hedging Instruments

                                                    

Foreign exchange contracts (current)

   Deferred income taxes and
other current assets
  $ 55      $      $ 4,548      $ 139      $      $ 5,306   

Foreign exchange contracts
(non-current)

   Other assets     8               232                        

Foreign exchange contracts (current)

   Accrued and other current liabilities            216        8,203               54        5,013   
         $ 63      $ 216      $ 12,983      $ 139      $ 54      $ 10,319   
         $ 731      $ 229      $ 26,556      $ 755      $ 108      $ 20,824   

 

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The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a cash flow hedging relationship, (iii) designated in a foreign currency net investment hedging relationship and (iv) not designated in a hedging relationship:

 

Years Ended December 31   2012     2011     2010  

Derivatives designated in fair value hedging relationships

     

Interest rate swap contracts

     

Amount of gain recognized in Other (income) expense, net on derivatives

  $      $ (196   $ (23

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

           196        23   

Derivatives designated in foreign currency cash flow hedging relationships

     

Foreign exchange contracts

     

Amount of loss reclassified from AOCI to Sales

    50        85        7   

Amount of loss (gain) recognized in OCI on derivatives

    204        143        (103

Derivatives designated in foreign currency net investment hedging relationships

     

Foreign exchange contracts

     

Amount of gain recognized in Other (income) expense, net on derivatives (1)

    (20     (10     (1

Amount of (gain) loss recognized in OCI on deriviatives

    (208     122        24   

Derivatives not designated in a hedging relationship

     

Foreign exchange contracts

     

Amount of loss (gain) recognized in Other (income) expense, net on derivatives (2)

    382        (113     (33

Amount of loss (gain) recognized in Sales

    30               (81

 

(1)  

There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing.

 

(2)  

These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates.

At December 31, 2012, the Company estimates $138 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 available-for-sale investments at December 31 is as follows:

 

     2012     2011  
                   Gross Unrealized                   Gross Unrealized  
      

Fair

Value

     Amortized
Cost
     Gains      Losses     Fair
Value
     Amortized
Cost
     Gains      Losses  

Corporate notes and bonds

   $ 5,063       $ 5,013       $ 52       $ (2   $ 2,032       $ 2,024       $ 16       $ (8

Commercial paper

     2,150         2,150                        1,029         1,029                   

U.S. government and agency securities

     1,206         1,204         2                1,021         1,018         3           

Asset-backed securities

     837         835         3         (1     292         292         1         (1

Mortgage-backed securities

     435         436         2         (3     223         223         1         (1

Foreign government bonds

     108         107         1                72         72                   

Other debt securities

                                    3         1         2           

Equity securities

     403         370         33                397         383         14           
     $ 10,202       $ 10,115       $ 93       $ (6   $ 5,069       $ 5,042       $ 37       $ (10

Available-for-sale debt securities included in Short-term investments totaled $2.7 billion at December 31, 2012. Of the remaining debt securities, $6.4 billion mature within five years. At December 31, 2012 and 2011, there were no debt securities pledged as collateral.

Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest:

Level 1  — Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2  — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3  — Unobservable inputs that are supported by little or no market activity. Level 3 assets 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.

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  
     

Quoted Prices
In Active

Markets for

Identical Assets

(Level 1)

   

Significant

Other

Observable
Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

    Total    

Quoted Prices

In Active

Markets for

Identical Assets

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

    Total  
      2012     2011  

Assets

               

Investments

               

Corporate notes and bonds

  $      $ 5,063      $      $ 5,063      $      $ 2,032      $      $ 2,032   

Commercial paper

           2,150               2,150               1,029               1,029   

U.S. government and agency securities

           1,206               1,206               1,021               1,021   

Asset-backed securities (1)

           837               837               292               292   

Mortgage-backed securities (1)

           435               435               223               223   

Foreign government bonds

           108               108               72               72   

Equity securities

    196                      196        205        22               227   

Other debt securities

                                       3               3   
      196        9,799               9,995        205        4,694               4,899   

Other assets

               

Securities held for employee compensation

    169        38               207        170                      170   

Derivative assets (2)

               

Purchased currency options

           546               546               613               613   

Forward exchange contracts

           185               185               142               142   
             731               731               755               755   

Total assets

  $ 365      $ 10,568      $      $ 10,933      $ 375      $ 5,449      $      $ 5,824   

Liabilities

               

Derivative liabilities (2)

               

Forward exchange contracts

  $      $ 216      $      $ 216      $      $ 107      $      $ 107   

Written currency options

           13               13               1               1   

Total liabilities

  $      $ 229      $      $ 229      $      $ 108      $      $ 108   

 

(1 )  

Primarily all of the asset-backed securities are highly-rated (Standard & Poor’s rating of AAA and Moody’s Investors Service rating of Aaa), secured primarily by credit card, auto loan, and home equity receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies.

 

(2)  

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

There were no transfers between Level 1 and Level 2 during 2012. As of December 31, 2012, Cash and cash equivalents of $13.5 billion included $12.5 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy).

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, 2012 was $22.8 billion compared with a carrying value of $20.6 billion and at December 31, 2011 was $19.5 billion compared with a carrying value of $17.5 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

 

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instruments that meet high credit quality standards, as specified in the Company’s investment policy guidelines. Approximately 50% of the Company’s cash and cash equivalents are invested in five highly rated money market funds.

The majority of the Company’s accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business, taking into consideration the global economic downturn and the sovereign debt issues in certain European countries. The Company continues to monitor the credit and economic conditions within Greece, Italy, Spain and Portugal, among other members of the EU. These economic conditions, as well as inherent variability of timing of cash receipts, have resulted in, and may continue to result in, an increase in the average length of time that it takes to collect accounts receivable outstanding. As such, time value of money discounts have been recorded for those customers for which collection of accounts receivable is expected to be in excess of one year. At December 31, 2012, the Company classified approximately $475 million of accounts receivable not expected to be collected within one year to Other assets . The Company does not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on its financial position, liquidity or results of operations.

As of December 31, 2012, the Company’s accounts receivable in Greece, Italy, Spain and Portugal totaled approximately $1.1 billion. Of this amount, hospital and public sector receivables were approximately $800 million in the aggregate, of which approximately 18%, 37%, 36% and 9% related to Greece, Italy, Spain and Portugal, respectively. As of December 31, 2012, the Company’s total accounts receivable outstanding for more than one year were approximately $200 million, of which approximately 70% related to accounts receivable in Greece, Italy, Spain and Portugal, mostly comprised of hospital and public sector receivables.

During 2012, the Company collected approximately $60 million of accounts receivable from the government of Portugal, which pertained to accounts receivable outstanding from 2011 and prior. Also during 2012, the Company collected approximately $500 million of accounts receivable in connection with the Spanish government’s debt stabilization/stimulus plan. In addition, the Company completed non-recourse factorings of approximately $230 million in 2012 of hospital and public sector accounts receivable in Italy.

As previously disclosed, the Company received zero coupon bonds from the Greek government in settlement of 2007-2009 receivables related to certain government sponsored institutions. The Company had recorded impairment charges to reduce the bonds to fair value. During 2011, the Company sold a portion of these bonds and the remainder was sold during 2012. During 2011 and 2012, the Company has continued to receive payments on 2011 and 2010 Greek hospital and public sector receivables.

Additionally, the Company continues to expand in the emerging markets. Payment terms in these markets tend to be longer, resulting in an increase in accounts receivable balances in certain of these markets.

The Company’s customers with the largest accounts receivable balances are: Cardinal Health, Inc., McKesson Corporation, AmerisourceBergen Corporation, Alliance Healthcare, Zuellig Pharma Ltd. (Asia Pacific) and Grupo Casa Saba (Mexico), which represented, in aggregate, approximately one-fourth of total accounts receivable at December 31, 2012. The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales.

Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Company’s financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Company’s credit rating, and the credit rating of the counterparty. As of December 31, 2012 and 2011, the Company had received cash collateral of $305 million and $327 million, respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities . The Company had not advanced any cash collateral to counterparties as of December 31, 2012 or 2011.

 

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7.    Inventories

Inventories at December 31 consisted of:

 

       2012      2011  

Finished goods

   $ 1,924       $ 1,983   

Raw materials and work in process

     5,921         5,396   

Supplies

     244         297   

Total (approximates current cost)

     8,089         7,676   

Increase (reduction) to LIFO costs

     52         (43
     $ 8,141       $ 7,633   

Recognized as:

     

Inventories

   $ 6,535       $ 6,254   

Other assets

     1,606         1,379   

Inventories valued under the LIFO method comprised approximately 26% and 27% of inventories at December 31, 2012 and 2011, respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2012 and 2011, these amounts included $1.4 billion and $1.3 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $196 million and $127 million at December 31, 2012 and 2011, respectively, of inventories produced in preparation for product launches.

8.    Goodwill and Other Intangibles

The following table summarizes goodwill activity by segment:

 

       Pharmaceutical     All
Other
     Total  

Goodwill balance January 1, 2011

   $ 10,345      $ 2,033       $ 12,378   

Additions

     144                144   

Other (1)

     (382     15         (367

Goodwill balance December 31, 2011

     10,107        2,048         12,155   

Other (1)

     (21             (21

Goodwill balance December 31, 2012

   $ 10,086      $ 2,048       $ 12,134   

 

(1)  

Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. In addition, the amounts in 2011 reflect the reclassification of goodwill from the Pharmaceutical segment to the Consumer Care segment as a result of a segment change.

Other intangibles at December 31 consisted of:

 

     2012      2011  
       Gross
Carrying
Amount
     Accumulated
Amortization
     Net      Gross
Carrying
Amount
     Accumulated
Amortization
     Net  

Products and product rights

   $ 41,932       $ 16,678       $ 25,254       $ 41,937       $ 11,872       $ 30,065   

In-process research
and development

     2,393                 2,393         2,671                 2,671   

Tradenames

     1,521         236         1,285         1,523         170         1,353   

Other

     896         745         151         895         682         213   
     $ 46,742       $ 17,659       $ 29,083       $ 47,026       $ 12,724       $ 34,302   

 

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Acquired intangibles include products and product rights, tradenames and patents, which are recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives. Some of the Company’s more significant acquired intangibles related to marketed products at December 31, 2012 include Zetia , $5.9 billion; Vytorin , $3.2 billion; Nasonex , $1.9 billion, Claritin , $1.6 billion and NuvaRing , $1.0 billion. During 2011, the Company recorded an impairment charge of $118 million related to a marketed product.

IPR&D represents the fair value assigned to incomplete research projects that the Company acquires through business combinations 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 assets and begin amortization. During 2012 and 2011, $78 million and $666 million, respectively, of IPR&D was reclassified to products and product rights upon receipt of marketing approval in a major market. Some of the more significant projects in late-stage development include sugammadex sodium injection and an ezetimibe/atorvastatin combination product, both of which are currently under review by the FDA, and vorapaxar, which remains in Phase III clinical development.

During 2012, the Company recorded $200 million of IPR&D impairment charges within Research and development expenses primarily for pipeline programs that had previously been deprioritized and were subsequently deemed to have no alternative use during the period. During 2011, the Company recorded $587 million of IPR&D impairment charges primarily for pipeline programs that were abandoned and determined to have no alternative use, as well as for expected delays in the launch timing or changes in the cash flow assumptions for certain compounds. In addition, the impairment charges related to pipeline programs that had previously been deprioritized and were either deemed to have no alternative use during the period or were out-licensed to a third party for consideration that was less than the related asset’s carrying value.

During 2010, the Company recorded $2.4 billion of IPR&D impairment charges within Research and development expenses. Of this amount, $1.7 billion related to the write-down of the vorapaxar intangible asset. The Company determined that developments in the clinical research program for vorapaxar, including the termination of a clinical trial, constituted a triggering event that required the Company to evaluate the vorapaxar intangible asset for impairment. The Company continues to monitor the remaining $350 million asset value for vorapaxar for further impairment. The remaining $763 million of IPR&D impairment charges recorded in 2010 were attributable to compounds that were abandoned and determined to have either no alternative use or were returned to the respective licensor, as well as from expected delays in the launch timing or changes in the cash flow assumptions for certain compounds.

All of 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.

Aggregate amortization expense primarily recorded within Materials and production costs was $5.0 billion in 2012, $5.1 billion in 2011 and $4.7 billion in 2010. The estimated aggregate amortization expense for each of the next five years is as follows: 2013, $4.7 billion; 2014, $4.4 billion; 2015, $4.1 billion; 2016, $3.5 billion; 2017, $3.2 billion.

9.    Joint Ventures and Other Equity Method Affiliates

Equity income from affiliates reflects the performance of the Company’s joint ventures and other equity method affiliates and was comprised of the following:

 

Years Ended December 31    2012      2011      2010  

AstraZeneca LP

   $ 621       $ 574       $ 546   

Other (1)

     21         36         41   
       $642       $ 610       $ 587   

 

(1)  

Primarily reflects results from Sanofi Pasteur MSD and Johnson & Johnson°Merck Consumer Pharmaceuticals Company (which was disposed of on September 29, 2011).

 

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AstraZeneca LP

In 1982, Merck entered into an agreement with Astra AB (“Astra”) to develop and market Astra products under a royalty-bearing license. In 1993, Merck’s total sales of Astra products reached a level that triggered the first step in the establishment of a joint venture business carried on by Astra Merck Inc. (“AMI”), in which Merck and Astra each owned a 50% share. This joint venture, formed in 1994, developed and marketed most of Astra’s new prescription medicines in the United States including Prilosec, the first of a class of medications known as proton pump inhibitors, which slows the production of acid from the cells of the stomach lining.

In 1998, Merck and Astra completed the restructuring of the ownership and operations of the joint venture whereby Merck acquired Astra’s interest in AMI, renamed KBI Inc. (“KBI”), and contributed KBI’s operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the “Partnership”), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AstraZeneca LP (“AZLP”) upon Astra’s 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights.

While maintaining a 1% limited partner interest in AZLP, Merck has consent and protective rights intended to preserve its business and economic interests, including restrictions on the power of the general partner to make certain distributions or dispositions. Furthermore, in limited events of default, additional rights will be granted to the Company, including powers to direct the actions of, or remove and replace, the Partnership’s chief executive officer and chief financial officer. Merck earns ongoing revenue based on sales of KBI products and such revenue was $915 million, $1.2 billion and $1.3 billion in 2012, 2011 and 2010, respectively, primarily relating to sales of Nexium, as well as Prilosec. In addition, Merck earns certain Partnership returns, which are recorded in Equity income from affiliates , as reflected in the table above. Such returns include a priority return provided for in the Partnership Agreement, a preferential return representing Merck’s share of undistributed AZLP GAAP earnings, and a variable return related to the Company’s 1% limited partner interest.

In conjunction with the 1998 restructuring discussed above, Astra purchased an option (the “Asset Option”) for a payment of $443 million, which was recorded as deferred income, to buy Merck’s interest in the KBI products, excluding the gastrointestinal medicines Nexium and Prilosec (the “Non-PPI Products”). In April 2010, AstraZeneca exercised the Asset Option. Merck received $647 million from AstraZeneca representing the net present value as of March 31, 2008 of projected future pretax revenue to be received by Merck from the Non-PPI Products, which was recorded as a reduction to the Company’s investment in AZLP. The Company recognized the $443 million of deferred income in 2010 as a component of Other (income) expense, net .

In addition, in 1998, Merck granted Astra an option to buy Merck’s common stock interest in KBI and, through it, Merck’s interest in Nexium and Prilosec as well as AZLP, exercisable in 2012. In June 2012, Merck and AstraZeneca amended the 1998 option agreement. The updated agreement eliminated AstraZeneca’s option to acquire Merck’s interest in KBI in 2012 and provides AstraZeneca a new option to acquire Merck’s interest in KBI in June 2014. As a result of the amended agreement, Merck continues to record supply sales and equity income from the partnership. In 2014, AstraZeneca has the option to purchase Merck’s interest in KBI based in part on the value of Merck’s interest in Nexium and Prilosec. AstraZeneca’s option is exercisable between March 1, 2014 and April 30, 2014. If AstraZeneca chooses to exercise this option, the closing date is expected to be June 30, 2014. Under the amended agreement, AstraZeneca will make a payment to Merck upon closing of $327 million, reflecting an estimate of the fair value of Merck’s interest in Nexium and Prilosec. This portion of the exercise price is subject to a true-up in 2018 based on actual sales from closing in 2014 to June 2018. The exercise price will also include an additional amount equal to a multiple of ten times Merck’s average 1% annual profit allocation in the partnership for the three years prior to exercise. The Company believes that it is likely that AstraZeneca will exercise its option in 2014.

 

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Summarized financial information for AZLP is as follows:

 

Years Ended December 31    2012      2011      2010  

Sales

   $ 4,694       $ 4,659       $ 4,991   

Materials and production costs

     2,177         2,023         2,568   

Other expense, net

     1,312         1,392         886   

Income before taxes (1)

     1,205         1,244         1,537   

 

December 31    2012      2011  

Current assets

   $ 3,662       $ 4,251   

Noncurrent assets

     206         250   

Current liabilities

     3,145         3,915   

 

(1)  

Merck’s partnership returns from AZLP are generally contractually determined as noted above and are not based on a percentage of income from AZLP, other than with respect to Merck’s 1% limited partnership interest.

Sanofi Pasteur MSD

In 1994, Merck and Pasteur Mérieux Connaught (now Sanofi Pasteur S.A.) established an equally-owned joint venture to market vaccines in Europe and to collaborate in the development of combination vaccines for distribution in Europe. Joint venture vaccine sales were $1.1 billion for 2012, $1.1 billion for 2011 and $1.2 billion for 2010.

Johnson & Johnson°Merck Consumer Pharmaceuticals Company

In September 2011, Merck sold its 50% interest in the Johnson & Johnson°Merck Consumer Pharmaceuticals Company (“JJMCP”) joint venture to J&J. The venture between Merck and J&J was formed in 1989 to develop, manufacture, market and distribute certain over-the-counter consumer products in the United States and Canada. Merck received a one-time payment of $175 million and recognized a pretax gain of $136 million in 2011 reflected in Other (income) expense, net . The partnership assets also included a manufacturing facility. Sales of products marketed by the joint venture were $62 million for the period from January 1, 2011 until the September 29, 2011 divestiture date and $129 million for 2010.

Investments in affiliates accounted for using the equity method, including the above joint ventures, totaled $1.3 billion at December 31, 2012 and $886 million at December 31, 2011. These amounts are reported in Other assets . Amounts due from the above joint ventures included in Deferred income taxes and other current assets were $302 million at December 31, 2012 and $276 million at December 31, 2011.

Summarized information for those affiliates (excluding AZLP disclosed separately above) is as follows:

 

Years Ended December 31    2012      2011 (1)      2010  

Sales

   $ 1,295       $ 1,331       $ 1,486   

Materials and production costs

     573         584         598   

Other expense, net

     705         642         776   

Income before taxes

     17         105         112   

 

December 31    2012      2011  

Current assets

   $ 971       $ 614   

Noncurrent assets

     112         75   

Current liabilities

     480         478   

Noncurrent liabilities

     97         140   

 

(1)

Includes information for the JJMCP joint venture until its divestiture on September 29, 2011.

 

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10.    Loans Payable, Long-Term Debt and Other Commitments

Loans payable at December 31, 2012 included $1.8 billion of notes due in 2013, $1.7 billion of commercial paper, $454 million of short-term foreign borrowings and $328 million of long-dated notes that are subject to repayment at the option of the holder. Loans payable at December 31, 2011 included $1.1 billion of commercial paper, $403 million of short-term foreign borrowings and $469 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of the commercial paper borrowings was 0.15% and 0.11% at December 31, 2012 and 2011, respectively.

Long-term debt at December 31 consisted of:

 

       2012      2011  

5.375% euro-denominated notes due 2014

   $ 2,058       $ 2,062   

6.50% notes due 2033

     1,310         1,314   

5.00% notes due 2019

     1,294         1,300   

3.875% notes due 2021

     1,147         1,147   

6.55% notes due 2037

     1,146         1,148   

6.00% notes due 2017

     1,112         1,134   

4.00% notes due 2015

     1,049         1,068   

4.75% notes due 2015

     1,044         1,064   

2.40% notes due 2022

     1,000           

1.10% notes due 2018

     998           

2.25% notes due 2016

     874         882   

5.85% notes due 2039

     749         749   

6.40% debentures due 2028

     499         499   

5.75% notes due 2036

     498         498   

5.95% debentures due 2028

     498         498   

3.60% notes due 2042

     492           

6.30% debentures due 2026

     248         248   

5.30% notes due 2013

             1,308   

4.375% notes due 2013

             508   

Other

     238         98   
     $ 16,254       $ 15,525   

Other (as presented in the table above) included $165 million and $28 million at December 31, 2012 and 2011, respectively, of borrowings at variable rates averaging 0.1% for 2012 and 0.2% for 2011. Other also included foreign borrowings of $70 million and $62 million at December 31, 2012 and 2011, respectively, at varying rates up to 8.5%.

With the exception of the 6.3% 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 September 2012, the Company closed an underwritten public offering of $2.5 billion senior unsecured notes consisting of $1.0 billion aggregate principal amount of 1.1% notes due 2018, $1.0 billion aggregate principal amount of 2.4% notes due 2022 and $500 million aggregate principal amount of 3.6% notes due 2042. Interest on the notes is payable semi-annually. The notes of each series are redeemable in whole or in part at any time at the Company’s option at varying redemption prices. Proceeds from the notes were used for general corporate purposes, including contributions to the Company’s pension plans and the repayment of outstanding commercial paper and certain debt maturities.

In connection with the Merger, effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary MSD and MSD executed a full and unconditional

 

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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 the Merger.

Certain of the Company’s borrowings require that Merck comply with financial covenants including a requirement that the Total Debt to Capitalization Ratio (as defined in the applicable agreements) not exceed 60%. At December 31, 2012, the Company was in compliance with these covenants.

The aggregate maturities of long-term debt for each of the next five years are as follows: 2013, $1.8 billion; 2014, $2.1 billion; 2015, $2.1 billion; 2016, $884 million; 2017, $1.1 billion.

In May 2012, the Company terminated its existing credit facilities and entered into a new $4.0 billion, five-year credit facility maturing in May 2017. The facility provides backup liquidity for the Company’s commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility.

Rental expense under operating leases, net of sublease income, was $396 million in 2012, $411 million in 2011 and $431 million in 2010. The minimum aggregate rental commitments under noncancellable leases are as follows: 2013, $203 million; 2014, $172 million; 2015, $146 million; 2016, $97 million; 2017, $72 million and thereafter, $145 million. The Company has no significant capital leases.

11.    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 additional matters such as antitrust actions and environmental matters. Except for the Vioxx Litigation (as defined below) for which a separate assessment is provided in this Note, in the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Company’s financial position, results of operations or cash flows.

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

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

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

Vioxx Litigation

Product Liability Lawsuits

As previously disclosed, Merck is a defendant in approximately 90 federal and state lawsuits (the “ Vioxx Product Liability Lawsuits”) alleging personal injury or economic loss as a result of the purchase or use of Vioxx . Most of the remaining cases are coordinated in a multidistrict litigation in the U.S. District Court for the Eastern District of Louisiana (the “ Vioxx MDL”) before Judge Eldon E. Fallon.

There are pending in various U.S. courts putative class actions purportedly brought on behalf of individual purchasers or users of Vioxx seeking reimbursement for alleged economic loss. In the Vioxx MDL

 

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proceeding, approximately 30 such class actions remain. In June 2010, Merck moved to strike the class claims or for judgment on the pleadings regarding the master complaint, which includes the above-referenced cases, and briefing on that motion was completed in September 2010. The Vioxx MDL court heard oral argument on Merck’s motion in October 2010 and took it under advisement.

In 2008, a Missouri state court certified a class of Missouri plaintiffs seeking reimbursement for out-of-pocket costs relating to Vioxx . On October 15, 2012, the parties executed a settlement agreement to resolve the litigation. The Company established a reserve of $39 million in the third quarter of 2012 in connection with that settlement agreement, which is the minimum amount that the Company is required to pay under the agreement. The court preliminarily approved the agreement and the class notice and claims program is underway.

In Indiana, plaintiffs filed a motion to certify a class of Indiana Vioxx purchasers in a case pending before the Circuit Court of Marion County, Indiana. That case has been dormant for several years. In April 2010, a Kentucky state court denied Merck’s motion for summary judgment and certified a class of Kentucky plaintiffs seeking reimbursement for out-of-pocket costs relating to Vioxx . The trial court subsequently entered an amended class certification order in January 2011. Merck appealed that order to the Kentucky Court of Appeals and, on February 10, 2012, the Kentucky Court of Appeals reversed the trial court’s amended class certification order and denied certification. The plaintiff petitioned the Kentucky Supreme Court to review the Court of Appeals’ order and, on November 16, 2012, the Kentucky Supreme Court granted review. Briefing before the Kentucky Supreme Court is underway.

Merck has also been named as a defendant in lawsuits brought by state Attorneys General in five states. All of these actions except for the Kentucky action are in the Vioxx MDL proceeding. These actions allege that Merck misrepresented the safety of Vioxx . These suits seek recovery for expenditures on Vioxx by government-funded health care programs, such as Medicaid, and/or penalties for alleged Consumer Fraud Act violations. The Kentucky action is currently scheduled to proceed to trial in Kentucky state court in October 2013. On January 10, 2013, Merck finalized a settlement in the action filed by the Pennsylvania Attorney General under which Merck agreed to pay Pennsylvania $8.25 million in exchange for the dismissal of its lawsuit.

Shareholder Lawsuits

As previously disclosed, in addition to the Vioxx Product Liability Lawsuits, various putative class actions and individual lawsuits under federal securities laws and state laws have been filed against Merck and various current and former officers and directors (the “ Vioxx Securities Lawsuits”). The Vioxx Securities Lawsuits are coordinated in a multidistrict litigation in the U.S. District Court for the District of New Jersey before Judge Stanley R. Chesler, and have been consolidated for all purposes. In August 2011, Judge Chesler granted in part and denied in part Merck’s motion to dismiss the Fifth Amended Class Action Complaint in the consolidated securities action. Among other things, the claims based on statements made on or after the voluntary withdrawal of Vioxx on September 30, 2004 have been dismissed. In October 2011, defendants answered the Fifth Amended Class Action Complaint. On April 10, 2012, plaintiffs filed a motion for class certification and, on January 30, 2013, Judge Chesler granted that motion. Discovery is currently proceeding in accordance with the court’s scheduling order.

As previously disclosed, several individual securities lawsuits filed by foreign institutional investors also are consolidated with the Vioxx Securities Lawsuits. In October 2011, plaintiffs filed amended complaints in each of the pending individual securities lawsuits. Also in October 2011, a new individual securities lawsuit (the “KBC Lawsuit”) was filed in the District of New Jersey by several foreign institutional investors; that case is also consolidated with the Vioxx Securities Lawsuits. On January 20, 2012, defendants filed motions to dismiss in one of the individual lawsuits (the “ABP Lawsuit”). Briefing on the motions to dismiss was completed on March 26, 2012. On August 1, 2012, Judge Chesler granted in part and denied in part the motions to dismiss the ABP Lawsuit. Among other things, certain alleged misstatements and omissions were dismissed as inactionable and all state law claims were dismissed in full. On September 15, 2012, defendants answered the complaints in all individual actions other than the KBC Lawsuit; on the same day, defendants moved to dismiss the complaint in the KBC Lawsuit on statute of limitations grounds. On December 20, 2012, Judge Chesler denied the motion to dismiss the KBC Lawsuit and, on January 4, 2013, defendants answered the complaint in the KBC Lawsuit. Discovery is currently proceeding in the individual securities lawsuits together with discovery in the class action.

 

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Insurance

The Company has Directors and Officers insurance coverage applicable to the Vioxx Securities Lawsuits with remaining stated upper limits of approximately $170 million, which is currently being used to partially fund the Company’s legal fees. As a result of the previously disclosed insurance arbitration, additional insurance coverage for these claims should also be available, if needed, under upper-level excess policies that provide coverage for a variety of risks. There are disputes with the insurers about the availability of some or all of the Company’s insurance coverage for these claims and there are likely to be additional disputes. The amounts actually recovered under the policies discussed in this paragraph may be less than the stated upper limits.

International Lawsuits

As previously disclosed, in addition to the lawsuits discussed above, Merck has been named as a defendant in litigation relating to Vioxx in Australia, Brazil, Canada, Europe and Israel (collectively, the “ Vioxx International Lawsuits”). As previously disclosed, the Company has entered into an agreement to resolve all claims related to Vioxx in Canada pursuant to which the Company will pay a minimum of approximately $21 million but not more than an aggregate maximum of approximately $36 million. The agreement is pending approval by courts in Canada’s provinces.

Reserves

The Company believes that it has meritorious defenses to the remaining Vioxx Product Liability Lawsuits, Vioxx Securities Lawsuits and Vioxx International Lawsuits (collectively, the “ Vioxx Lawsuits”) and will vigorously defend against them. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek indeterminate damages, the Company is unable to predict the outcome of these matters and, at this time, cannot reasonably estimate the possible loss or range of loss with respect to the remaining Vioxx Lawsuits. The Company has established a reserve with respect to the Canadian settlement and with respect to certain other Vioxx Product Liability Lawsuits, including the Missouri matter discussed above. The Company also has an immaterial remaining reserve relating to the previously disclosed Vioxx investigation for the non-participating states with which litigation is continuing. The Company has established no other liability reserves with respect to the Vioxx Litigation. Unfavorable outcomes in the Vioxx Litigation could have a material adverse effect on the Company’s financial position, liquidity and results of operations.

Other Product Liability Litigation

Fosamax

As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax (the “ Fosamax Litigation”). As of December 31, 2012, approximately 4,560 cases, which include approximately 5,140 plaintiff groups, had been filed and were pending against Merck in either federal or state court, including one case which seeks class action certification, as well as damages and/or medical monitoring. In approximately 1,230 of these actions, plaintiffs allege, among other things, that they have suffered osteonecrosis of the jaw (“ONJ”), generally subsequent to invasive dental procedures, such as tooth extraction or dental implants and/or delayed healing, in association with the use of Fosamax . In addition, plaintiffs in approximately 3,330 of these actions generally allege that they sustained femur fractures and/or other bone injuries (“Femur Fractures”) in association with the use of Fosamax .

Cases Alleging ONJ and/or Other Jaw Related Injuries

In August 2006, the Judicial Panel on Multidistrict Litigation (the “JPML”) ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation (the “ Fosamax ONJ MDL”) for coordinated pre-trial proceedings. The Fosamax ONJ MDL has been transferred to Judge John Keenan in the U.S. District Court for the Southern District of New York. As a result of the JPML order, approximately 960 of the cases are before Judge Keenan. In the first Fosamax ONJ MDL trial, Boles v. Merck , the Fosamax ONJ MDL court declared a mistrial because the eight person jury could not reach a unanimous verdict. The Boles case was retried in June 2010 and resulted in a verdict in favor of the plaintiff in the amount of $8 million. Merck filed post-trial motions seeking judgment as a matter of law or, in the alternative, a new trial. In October 2010, the court denied Merck’s post-trial motions but sua sponte ordered a remittitur reducing

 

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the verdict to $1.5 million. Plaintiff rejected the remittitur ordered by the court and requested a new trial on damages. Plaintiff and Merck subsequently entered into a confidential stipulation as to the amount of plaintiff’s damages that enabled Merck to appeal the underlying judgment, and Merck filed its appeal in the Boles case on October 18, 2012. Prior to 2013, three other cases were tried to verdict in the Fosamax ONJ MDL. Defense verdicts in favor of Merck were returned in each of those three cases. Plaintiffs have filed an appeal in two of the cases – Graves v. Merck and Secrest v. Merck. On January 30, 2013, the U.S. Court of Appeals for the Second Circuit affirmed the judgment in Merck’s favor in Secrest.

In February 2011, Judge Keenan ordered that there will be two further bellwether trials conducted in the Fosamax ONJ MDL. Spano v. Merck and Jellema v. Merck were selected by the court to be tried in 2012, but each case was dismissed by the plaintiffs. On March 28, 2012, the court selected Scheinberg v. Merck as the next case to be tried. Trial in the Scheinberg case began on January 14, 2013 and, on February 5, 2013, the jury returned a mixed verdict finding in favor of Merck on plaintiff’s design defect claim and finding in favor of plaintiff on her failure to warn claim awarding her $285 thousand in compensatory damages.

Outside the Fosamax ONJ MDL, in Florida, Carballo v. Merck was set for trial on October 15, 2012, but plaintiff dismissed the case and refiled it in the Fosamax ONJ MDL. Anderson v. Merck had been set for trial on January 14, 2013, but plaintiff dismissed the case prior to trial.

In addition, in July 2008, an application was made by the Atlantic County Superior Court of New Jersey requesting that all of the Fosamax cases pending in New Jersey be considered for mass tort designation and centralized management before one judge in New Jersey. In October 2008, the New Jersey Supreme Court ordered that all pending and future actions filed in New Jersey arising out of the use of Fosamax and seeking damages for existing dental and jaw-related injuries, including ONJ, but not solely seeking medical monitoring, be designated as a mass tort for centralized management purposes before Judge Carol E. Higbee in Atlantic County Superior Court. As of December 31, 2012, approximately 260 ONJ cases were pending against Merck in Atlantic County, New Jersey. In July 2009, Judge Higbee entered a Case Management Order (and various amendments thereto) setting forth a schedule that contemplates completing fact and expert discovery in an initial group of cases to be reviewed for trial. In February 2011, the jury in Rosenberg v. Merck , the first trial in the New Jersey coordinated proceeding, returned a verdict in Merck’s favor. In April 2012, the jury in Sessner v. Merck , the second case tried in New Jersey, also returned a verdict in Merck’s favor. Plaintiffs have filed an appeal in both cases.

In California, the parties are reviewing the claims of two plaintiffs in the Carrie Smith, et al. v. Merck case and the claims in Pedrojetti v. Merck . The cases of one or more of these plaintiffs may be tried in 2013.

Discovery is ongoing in the Fosamax ONJ MDL litigation, the New Jersey coordinated proceeding, and the remaining jurisdictions where Fosamax ONJ cases are pending. The Company intends to defend against these lawsuits.

Cases Alleging Femur Fractures

In March 2011, Merck submitted a Motion to Transfer to the JPML seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. The Motion to Transfer was granted in May 2011, and all federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (the “ Fosamax Femur Fracture MDL”). As a result of the JPML order, approximately 820 cases were pending in the Fosamax Femur Fracture MDL as of December 31, 2012. A Case Management Order has been entered that requires the parties to review 40 cases (later reduced to 33 cases). Judge Joel Pisano has selected four cases from that group to be tried as the initial bellwether cases in the Fosamax Femur Fracture MDL and has set an April 8, 2013 trial date for the first bellwether case, which will be Glynn v. Merck . The Zessin v. Merck case is set to be tried in September 2013; the Young v. Merck case is set to be tried in January 2014; and the Johnson v. Merck case is set to be tried in May 2014.

As of December 31, 2012, approximately 2,075 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge Higbee in Atlantic County Superior Court. The parties have selected an initial group of 30 cases to be reviewed through fact discovery. Judge Higbee has set March 11, 2013 as the date for the first trial of the New Jersey state Femur Fracture cases, which will be Su v. Merck .

 

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As of December 31, 2012, approximately 420 cases alleging Femur Fractures have been filed in California state court. A petition was filed seeking to coordinate all Femur Fracture cases filed in California state court before a single judge in Orange County, California. The petition was granted and Judge Steven Perk is now presiding over the coordinated proceedings. No scheduling order has yet been entered.

Additionally, there are eight Femur Fracture cases pending in other state courts. A trial date has been set for August 12, 2013 for the Barnes v. Merck case pending in Alabama state court.

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

NuvaRing

As previously disclosed, beginning in May 2007, a number of complaints were filed in various jurisdictions asserting claims against the Company’s subsidiaries Organon USA, Inc., Organon Pharmaceuticals USA, Inc., Organon International (collectively, “Organon”), and the Company arising from Organon’s marketing and sale of NuvaRing , a combined hormonal contraceptive vaginal ring. The plaintiffs contend that Organon and Schering-Plough, among other things, failed to adequately design and manufacture NuvaRing and failed to adequately warn of the alleged increased risk of venous thromboembolism (“VTE”) posed by NuvaRing , and/or downplayed the risk of VTE. The plaintiffs seek damages for injuries allegedly sustained from their product use, including some alleged deaths, heart attacks and strokes. The majority of the cases are currently pending in a federal multidistrict litigation (the “ NuvaRing MDL”) venued in Missouri and in a coordinated proceeding in New Jersey state court.

As of December 31, 2012, there were approximately 1,315 NuvaRing cases. Of these cases, approximately 1,105 are or will be pending in the NuvaRing MDL in the U.S. District Court for the Eastern District of Missouri before Judge Rodney Sippel, and approximately 200 are pending in coordinated discovery proceedings in the Bergen County Superior Court of New Jersey before Judge Brian R. Martinotti. Five additional cases are pending in various other state courts.

Pursuant to orders of Judge Sippel in the NuvaRing MDL, the parties originally selected a pool of more than 20 cases to prepare for trial and that pool has since been narrowed to eight cases from which the first trials in the NuvaRing MDL will be selected. The first NuvaRing MDL trial is expected to take place in the summer of 2013. Pursuant to Judge Martinotti’s order in the New Jersey proceeding, the parties selected nine trial pool cases to be prepared for trial and the first trial is expected to commence in May 2013. The parties have completed fact discovery in the originally selected trial pool cases in each jurisdiction and expert discovery has been completed in those first trial pool cases. Certain replacement trial pool cases remain in fact discovery.

The Company has filed motions related to the admissibility of expert testimony and motions for summary judgment. The Company expects substantive hearings on the motions for summary judgment to take place in the New Jersey cases in early 2013, followed by substantive hearings on the admissibility of expert testimony after the resolution of the summary judgment motions. The Company expects substantive hearings on the motions for summary judgment in the NuvaRing MDL cases to take place in spring 2013, followed by hearings on the admissibility of expert testimony. The Company has certain insurance coverage available to it, which is currently being used to partially fund the Company’s legal fees. The Company intends to defend against these lawsuits.

Propecia/Proscar

As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar . As of December 31, 2012, approximately 385 lawsuits involving a total of approximately 550 plaintiffs (in a few instances spouses are joined in the suits) who allege that they have experienced persistent sexual side effects following cessation of treatment with Propecia and/or Proscar have been filed against Merck. The lawsuits, which are in their early stages, have been filed in various federal courts and in state court in New Jersey. The federal lawsuits have been consolidated for pretrial purposes in a federal MDL before Judge John Gleeson of the Eastern District of New York. The matters pending in state court in New Jersey have been consolidated before Judge Jessica Mayer in Middlesex County. The Company intends to defend against these lawsuits.

 

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Vytorin/Zetia Litigation

As previously disclosed, in April 2008, a Merck shareholder filed a putative class action lawsuit in federal court which has been consolidated in the District of New Jersey with another federal securities lawsuit under the caption In re Merck & Co., Inc. Vytorin Securities Litigation . An amended consolidated complaint was filed in October 2008 and named as defendants Merck; Merck/Schering-Plough Pharmaceuticals, LLC; and certain of the Company’s current and former officers and directors. The complaint alleges that Merck delayed releasing unfavorable results of the ENHANCE clinical trial regarding the efficacy of Vytorin and that Merck made false and misleading statements about expected earnings, knowing that once the results of the ENHANCE study were released, sales of Vytorin would decline and Merck’s earnings would suffer. In December 2008, Merck and the other defendants moved to dismiss this lawsuit on the grounds that the plaintiffs failed to state a claim for which relief can be granted. In September 2009, the court denied defendants’ motion to dismiss. On March 1, 2012, defendants filed a motion for summary judgment. On September 25, 2012, the court granted lead plaintiffs’ amended motion for class certification and denied defendants’ motion for summary judgment. On February 13, 2013, Merck announced that it had reached an agreement in principle with plaintiffs to settle this matter for $215 million. The settlement is subject to court approval. The proposed settlement has been reflected in the Company’s 2012 financial results as discussed below.

There is a similar consolidated, putative class action securities lawsuit pending in the District of New Jersey, filed by a Schering-Plough shareholder against Schering-Plough and its former Chairman, President and Chief Executive Officer, Fred Hassan, under the caption In re Schering-Plough Corporation/ENHANCE Securities Litigation . The amended consolidated complaint was filed in September 2008 and names as defendants Schering-Plough; Merck/Schering-Plough Pharmaceuticals, LLC; certain of the Company’s current and former officers and directors; and underwriters who participated in an August 2007 public offering of Schering-Plough’s common and preferred stock. In December 2008, Schering-Plough and the other defendants filed motions to dismiss this lawsuit on the grounds that the plaintiffs failed to state a claim for which relief can be granted. In September 2009, the court denied defendants’ motions to dismiss. On March 1, 2012, the Schering-Plough defendants filed a motion for partial summary judgment and the underwriter defendants filed a motion for summary judgment. On September 25, 2012, the court granted lead plaintiffs’ amended motion for class certification and denied defendants’ motions for summary judgment. On February 13, 2013, Merck announced that it had reached an agreement in principle with plaintiffs to settle this matter for $473 million. The settlement is subject to court approval. If approved, this settlement will exhaust the remaining Directors and Officers insurance coverage applicable to the Vytorin lawsuits brought by the legacy Schering-Plough shareholders. The proposed settlement has been reflected in the Company’s 2012 financial results and, together with the settlement described in the preceding paragraph, resulted in an aggregate charge of $493 million after taking into account anticipated insurance recoveries of $195 million.

Governmental Proceedings

As previously disclosed, Merck has received a Civil Investigative Demand (“CID”) issued by the Department of Justice (the “DOJ”) addressed to Inspire, a company acquired by Merck in May 2011. The CID advises that it relates to a False Claims Act investigation concerning allegations that Inspire caused the submission of false claims to federal health benefits programs for the drug AzaSite by marketing it for the treatment of indications not approved by the FDA. The Company is cooperating with the DOJ in its investigation.

As previously disclosed, the Company received a subpoena from the U.S. Attorney’s Office for the Eastern District of California in 2010 requesting information in a civil federal health care investigation relating to the Company’s marketing and selling activities with respect to Integrilin and Avelox from January 2003 to June 2010. In December 2012, the U.S. District Court for the Eastern District of California unsealed a complaint that a former employee of the Company had filed against it in 2009 under the federal False Claims Act and the False Claims Acts of various states. The complaint alleges that the Company caused false claims to be made to federal and state health care programs by promoting Integrilin for unapproved indications and providing unlawful payments and benefits to physicians and others to increase the utilization of Integrilin and Avelox . The federal government and the states under whose statutes the suit was filed each had the right, after investigating these allegations, to intervene in this suit and assume responsibility for its direction, but each of them has notified the court that they decline to intervene. The Company intends to defend against the suit.

 

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The Company has also previously disclosed that it has received a subpoena requesting information related to the Company’s marketing and selling activities with respect to Temodar , PegIntron and Intron A , from January 1, 2004 to the present, in a federal health care investigation under criminal statutes. The Company has been informed by the U.S. Attorney’s Office for the District of Massachusetts that this subpoena will not be enforced and that no further action on the Company’s part is required.

As previously disclosed, the Company has received letters from the DOJ and the SEC that seek information about activities in a number of countries and reference the Foreign Corrupt Practices Act. The Company is cooperating with the agencies in their requests and believes that this inquiry is part of a broader review of pharmaceutical industry practices in foreign countries. In that regard, the Company has received and may continue to receive additional requests for information from either or both of the DOJ and the SEC.

As previously disclosed, on June 21, 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Company’s M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit, but has 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, a putative class action lawsuit has been filed against the Company in the Eastern District of Pennsylvania on behalf of direct purchasers of the M-M-R II vaccine which is predicated on the allegations in the False Claims Act complaint and charges 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. The Company intends to defend against these lawsuits.

Commercial Litigation

AWP Litigation

As previously disclosed, the Company and/or certain of its subsidiaries remain defendants in cases brought by various states alleging manipulation by pharmaceutical manufacturers of Average Wholesale Prices (“AWP”), which are sometimes used by public and private payors in calculating provider reimbursement levels. The outcome of these lawsuits could include substantial damages, the imposition of substantial fines and penalties and injunctive or administrative remedies.

Since the start of 2012, the Company has settled certain AWP cases brought by the states of Alabama, Alaska, Kansas, Kentucky, Louisiana, Oklahoma, and Mississippi. The Company and/or certain of its subsidiaries continue to be defendants in cases brought by six states.

The Company has also been reinstated as a defendant in a putative class action in New Jersey Superior Court which alleges on behalf of third-party payers and individuals that manufacturers inflated drug prices by manipulation of AWPs and other means. This case was originally dismissed against the Company without prejudice in 2007. The Company intends to defend against this lawsuit.

K-DUR Antitrust Litigation

As previously disclosed, in June 1997 and January 1998, Schering-Plough settled patent litigation with Upsher-Smith, Inc. (“Upsher-Smith”) and ESI Lederle, Inc. (“Lederle”), respectively, relating to generic versions of K-DUR, Schering-Plough’s long-acting potassium chloride product supplement used by cardiac patients, for which Lederle and Upsher-Smith had filed Abbreviated New Drug Applications (“ANDAs”). Following the commencement of an administrative proceeding by the U.S. Federal Trade Commission (the “FTC”) in 2001 alleging anti-competitive effects from those settlements (which has been resolved in Schering-Plough’s favor), putative class and non-class action suits were filed on behalf of direct and indirect purchasers of K-DUR against Schering-Plough, Upsher-Smith and Lederle and were consolidated in a multi-district litigation in the U.S. District Court for the District of New Jersey. These suits claimed violations of federal and state antitrust laws, as well as other state statutory and common law causes of action, and sought unspecified damages. In April 2008, the indirect purchasers voluntarily dismissed their case. In March 2010, the District Court granted summary judgment to the defendants on the remaining lawsuits and dismissed the matter in its entirety. However, in July 2012, the 3rd Circuit

 

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Court of Appeals reversed the District Court’s judgment and remanded the case for further proceedings. At the same time, the 3rd Circuit upheld a December 2008 decision by the District Court to certify certain direct purchaser plaintiffs’ claims as a class action.

In August 2012, the Company filed a petition for certiorari with the U.S. Supreme Court seeking review of the Third Circuit’s reversal of summary judgment. The Supreme Court has taken no action on that petition, but in December 2012 it granted certiorari in an unrelated case in which the 11th Circuit Court of Appeals reached a decision that appears in conflict with the 3rd Circuit’s holding in the Company’s case. The Company expects that the issue it sought to raise with the Supreme Court will be resolved by the Supreme Court’s pending decision in this 11th Circuit case.

Nexium Antitrust Litigation

As previously disclosed, in September 2012, the Company and certain of its subsidiaries were among the defendants named in a putative class action lawsuit brought on behalf of direct purchasers of Nexium in federal court in New Jersey. The lawsuit alleges violations of federal antitrust law arising from settlements reached by and among the defendants to resolve certain patent litigation relating to the entry of generic esomeprazole on the U.S. market. Specifically, the plaintiffs contend that these settlements had the effect of impermissibly delaying the entry of generic esomeprazole in the United States and extending the monopoly power of Nexium, leading to higher average market prices. On January 8, 2013, the Company and its subsidiaries were dismissed without prejudice from the lawsuit.

Coupon Litigation

As previously disclosed, since March 2012, a number of private health plans have filed separate putative class action lawsuits against the Company alleging that Merck’s coupon programs injured health insurers by reducing beneficiary co-payment amounts, thereby allegedly causing beneficiaries to purchase higher-priced drugs than they otherwise would have purchased and increasing the insurers’ reimbursement costs. The actions, which are pending in the U.S. District Court for the District of New Jersey, seek damages and injunctive relief barring the Company from issuing coupons that would reduce beneficiary co-pays on behalf of putative nationwide classes of health insurers. Similar actions relating to manufacturer coupon programs have been filed against several other pharmaceutical manufacturers in a variety of federal courts. The Company intends to defend against these lawsuits.

Patent Litigation

From time to time, generic manufacturers of pharmaceutical products file ANDAs 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. Certain products of the Company (or marketed via agreements with other companies) currently involved in such patent infringement litigation in the United States include: AzaSite, Emend for Injection, Integrilin, Nasonex , Nexium, Vytorin and Zetia . Similar lawsuits defending the Company’s patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by generic companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through mergers and acquisitions, potentially significant intangible asset impairment charges.

AzaSite — In May 2011, a patent infringement lawsuit was filed in the United States against Sandoz Inc. (“Sandoz”) in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to market a generic version of AzaSite. The lawsuit automatically stays FDA approval of Sandoz’s ANDA until October 2013 or until an adverse court decision, if any, whichever may occur earlier.

Emend for Injection — In May 2012, a patent infringement lawsuit was filed in the United States against Sandoz in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to market a generic version of Emend for Injection. The lawsuit automatically stays FDA approval of Sandoz’s ANDA until July 2015 or until an adverse court decision, if any, whichever may occur earlier. In June 2012, a patent infringement lawsuit was filed in the United States against Accord Healthcare, Inc. US, Accord Healthcare, Inc. and Intas

 

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Pharmaceuticals Ltd (collectively, “Intas”) in respect of Intas’ application to the FDA seeking pre-patent expiry approval to market a generic version of Emend for Injection. The lawsuit automatically stays FDA approval of Intas’ ANDA until July 2015 or until an adverse court decision, if any, whichever may occur earlier.

Integrilin — In February 2009, a patent infringement lawsuit was filed (jointly with Millennium Pharmaceuticals, Inc.) in the United States against Teva Parenteral Medicines, Inc. (“TPM”) in respect of TPM’s application to the FDA seeking approval to sell a generic version of Integrilin prior to the expiry of the last to expire listed patent. In October 2011, the parties entered a settlement agreement allowing TPM to sell a generic version of Integrilin beginning June 2, 2015. In November 2012, a patent infringement lawsuit was filed against APP Pharmaceuticals, Inc. and Fresenius Kabi USA Inc. (collectively “APP”) in respect of APP’s application to the FDA seeking approval to sell a generic version of Integrilin prior to the expiry of the last to expire listed patent. The lawsuit automatically stays FDA approval of APP’s ANDA until April 2015 or until an adverse court decision, if any, whichever may occur earlier.

Nasonex  — In December 2009, a patent infringement lawsuit was filed in the United States against Apotex Corp. (“Apotex”) in respect of Apotex’s application to the FDA seeking pre-patent expiry approval to market a generic version of Nasonex . A trial in this matter was held in April 2012. A decision was issued on June 15, 2012, holding that the Merck patent covering mometasone furoate monohydrate was valid, but that it was not infringed by Apotex’s proposed product. The finding of non-infringement is under appeal.

Nexium   — Patent infringement lawsuits were brought (jointly with AstraZeneca) in the United States against the following generic companies: Ranbaxy Laboratories Ltd., IVAX Pharmaceuticals, Inc. (later acquired by Teva Pharmaceuticals, Inc. (“Teva”)), Dr. Reddy’s Laboratories, Sandoz, Lupin Ltd., Hetero Drugs Limited Unit III and Torrent Pharmaceuticals Ltd. in response to each generic company’s application seeking pre-patent expiry approval to sell a generic version of Nexium. Settlements have been reached in each of these lawsuits, the terms of which provide that the respective generic company may bring a generic version of esomeprazole product to market on May 27, 2014. In addition, a patent infringement lawsuit was also filed (jointly with AstraZeneca) in February 2010 in the United States against Sun Pharma Global Fze (“Sun Pharma”) in respect of its application to the FDA seeking pre-patent expiry approval to sell a generic version of Nexium IV, which lawsuit was settled with an agreement which provides that Sun Pharma will be entitled to bring its generic esomeprazole IV product to market in the United States on January 1, 2014. Finally, additional patent infringement lawsuits have been filed (jointly with AstraZeneca) in the United States against Hamni USA, Inc. (“Hamni”) and Mylan Laboratories Limited (“Mylan Labs”) related to their applications to the FDA seeking pre-patent expiry approval to sell generic versions of Nexium. The Hamni and Mylan Labs applications to the FDA remain stayed until May 2013 and August 2014, respectively, or until earlier adverse court decisions, if any, whichever may occur earlier.

Vytorin  — In December 2009, a patent infringement lawsuit was filed in the United States against Mylan Pharmaceuticals, Inc. (“Mylan”) in respect of Mylan’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Vytorin . A trial against Mylan jointly in respect of Zetia and Vytorin was conducted in December 2011. In April 2012, the court issued a decision finding the patent valid and enforceable. Accordingly, Mylan’s ANDA will not be approvable until April 25, 2017. On February 7, 2013, the Court of Appeals for the Federal Circuit affirmed the lower court decision. In February 2010, a patent infringement lawsuit was filed in the United States against Teva in respect of Teva’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Vytorin . In July 2011, the patent infringement lawsuit was dismissed and Teva agreed not to sell generic versions of Zetia or Vytorin until the Company’s exclusivity rights expire on April 25, 2017, except in certain circumstances. In August 2010, a patent infringement lawsuit was filed in the United States against Impax Laboratories Inc. (“Impax”) in respect of Impax’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Vytorin . An agreement was reached with Impax to stay the lawsuit pending the outcome of the lawsuit with Mylan. In October 2011, a patent infringement lawsuit was filed in the United States against Actavis Inc. (“Actavis”) in respect to Actavis’ application to the FDA seeking pre-patent expiry approval to sell a generic version of Vytorin . An agreement was reached with Actavis to stay the lawsuit pending the outcome of the lawsuit with Mylan.

Zetia —  In March 2007, a patent infringement lawsuit was filed in the United States against Glenmark Pharmaceuticals Inc., USA and its parent corporation (collectively, “Glenmark”) in respect of Glenmark’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Zetia . In May 2010,

 

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Glenmark agreed to a settlement by virtue of which Glenmark will be permitted to launch its generic product in the United States on December 12, 2016, subject to receiving final FDA approval. In June 2010, a patent infringement lawsuit was filed in the United States against Mylan in respect of Mylan’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Zetia . A trial against Mylan jointly in respect of Zetia and Vytorin was conducted in December 2011. In April 2012, the court issued a decision finding the patent valid and enforceable. Accordingly, Mylan’s ANDA will not be approvable until April 25, 2017. On February 7, 2013, the Court of Appeals for the Federal Circuit affirmed the lower court decision. In September 2010, a patent infringement lawsuit was filed in the United States against Teva in respect of Teva’s application to the FDA seeking pre-patent expiry approval to sell a generic version of Zetia . In July 2011, the patent infringement lawsuit was dismissed without any rights granted to Teva. In September 2012, a patent infringement suit was filed in the United States against Sandoz in respect of Sandoz’s application to the FDA seeking pre-patent expiry approval to market a generic version of Zetia . The lawsuit automatically stays FDA approval of Sandoz’s ANDA until February 2015 or until an adverse court decision, if any, whichever may occur earlier.

Environmental Litigation

As previously disclosed, approximately 2,200 plaintiffs filed an amended complaint against Merck and 12 other defendants in U.S. District Court, Eastern District of California asserting claims under the Clean Water Act, the Resource Conservation and Recovery Act, as well as negligence and nuisance. The suit seeks damages for personal injury, diminution of property value, medical monitoring and other alleged real and personal property damage associated with groundwater, surface water and soil contamination found at the site of a former Merck subsidiary in Merced, California. Certain of the other defendants in this suit have settled with plaintiffs regarding some or all aspects of plaintiffs’ claims. This lawsuit is proceeding in a phased manner. A jury trial commenced in February 2011 during which a jury was asked to make certain factual findings regarding whether contamination moved off-site to any areas where plaintiffs could have been exposed to such contamination and, if so, when, where and in what amounts. Defendants in this “Phase 1” trial included Merck and three of the other original 12 defendants. In March 2011, the Phase 1 jury returned a mixed verdict, finding in favor of Merck and the other defendants as to some, but not all, of plaintiffs’ claims. Specifically, the jury found that contamination from the site did not enter or affect plaintiffs’ municipal water supply wells or any private domestic wells. The jury found, however, that plaintiffs could have been exposed to contamination via air emissions prior to 1994, as well as via surface water in the form of storm drainage channeled into an adjacent irrigation canal, including during a flood in April 2006. In response to post-trial motions by Merck and other defendants, on September 7, 2011, the court entered an order setting aside a part of the Phase 1 jury’s findings that had been in favor of plaintiffs. Specifically, the court held that plaintiffs could not have been exposed to any contamination in surface or flood water during the April 2006 flood or, in fact, at any time later than 1991. Merck’s motion for reconsideration of the remainder of the jury’s Phase I verdict that was adverse to Merck was denied. Following the retirement of the judge handling this case, on September 21, 2011, the case was assigned to Judge David O. Carter of the U.S. District Court for the Central District of California. Judge Carter selected 10 plaintiffs whose claims would be reviewed and, depending on the outcome of Merck’s summary judgment motions, possibly tried in early 2013. Plaintiffs subsequently withdrew the claim of one of those 10 plaintiffs, leaving nine whose claims may proceed to trial. The court has dismissed the claims of 1,083 of the plaintiffs in this action whose claims were precluded by aspects of the Phase I jury findings and the court’s subsequent orders. Subject to the court’s anticipated rulings on defendants’ potentially dispositive summary judgment and other pre-trial motions, trial of the nine selected trial plaintiffs’ claims is anticipated to begin near the end of March 2013.

Other Litigation

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

 

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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, 2012 and December 31, 2011 of approximately $260 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 position, results of operations, liquidity or capital resources of the Company. The Company has taken an active role in identifying and providing 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 $145 million and $171 million at December 31, 2012 and 2011, respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $112 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Company’s financial position, results of operations, liquidity or capital resources for any year.

12.    Equity

The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Of the authorized shares of preferred stock, there was a series of 11,500,000 shares which was designated as 6% mandatory convertible preferred stock.

 

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Capital Stock

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

 

     2012     2011     2010  
       Common
Stock
     Treasury
Stock
    Common
Stock
     Treasury
Stock
    Common
Stock
     Treasury
Stock
 

Balance January 1

     3,577         536        3,577         495        3,563         454   

Purchases of treasury stock

             62                58                47   

Issuances (1)

             (48             (17     10         (6

Mandatory conversion of 6% convertible preferred stock (2)

                                   4           

Balance December 31

     3,577         550        3,577         536        3,577         495   

 

(1)

Issuances primarily reflect activity under share-based compensation plans.

 

(2)

In 2010, the remaining outstanding 6% mandatory convertible preferred stock not converted in connection with the Merger automatically converted by its terms into the right to receive cash and shares of Merck common stock. As a result of the conversion, approximately $72 million was paid to the holders and approximately 4 million Merck common shares were issued.

Noncontrolling Interests

In connection with the 1998 restructuring of AMI, Merck assumed $2.4 billion par value preferred stock with a dividend rate of 5% per annum, which is carried by KBI and included in Noncontrolling interests . If AstraZeneca exercises its option to acquire Merck’s interest in AZLP (see Note 9) this preferred stock obligation will be retired.

13.    Share-Based Compensation Plans

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

At December 31, 2012, 180 million shares collectively were authorized for future grants under the Company’s share-based compensation plans. These awards are settled primarily with treasury shares.

Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three-year period, with a contractual term of 7-10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Company’s stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Company’s performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Company’s stock price. For RSUs and certain PSUs granted before December 31, 2009 employees participate in dividends on the same basis as common shares and such dividends are nonforfeitable by the holder. For RSUs and PSUs issued on or after January 1, 2010, 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, generally three years, subject to the terms applicable to such awards.

Total pretax share-based compensation cost recorded in 2012, 2011 and 2010 was $335 million, $369 million and $509 million, respectively, with related income tax benefits of $105 million, $118 million and $173 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 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 2012, 2011 and 2010 was $39.51, $36.47 and $34.30 per option, respectively. The weighted average fair value of options granted in 2012, 2011 and 2010 was $5.47, $5.39 and $7.99 per option, respectively, and were determined using the following assumptions:

 

Years Ended December 31    2012     2011     2010  

Expected dividend yield

     4.4     4.3     4.1

Risk-free interest rate

     1.3     2.5     2.8

Expected volatility

     25.2     23.4     33.7

Expected life (years)

     7.0        7.0        6.8   

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
     Aggregate
Intrinsic
Value
 

Outstanding January 1, 2012

     230,760      $ 39.51         

Granted

     7,641        39.51         

Exercised

     (44,177     29.64         

Forfeited

     (28,283     55.20                     

Outstanding December 31, 2012

     165,941      $ 39.46         3.90       $ 762   

Exercisable December 31, 2012

     149,407      $ 39.64         3.45       $ 700   

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

 

Years Ended December 31    2012      2011      2010  

Total intrinsic value of stock options exercised

   $ 528       $ 125       $ 177   

Fair value of stock options vested

     80         189         290   

Cash received from the exercise of stock options

     1,310         321         363   

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, 2012

     21,145      $ 33.73         1,513      $ 31.58   

Granted

     6,899        39.45         996        35.35   

Vested

     (4,340     28.43         (756     31.52   

Forfeited

     (961     36.02         (105     33.38   

Nonvested December 31, 2012

     22,743      $ 36.38         1,648      $ 33.78   

 

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At December 31, 2012, there was $370 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 1.8 years. For segment reporting, share-based compensation costs are unallocated expenses.

14.    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 December 2011, the Compensation and Benefits Committee of the Company’s Board of Directors approved management’s proposal to change Merck’s primary U.S. defined benefit pension plans’ benefit formulas to “cash balance” formulas beginning for service on or after January 1, 2013. Active participants in these plans as of December 31, 2012 are accruing pension benefits prospectively using the new cash balance formulas based on age, service, pay and interest. However, during a transition period from January 1, 2013 through December 31, 2019, participants will earn the greater of the benefit as calculated under the employee’s legacy final average pay formula or their new cash balance formula. For all years of service after December 31, 2019, participants will earn future benefits under only the cash balance formula.

In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. In December 2011, the Company approved changes to its U.S. retiree healthcare plans, including changes for certain employees to the contribution subsidy level and eligibility criteria for subsidized retiree medical coverage and the elimination of certain retiree dental coverage.

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 for pension and other postretirement benefit plans consisted of the following components:

 

     Pension Benefits     Other Postretirement Benefits  
Years Ended December 31    2012     2011     2010       2012         2011         2010    

Service cost

   $ 555      $ 619      $ 584      $ 82      $ 110      $ 108   

Interest cost

     661        718        688        121        141        148   

Expected return on plan assets

     (970     (972     (891     (136     (142     (132

Net amortization

     185        201        148        (35     (17     8   

Termination benefits

     27        59        54        18        29        42   

Curtailments

     (10     (86     (50     (7     1        (10

Settlements

     18        4        (1                     

Net periodic benefit cost

   $ 466      $ 543      $ 532      $ 43      $ 122      $ 164   

The decline in net periodic benefit cost for pension and other postretirement benefit plans in 2012 as compared with 2011 and 2010 is largely attributable to the benefit plan design changes discussed above. The changes to Merck’s primary U.S. defined benefit pension plans and U.S. retiree healthcare plans reduced benefit obligations at December 31, 2011 by $752 million and $150 million, respectively, with a corresponding offset to AOCI , which is being amortized as reduction to net periodic benefit cost over the employees’ future service period (approximately 11 years).

The net periodic benefit cost attributable to U.S. pension plans included in the above table was $268 million in 2012, $406 million in 2011 and $289 million in 2010.

In connection with restructuring actions (see Note 3), termination charges were recorded in 2012, 2011 and 2010 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 in 2012, 2011 and 2010 on pension and other postretirement benefit plans.

In addition, settlements were recorded in 2012, 2011 and 2010 on certain domestic and international pension plans.

 

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Obligations and Funded Status

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

 

     Pension Benefits     Other
Postretirement
Benefits
 
       2012     2011     2012     2011  

Fair value of plan assets January 1

   $ 12,481      $ 12,705      $ 1,628      $ 1,685   

Actual return on plan assets

     1,739        6        200        (20

Company contributions

     1,853        556        48        58   

Mergers, acquisitions and divestitures

            (202              

Effects of exchange rate changes

     3        56                 

Benefits paid

     (673     (581     (115     (95

Settlements

     (75     (78              

Other

     21        19        (1       

Fair value of plan assets December 31

   $ 15,349      $ 12,481      $ 1,760      $ 1,628   

Benefit obligation January 1

     14,416        13,978        2,529        2,745   

Service cost

     555        619        82        110   

Interest cost

     661        718        121        141   

Mergers, acquisitions and divestitures

            (180              

Actuarial losses (gains)

     2,660        688        88        (266

Benefits paid

     (673     (581     (115     (95

Effects of exchange rate changes

     67        53               (3

Plan amendments

     2        (763     (86     (150

Curtailments

     (17     (150     1        16   

Termination benefits

     27        59        18        29   

Settlements

     (75     (78              

Other

     23        53        12        2   

Benefit obligation December 31

   $ 17,646      $ 14,416      $ 2,650      $ 2,529   

Funded status December 31

   $ (2,297   $ (1,935   $ (890   $ (901

Recognized as:

        

Other assets

   $ 355      $ 669      $ 506      $ 391   

Accrued and other current liabilities

     (50     (81     (9     (10

Deferred income taxes and noncurrent liabilities

     (2,602     (2,523     (1,387     (1,282

 

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The fair value of U.S. pension plan assets included in the preceding table was $8.7 billion and $6.8 billion at December 31, 2012 and 2011, respectively, and the projected benefit obligation of U.S. pension plans was $10.0 billion and $8.7 billion, respectively. Approximately 44% and 40% of the Company’s pension projected benefit obligation at December 31, 2012 and 2011, respectively, relates to international defined benefit plans, of which each individual plan is not significant relative to the total projected benefit obligation.

At December 31, 2012 and 2011, the accumulated benefit obligation was $15.9 billion and $12.9 billion, respectively, for all pension plans, of which $9.0 billion and $7.8 billion, respectively, related to U.S. pension plans.

For pension plans with projected benefit obligations in excess of plan assets at December 31, 2012 and 2011, the fair value of plan assets was $12.8 billion and $9.3 billion, respectively, and the benefit obligations were $15.5 billion and $11.9 billion, respectively. For those plans with accumulated benefit obligations in excess of plan assets at December 31, 2012 and 2011, the fair value of plan assets was $6.1 billion and $3.6 billion, respectively, and the accumulated benefit obligations were $7.7 billion and $5.4 billion, respectively.

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, 2012 and 2011, $692 million and $637 million, respectively, or approximately 5% of the Company’s pension investments at each year end, 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  
      Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
    Total     Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
    Total  
      2012             2011          
Assets                                                                

Cash and cash equivalents

  $ 142      $ 587      $      $ 729      $ 93      $ 217      $      $ 310   

Investment funds

               

U.S. large cap equities

    63        2,899               2,962        65        2,226               2,291   

U.S. small/mid cap equities

    10        954               964        9        710               719   

Non-U.S. developed markets equities

    610        2,133               2,743        390        1,735               2,125   

Non-U.S. emerging markets equities

    121        771               892        82        575               657   

Government and agency obligations

    279        720               999        119        632               751   

Corporate obligations

    166        94               260        112        193               305   

Fixed income obligations

    14        206               220               144               144   

Real estate (1)

    4        14        141        159               9        144        153   

Equity securities

               

U.S. large cap

    351                      351        330                      330   

U.S. small/mid cap

    1,258                      1,258        1,085                      1,085   

Non-U.S. developed markets

    668                      668        623                      623   

Fixed income securities

               

Government and agency obligations

    2        1,052               1,054               1,248               1,248   

Corporate obligations

           1,008               1,008               703               703   

Mortgage and asset-backed securities

           269               269               275               275   

Other investments

               

Insurance contracts (2)

           117        496        613               138        428        566   

Derivatives

           162               162               141               141   

Other

           53        55        108        3        42        65        110   

Liabilities

                                                               

Derivatives

  $      $ 70      $      $ 70      $      $ 55      $      $ 55   
    $ 3,688      $ 10,969      $ 692      $ 15,349      $ 2,911      $ 8,933      $ 637      $ 12,481   

 

(1)  

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

 

(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:

 

     2012     2011  
       Insurance
Contracts
    Real
Estate
    Other     Total     Insurance
Contracts
    Real
Estate
    Other     Total  

Balance January 1

   $ 428      $ 144      $ 65      $ 637      $ 420      $ 165      $ 63      $ 648   

Actual return on plan assets:

                

Relating to assets still held at December 31

     35        20        (2     53        16        (7     (2     7   

Relating to assets sold during the year

     1        (12     5        (6     1               4        5   

Purchases

     21               4        25        19        13        (3     29   

Sales

     (11     (1     (14     (26     (28     (27     3        (52

Transfers to Level 3

     22        (10     (3     9                               

Balance December 31

   $ 496      $ 141      $ 55      $ 692      $ 428      $ 144      $ 65      $ 637   

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

 

    Fair Value Measurements Using     Fair Value Measurements Using  
      Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
    Total     Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
    Total  
      2012             2011          

Assets

               

Cash and cash equivalents

  $ 27      $ 48      $      $ 75      $ 28      $ 40      $      $ 68   

Investment funds

               

U.S. large cap equities

           275               275               443               443   

U.S. small/mid cap equities

           150               150               286               286   

Non-U.S. developed markets equities

    37        76               113        60        101               161   

Non-U.S. emerging markets equities

    37        75               112        30        65               95   

Fixed income obligations

    3        23               26               34               34   

Equity securities

               

U.S. large cap

    6                      6        4                      4   

U.S. small/mid cap

    101                      101        101                      101   

Non-U.S. developed markets

    32                      32        94                      94   

Fixed income securities

               

Government and agency obligations

           298               298               76               76   

Corporate obligations

           310               310               208               208   

Mortgage and asset-backed securities

           238               238               46               46   

Other fixed income obligations

           24               24               12               12   
    $ 243      $ 1,517      $      $ 1,760      $ 317      $ 1,311      $      $ 1,628   

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 45% to 60% in U.S. equities, 20% to 30% in international equities, 15% to 25% in fixed-income investments, and up to 8% 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

 

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deviation of returns of the target portfolio, which approximates 13%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines.

Expected Contributions

Contributions to the pension plans and other postretirement benefit plans during 2013 are expected to be approximately $340 million and $40 million, respectively.

Expected Benefit Payments

Expected benefit payments are as follows:

 

       Pension
Benefits
     Other
Postretirement
Benefits
 

2013

   $ 643       $ 123   

2014

     636         128   

2015

     693         133   

2016

     713         138   

2017

     742         143   

2018 — 2022

     4,566         802   

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

Amounts Recognized in Other Comprehensive Income

Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net pension and other postretirement 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
 
Years Ended December 31    2012     2011     2010      2012     2011     2010  

Net (loss) gain arising during the period

   $ (1,907   $ (1,628   $ 361       $ (24   $ 106      $ 66   

Prior service (cost) credit arising during the period

     (13     783        1         78        133        99   
     $ (1,920   $ (845   $ 362       $ 54      $ 239      $ 165   

Net loss amortization included in benefit cost

   $ 256      $ 196      $ 140       $ 31      $ 38      $ 55   

Prior service (credit) cost amortization included in benefit cost

     (71     5        8         (66     (55     (47
     $ 185      $ 201      $ 148       $ (35   $ (17   $ 8   

The estimated net loss (gain) and prior service cost (credit) amounts that will be amortized from AOCI into net pension and postretirement benefit cost during 2013 are $410 million and $(72) million, respectively, for pension plans and are $25 million and $(73) million, respectively, for other postretirement benefit plans.

 

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Actuarial Assumptions

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

 

     Pension Plans     U.S. Pension and Other
Postretirement Benefit Plans
 
December 31        2012             2011             2010             2012             2011             2010      

Net periodic benefit cost

                                                

Discount rate

     4.70     5.20     5.50     4.80     5.40     5.90

Expected rate of return on plan assets

     7.50     7.50     7.60     8.70     8.70     8.70

Salary growth rate

     4.00     4.20     4.15     4.50     4.50     4.50

Benefit obligation

                                                

Discount rate

     3.90     4.70     5.20     4.10     4.80     5.40

Salary growth rate

     4.20     4.00     4.20     4.50     4.50     4.50

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 country basis. In developing the expected rate of return within each country, long-term historical returns data are considered as well as actual returns on the plan assets and other capital markets experience. Using this reference information, the long-term return expectations for each asset category and a weighted average expected return for each country’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 2013, the Company’s expected rate of return will range from 6.00% to 8.75% compared to a range of 5.75% to 8.75% in 2012 for its U.S. pension and other postretirement benefit plans.

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

 

December 31    2012     2011  

Health care cost trend rate assumed for next year

     7.5     7.9

Rate to which the cost trend rate is assumed to decline

     5.0     5.0

Year that the trend rate reaches the ultimate trend rate

     2018        2018   

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

 

     One Percentage Point  
       Increase      Decrease  

Effect on total service and interest cost components

   $ 38       $ (30

Effect on benefit obligation

   $ 396       $ (324

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 2012, 2011 and 2010 were $146 million, $166 million and $155 million, respectively.

 

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15.    Other (Income) Expense, Net

 

Years Ended December 31    2012     2011     2010  

Interest income

   $ (232   $ (145   $ (83

Interest expense

     714        695        715   

Exchange losses

     185        143        214   

Other, net

     449        253        458   
     $ 1,116      $ 946      $ 1,304   

The increase in interest income in 2012 as compared with 2011 reflects the accretion of time value of money discounts related to certain accounts receivables, including accelerated accretion related to significant collections of accounts receivable in Spain (see Note 6). The increase in interest income in 2011 as compared with 2010 primarily reflects higher average investment balances. Exchange losses in 2010 reflect $200 million of losses due to two Venezuelan currency devaluations as discussed below. Other, net (as presented in the table above) in 2012 reflects a $493 million net charge related to the settlement of the ENHANCE Litigation (see Note 11). Other, net in 2011 reflects a $500 million charge related to the resolution of the arbitration proceeding involving the Company’s rights to market Remicade and Simponi (see Note 5), a $136 million gain on the disposition of the Company’s interest in the JJMCP joint venture (see Note 9), and a $127 million gain on the sale of certain manufacturing facilities and related assets (see Note 4). Other, net in 2010 reflects a $950 million charge to settle certain Vioxx litigation, and charges related to the settlement of certain pending AWP litigation, partially offset by $443 million of income recognized upon AstraZeneca’s asset option exercise (see Note 9) and $102 million of income recognized on the settlement of certain disputed royalties.

In January 2010, the Company was required to remeasure its local currency operations in Venezuela to U.S. dollars as the Venezuelan economy was determined to be hyperinflationary. In addition, as noted above, exchange losses for 2010 reflect losses relating to Venezuelan currency devaluations. Effective January 11, 2010, the Venezuelan government devalued its currency to a two-tiered official exchange rate with an “essentials rate” and a “non-essentials rate.” In December 2010, the Venezuelan government announced it would eliminate the essentials rate effective January 1, 2011. As a result of this announcement, the Company remeasured its December 31, 2010 monetary assets and liabilities at the new official rate.

Interest paid was $898 million in 2012, $600 million in 2011 and $763 million in 2010, which excludes commitment fees. Interest paid for 2011 is net of $288 million received by the Company from the termination of certain interest rate swap contracts during the year (see Note 6).

 

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16.    Taxes on Income

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

 

     2012     2011     2010  
       Amount     Tax Rate     Amount     Tax Rate     Amount     Tax Rate  

U.S. statutory rate applied to income before taxes

   $ 3,059        35.0   $ 2,567        35.0   $ 579        35.0

Differential arising from:

            

Foreign earnings

     (1,955     (22.4     (2,220     (30.3     (1,878     (113.6

Tax settlements

     (113     (1.3     (721     (9.8     (17     (1.0

Unremitted foreign earnings

     (11     (0.1     (86     (1.2     (217     (13.1

Amortization of purchase accounting adjustments

     905        10.3        875        11.9        1,394        84.3   

Vioxx and ENHANCE litigation settlements

     98        1.2                      332        20.1   

Restructuring

     62        0.7        163        2.2        134        8.1   

U.S. health care reform legislation

     60        0.7        50        0.7        147        8.9   

Tax rate changes

     57        0.6        (295     (4.0     (391     (23.7

IPR&D impairment charges

     40        0.5        (5     (0.1     484        29.3   

Arbitration settlement charge

                   177        2.4                 

State taxes

     31        0.3        72        1.0        (42     (2.6

Other (1)

     207        2.4        365        5.0        146        8.9   
     $ 2,440        27.9   $ 942        12.8   $ 671        40.6

 

(1)  

Other includes the tax effect of contingency reserves, research credits and miscellaneous items.

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 Singapore, Ireland, Switzerland and Puerto Rico (which operates under a tax incentive grant), where the earnings have been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate as compared with the 35% U.S. statutory rate. The foreign earnings tax rate differentials do not include the impact of IPR&D impairment charges, amortization of purchase accounting adjustments, restructuring costs and the arbitration settlement charge. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate as compared to the 35% U.S. statutory rate.

Income before taxes consisted of:

 

Years Ended December 31    2012      2011      2010  

Domestic

   $ 4,500       $ 2,626       $ 1,154   

Foreign

     4,239         4,708         499   
     $ 8,739       $ 7,334       $ 1,653   

 

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Taxes on income consisted of:

 

Years Ended December 31    2012     2011     2010  

Current provision

      

Federal

   $ 1,346      $ 859      $ 399   

Foreign

     651        1,568        1,446   

State

     (226     52        (82
       1,771        2,479        1,763   

Deferred provision

      

Federal

     749        (584     764   

Foreign

     (323     (683     (1,777

State

     243        (270     (79
       669        (1,537     (1,092
     $ 2,440      $ 942      $ 671   

Deferred income taxes at December 31 consisted of:

 

     2012      2011  
       Assets     Liabilities      Assets     Liabilities  

Intangibles

   $      $ 4,584       $      $ 5,329   

Inventory related

     79        488         66        325   

Accelerated depreciation

     129        1,348         140        1,244   

Unremitted foreign earnings

            2,435                2,413   

Equity investments

            451                280   

Pensions and other postretirement benefits

     1,098        109         1,179        149   

Compensation related

     748                768          

Unrecognized tax benefits

     706                788          

Net operating losses and other tax credit carryforwards

     425                538          

Other

     1,798        91         2,294        108   

Subtotal

     4,983        9,506         5,773        9,848   

Valuation allowance

     (107              (246        

Total deferred taxes

   $ 4,876      $ 9,506       $ 5,527      $ 9,848   

Net deferred income taxes

           $ 4,630               $ 4,321   

Recognized as:

         

Deferred income taxes and other current assets

   $ 624         $ 827     

Other assets

     527           497     

Income taxes payable

     $ 41         $ 19   

Deferred income taxes and noncurrent liabilities

             5,740                 5,626   

The Company has net operating loss (“NOL”) carryforwards in several jurisdictions. As of December 31, 2012, approximately $194 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions, none of which are individually significant. Approximately $107 million of valuation allowances have been established on these foreign NOL carryforwards. In addition, the Company has approximately $231 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.

 

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Income taxes paid in 2012, 2011 and 2010 were $2.5 billion, $2.7 billion and $1.6 billion, respectively. Tax benefits relating to stock option exercises reflected in paid-in capital were $94 million in 2012. These amounts were not material in 2011 or 2010.

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

 

       2012     2011     2010  

Balance January 1

   $ 4,277      $ 4,919      $ 4,743   

Additions related to current year positions

     496        695        479   

Additions related to prior year positions

     58        145        124   

Reductions for tax positions of prior years (1)

     (320     (1,223     (157

Settlements

     (67     (259     (256

Lapse of statute of limitations

     (19            (14

Balance December 31

   $ 4,425      $ 4,277      $ 4,919   

 

(1)  

Amount for 2012 reflects the settlement with the CRA as discussed below. Amount for 2011 reflects the conclusion of the IRS examination of Merck’s 2002-2005 federal income tax returns and the resolution of the interest rate swap dispute with the IRS, both as discussed below.

If the Company were to recognize the unrecognized tax benefits of $4.4 billion at December 31, 2012, the income tax provision would reflect a favorable net impact of $3.8 billion.

The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2012 could decrease by up to $900 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 a (benefit) expense of $(88) million in 2012, $(95) million in 2011 and $144 million in 2010. Liabilities for accrued interest and penalties were $1.2 billion and $1.3 billion as of December 31, 2012 and 2011, respectively.

As previously disclosed, the Canada Revenue Agency (the “CRA”) had proposed adjustments for 1999 and 2000 relating to intercompany pricing matters and, in July 2011, the CRA issued assessments for other miscellaneous audit issues for tax years 2001-2004. In 2012, Merck and the CRA reached a settlement for these years that calls for Merck to pay additional Canadian tax of approximately $65 million. The Company’s unrecognized tax benefits related to these matters exceeded the settlement amount and therefore the Company recorded a net $112 million tax provision benefit in 2012. A portion of the taxes paid is expected to be creditable for U.S. tax purposes. The Company had previously established reserves for these matters. The resolution of these matters did not have a material effect on the Company’s results of operations, financial position or liquidity.

In April 2011, the Internal Revenue Service (the “IRS”) concluded its examination of Merck’s 2002-2005 federal income tax returns and as a result the Company was required to make net payments of approximately $465 million. The Company’s unrecognized tax benefits for the years under examination exceeded the adjustments related to this examination period and therefore the Company recorded a net $700 million tax provision benefit in 2011. This net benefit reflects the decrease of unrecognized tax benefits for the years under examination partially offset by increases to unrecognized tax benefits for years subsequent to the examination period as a result of this settlement. The Company disagrees with the IRS treatment of one issue raised during this examination and is appealing the matter through the IRS administrative process.

In 2010, the IRS finalized its examination of Schering-Plough’s 2003-2006 tax years. In this audit cycle, the Company reached an agreement with the IRS on an adjustment to income related to intercompany pricing matters. This income adjustment mostly reduced NOLs and other tax credit carryforwards. Additionally, the Company is seeking resolution of one issue raised during this examination through the IRS administrative appeals process. The Company’s reserves for uncertain tax positions were adequate to cover all adjustments related to this examination period. The IRS began its examination of the 2007-2009 tax years in 2010.

 

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In addition, various state and foreign tax examinations are in progress. For most of its other significant tax jurisdictions (both U.S. state and foreign), the Company’s income tax returns are open for examination for the period 2001 through 2012.

At December 31, 2012, foreign earnings of $53.4 billion have been retained indefinitely by subsidiary companies for reinvestment; therefore, no provision has been made for income taxes that would be payable upon the distribution of such earnings and it would not be practicable to determine the amount of the related unrecognized deferred income tax liability. In addition, the Company has subsidiaries operating in Puerto Rico and Singapore under tax incentive grants that begin to expire in 2013.

17.    Earnings per Share

The Company calculates earnings per share pursuant to the two-class method, which is an earnings allocation formula that determines earnings per share for common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. RSUs and certain PSUs granted before December 31, 2009 to certain management level employees (see Note 13) participate in dividends on the same basis as common shares and such dividends are nonforfeitable by the holder. As a result, these RSUs and PSUs meet the definition of a participating security. For RSUs and PSUs issued on or after January 1, 2010, dividends declared during the vesting period are payable to the employees only upon vesting and therefore such RSUs and PSUs do not meet the definition of a participating security.

The calculations of earnings per share under the two-class method are as follows:

 

Years Ended December 31    2012      2011      2010  

Basic Earnings per Common Share

        

Net income attributable to Merck & Co., Inc.

   $ 6,168       $ 6,272       $ 861   

Less: Income allocated to participating securities

     3         15         2   

Net income allocated to common shareholders

   $ 6,165       $ 6,257       $ 859   

Average common shares outstanding

     3,041         3,071         3,095   
     $ 2.03       $ 2.04       $ 0.28   

Earnings per Common Share Assuming Dilution

        

Net income attributable to Merck & Co., Inc.

   $ 6,168       $ 6,272       $ 861   

Less: Income allocated to participating securities

     3         15         2   

Net income allocated to common shareholders

   $ 6,165       $ 6,257       $ 859   

Average common shares outstanding

     3,041         3,071         3,095   

Common shares issuable (1)

     35         23         25   

Average common shares outstanding assuming dilution

     3,076         3,094         3,120   
     $ 2.00       $ 2.02       $ 0.28   

 

(1)  

Issuable primarily under share-based compensation plans.

In 2012, 2011 and 2010, 104 million, 169 million and 174 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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18.    Other Comprehensive (Loss) Income

The components of Other comprehensive (loss) income are as follows:

 

       Pretax     Tax     After Tax  

Year Ended December 31, 2012

                        

Net unrealized loss on derivatives

   $ (198   $ 77      $ (121

Net loss realization

     33        (13     20   

Derivatives

     (165     64        (101

Net unrealized gain on investments

     74        (10     64   

Net gain realization

     (13     1        (12

Investments

     61        (9     52   

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

     (1,716     395        (1,321

Cumulative translation adjustment

     (99     (81     (180
     $ (1,919   $ 369      $ (1,550

Year Ended December 31, 2011

                        

Net unrealized loss on derivatives

   $ (143   $ 56      $ (87

Net loss realization

     83        (33     50   

Derivatives

     (60     23        (37

Net unrealized loss on investments

     (10     5        (5

Net gain realization

     (7     2        (5

Investments

     (17     7        (10

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

     (422     119        (303

Cumulative translation adjustment

     435        (1     434   
     $ (64   $ 148      $ 84   

Year Ended December 31, 2010

                        

Net unrealized gain on derivatives

   $ 120      $ (41   $ 79   

Net loss realization

     7        (3     4   

Derivatives

     127        (44     83   

Net unrealized gain on investments

     41        (11     30   

Net gain realization

     (48     16        (32

Investments

     (7     5        (2

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

     683        (257     426   

Cumulative translation adjustment

     (835     (121     (956
     $ (32   $ (417   $ (449

Also included in cumulative translation adjustment are pretax gains (losses) of approximately $392 million and $(1.2) billion for 2011 and 2010, respectively, relating to translation impacts of intangible assets recorded in conjunction with the Merger.

 

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The components of Accumulated other comprehensive loss are as follows:

 

December 31    2012     2011  

Net unrealized (loss) gain on derivatives

   $ (97   $ 4   

Net unrealized gain on investments

     73        21   

Pension plan net loss

     (4,056     (2,793

Other postretirement benefit plan net loss

     (414     (402

Pension plan prior service credit

     449        502   

Other postretirement benefit plan prior service credit

     354        347   

Cumulative translation adjustment

     (991     (811
     $ (4,682   $ (3,132

19.    Segment Reporting

The Company’s operations are principally managed on a products basis and are comprised of four operating segments – Pharmaceutical, Animal Health, Consumer Care and Alliances (which includes revenue and equity income from the Company’s relationship with AZLP). The Animal Health, Consumer Care and Alliances segments are not material for separate reporting and are included in all other in the table below. The Pharmaceutical segment includes human health pharmaceutical and vaccine products marketed either directly by the Company or through joint ventures. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccines is sold 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 Company also has animal health operations that discover, develop, manufacture and market animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. Additionally, the Company has consumer care operations that develop, manufacture and market over-the-counter, foot care and sun care products, which are sold through wholesale and retail drug, food chain and mass merchandiser outlets, as well as club stores and specialty channels.

The accounting policies for the segments described above are the same as those described in Note 2.

 

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Sales of the Company’s products were as follows:

 

       2012      2011      2010  

Primary Care and Women’s Health

        

Cardiovascular

        

Zetia

   $ 2,567       $ 2,428       $ 2,297   

Vytorin

     1,747         1,882         2,014   

Diabetes and Obesity

        

Januvia

     4,086         3,324         2,385   

Janumet

     1,659         1,363         954   

Respiratory

        

Singulair

     3,853         5,479         4,987   

Nasonex

     1,268         1,286         1,219   

Clarinex

     393         621         623   

Dulera

     207         96         8   

Asmanex

     185         206         208   

Women’s Health and Endocrine

        

Fosamax

     676         855         926   

NuvaRing

     623         623         559   

Follistim AQ

     468         530         528   

Implanon

     348         294         236   

Cerazette

     271         268         209   

Other

        

Maxalt

     638         639         550   

Arcoxia

     453         431         398   

Avelox

     201         322         316   

Hospital and Specialty

        

Immunology

        

Remicade

     2,076         2,667         2,714   

Simponi

     331         264         97   

Infectious Disease

        

Isentress

     1,515         1,359         1,090   

PegIntron

     653         657         737   

Cancidas

     619         640         611   

Victrelis

     502         140           

Invanz

     445         406         362   

Primaxin

     384         515         610   

Noxafil

     258         230         198   

Oncology

        

Temodar

     917         935         1,065   

Emend

     489         419         378   

Other

        

Cosopt/Trusopt

     444         477         484   

Bridion

     261         201         103   

Integrilin

     211         230         266   

Diversified Brands

        

Cozaar/Hyzaar

     1,284         1,663         2,104   

Propecia

     424         447         447   

Zocor

     383         456         468   

Claritin Rx

     244         314         296   

Remeron

     232         241         223   

Proscar

     217         223         216   

Vasotec/Vaseretic

     192         231         255   

Vaccines (1)

        

Gardasil

     1,631         1,209         988   

ProQuad/M-M-R II/Varivax

     1,273         1,202         1,378   

Zostavax

     651         332         243   

RotaTeq

     601         651         519   

Pneumovax

     580         498         376   

Other pharmaceutical (2)

     4,141         4,035         4,622   

Total Pharmaceutical segment sales

     40,601         41,289         39,267   

Other segment sales (3)

     6,412         6,428         6,159   

Total segment sales

     47,013         47,717         45,426   

Other (4)

     254         330         561   
     $ 47,267       $ 48,047       $ 45,987   

 

(1)  

These amounts do not reflect sales of vaccines sold in most major European markets through the Company’s joint venture, Sanofi Pasteur MSD, the results of which are reflected in Equity income from affiliates . These amounts do, however, reflect supply sales to Sanofi Pasteur MSD.

 

(2)  

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

 

(3)  

Represents the non-reportable segments of Animal Health, Consumer Care and Alliances. The Alliances segment includes revenue from the Company’s relationship with AZLP .

 

(4)

Other revenues are primarily comprised of miscellaneous corporate revenues, third-party manufacturing sales, sales related to divested products or businesses and other supply sales not included in segment results.

 

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Consolidated revenues by geographic area where derived are as follows:

 

Years Ended December 31    2012      2011      2010  

United States

   $ 20,392       $ 20,495       $ 20,226   

Europe, Middle East and Africa

     12,990         13,782         13,497   

Japan

     5,102         4,835         3,768   

Other

     8,783         8,935         8,496   
     $ 47,267       $ 48,047       $ 45,987   

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

 

Years Ended December 31    2012     2011     2010  

Segment profits:

      

Pharmaceutical segment

   $ 25,852      $ 25,617      $ 23,864   

Other segments

     3,163        2,995        2,849   

Total segment profits

     29,015        28,612        26,713   

Other profits (losses)

     26        (11     (8

Unallocated:

      

Interest income

     232        145        83   

Interest expense

     (714     (695     (715

Equity income from affiliates

     102        41        (18

Depreciation and amortization

     (2,059     (2,412     (2,671

Research and development

     (7,240     (7,527     (10,710

Amortization of purchase accounting adjustments

     (4,872     (5,000     (6,566

Restructuring costs

     (664     (1,306     (985

Net charge related to settlement of ENHANCE Litigation

     (493              

Arbitration settlement charge

            (500       

Vioxx Liability Reserve

                   (950

Gain on AstraZeneca asset option exercise

                   443   

Other unallocated, net

     (4,594     (4,013     (2,963
     $ 8,739      $ 7,334      $ 1,653   

Segment profits are comprised of segment sales less standard costs and certain operating expenses directly incurred by the segments. For internal management reporting presented to the chief operating decision maker, Merck does not allocate materials and production costs, other than standard costs, the majority of research and development expenses 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 (losses) are primarily comprised of miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales, divested products or businesses and other supply sales.

Other unallocated, net includes expenses from corporate and manufacturing cost centers, product intangible asset impairment charges, gain or losses on sales of businesses and other miscellaneous income or expense items.

 

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

 

       Pharmaceutical     All
Other
    Total  
Year Ended December 31, 2012                         

Included in segment profits:

      

Equity income from affiliates

   $ 36      $ 504      $ 540   

Depreciation and amortization

     (25     (20     (45
Year Ended December 31, 2011                         

Included in segment profits:

      

Equity income from affiliates

     59        510        569   

Depreciation and amortization

     (51     (20     (71
Year Ended December 31, 2010                         

Included in segment profits:

      

Equity income from affiliates

     90        515        605   

Depreciation and amortization

     (101     (17     (118

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

 

Years Ended December 31    2012      2011      2010  

United States

   $ 10,490       $ 10,646       $ 11,078   

Europe, Middle East and Africa

     3,688         3,780         4,014   

Japan

     243         279         315   

Other

     1,609         1,592         1,675   
     $ 16,030       $ 16,297       $ 17,082   

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 Shareholders of Merck & Co., Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, equity and cash flows present fairly, in all material respects, the financial position of Merck & Co., Inc. and its subsidiaries at December 31, 2012 and December 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Merck maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Merck’s management is responsible for these 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 under Item 9A. Our responsibility is to express opinions on these financial statements and on Merck’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. 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.

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

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

 

LOGO

PricewaterhouseCoopers LLP

Florham Park, New Jersey

February 26, 2013

 

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(b) Supplementary Data

Selected quarterly financial data for 2012 and 2011 are contained in the Condensed Interim Financial Data table below.

Condensed Interim Financial Data (Unaudited)

 

($ in millions except per share amounts)    4th Q (1)     3rd Q     2nd Q (2)     1st Q (3)  

2012 (4)

                                

Sales

   $ 11,738      $ 11,488      $ 12,311      $ 11,731   

Materials and production

     4,160        4,137        4,112        4,037   

Marketing and administrative

     3,390        3,063        3,249        3,074   

Research and development

     2,224        1,918        2,165        1,862   

Restructuring costs

     191        110        144        219   

Equity income from affiliates

     (231     (158     (142     (110

Other (income) expense, net

     669        200        103        142   

Income before taxes

     1,335        2,218        2,680        2,507   

Net income attributable to Merck & Co., Inc.

     908        1,729        1,793        1,738   

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

   $ 0.30      $ 0.57      $ 0.59      $ 0.57   

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

   $ 0.30      $ 0.56      $ 0.58      $ 0.56   

2011 (4)

                                

Sales

   $ 12,294      $ 12,022      $ 12,151      $ 11,580   

Materials and production

     4,176        4,352        4,284        4,059   

Marketing and administrative

     3,704        3,340        3,525        3,164   

Research and development

     2,419        1,954        1,936        2,158   

Restructuring costs

     533        119        668        (14

Equity income from affiliates

     (257     (161     (55     (138

Other (income) expense, net

     139        66        121        622   

Income before taxes

     1,580        2,352        1,672        1,729   

Net income attributable to Merck & Co., Inc.

     1,512        1,692        2,024        1,043   

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

   $ 0.50      $ 0.55      $ 0.65      $ 0.34   

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

   $ 0.49      $ 0.55      $ 0.65      $ 0.34   

 

(1)  

Amounts for 2012 include a net charge related to a litigation settlement (see Note 11).

 

(2)  

Amounts for 2011 include a net benefit relating to the settlement of a federal income tax audit (see Note 16).

 

(3)  

Amounts for 2011 include a charge relating to the resolution of the arbitration proceeding with J&J (see Note 5).

 

(4)  

Amounts for 2012 and 2011 reflect acquisition-related costs (see Note 8) and the impact of restructuring actions (see Note 3).

 

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Item 9.      Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

Not applicable.

Item 9A.   Controls and Procedures.

Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Act”)) are effective.

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2012. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Company’s internal control over financial reporting and its attestation report is included in this Form 10-K filing.

Management’s Report

Management’s Responsibility for Financial Statements

Responsibility for the integrity and objectivity of the Company’s financial statements rests with management. The financial statements report on management’s stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on management’s best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements.

To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis.

To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training, which includes financial stewardship. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Company’s long-standing commitment to high ethical standards in the conduct of its business.

The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Company’s financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing.

 

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Management’s Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is 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 in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2012.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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.

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

LOGO   LOGO

Kenneth C. Frazier

 

Peter N. Kellogg

Chairman, President

and Chief Executive Officer

 

Executive Vice President

and Chief Financial Officer

Item 9B.     Other Information.

None.

 

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PART III

 

Item 10. Directors, Executive Officers and Corporate Governance.

The required information on directors and nominees is incorporated by reference from the discussion under Proposal 1. Election of Directors of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013. Information on executive officers is set forth in Part I of this document on pages 33 through 36.

The required information on compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference from the discussion under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

The Company has a Code of Conduct — Our Values and Standards applicable to all employees, including the principal executive officer, principal financial officer, and principal accounting officer. The Code of Conduct is available on the Company’s website at www.merck.com/about/code_of_conduct.pdf . Every Merck employee is responsible for adhering to business practices that are in accordance with the law and with ethical principles that reflect the highest standards of corporate and individual behavior. A printed copy will be sent, without charge, to any shareholder who requests it by writing to the Chief Ethics and Compliance Officer of Merck & Co., Inc., One Merck Drive, Whitehouse Station, NJ 08889-0100.

The required information on the identification of the audit committee and the audit committee financial expert is incorporated by reference from the discussion under the heading “Board Committees” of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

 

Item 11. Executive Compensation.

The information required on executive compensation is incorporated by reference from the discussion under the headings “Compensation Discussion and Analysis”, “Summary Compensation Table”, “All Other Compensation” table, “Grants of Plan-Based Awards” table, “Outstanding Equity Awards” table, “Option Exercises and Stock Vested” table, “Pension Benefits” table, Nonqualified Deferred Compensation and related table, Potential Payments Upon Termination or Change in Control, including the discussion under the subheadings “Separation”, “Individual Agreements” and “Change in Control”, as well as all footnote information to the various tables, of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

The required information on director compensation is incorporated by reference from the discussion under the heading “Director Compensation” and related “Director Compensation” table and “Schedule of Director Fees” table of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

The required information under the headings “Compensation Committee Interlocks and Insider Participation” and “Compensation and Benefits Committee Report” is incorporated by reference from the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

 

Item 12.     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Information with respect to securities authorized for issuance under equity compensation plans is set forth in Part II of this document on page 38. Information with respect to security ownership of certain beneficial owners and management is incorporated by reference from the discussion under the heading “Security Ownership of Certain Beneficial Owners and Management” of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence.

The required information on transactions with related persons is incorporated by reference from the discussion under the heading “Related Person Transactions” of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

 

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The required information on director independence is incorporated by reference from the discussion under the heading “Independence of Directors” of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

 

Item 14. Principal Accountant Fees and Services.

The information required for this item is incorporated by reference from the discussion under “Audit Committee” beginning with the caption “Pre-Approval Policy for Services of Independent Registered Public Accounting Firm” through “All Other Fees” of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held May 28, 2013.

PART IV

 

Item 15. Exhibits and Financial Statement Schedules.

(a) The following documents are filed as part of this Form 10-K

1.  Financial Statements

Consolidated statement of income for the years ended December 31, 2012, 2011 and 2010

Consolidated statement of comprehensive income for the years ended December 31, 2012, 2011 and 2010

Consolidated balance sheet as of December 31, 2012 and 2011

Consolidated statement of equity for the years ended December 31, 2012, 2011 and 2010

Consolidated statement of cash flows for the years ended December 31, 2012, 2011 and 2010

Notes to consolidated financial statements

Report of PricewaterhouseCoopers LLP, independent registered public accounting firm

2. Financial Statement Schedules

Schedules are omitted because they are either not required or not applicable.

Financial statements of affiliates carried on the equity basis have been omitted because, considered individually or in the aggregate, such affiliates do not constitute a significant subsidiary.

 

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3.  Exhibits

 

Exhibit

Number

      

Description

    2.1      Master Restructuring Agreement dated as of June 19, 1998 between Astra AB, Merck & Co., Inc., Astra Merck Inc., Astra USA, Inc., KB USA, L.P., Astra Merck Enterprises, Inc., KBI Sub Inc., Merck Holdings, Inc. and Astra Pharmaceuticals, L.P. (Portions of this Exhibit are subject to a request for confidential treatment filed with the Commission) — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
    2.2      Agreement and Plan of Merger by and among Merck & Co., Inc., Schering-Plough Corporation, Blue, Inc. and Purple, Inc. dated as of March 8, 2009 — Incorporated by reference to Schering-Plough’s Current Report on Form 8-K filed March 11, 2009
    2.3      Share Purchase Agreement, dated July 29, 2009, by and among Merck & Co., Inc., Merck SH Inc., Merck Sharp & Dohme (Holdings) Limited and sanofi-aventis — Incorporated by reference to MSD’s Current Report on Form 8-K dated July 31, 2009
    3.1      Restated Certificate of Incorporation of Merck & Co., Inc. (November 3, 2009) — Incorporated by reference to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
    3.2      By-Laws of Merck & Co., Inc. (effective January 1, 2013) — Incorporated by reference to Merck & Co., Inc.’s Current Report on Form 8-K filed December 21, 2011
    4.1      Indenture, dated as of April 1, 1991, between Merck & Co., Inc. and Morgan Guaranty Trust Company of New York, as Trustee — Incorporated by reference to Exhibit 4 to MSD’s Registration Statement on Form S-3 (No. 33-39349)
    4.2      First Supplemental Indenture, dated as of October 1, 1997, between Merck & Co., Inc. and First Trust of New York, National Association, as Trustee — Incorporated by reference to Exhibit 4(b) to MSD’s Registration Statement on Form S-3 (No. 333-36383)
    4.3      Second Supplemental Indenture, dated November 3, 2009, among Merck Sharp & Dohme Corp., Merck & Co., Inc. and U.S. Bank Trust National Association, as Trustee — Incorporated by reference to Exhibit 4.3 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
    4.4      Indenture, dated November 26, 2003, between Schering-Plough and The Bank of New York as Trustee — Incorporated by reference to Exhibit 4.1 to Schering-Plough’s Current Report on Form 8-K filed November 28, 2003
    4.5      First Supplemental Indenture (including Form of Note), dated November 26, 2003 — Incorporated by reference to Exhibit 4.2 to Schering-Plough’s Current Report on Form 8-K filed November 28, 2003
    4.6      Second Supplemental Indenture (including Form of Note), dated November 26, 2003 —Incorporated by reference to Exhibit 4.3 to Schering-Plough’s Current Report on Form 8-K filed November 28, 2003
    4.7      Third Supplemental Indenture (including Form of Note), dated September 17, 2007 — Incorporated by reference to Exhibit 4.1 to Schering-Plough’s Current Report on Form 8-K filed September 17, 2007
    4.8      Fourth Supplemental Indenture (including Form of Note), dated October 1, 2007 — Incorporated by reference to Exhibit 4.1 to Schering-Plough’s Current Report on Form 8-K filed October 2, 2007
    4.9      Fifth Supplemental Indenture, dated November 3, 2009, among Merck Sharp & Dohme Corp., Merck & Co., Inc. and The Bank of New York Mellon, as Trustee — Incorporated by reference to Exhibit 4.4 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
    4.10      Indenture, dated as of January 6, 2010, between Merck & Co., Inc. and U.S. Bank Trust National Association, as Trustee — Incorporated by reference to Exhibit 4.1 to Merck & Co., Inc.’s Current Report on Form 8-K filed December 10, 2010
    4.11      Third Supplemental Indenture, dated May 1, 2012, among Merck Sharp & Dohme Corp., Schering Corporation, Merck & Co., Inc. and U.S. Bank Trust National Association, as Trustee —Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the quarter year ended March 31, 2012
*10.1      Executive Incentive Plan (as amended effective February 27, 1996) — Incorporated by reference to MSD’s Form 10-K Annual Report for the fiscal year ended December 31, 1995

 

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Exhibit

Number

      

Description

*10.2      Merck & Co., Inc. Deferral Program Including the Base Salary Deferral Plan (Amended and Restated effective January 1, 2013)
*10.3      Merck Sharp & Dohme Corp. 2001 Incentive Stock Plan (amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.9 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.4      Merck Sharp & Dohme Corp. 2004 Incentive Stock Plan (amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.8 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.5      Merck Sharp & Dohme Corp. 2007 Incentive Stock Plan (effective as amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.7 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.6      Amendment One to the Merck Sharp & Dohme Corp. 2007 Incentive Stock Plan (effective February 15, 2010) — Incorporated by reference to Exhibit 10.2 to Merck & Co., Inc.’s Current Report on Form 8-K filed February 18, 2010
*10.7      2002 Stock Incentive Plan (as amended to February 25, 2003) — Incorporated by reference to Exhibit 10(d) to Schering-Plough’s 10-K for the year ended December 31, 2002
*10.8      Merck & Co., Inc. Schering-Plough 2006 Stock Incentive Plan (as amended and restated, effective November 3, 2009) — Incorporated by reference to Exhibit 10.13 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.9      Merck & Co., Inc. 2010 Incentive Stock Plan (effective as of May 1, 2010) — Incorporated by reference to Merck & Co., Inc.’s Schedule 14A filed April 12, 2010
*10.10      Stock option terms for a non-qualified stock option under the Merck Sharp & Dohme Corp. 2007 Incentive Stock Plan and the Schering-Plough 2006 Stock Incentive Plan — Incorporated by reference to Exhibit 10.3 to Merck & Co., Inc.’s Current Report on Form 8-K filed February 15, 2010
*10.11      Restricted stock unit terms for annual grant under the Merck Sharp & Dohme Corp. 2007 Incentive Stock Plan and the Schering-Plough 2006 Stock Incentive Plan — Incorporated by reference to Exhibit 10.4 to Merck & Co., Inc.’s Current Report on Form 8-K filed February 15, 2010
*10.12      Restricted stock unit terms for 2011 grants for Richard T. Clark under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co.’s Form 10-Q Quarterly Report for the period ended March 31, 2011
*10.13      Stock option terms for 2011 quarterly and annual non-qualified option grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the period ended March 31, 2011
*10.14      Restricted stock unit terms for 2011 quarterly and annual grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the period ended March 31, 2011
*10.15      Form of Performance share unit terms for 2011 and 2012 grants under the Merck & Co., Inc. 2010 Incentive Stock Plan
*10.16      Stock option terms for 2012 quarterly and annual non-qualified option grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2011
*10.17      Restricted stock unit terms for 2012 quarterly and annual grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2011
*10.18      Performance share unit terms for 2012 grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the period ended March 31, 2012
*10.19      Form of Stock option agreement for 2013 and later quarterly and annual non-qualified option grants under the Merck & Co., Inc. 2010 Incentive Stock Plan
*10.20      Form of Restricted stock unit agreement for 2013 and later quarterly and annual grants under the Merck & Co., Inc. 2010 Incentive Stock Plan

 

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Exhibit

Number

      

Description

*10.21      Merck & Co., Inc. Change in Control Separation Benefits Plan — Incorporated by reference to Merck & Co., Inc.’s Current Report on Form 8-K dated November 23, 2009
*10.22      Amendment One to Merck & Co., Inc. Change in Control Separation Benefits Plan (effective February 15, 2010) — Incorporated by reference to Exhibit 10.1 to Merck & Co., Inc.’s Current Report on Form 8-K filed February 18, 2010
*10.23      Merck & Co., Inc. Change in Control Separation Benefits Plan (Effective as Amended and Restated, as of January 1, 2013) — Incorporated by reference to Merck & Co., Inc.’s Current Report on Form 8-K dated November 29, 2012
*10.24      Merck & Co., Inc. U.S. Separation Benefits Plan (effective as of January 1, 2012) — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2011
*10.25      Merck & Co., Inc. U.S. Separation Benefits Plan (effective as of January 1, 2013)
*10.26      Merck & Co., Inc. 2001 Non-Employee Directors Stock Option Plan (amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.11 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.27      Merck & Co., Inc. 2006 Non-Employee Directors Stock Option Plan (amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.5 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.28      Merck & Co., Inc. 2010 Non-Employee Directors Stock Option Plan (amended and restated as of December 1, 2010) — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2010
*10.29      Retirement Plan for the Directors of Merck & Co., Inc. (amended and restated June 21, 1996) —Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1996
*10.30      Merck & Co., Inc. Plan for Deferred Payment of Directors’ Compensation (effective as amended and restated as of December 1, 2010) — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2010
*10.31      Offer Letter between Merck & Co., Inc. and Peter S. Kim, dated December 15, 2000 —Incorporated by reference to MSD’s Form 10-K Annual Report for the fiscal year ended December 31, 2003
*10.32      Offer Letter between Merck & Co., Inc. and Peter N. Kellogg, dated June 18, 2007 —Incorporated by reference to MSD’s Current Report on Form 8-K dated June 28, 2007
*10.33      Form of employment agreement effective upon a change of control between Schering-Plough and certain executives for new agreements beginning in January 1, 2008 — Incorporated by reference to Exhibit 10(e)(xv) to Schering-Plough’s 10-K for the year ended December 31, 2008
  10.34      Share Purchase Agreement between Akzo Nobel N.V., Schering-Plough International C.V., and Schering-Plough Corporation — Incorporated by reference to Exhibit 10.1 to Schering-Plough’s 8-K filed October 2, 2007
  10.35      Amended and Restated License and Option Agreement dated as of July 1, 1998 between Astra AB and Astra Merck Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.36      KBI Shares Option Agreement dated as of July 1, 1998 by and among Astra AB, Merck & Co., Inc. and Merck Holdings, Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.37      Amended and Restated KBI Shares Option Agreement dated as of June 26, 2012 by and among AstraZeneca AB, Merck Sharp & Dohme Corp. and Merck Holdings LLC — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the period ended September 30, 2012
  10.38      KBI-E Asset Option Agreement dated as of July 1, 1998 by and among Astra AB, Merck & Co., Inc., Astra Merck Inc. and Astra Merck Enterprises Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.39      KBI Supply Agreement dated as of July 1, 1998 between Astra Merck Inc. and Astra Pharmaceuticals, L.P. (Portions of this Exhibit are subject to a request for confidential treatment filed with the Commission). — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998

 

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Exhibit

Number

      

Description

  10.40      Second Amended and Restated Manufacturing Agreement dated as of July 1, 1998 among Merck & Co., Inc., Astra AB, Astra Merck Inc. and Astra USA, Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.41      Limited Partnership Agreement dated as of July 1, 1998 between KB USA, L.P. and KBI Sub Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.42      Distribution Agreement dated as of July 1, 1998 between Astra Merck Enterprises Inc. and Astra Pharmaceuticals, L.P. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.43      Agreement to Incorporate Defined Terms dated as of June 19, 1998 between Astra AB, Merck & Co., Inc., Astra Merck Inc., Astra USA, Inc., KB USA, L.P., Astra Merck Enterprises Inc., KBI Sub Inc., Merck Holdings, Inc. and Astra Pharmaceuticals, L.P. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.44      Form of Voting Agreement made and entered into as of October 30, 2006 by and between Merck & Co., Inc. and Sirna Therapeutics, Inc. — Incorporated by reference to MSD’s Current Report on Form 8-K dated October 30, 2006
  10.45      Commitment Letter by and among Merck & Co., Inc., J.P. Morgan Securities Inc. and JPMorgan Chase Bank, N.A. dated as of March 8, 2009 — Incorporated by reference to MSD’s Current Report on Form 8-K dated March 8, 2009
  10.46      Incremental Credit Agreement dated as of May 6, 2009, among Merck & Co., Inc., the Guarantors and Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent — Incorporated by reference to MSD’s Current Report on Form 8-K dated May 6, 2009
  10.47      Asset Sale Facility Agreement dated as of May 6, 2009, among Merck & Co., Inc., the Guarantors and Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent — Incorporated by reference to MSD’s Current Report on Form 8-K dated May 6, 2009
  10.48      Bridge Loan Agreement dated as of May 6, 2009, among Merck & Co., Inc., the Guarantors and Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent — Incorporated by reference to MSD’s Current Report on Form 8-K dated May 6, 2009
  10.49      Amendment No. 1 to Amended and Restated Five-Year Credit Agreement dated as of April 20, 2009 among Merck & Co., Inc., the Lenders party thereto and Citicorp USA, Inc., as Administrative Agent — Incorporated by reference to Exhibit 10.1 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
  10.50      Guarantee and Joinder Agreement dated as of November 3, 2009 by Merck & Co., Inc., the Guarantor, for the benefit of the Guaranteed Parties — Incorporated by reference to Exhibit 10.3 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
  10.51      Guarantor Joinder Agreement dated as of November 3, 2009, by Merck & Co., Inc., the Guarantor and JPMorgan Chase Bank, N.A., as Administrative Agent — Incorporated by reference to Exhibit 10.4 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
  10.52      Call Option Agreement, dated July 29, 2009, by and among Merck & Co., Inc., Schering-Plough Corporation and sanofi-aventis — Incorporated by reference to MSD’s Current Report on Form 8-K dated July 31, 2009
  10.53      Termination Agreement, dated as of September 17, 2009, by and among Merck & Co., Inc., Merck SH Inc., Merck Sharp & Dohme (Holdings) Limited, sanofi-aventis, sanofi 4 and Merial Limited — Incorporated by reference to MSD’s Current Report on Form 8-K dated September 21, 2009
  10.54      Letter Agreement dated April 14, 2003 relating to Consent Decree — Incorporated by reference to Exhibit 99.3 to Schering-Plough’s 10-Q for the period ended March 31, 2003
  10.55      Distribution agreement between Schering-Plough and Centocor, Inc., dated April 3, 1998 — Incorporated by reference to Exhibit 10(u) to Schering-Plough’s Amended 10-K for the year ended December 31, 2003, filed May 3, 2004†
  10.56      Amendment Agreement to the Distribution Agreement between Centocor, Inc., CAN Development, LLC, and Schering-Plough (Ireland) Company — Incorporated by reference to Exhibit 10.1 to Schering-Plough’s Current Report on Form 8-K filed December 21, 2007†

 

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Table of Contents

Exhibit

Number

      

Description

12      Computation of Ratios of Earnings to Fixed Charges
21      Subsidiaries of Merck & Co., Inc.
23.1      Consent of Independent Registered Public Accounting Firm — Contained on page 148 of this Report
24.1      Power of Attorney
24.2      Certified Resolution of Board of Directors
31.1      Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2      Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.1      Section 1350 Certification of Chief Executive Officer
32.2      Section 1350 Certification of Chief Financial Officer
101      The following materials from Merck & Co., Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statement of Income, (ii) the Consolidated Statement of Comprehensive Income, (iii) the Consolidated Balance Sheet, (iv) the Consolidated Statement of Cash Flows, and (v) Notes to Consolidated Financial Statements.

 

 

* Management contract or compensatory plan or arrangement.

 

Certain portions of the exhibit have been omitted pursuant to a request for confidential treatment. The non-public information has been filed separately with the Securities and Exchange Commission pursuant to rule 24b-2 under the Securities Exchange Act of 1934, as amended.

 

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Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: February 28, 2013

 

MERCK & CO., INC.
By:   KENNETH C. FRAZIER
  (Chairman, President and Chief Executive Officer)
  By:   /S/ GERALYN S. RITTER
    Geralyn S. Ritter
    (Attorney-in-Fact)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

Signatures

  

Title

 

Date

KENNETH C. FRAZIER   

Chairman, President and Chief Executive Officer; Principal Executive Officer; Director

  February 28, 2013
PETER N. KELLOGG   

Executive Vice President and Chief Financial Officer; Principal Financial Officer

  February 28, 2013
JOHN CANAN   

Senior Vice President Finance-Global Controller;
Principal Accounting Officer

  February 28, 2013
LESLIE A. BRUN   

Director

  February 28, 2013
THOMAS R. CECH   

Director

  February 28, 2013
THOMAS H. GLOCER   

Director

  February 28, 2013
WILLIAM B. HARRISON, JR.   

Director

  February 28, 2013
C. ROBERT KIDDER   

Director

  February 28, 2013
ROCHELLE B. LAZARUS   

Director

  February 28, 2013
CARLOS E. REPRESAS   

Director

  February 28, 2013
PATRICIA F. RUSSO   

Director

  February 28, 2013
CRAIG B. THOMPSON   

Director

  February 28, 2013
WENDELL P. WEEKS   

Director

  February 28, 2013
PETER C. WENDELL   

Director

  February 28, 2013

Geralyn S. Ritter, by signing her name hereto, does hereby sign this document pursuant to powers of attorney duly executed by the persons named, filed with the Securities and Exchange Commission as an exhibit to this document, on behalf of such persons, all in the capacities and on the date stated, such persons including a majority of the directors of the Company.

 

By:   /S/ GERALYN S. RITTER
  Geralyn S. Ritter
  (Attorney-in-Fact)

 

147


Table of Contents

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-185248, 333-185245, 333-164482, 333-163858 and 333-163546) and on Form S-8 (Nos. 333-173025, 333-173024, 333-162882, 333-162883, 333-162884, 333-162885, 333-162886, 033-57111, 333-112421, 333-134281, 333-121089, 333-30331, 333-87077, 333-153542, 333-162007, 333-91440 and 333-105567) of Merck & Co., Inc. of our report dated February 26, 2013 relating to the financial statements and the effectiveness of internal control over financial reporting, which appears in this Form 10-K.

 

LOGO

PricewaterhouseCoopers LLP

Florham Park, New Jersey

February 26, 2013

 

148


Table of Contents

EXHIBIT INDEX

 

Exhibit

Number

     

Description

    2.1     Master Restructuring Agreement dated as of June 19, 1998 between Astra AB, Merck & Co., Inc., Astra Merck Inc., Astra USA, Inc., KB USA, L.P., Astra Merck Enterprises, Inc., KBI Sub Inc., Merck Holdings, Inc. and Astra Pharmaceuticals, L.P. (Portions of this Exhibit are subject to a request for confidential treatment filed with the Commission) — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
    2.2     Agreement and Plan of Merger by and among Merck & Co., Inc., Schering-Plough Corporation, Blue, Inc. and Purple, Inc. dated as of March 8, 2009 — Incorporated by reference to Schering-Plough’s Current Report on Form 8-K filed March 11, 2009
    2.3     Share Purchase Agreement, dated July 29, 2009, by and among Merck & Co., Inc., Merck SH Inc., Merck Sharp & Dohme (Holdings) Limited and sanofi-aventis — Incorporated by reference to MSD’s Current Report on Form 8-K dated July 31, 2009
    3.1     Restated Certificate of Incorporation of Merck & Co., Inc. (November 3, 2009) — Incorporated by reference to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
    3.2     By-Laws of Merck & Co., Inc. (effective January 1, 2013) — Incorporated by reference to Merck & Co., Inc.’s Current Report on Form 8-K filed December 21, 2011
    4.1     Indenture, dated as of April 1, 1991, between Merck & Co., Inc. and Morgan Guaranty Trust Company of New York, as Trustee — Incorporated by reference to Exhibit 4 to MSD’s Registration Statement on Form S-3 (No. 33-39349)
    4.2     First Supplemental Indenture, dated as of October 1, 1997, between Merck & Co., Inc. and First Trust of New York, National Association, as Trustee — Incorporated by reference to Exhibit 4(b) to MSD’s Registration Statement on Form S-3 (No. 333-36383)
    4.3     Second Supplemental Indenture, dated November 3, 2009, among Merck Sharp & Dohme Corp., Merck & Co., Inc. and U.S. Bank Trust National Association, as Trustee — Incorporated by reference to Exhibit 4.3 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
    4.4     Indenture, dated November 26, 2003, between Schering-Plough and The Bank of New York as Trustee — Incorporated by reference to Exhibit 4.1 to Schering-Plough’s Current Report on Form 8-K filed November 28, 2003
    4.5     First Supplemental Indenture (including Form of Note), dated November 26, 2003 — Incorporated by reference to Exhibit 4.2 to Schering-Plough’s Current Report on Form 8-K filed November 28, 2003
    4.6     Second Supplemental Indenture (including Form of Note), dated November 26, 2003 — Incorporated by reference to Exhibit 4.3 to Schering-Plough’s Current Report on Form 8-K filed November 28, 2003
    4.7     Third Supplemental Indenture (including Form of Note), dated September 17, 2007 — Incorporated by reference to Exhibit 4.1 to Schering-Plough’s Current Report on Form 8-K filed September 17, 2007
    4.8     Fourth Supplemental Indenture (including Form of Note), dated October 1, 2007 — Incorporated by reference to Exhibit 4.1 to Schering-Plough’s Current Report on Form 8-K filed October 2, 2007
    4.9     Fifth Supplemental Indenture, dated November 3, 2009, among Merck Sharp & Dohme Corp., Merck & Co., Inc. and The Bank of New York Mellon, as Trustee — Incorporated by reference to Exhibit 4.4 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
    4.10     Indenture, dated as of January 6, 2010, between Merck & Co., Inc. and U.S. Bank Trust National Association, as Trustee — Incorporated by reference to Exhibit 4.1 to Merck & Co., Inc.’s Current Report on Form 8-K filed December 10, 2010
    4.11     Third Supplemental Indenture, dated May 1, 2012, among Merck Sharp & Dohme Corp., Schering Corporation, Merck & Co., Inc. and U.S. Bank Trust National Association, as Trustee — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the quarter year ended March 31, 2012
*10.1     Executive Incentive Plan (as amended effective February 27, 1996) — Incorporated by reference to MSD’s Form 10-K Annual Report for the fiscal year ended December 31, 1995


Table of Contents

Exhibit

Number

     

Description

*10.2     Merck & Co., Inc. Deferral Program Including the Base Salary Deferral Plan (Amended and Restated effective January 1, 2013)
*10.3     Merck Sharp & Dohme Corp. 2001 Incentive Stock Plan (amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.9 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.4     Merck Sharp & Dohme Corp. 2004 Incentive Stock Plan (amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.8 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.5     Merck Sharp & Dohme Corp. 2007 Incentive Stock Plan (effective as amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.7 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.6     Amendment One to the Merck Sharp & Dohme Corp. 2007 Incentive Stock Plan (effective February 15, 2010) — Incorporated by reference to Exhibit 10.2 to Merck & Co., Inc.’s Current Report on Form 8-K filed February 18, 2010
*10.7     2002 Stock Incentive Plan (as amended to February 25, 2003) — Incorporated by reference to Exhibit 10(d) to Schering-Plough’s 10-K for the year ended December 31, 2002
*10.8     Merck & Co., Inc. Schering-Plough 2006 Stock Incentive Plan (as amended and restated, effective November 3, 2009) — Incorporated by reference to Exhibit 10.13 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.9     Merck & Co., Inc. 2010 Incentive Stock Plan (effective as of May 1, 2010) — Incorporated by reference to Merck & Co., Inc.’s Schedule 14A filed April 12, 2010
*10.10     Stock option terms for a non-qualified stock option under the Merck Sharp & Dohme Corp. 2007 Incentive Stock Plan and the Schering-Plough 2006 Stock Incentive Plan — Incorporated by reference to Exhibit 10.3 to Merck & Co., Inc.’s Current Report on Form 8-K filed February 15, 2010
*10.11     Restricted stock unit terms for annual grant under the Merck Sharp & Dohme Corp. 2007 Incentive Stock Plan and the Schering-Plough 2006 Stock Incentive Plan — Incorporated by reference to Exhibit 10.4 to Merck & Co., Inc.’s Current Report on Form 8-K filed February 15, 2010
*10.12     Restricted stock unit terms for 2011 grants for Richard T. Clark under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co.’s Form 10-Q Quarterly Report for the period ended March 31, 2011
*10.13     Stock option terms for 2011 quarterly and annual non-qualified option grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the period ended March 31, 2011
*10.14     Restricted stock unit terms for 2011 quarterly and annual grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the period ended March 31, 2011
*10.15     Form of Performance share unit terms for 2011 and 2012 grants under the Merck & Co., Inc. 2010 Incentive Stock Plan
*10.16     Stock option terms for 2012 quarterly and annual non-qualified option grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2011
*10.17     Restricted stock unit terms for 2012 quarterly and annual grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2011
*10.18     Performance share unit terms for 2012 grants under the Merck & Co., Inc. 2010 Incentive Stock Plan — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the period ended March 31, 2012
*10.19     Form of Stock option agreement for 2013 and later quarterly and annual non-qualified option grants under the Merck & Co., Inc. 2010 Incentive Stock Plan
*10.20     Form of Restricted stock unit agreement for 2013 and later quarterly and annual grants under the Merck & Co., Inc. 2010 Incentive Stock Plan


Table of Contents

Exhibit

Number

     

Description

*10.21     Merck & Co., Inc. Change in Control Separation Benefits Plan — Incorporated by reference to Merck & Co., Inc.’s Current Report on Form 8-K dated November 23, 2009
*10.22     Amendment One to Merck & Co., Inc. Change in Control Separation Benefits Plan (effective February 15, 2010) — Incorporated by reference to Exhibit 10.1 to Merck & Co., Inc.’s Current Report on Form 8-K filed February 18, 2010
*10.23     Merck & Co., Inc. Change in Control Separation Benefits Plan (Effective as Amended and Restated, as of January 1, 2013) — Incorporated by reference to Merck & Co., Inc.’s Current Report on Form 8-K dated November 29, 2012
*10.24     Merck & Co., Inc. U.S. Separation Benefits Plan (effective as of January 1, 2012) — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2011
*10.25     Merck & Co., Inc. U.S. Separation Benefits Plan (effective as of January 1, 2013)
*10.26     Merck & Co., Inc. 2001 Non-Employee Directors Stock Option Plan (amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.11 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.27     Merck & Co., Inc. 2006 Non-Employee Directors Stock Option Plan (amended and restated as of November 3, 2009) — Incorporated by reference to Exhibit 10.5 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
*10.28     Merck & Co., Inc. 2010 Non-Employee Directors Stock Option Plan (amended and restated as of December 1, 2010) — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2010
*10.29     Retirement Plan for the Directors of Merck & Co., Inc. (amended and restated June 21, 1996) — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1996
*10.30     Merck & Co., Inc. Plan for Deferred Payment of Directors’ Compensation (effective as amended and restated as of December 1, 2010) — Incorporated by reference to Merck & Co., Inc.’s Form 10-K Annual Report for the fiscal year ended December 31, 2010
*10.31     Offer Letter between Merck & Co., Inc. and Peter S. Kim, dated December 15, 2000 — Incorporated by reference to MSD’s Form 10-K Annual Report for the fiscal year ended December 31, 2003
*10.32     Offer Letter between Merck & Co., Inc. and Peter N. Kellogg, dated June 18, 2007 — Incorporated by reference to MSD’s Current Report on Form 8-K dated June 28, 2007
*10.33     Form of employment agreement effective upon a change of control between Schering-Plough and certain executives for new agreements beginning in January 1, 2008 — Incorporated by reference to Exhibit 10(e)(xv) to Schering-Plough’s 10-K for the year ended December 31, 2008
  10.34     Share Purchase Agreement between Akzo Nobel N.V., Schering-Plough International C.V., and Schering-Plough Corporation — Incorporated by reference to Exhibit 10.1 to Schering-Plough’s 8-K filed October 2, 2007
  10.35     Amended and Restated License and Option Agreement dated as of July 1, 1998 between Astra AB and Astra Merck Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.36     KBI Shares Option Agreement dated as of July 1, 1998 by and among Astra AB, Merck & Co., Inc. and Merck Holdings, Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.37     Amended and Restated KBI Shares Option Agreement dated as of June 26, 2012 by and among AstraZeneca AB, Merck Sharp & Dohme Corp. and Merck Holdings LLC — Incorporated by reference to Merck & Co., Inc.’s Form 10-Q Quarterly Report for the period ended September 30, 2012
  10.38     KBI-E Asset Option Agreement dated as of July 1, 1998 by and among Astra AB, Merck & Co., Inc., Astra Merck Inc. and Astra Merck Enterprises Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998


Table of Contents

Exhibit

Number

     

Description

  10.39     KBI Supply Agreement dated as of July 1, 1998 between Astra Merck Inc. and Astra Pharmaceuticals, L.P. (Portions of this Exhibit are subject to a request for confidential treatment filed with the Commission). — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.40     Second Amended and Restated Manufacturing Agreement dated as of July 1, 1998 among Merck & Co., Inc., Astra AB, Astra Merck Inc. and Astra USA, Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.41     Limited Partnership Agreement dated as of July 1, 1998 between KB USA, L.P. and KBI Sub Inc. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.42     Distribution Agreement dated as of July 1, 1998 between Astra Merck Enterprises Inc. and Astra Pharmaceuticals, L.P. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.43     Agreement to Incorporate Defined Terms dated as of June 19, 1998 between Astra AB, Merck & Co., Inc., Astra Merck Inc., Astra USA, Inc., KB USA, L.P., Astra Merck Enterprises Inc., KBI Sub Inc., Merck Holdings, Inc. and Astra Pharmaceuticals, L.P. — Incorporated by reference to MSD’s Form 10-Q Quarterly Report for the period ended June 30, 1998
  10.44     Form of Voting Agreement made and entered into as of October 30, 2006 by and between Merck & Co., Inc. and Sirna Therapeutics, Inc. — Incorporated by reference to MSD’s Current Report on Form 8-K dated October 30, 2006
  10.45     Commitment Letter by and among Merck & Co., Inc., J.P. Morgan Securities Inc. and JPMorgan Chase Bank, N.A. dated as of March 8, 2009 — Incorporated by reference to MSD’s Current Report on Form 8-K dated March 8, 2009
  10.46     Incremental Credit Agreement dated as of May 6, 2009, among Merck & Co., Inc., the Guarantors and Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent — Incorporated by reference to MSD’s Current Report on Form 8-K dated May 6, 2009
  10.47     Asset Sale Facility Agreement dated as of May 6, 2009, among Merck & Co., Inc., the Guarantors and Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent — Incorporated by reference to MSD’s Current Report on Form 8-K dated May 6, 2009
  10.48     Bridge Loan Agreement dated as of May 6, 2009, among Merck & Co., Inc., the Guarantors and Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent — Incorporated by reference to MSD’s Current Report on Form 8-K dated May 6, 2009
  10.49     Amendment No. 1 to Amended and Restated Five-Year Credit Agreement dated as of April 20, 2009 among Merck & Co., Inc., the Lenders party thereto and Citicorp USA, Inc., as Administrative Agent — Incorporated by reference to Exhibit 10.1 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
  10.50     Guarantee and Joinder Agreement dated as of November 3, 2009 by Merck & Co., Inc., the Guarantor, for the benefit of the Guaranteed Parties — Incorporated by reference to Exhibit 10.3 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
  10.51     Guarantor Joinder Agreement dated as of November 3, 2009, by Merck & Co., Inc., the Guarantor and JPMorgan Chase Bank, N.A., as Administrative Agent — Incorporated by reference to Exhibit 10.4 to Merck & Co., Inc.’s Current Report on Form 8-K filed November 4, 2009
  10.52     Call Option Agreement, dated July 29, 2009, by and among Merck & Co., Inc., Schering-Plough Corporation and sanofi-aventis — Incorporated by reference to MSD’s Current Report on Form 8-K dated July 31, 2009
  10.53     Termination Agreement, dated as of September 17, 2009, by and among Merck & Co., Inc., Merck SH Inc., Merck Sharp & Dohme (Holdings) Limited, sanofi-aventis, sanofi 4 and Merial Limited — Incorporated by reference to MSD’s Current Report on Form 8-K dated September 21, 2009
  10.54     Letter Agreement dated April 14, 2003 relating to Consent Decree — Incorporated by reference to Exhibit 99.3 to Schering-Plough’s 10-Q for the period ended March 31, 2003
  10.55     Distribution agreement between Schering-Plough and Centocor, Inc., dated April 3, 1998 — Incorporated by reference to Exhibit 10(u) to Schering-Plough’s Amended 10-K for the year ended December 31, 2003, filed May 3, 2004†


Table of Contents

Exhibit

Number

     

Description

  10.56     Amendment Agreement to the Distribution Agreement between Centocor, Inc., CAN Development, LLC, and Schering-Plough (Ireland) Company — Incorporated by reference to Exhibit 10.1 to Schering-Plough’s Current Report on Form 8-K filed December 21, 2007†
  12     Computation of Ratios of Earnings to Fixed Charges
  21     Subsidiaries of Merck & Co., Inc.
  23.1     Consent of Independent Registered Public Accounting Firm — Contained on page 148 of this Report
  24.1     Power of Attorney
  24.2     Certified Resolution of Board of Directors
  31.1     Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
  31.2     Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
  32.1     Section 1350 Certification of Chief Executive Officer
  32.2     Section 1350 Certification of Chief Financial Officer
  101     The following materials from Merck & Co., Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statement of Income, (ii) the Consolidated Statement of Comprehensive Income, (iii) the Consolidated Balance Sheet, (iv) the Consolidated Statement of Cash Flows, and (v) Notes to Consolidated Financial Statements.

 

* Management contract or compensatory plan or arrangement.

 

Certain portions of the exhibit have been omitted pursuant to a request for confidential treatment. The non-public information has been filed separately with the Securities and Exchange Commission pursuant to rule 24b-2 under the Securities Exchange Act of 1934, as amended.

Exhibit 10.2

 

 

 

 

 

 

MERCK & CO., INC.

DEFERRAL PROGRAM

Including the Base Salary Deferral Plan

( Amended and Restated effective January 1, 2013 )

 

 

 

 


TABLE OF CONTENTS

 

Page

Article I

     Administration        

Article II

     Eligibility        

Article III

     Contributions to a Deferred Compensation Account        

Article IV

     Valuation of Deferred Compensation Accounts        

Article V

     Redesignation within a Deferred Compensation Account        

Article VI

     Distribution of Deferred Compensation Accounts        

Article VII

     Deductions from Distributions      10    

Article VIII

     Beneficiary Designations      11    

Article IX

     Amendments      11    

Article X

     No Assignment, Alienation      11    

Article XI

     Claims and Appeal Procedures      11    

Article XII

     Domestic Relations Orders      12    

Article XII

     Effective Date      13    

Schedule I

     Deferral Program Investment Alternatives      14    

Schedule II

     Special Provisions Applicable to Medco Health Employees      15    


MERCK & CO. INC.

DEFERRAL PROGRAM

The Deferral Program (the “Program”) is an unfunded arrangement intended to permit a select group of management employees of Merck & Co., Inc. (“Merck”) or its affiliate to defer income that would otherwise be immediately payable to them as annual base salary or under various incentive plans of Merck or its affiliates.

The Program is a “nonqualified deferred compensation plan” within the meaning of Section 409A (“Section 409A”) of the Internal Revenue Code of 1986, as amended (the “Code”).

Anything in the Program to the contrary notwithstanding, the Program shall be interpreted and operated in compliance with the requirements, if any, of Section 409A of the Code (or any successor thereto) as in effect from time to time, including but not limited to applicable regulations of the U.S. Department of the Treasury or Internal Revenue Service and Treas. Reg. Secs. 1.409A-1 through 1.409A-6 or any successor thereto. Any payment called for under the Program as of a designated date shall be made no later than a date within the same tax year of a participant, or by March 15 of the following year, if later (or such other dates as specified in Treas. Reg. Sec. 1.409A 3(d) or any successor thereto); provided further, that the participant is not permitted to change the taxable year of payment except in accordance with Article VI, Section F and Section 409A of the Code. Where the Program’s obligation to pay is unclear Merck, including a dispute about who is the proper beneficiary of a participant who dies, payment shall be made as soon as administratively feasible after the Program’s obligation becomes clear and at a time permitted by Treas. Reg. Sec. 1.409A-3(g)(4) or any successor thereto.

I. ADMINISTRATION

The Program is administered by the Compensation and Benefits Committee (“Committee”) of the Merck Board of Directors. The Committee is composed of non-employee directors only. The Committee shall have responsibility for determining which investments will be available under the Program, and those investments shall be listed on Schedule I hereto. The Committee shall make all decisions affecting the timing, price or amount of any and all of the Deferred Compensation of Section 16 Officers, as defined below, other than rules of general application to all Participants, but may otherwise delegate any of its authority under this Program.

II. ELIGIBILITY

 

A. Eligible Employees

1.    Eligible Employees in General. An employee of Merck or its controlled group (the “Company Group”) is eligible to participate in the Program (an “Eligible Employee”) for a deferral of awards under the Annual Incentive Plan, Executive Incentive Plan or Sales Incentive Plan or similar plans as approved from time to time by the Committee if (a) his or her annual base compensation is at least $200,000 according to the Company payroll system applicable to him or her on November 1 of the year in which the election is made (or, for a newly hired employee only, his or her annualized base compensation is at least $200,000 when employment begins) (b) he or she is a regular full- or part-time employee of the Company or an affiliate who is eligible to make contributions to the Merck U.S. Savings Plan and (c) he or she is based in the U.S. and subject to U.S. income taxes.

2.    Base Salary Deferral. Eligible Employees who are Merck officers (“Section 16 Officers”) as defined in Rule 16(a)-1(f) of the Securities Exchange Act of 1934 as amended


(the “Exchange Act”) are also eligible to defer under the Base Salary Deferral Plan. The Base Salary Deferred Plan as described below is a component of the Deferral Program contained entirely herein and is intended to permit eligible Section 16 Officers to defer a portion of their base salaries.

3.    Company Contribution Eligible Employees. An employee of the Company Group is eligible for Company Contribution Credits as described in Section D of Article III if (a) the sum of his or her annual base compensation and target Annual Incentive Plan or Executive Incentive Plan award is at least equal to the applicable Code Section 401(a)(17) limit according to the Company payroll system applicable to him or her on November 1 of the year before the plan year in which a Company Contribution is made (or, for a newly hired employee only, his or her annualized based compensation is at least equal to the applicable Code Section 401(a)(17) limit when employment begins) (b) he or she is a regular full- or part-time employee of the Company or an affiliate who is eligible to make contributions to the Merck U.S. Savings Plan (c) he or she is based in the U.S. and subject to U.S. income taxes and (d) the employee’s compensation actually exceeds the applicable Code Section 401(a)(17) limit for that year (a “Company Contribution Eligible Employee”).

4.    Discretion Reserved. Notwithstanding the foregoing, the Committee may permit, or refuse to permit, any member of a select group of management or highly compensated employees to participate in this Program other than excluded individuals described in Section B below.

B.       Excluded Individuals. Anything in the Program to the contrary notwithstanding, the following are not eligible to make an election or receive a Company Contribution Credit (as described below): any person who (1) is an independent contractor for the Company Group; (2) agrees or has agreed that he or she is an independent contractor for the Company Group; (3) has an agreement or understanding with any member of the Company Group that such person is not an employee, even if that person previously has been an employee; or (4) is employed by a temporary or other employment agency, regardless of the amount of control, supervision or training provided by the Company Group. The foregoing exclusion applies even if a court, agency or other authority rules that the person happens to be a common law employee of the Company Group. Also excluded are individuals who are included in a unit of employees covered by a collective bargaining agreement between employee representatives and one or more employers; provided, however, that such an employee may be an eligible employee during the period he or she is not covered by a collective bargaining agreement and during which he or she otherwise is eligible to participate according to Article II, Section A.

C.       Participation Continues. An eligible person who has made an election into the Program pursuant to Section A above or who is eligible for Company Contribution Credits pursuant to Section D of Article III shall be a Participant for so long as he or she has an account balance. No such person can make an election to defer unless he or she is then eligible pursuant to Article II, Section A. If a person has made an election to defer but thereafter becomes ineligible to defer (for example, employment transfers to a position that is ineligible to participate in the Merck U.S. Savings Plan), the election nonetheless will be given effect.

III. CONTRIBUTIONS TO DEFERRED COMPENSATION ACCOUNTS

Amounts contributed or deferred pursuant to this Article III are known as “Deferred Compensation” and will be credited to the participant’s “Deferred Compensation Account.” Deferred Compensation shall be accounted for in one account regardless of the plan (e.g., Base

 

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Salary Deferral or incentive plan) under which it was deferred, but a separate election to defer applies for each year for base salary, annual incentive, or grant of RSUs or PSUs, and records shall show each separate election. Further, for purposes of modifications to a distribution schedule, each separate election is eligible for such a modification. Only amounts described above may be deferred; stock option gains may not be deferred.

 

A. Initial Election to Defer

To make an election to defer Base Salary, Annual Incentive Plans or Restricted Stock Units (“RSUs”) and Performance Share Units (“PSUs”), an Eligible Employee must irrevocably elect to defer under the Program by the earlier of the time specified in Treas. Reg. Sec. 1.409A-2 or any successor thereto or:

1 .     Base Salary Deferral Plan , prior to the end of the year preceding the year during which annual base salary exclusive of any bonus or any other compensation or allowance paid by the Company Group (“Annual Base Salary”) will be earned. The amount that may be deferred is

(a) Not less than 5 percent of Annual Base Salary and

(b) Not more than the lesser of

(1) 50 percent of Annual Base Salary or

(2) The portion of the Participant’s Annual Base Salary that exceeds the amount determined under
Section 401(a)(17) of the Code

provided, however, that amounts may be expressed in relation to amounts that may be deducted by the Company Group under Section 162(m) of the Code.

2.    Annual Incentive Plans (such as the Annual Incentive Plan and the Executive Incentive Plan), prior to the commencement of the calendar year coincident with the performance year during which the bonus monies to be deferred will be earned (if the performance year is not the calendar year, the election must be made prior to the first calendar year that includes any part of the performance year to the extent required by Section 409A), provided :

(a) A participant who is hired by the Company Group during a performance year may make an election, no later than the 30th day from the participant’s date of hire, to defer bonus monies to be earned during such performance year, and

(b) The minimum that may be deferred in any year under this Section IV.A.2. is $3,000; provided, however, this minimum does not apply for elections made during or after 2010.

3.    Annual Grants of RSUs and PSUs may be deferred prior to the commencement of the last year of the award period during which they will be earned. Other RSUs and PSUs may not be deferred. After 2008, RSUs and PSUs for which the deferral election is made after grant must be deferred in compliance with the rules applicable to re-deferral (as opposed to initial elections) under Section 409A as described in Article VI, Section F. Deferrals of RSUs and PSUs must be made initially into the Merck Common Stock fund and may not

 

3


thereafter be reallocated into any other investment alternative provided pursuant to Schedule I (a “Mutual Fund”). Effective November 1, 2010, no further elections of RSUs or PSUs will be permitted, but elections made prior to that date will be given effect.

Notwithstanding the foregoing, a participant’s Deferral Election will be cancelled if he or she receives a hardship distribution from any qualified savings plan with a 401(k) feature maintained by the Company Group if and only if such cancellation is required by applicable regulation of the Internal Revenue Service. If a participant terminates employment or transfers to a class of employees that is ineligible to make a deferral election after having made a deferral election, the election will nevertheless be effected. If the Company Group pays an amount that it reasonably believes is or may be held to be a “substitute payment,” within the meaning of Treas. Reg. Sec. 1.409A-1(b)(9), for an amount that would have been deferred pursuant to the foregoing, that substitute payment also will be deferred according to the participant’s election.

 

B. Initial Election of Distribution Schedule

1.     Timing of Election

The Eligible Employee must elect an initial distribution schedule when making the initial election pursuant to III.A., above.

2.     Distribution Schedule

An Eligible Employee may elect to have payments begin (a) in a particular year (whether or not employment has then ended); provided, however, this provision does not apply to Company Contributions or (b) in the year following the participant’s “Separation from Service” as defined below, or (c) up to 15 years subsequent to the participant’s Separation from Service. Separation from Service means Separation from Service as defined in Treas. Reg. Sec. 1.409A-1(h) or any successor thereto and includes but is not limited to: retirement; separation due to lack of work; voluntary resignation; or involuntary termination of employment. It does not include termination of service due to death, transfer to another member of the Company Group or commencement of employment with a joint venture (as described below). A participant may elect a lump sum or a schedule of annual installments, up to a maximum of 15 annual installments.

3.      Manner of Elections

All elections under the Program shall be made with the Program’s designated record keeper (the “Record Keeper”) in the manner and in accordance with the process approved by the Company’s head of Human Resources Department from time to time.

4.    Default Designation

Where a Participant’s initial election of a distribution schedule is for any reason unclear to the Company (including but not limited to where a Participant failed to elect when amounts will be distributed), the Participant shall be deemed to have elected to receive distribution in a lump sum in the year following the year in which his or her Separation from Service occurs.

 

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C. Election of Investment Alternatives

The participant shall designate, in accordance with procedures established by the Company for such designation, the portion (in multiples of 1 percent) of the Deferred Compensation to be allocated to any investment alternative available under this Program.

 

D. Company Contribution Credits

With respect to each Plan Year after 2012, for a Company Contribution Eligible Employee the Company shall make contribution credits (“Company Contribution Credits”) to an account (the “Company Contribution Account”). The amount of the Company Contribution Credits shall be equal to 4.5 percent of such Eligible Employee’s Compensation for the Plan Year that exceeds the limit set forth in Section 401(a)(17) of the Code for that year; provided, however, that for a Company Contribution Eligible Employee who is eligible for the Transition Provisions of the Retirement Program as described in the Merck U.S. Savings Plan Summary Plan Description and apply to certain legacy Schering Plough employees, the Company Contribution Credit shall be 5.0 percent for the period during which that Company Contribution Eligible Employee is subject to the Transition Provisions (generally, the earlier of through 2019 or until employment terminates). Company Contribution Credits shall be credited to the Participant’s Account on the same date on which the related employer contributions are made to the tax-qualified savings plan in which the Company Contribution Eligible Employee participates or such other date as the Committee shall determine.

IV. VALUATION OF DEFERRED COMPENSATION ACCOUNTS

The Deferral Program shall offer as investment alternatives (a) a fund of Merck Common Stock and (b) Mutual Funds.

 

A. Merck Common Stock

1.     Initial Crediting

The amount allocated to Merck Common Stock shall be used to determine the number of full and partial shares of Merck Common Stock which such amount would purchase at the closing price of Merck Common Stock on the New York Stock Exchange (“NYSE”) on the date cash payments of base salary, for amounts deferred under the Base Salary Deferral Plan, or incentive awards, for amounts deferred under the various incentive plans, would otherwise be paid to the participant (the “Deferral Date”). The Company shall credit the participant’s Deferred Compensation Account with the number of full and partial shares of Merck Common Stock so determined. However, at no time prior to the delivery of such shares shall any actual shares be purchased or earmarked for such Account and the participant shall not have any of the rights of a shareholder with respect to shares credited to his/her Deferred Compensation Account.

2.     Dividends

The Company shall credit the Participant’s Deferred Compensation Account with the number of full and partial shares of Merck Common Stock purchasable at the closing price of Merck Common Stock on the NYSE as of the date each dividend is paid on the Common Stock, with the dividends that would have been paid on the number of shares credited to such Account (including pro rata dividends on any partial share) had the shares so credited then been issued and outstanding.

 

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3.     Redesignations

The value of Merck Common Stock for purposes of redesignation shall be the closing price of Merck Common Stock on the NYSE on the first day the NYSE is open after the request is received by the Record Keeper.

4.     Distributions

Distributions of Merck Common Stock will be valued at the closing price of Merck Common Stock on the NYSE on the Distribution Date.

5.     Source of Shares

Shares of Merck Common Stock to be delivered under the provisions of this Program may be delivered by the Company from its authorized but unissued shares of Common Stock or from Common Stock held in the treasury. The Company also may, in its sole and nonreviewable discretion, purchase shares on public markets in order to make distributions under the Program.

6.     Adjustments

In the event of a reorganization, recapitalization, stock split, stock dividend, combination of shares, merger, consolidation, rights offering or any other change in the corporate structure or shares of the Company, the number and kind of shares of Merck Common Stock available under this Program or credited to participants’ Deferred Compensation Accounts shall be adjusted accordingly.

7.     Fair Market Value of Merck Common Stock

For purposes of valuation of Merck Common Stock, if Merck Common Stock is no longer traded on the NYSE, but is publicly traded on any other exchange, references to NYSE shall mean such other exchange. If Merck Common Stock is not publicly traded and if the Committee determines that a measurement of Merck Common Stock on any applicable date would not constitute fair market value, then the Committee shall decide on the date and method to determine fair market value, which shall be in accord with any requirements set forth under Section 409A or any successor thereto.

8.     Limits on Amount of Merck Common Stock

Beginning January 1, 2013, participants cannot rebalance their account balance so that after the account rebalance, more than 20% of the value of their account is in the Merck Common Stock Fund. In addition, participants cannot elect an exchange into the Merck Common Stock Fund that will cause the balance in the Merck Common Stock Fund to exceed 20% of the total Account Balance. Participants will not be required to exchange out of the Merck Company Stock Fund if the fund balance exceeds 20% of their Account Balance, either through prior investment elections or relative fund performance.

 

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B. Mutual Funds

1.     Initial Crediting

The amount allocated to each Mutual Fund shall be used to determine the number of full and partial Mutual Fund shares that such amount would purchase at the closing net asset value of the Mutual Fund shares on the Deferral Date. The Company shall credit the participant’s Deferred Compensation Account with the number of full and partial Mutual Fund shares so determined. However, no actual Mutual Fund shares shall be purchased or earmarked for such Account, nor shall the participant have the rights of a shareholder with respect to such Mutual Fund shares.

2.     Dividends

The Company shall credit the participant’s Deferred Compensation Account with the number of full and partial Mutual Fund shares purchasable, at the closing net asset value of the Mutual Fund shares as of the date each dividend is paid on the Mutual Fund shares, with the dividends that would have been paid on the number of shares credited to such Account (including pro rata dividends on any partial share) had the shares then been owned by the participant for purposes of the above computation.

3.     Redesignations

The value of Mutual Fund shares for purposes of redesignation shall be the net asset value of such Mutual Fund at the close of business on the first day the NYSE is open after the request is received by the Record Keeper.

4.     Distributions

Mutual Fund distributions will be valued based on the closing net asset value of the Mutual Fund shares on the Distribution Date (as defined below).

5.     Adjustments

In the event of a reorganization, recapitalization, stock split, stock dividend, combination of shares, merger, consolidation, rights offering or any other change in the corporate structure or shares of a Mutual Fund, the number and kind of shares of that Mutual Fund credited to participants’ Deferred Compensation Accounts shall be adjusted accordingly.

6.     Default Designation

Where a Participant’s designation of investment alternatives is for any reason not clear (including but not limited to where a Participant failed to make such an election), the Participant shall be deemed to have designated deferrals into the life cycle, target or similar Mutual Fund with a target date closest to the date the Participant attains age 65.

 

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V. REDESIGNATION WITHIN A DEFERRED COMPENSATION ACCOUNT

 

A. Basic Redesignation Rules

A participant, or the beneficiary or legal representative of a deceased participant, may redesignate amounts credited to a Deferred Compensation Account among the investments available under this Program in accordance with the following rules:

1.     Eligible Participants – All Participants and beneficiaries may redesignate.

2.     Frequency and Timing – Redesignation shall be effective as of 4:00 p.m. E.T. on the first day the NYSE is open after the request is received by the Recordkeeper.

3.     Amount and Extent of Redesignation – Redesignation must be in 1% multiples of the investment from which redesignation is being made.

4.     Beneficiaries or Legal Representatives – The beneficiary or legal representative of a deceased participant may redesignate subject to the same rules as participants.

 

B. Special Rules for Redesignation Into or Out of Merck Common Stock

1.     Frequency and Timing

For Section 16 Officers, redesignations may only be made into or out of Merck Common Stock during any window period established by the Company from time-to-time. Redesignation out of Merck Common Stock is restricted to amounts held in Merck Common Stock for longer than six months. Redesignation shall not be permitted to the extent the Company is aware of a transaction that the Company reasonably believes may cause a violation under Section 16 of the Exchange Act.

2.     Material, Nonpublic Information

The Committee, in its sole discretion and with advice of counsel, at any time may rescind a redesignation into or out of Merck Common Stock if such redesignation was made by a participant who, (a) at the time of the redesignation was in the possession of material, nonpublic information with respect to the Company; and (b) in the Committee’s estimation benefited from such information in the timing of his/her redesignation. The Committee’s determination shall be final and binding. In the event of such rescission, the participant’s Deferred Compensation Account shall be returned to a status as though such redesignation had not occurred. Notwithstanding the above, the Committee shall not rescind a redesignation if the facts were reviewed by the participant with the General Counsel of the Company or a designee prior to the redesignation and if the General Counsel or designee had concluded that such participant was not in possession of adverse material, nonpublic information.

 

C. Conversion of Common Stock Accounts

The Committee may, in its sole discretion, convert all of the shares of Merck Common Stock allocated to a participant’s Deferred Compensation Account in the manner provided below where a position which a participant has taken or wishes to take is, in the

 

8


opinion of the Committee, such as would make uncertain the propriety of the participant’s having a continued interest in Merck Common Stock. The date of conversion shall be the date of commencement of such other employment or the date of the Committee’s action, whichever is later.

Conversion shall be from an expression of value in shares of Merck Common Stock in the participant’s Deferred Compensation Account to an expression of value in United States dollars in another available investment. The value of the Merck Common Stock shall be based upon its closing price on the NYSE on the date of conversion or if no trading took place on such day, the next business day on which trading took place. Any conversion under this Section shall be irrevocable and absolute.

VI. DISTRIBUTION OF DEFERRED COMPENSATION ACCOUNTS

Distribution of Deferred Compensation Accounts shall be made in accordance with the participant’s distribution schedule pro rata by investment. Distributions from Merck Common Stock will be made in shares, with cash payable for any partial share, subject to the limitations set forth in Article IV, Section A.5. For Section 16 Officers, distribution of amounts in Merck Common Stock is also restricted to amounts held in Merck Common Stock for longer than six months. Distributions from Mutual Funds will be in cash. Distributions will be valued on the Distribution Date (i.e, the 15 th day of the distribution month or, if such day is not a business day, the next business day) and paid as soon thereafter as practicable. Distribution months shall mean only January, April, July, and October.

 

A. Separation from Service

1.     Distribution Commences

Upon a participant’s Separation from Service, Deferred Compensation Accounts will commence in accordance with the participant’s previously elected schedule. If a participant incurs a Separation from Service and thereafter is rehired by the Company Group, such rehire shall be ignored and distributions shall commence notwithstanding such rehire; provided, however, that if the participant is eligible and elects to make additional deferrals, those additional deferrals may be payable in relation to the subsequent Separation from Service.

2.     Specified Employee

Anything in the Program to the contrary notwithstanding, to the extent required by Section 409A, distributions on account of a Separation from Service to a “Specified Employee,” as such term is defined in Section 409A, may not be made before the date which is 6 months after the date of Separation from Service (or, if earlier, the date of death of the employee). Where a payment would have been made to a Specified Employee within such 6-month period and such payment is one of a series of annual payments, the first payment shall be delayed as necessary and the remaining payments shall be made according to their elected schedule notwithstanding such delay, such that two otherwise annual payments may be made in a single year.

 

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B. Death

In the event of a participant’s death, whether or not distributions have commenced pursuant to a Participant’s election, Deferred Compensation Accounts under this Program will be distributed to the participant’s beneficiary or estate in a lump sum as soon as administratively feasible and in any event by March 15 of the year following death (except as otherwise permitted by Treas. Reg. Sec. 1.409A-3(g)(4) or any successor thereto).

 

C. Automatic Distribution

Except as provided in Schedule II, if a participant incurs a Separation from Service and has a Deferred Compensation Account valued at less than $125,000 on the first Distribution Date thereafter, the Deferred Compensation Account shall be distributed in a lump sum as soon as administratively feasible following such termination and in any event by March 15 of the year following such termination (except as otherwise permitted by Treas. Reg. Sec. 1.409A-3(g)(4) or any successor thereto).

 

D. Joint Venture Service

A participant’s termination of employment in order to take a position with a joint venture or other business entity in which the Company shall directly or indirectly own 50 percent or more of the outstanding voting or other ownership interest shall not be considered a Separation from Service.

 

E. Hardship Distributions

The Committee shall distribute a participant’s Deferred Compensation Account, if and to the extent a participant applies to receive a distribution due to an Unforeseeable Emergency as defined in Treas. Reg. Sec. 1.409A-3(i). A participant wishing a hardship distribution must provide the Committee or its delegate with sufficient evidence to prove compliance with Treas. Reg. Sec. 1.409A-3(i).

 

F. Modifications to Distribution Schedule

After making an initial election, a participant may elect to change his or her distribution schedule from time to time, provided, however, such changes shall not be permitted if it might reasonably be expected to cause a “plan failure” as such term is used in Section 409A of the Code. For example, except as otherwise permitted by Section 409A, no election may permit an acceleration of a distribution, or may become effective earlier than one year from the date it is made, or may permit an additional deferral after the initial election unless it results in a deferral of at least five additional years from the previously schedule distribution date. For purposes of this provision, where a participant has elected to receive a distribution as a series of payments, such series shall be considered a single distribution for purposes of Section 409A. Any such elections shall be made with the Record Keeper in the manner and in accordance with the process approved by the Company’s’ head of Human Resources Department from time to time.

VII. DEDUCTIONS FROM DISTRIBUTIONS

The Company will deduct from each distribution amounts required to be withheld for income, Social Security and other tax purposes. Such withholding will be done on a pro rata basis per investment. The Company may also deduct any amounts the participant owes the Company Group for any reason.

 

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VIII. BENEFICIARY DESIGNATIONS

A participant may designate a beneficiary to receive his/her Deferred Compensation Account upon the participant’s death. If the beneficiary predeceases the participant or if the participant does not name a beneficiary, the participant’s Deferred Compensation Account will be distributed to the participant’s estate. Such designation shall be in the form designated by the Company’s head of Human Resources Department from time to time, and it must be received by the Company’s Human Resources Department prior to such participant’s death to be valid.

IX. AMENDMENTS

The Committee may amend or terminate this Program at any time. However, such amendment may not retroactively reduce a participant’s Deferred Compensation Account.

For two years following a change in control of the Company (as such term is defined in the Change in Control Separation Benefits Plan) the material terms of the Program (including terms relating to eligibility, benefit calculation, benefit accrual, cost to participants, subsidies and rates of employee contributions) may not be modified in a manner that is materially adverse to individuals who participated immediately before the change in control. The Company will pay the legal fees and expenses of any participant that prevails on his or her claim for relief in an action regarding an impermissible amendment to the Program (other than ordinary claims for benefits) or, if applicable, in an action regarding restrictive covenants applicable to the participant.

X. NO ASSIGNMENT, ALIENATION

Except as provided in Article XII, no benefit payable under this Program shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, or charge, and any attempt to so anticipate, alienate, sell, transfer, assign, pledge, encumber or charge the same shall be void, except as specifically provided in this Plan. No such benefit shall be in any manner liable for or subject to the debts, contracts, liabilities, encroachments or torts of any participant or beneficiary.

XI. CLAIMS AND APPEALS PROCEDURE

 

A. Determination of Claim

An Employee or his/her authorized representative may present a claim for benefits to the Executive Director, Compensation and Benefit Administration or the successor thereto (the “Director”) or such other person as the Committee may determine to handle claims and appeals from the Program. The Director will make all determinations as to the Employee’s claim for benefits under the Program. If the Director grants a claim, benefits payable under the Program will be paid to the Employee as soon as feasible thereafter. If the Director denies in whole or part any claim for a benefit under the Program, he/she will furnish the claimant with notice of the decision not later than 90 days after receipt of the claim. If special circumstances require an extension of time for processing the claim, the Director will provide a written notice of the extension during the initial 90-day period, in which case a decision will be rendered not more than 180 days after receipt of the claim. The written notice which the Director will provide to every claimant who is denied a claim for benefits will set forth in a manner calculated to be understood by the claimant:

 

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1.      the specific reason or reasons for the denial;

2.      specific reference to pertinent Program provisions on which the denial is based;

3.      a description of any additional material or information necessary for the claimant to perfect the claim and an explanation of why such material or information is necessary; and

4.      appropriate information as to the steps to be taken if the claimant wishes to submit his/her claim for review.

 

B. Appeal of Denied Claim

A claimant or his/her authorized representative may request a review of the denied claim by the Committee. Such request will be made in writing and will be presented to the Committee not more than 60 days after receipt by the claimant of written notification of the denial of the claim. The Committee will render its decision on review not later than 60 days after receipt of the claimant’s request for review, unless special circumstances require an extension of time, in which case a decision will be rendered as soon as possible but not later than 120 days after receipt of the request for review. The decision on review will be in writing and will include specific reasons for the decision.

 

C. ERISA Section 503

It is intended that the claims procedure of the Program be administered in accordance with regulations of the Department of Labor issued under ERISA Section 503.

 

D. Limitation of Action

No action at law or in equity (an “Action”) shall be maintained by a Participant, Beneficiary or other individual, entity or party (including but not limited to a person determined to be other than a Participant or Beneficiary) (a “Claimant”) against the Program, the Company Group, their affiliates, agents, fiduciaries, officers, directors, employees, successors, assigns or plans (collectively, the “Program Group”) unless (a) the Claimant has presented every basis or argument in support of the Action (a “Claim”) in strict accordance with both Sections A and B of this Article X which Claim is denied in whole or in part and (b) unless the Action is commenced no later than one year after the date the Company Group provides notice of the adverse decision pursuant to Section B. Where the Company Group puts the Claimant on notice of the Company Group’s or Program’s intention with respect to the basis or argument in support of the Action, the Claimant must commence the process described in Section A of this Article X within one year of such notice. A “Claim” includes but is not limited to a claim for benefits or for a purported or actual fiduciary breach by any member of the Program Group. The Limitation of Action pursuant to this Article may only be tolled by a writing executed by the Director.

XII. DOMESTIC RELATIONS ORDERS

Notwithstanding any other provision of this Program to the contrary, the creation, assignment or recognition of a right to any benefit payable with respect to a Participant pursuant to a “domestic relations order” (as hereinafter defined) is not prohibited. In the event a right to a

 

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benefit hereunder is established pursuant to a domestic relations order, any benefit otherwise payable to the Participant or his/her beneficiary hereunder shall be appropriately reduced to reflect the effect of the qualified domestic relations order. For purposes of the Program, “Alternate Payee” means a person who would be an alternate payee under Section 414(p)(8) of the Code if the Program were subject to Section 401(a) of the Code. A “domestic relations order” means any judgment, decree or order within the meaning of Section 414(p), including the approval of a property settlement agreement, provided that:

1.     the order relates to the provision of child support, alimony or marital property rights and is made pursuant to state domestic relations or community property laws;

2.     the order creates or recognizes the existence of an Alternate Payee’s right to receive all or a portion of the Participant’s Account Balance;

3.     the order specifies the name and last known mailing address of the Participant and each Alternate Payee covered by the order;

4.     the order precisely and unambiguously specifies the amount or percentage of the Participant’s Account Balance to be paid to each Alternate Payee or the manner in which the amount or percentage is to be determined;

5.     the order clearly specifies that it applies to this Program;

6.     the order does not require this Program to provide any type of benefits or form of benefits not otherwise provided under this Program; and

7.     the order provides that the Alternate Payee shall receive his or her interest in the Program in a lump sum as soon as administratively feasible following determination by the Company’s legal department (or its delegate) that the order satisfies the requirements of this Article.

XIII. EFFECTIVE DATE

This amendment and restatement of this Program shall be effective as of January 1, 2013.

IN WITNESS WHEREOF, the Merck Oversight Committee has caused this instrument to be executed by the Executive Director, Legal, Global Benefits & Executive Compensation, as of the                  day of December, 2012

 

MERCK & CO., INC.

By                                                                                   

Bruce W. Ellis

Executive Director, Legal

Global Benefits & Executive Compensation

 

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SCHEDULE I

DEFERRAL PROGRAM INVESTMENT ALTERNATIVES

“Mutual Funds” shall mean all of the same investment alternatives offered under the Merck U.S. Savings Plan as in effect from time to time, excluding participant loans and Merck Common Stock.

The Merck Common Stock fund offered under the Deferral Program shall be measured as if it were invested 100% in Merck Common Stock with dividends reinvested in additional shares of Merck Common Stock.

 

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SCHEDULE II

SPECIAL PROVISIONS APPLICABLE TO

MEDCO HEALTH EMPLOYEES

(Approved July 23, 2002)

DEFINITIONS

Medco Health – Medco Health Solutions, Inc.

Medco Health Employee – A participant who is (i) employed by Medco Health prior to the Spin-Off or (ii) employed by Merck prior to the Spin-Off and expected to be employed by Medco Health prior to or as of the Spin-Off.

Separated Medco Health Employee – A participant in the Deferral Program who is employed by Medco Health as of the date of the Spin-Off and is considered to have terminated employment with the Company as a result of the Spin-Off.

Spin-Off – The distribution by Merck to its shareholders of the equity securities of Medco Health. The Spin-Off will be a divestiture for purposes of the Deferral Program.

SPECIAL PROVISIONS

Notwithstanding anything to the contrary in Article VI, Section C of the Deferral Program, the Deferred Compensation Account of each Separated Medco Health Employee shall be paid out in accordance with Article VI, Section D, without regard to the $125,000 threshold set forth in Section C.

 

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Exhibit 10.15

FORM OF 2011 & 2012 PERFORMANCE SHARE UNIT TERMS

UNDER THE MERCK & CO., INC. 2010 STOCK INCENTIVE PLAN

 

I.      GENERAL. These Performance Share Units (“PSUs”) are granted under and subject to the Merck & Co., Inc. 2010 Stock Incentive Plan (the “Merck ISP”).  

Grant Type:

Grant Date:

   PSU - Annual     
  Award Period:          
II.     ELIGIBILITY. Employees who are Legacy Merck Employees in Grade              

M01-M02 jobs or Legacy Schering employees who are in Vice President or above positions as of December 31of the year prior to the grant are eligible to receive Performance Shares if the Committee in its sole and non-reviewable discretion designates him or her to receive a Performance Share Unit (“Performance Unit Grantee”).

 

III. PSUs

A.      Definitions: For the purpose of this Schedule:

“Award Period” means three years, with the first Award Period commencing on January 1, [grant year] and ending December 31, [grant year plus two].

“Code” means the Internal Revenue Code of 1986 or any successor thereto.

“Final Award” for each Award Period means the percentage of Target described in paragraph C of this Article III.

“Earnings Per Share” or “EPS” means the Company’s diluted earnings per shares of common stock adjusted to exclude charges or items from the measurement of performance relating to (1) restructurings, discontinued operations, purchase accounting items, merger-related costs, extraordinary items and other unusual or non-recurring charges and/or events; (2) an event either not directly related to Company operations or not reasonably within the control of Company management; and (3) the effects of tax or accounting changes in accordance with U.S. generally accepted accounting principles, or other significant legislative changes.

“Grant Date” means the date a Performance Share Unit is granted, which for Performance Share Units intended to constitute “performance-based compensation” under Section 162(m) of the Code shall not be later than 90 days after the beginning of an Award Period.

“Legacy Merck Employee” means an employee of Merck Sharp & Dohme Corp. or one of its subsidiaries.

“Legacy Schering Employee” means an employee of Schering Corporation or one of its subsidiaries.


“Peer Healthcare Companies” are:

 

Abbott Labs    Roche
Amgen    Johnson & Johnson
Astra Zeneca    Novartis
Bristol-Myers Squibb    Pfizer
Eli Lilly    Sanofi-Aventis
GlaxoSmithKline   

“Performance Unit Grantee” means an Eligible Employee who receives a Performance Share Unit.

“Performance Share Unit” means an award of Performance Shares as described in this Schedule.

“Performance Share” means a phantom share of Common Stock. Until distributed pursuant to paragraph F of this Article III, Performance Shares shall not entitle the holder to any of the rights of a holder of Common Stock; provided, however, that the Committee retains the right to make adjustments as described in Section 7 of the Merck ISP.

“Target Shares” means the number of Performance Shares that will be distributable if the Performance Measures are achieved at the level identified as “target” for the entire Award Period without regard to the Payout Modifier.

“Total Shareholder Return (TSR)” shall mean the change in the value of the Common Stock over the Award Period, taking into account both stock price appreciation (or depreciation) and the reinvestment of dividends. The beginning and ending stock prices will be based on the average closing stock prices during the months of December [immediately prior to grant year] and December [grant year plus two], respectively. TSR will be calculated on a compound annualized basis over the Award Period.

“TSR Percentile Rank” shall mean the percentage of annualized TSR values among the Peer Healthcare Companies that are lower than the Company’s annualized TSR. For example, if the Company’s annualized TSR is in the 51 st percentile, 49% of the Peer Healthcare Companies had higher annualized TSR and 51% of the companies in the Peer Healthcare Companies had equal or lower annualized TSR. For purposes of the TSR Percentile Rank calculation, Merck will be excluded from the array of Peer Healthcare Companies.

“Year” means calendar year.

B.       Establishment of Targets

The Committee, in its sole and non-reviewable discretion, shall determine the Target Shares for each Performance Share Unit for each Performance Unit Grantee.

C.       Determination of Performance Share Units .

The Final Award is derived as follows:

1.       The Target Award is divided by 3 (the “First Annual Tranche,” “Second Annual Tranche” and “Third Annual Tranche,” respectively, and each an “Annual Tranche”). Each Annual Tranche is a separate award for purposes of Section 162(m) of the Code.


2.       Within 90 days of the start of an award year, the Committee shall associate an EPS for each Payout Percentage in the following table with respect to that Year (the following table applies for the First Annual Tranche for [this year’s] PSU grants, the Second Annual Tranche for [last year’s] PSU grants, and the Third Annual Tranche for the PSU grants from [two years ago]):

 

EPS    Payout Percentage
Less than $[minimum]    0.0%
$[Minimum]    50.0%
$ Target    100.0%
$ Stretch    200.0%
 
A Payout Percentage corresponding to performance between two discrete EPS values in the table will be interpolated.

3.       After the award year ends, the Annual Tranche is multiplied by the Payout Percentage according to the above table after the Committee determines actual EPS for that award year.

4.       Steps 2 and 3 are completed for each of the First, Second and Third Year Annual Tranches, (yielding the “First, Second and Third Year Results,” respectively).

5.       The Sum of the First, Second and Third Year Results is multiplied by the sum of One and the Payout Modifier Percentage based on the Company’s TSR percentile rank compared to the TSR of the Peer Healthcare Companies during the Award Period according to the following table. The result is the Final Award.

 

TSR Percentile Rank    Payout Modifier
(0-20%)    -20%
(21-40%)    -10%
(41-60%)    0%
(61-80%)    +10%
(81-100%)    +20%

D.       Dividends

Dividends or dividend equivalents are not paid, accrued or accumulated on Performance Shares during the Award Period.

E.       Termination of Employment

1.       General Rule – If a Performance Unit Grantee’s employment is terminated during the Award Period for any reason other than those specified in the following paragraphs, this PSU award will be forfeited on the date employment ends.


2.       Involuntary Termination – If a Performance Unit Grantee’s employment terminates during the Award Period and the Company determines that employment was involuntarily terminated on or after the first anniversary of the Grant Date, a pro rata portion (based on the number of completed months held during the Award Period prior to the date employment terminated) of this PSU Award will be distributed at such time as it would have been paid if employment had continued, based on actual performance during the Award Period. The remainder will be forfeited on the date employment ends. The pro rata portion shall be determined by multiplying the Final Award by a fraction, the numerator of which is the number of completed months in the Award Period during which the Performance Unit Grantee was employed by the Company or JV, and the denominator of which is 36. An “involuntary termination” includes termination of employment by the Company as the result of a restructuring or job elimination, but excludes non-performance of duties and the reasons listed under paragraphs 3 through 7 of this section.

3.       Sale – If a Performance Unit Grantee’s employment is terminated during the Award Period and the Company determines that such termination resulted from the sale of his or her subsidiary, division or joint venture, the following portion of this PSU Award will be distributed at such time as it would have been paid if employment had continued, based on actual performance during the Award Period: one-third if employment terminates on or after the first day of the Award Period but before the first anniversary thereof; two-thirds if employment terminates on or after the first anniversary of the first day of the Award Period but before the second anniversary thereof; and all if employment terminates on or after the second anniversary of the first day of the Award Period. The remainder will be forfeited on the date a Performance Unit Grantee’s employment ends.

4.       Retirement – If a Performance Unit Grantee terminates employment during the Award Period by retirement (including early and disability retirement) on or after the same day of the sixth month after the Grant Date, then this PSU Award will continue and be distributable on a pro rata basis at the time active Performance Unit Grantees receive such distributions with respect to that Award Period based on actual performance during the Award Period. The pro rata portion shall be determined by multiplying the Final Award by a fraction, the numerator of which is the number of completed months in the Award Period during which the Performance Unit Grantee was employed by the Company or JV, and the denominator of which is 36. If a Performance Unit Grantee’s Retirement occurs before the same day of the sixth month after the Grant Date, then this PSU Award will be forfeited on the date employment ends. For participants in a U.S.-based tax-qualified defined benefit retirement plan, “retirement” means a termination of employment at a time that qualifies as a disability, early, normal or late retirement according to the terms of that plan as in effect from time to time. For other grantees, “retirement” is determined by the Company.

5.       Death – If a Performance Unit Grantee’s employment terminates due to death during the Award Period, all of this PSU Award will continue and be distributed to his or her estate at the time active Performance Unit Grantees receive such distributions with respect to this PSU Award, based on actual performance during the Award Period.

6.       Misconduct – If a Performance Unit Grantee’s employment is terminated as a result of deliberate, willful or gross misconduct, this PSU Award will be forfeited immediately upon the Performance Unit Grantee’s receipt of notice of such termination.


7.       Disability – If a Performance Unit Grantee’s employment is terminated during the Award Period and the Company determines that such termination resulted from inability to perform the material duties of his or her role by reason of a physical or mental infirmity that is expected to last for at least six months or to result in death, whether or not he or she is eligible for disability benefits from any applicable disability program, then this PSU Award will continue and be distributable in accordance with its terms as if employment had continued based on actual performance during the Award Period and will be distributed at the time active PSU Grantees receive distributions with respect to this PSU Award.

8.       Joint Venture Service – A transfer of a Performance Unit Grantee’s employment to a joint venture, including, in the case of grants to Legacy Merck Employees, any other entity in which the Company has determined that it has a significant business or ownership interest, is not considered termination of employment for purposes of this PSU Award. Such employment must be approved by, and contiguous with employment by, the Company, as described more fully in the Rules and Regulations. The terms set out in paragraphs 1-7 above apply to this PSU Award while a Performance Unit Grantee is employed by the joint venture or other entity.

F.       Distribution of Performance Shares

1.       General Rule. Following the end of an Award Period, each Performance Unit Grantee shall be entitled to receive a number of shares of Common stock equal to the Final Award, rounded to the nearest whole number (no fractional shares shall be issued). Such distribution shall be made as soon as administratively feasible, but in no event later than the end of the calendar year in which the Final Award is determined. Unless otherwise determined by the Committee, the Company shall withhold any applicable taxes directly from a Performance Share Unit before it is denominated in actual shares of Common Stock.

2.       Death. In the case of distribution on account of a Performance Unit Grantee’s death, the portion of the Performance Share Unit distributable shall be distributed to the Performance Unit Grantee’s estate. Unless the Committee determines otherwise, the Company will withhold any applicable taxes directly from a Performance Unit before it is denominated in actual shares of Common Stock.

G.       Transferability

Prior to distribution pursuant to paragraph F. of this Article III, Performance Share Units shall not be transferable, assignable or alienable except by will or the laws of descent or distribution following a Performance Unit Grantee’s death.

 

IV. Administrative Powers

In addition to the Committee’s powers set forth in the Merck ISP, anything in this Schedule to the contrary notwithstanding, the Committee may revise the terms of any Performance Share Unit not yet granted or, with respect to any Performance Share Unit not intended to constitute “performance-based compensation” under Section 162(m) of the Code, granted but prior to the end of an Award Period if unforeseen events occur and which, in the judgment of the Committee, make the application of original terms of this Schedule or the Performance Share Unit unfair and contrary to the intentions of this Schedule unless a revision is made.


V. Clawback Policy for PSUs Upon Significant Restatement of Financial Results

A.   PSUs Subject to Clawback. PSUs, and any proceeds therefrom, are subject to the Company’s right to reclaim their benefits in the event of a significant restatement of financial results for any Award Period, pursuant to the process described below.

1.   The Audit Committee of the Board will review the issues and circumstances that resulted in a restatement of financial results to determine if the restatement was significant and make an initial determination of the cause of the restatement—that is whether the restatement was caused, in whole or in part, by Executive Fault (as those terms are defined below); and

2.   The Compensation and Benefits Committee of the Board will (a) recalculate the Company’s results for any Award Period with respect to PSUs that included an Award Period which occurred during the restatement period; and (b) if it is determined that such restatement was caused in whole or in part by the Executive’s Fault, the Compensation and Benefits Committee will seek reimbursement from the Executive of that portion of the payout of the PSU that the Executive received within 18 months of the restatement based on the erroneous financial results.

B.   “Executive” means executive officers for the purposes of the Securities Exchange Act of 1934, as amended.

C.   “Fault” means fraud or willful misconduct. “Willful misconduct” is generally viewed as dereliction of a duty or unlawful or improper behavior committed voluntarily and intentionally; something more than negligence. If the Audit Committee determines that Fault may have been a factor causing the restatement, the Audit Committee will appoint an independent investigator whose determination shall be final and binding.

D.   Exclusions from Clawback. This Article does not apply to restatements that the Audit Committee determines (1) are required or permitted under generally accepted accounting principles (“GAAP”) in connection with the adoption or implementation of a new accounting standard or (2) are caused due to the Company’s decision to change its accounting practice as permitted under GAAP.

 

VI. Change-in-Control

Upon the occurrence of a change-in-control (as such term is defined in the Merck ISP, Final Awards will be determined as follows: Sum of (i) the Annual Tranche multiplied by the Payout Percentage based on actual performance for each completed Year in the Award Period prior to the change-in-control; and (ii) the Annual Tranche assuming a Payout Percentage of 100 percent for all other Years during the Award Period, in all cases without adjustment for Total Shareholder Return. The Final Award will be distributed at the same time and in the same manner as described in Article F.1.

If the Company terminates a Performance Unit Grantee’s employment for any reason other than those described in Articles E.1 and E.6, (1) during the Award Period and (2) within 2 years following a change-in-control, the Final Award will be determined and paid as described in the immediately preceding paragraph.


VII. Section 409A Compliance .

Anything in the ISP or this Schedule to the contrary notwithstanding, no distribution of Performance Share Units may be made unless in compliance with Section 409A of the Code or any successor thereto. In addition, distributions, if any, to a “Specified Employee” as defined in Treas. Reg. Sec. 1.409A-1(i) or any successor thereto, to the extent required by Section 409A of the Code, made due to a separation from service (as defined in Section 409A) will not be made before the first day of the sixth month following the separation from service, in the same form as they would have been made had this restriction not applied; provided further, that no dividend or dividend equivalents will be paid, accrued or accumulated in respect of the period during which distribution was suspended.

Exhibit 10.19

FORM OF OPTION QUARTERLY, ANNUAL GRANTS

STOCK OPTION TERMS

STARTING 2013

FOR A NON-QUALIFIED STOCK OPTION (NQSO)

UNDER THE MERCK & CO., INC. 2010 INCENTIVE STOCK PLAN

This is a summary of the terms applicable to the stock option specified in this document. Different terms may apply to any prior or future stock option.

 

Grant Type:      NQSO – Annual
Option Price:     
Grant Date:     
Expiration Date:      Day before 10 th anniversary

 

Vesting Date

  

Portion that Vests

1 st Anniversary    First: 33.333%
2 nd Anniversary    Second: 33.333%
3 rd Anniversary    Balance

I. GENERAL INFORMATION

This stock option becomes exercisable in equal installments (subject to a rounding process) on the Vesting Dates indicated in the accompanying box. This stock option expires on its Expiration Date, which is the day before the tenth anniversary of the Grant Date. If your employment with the Company is terminated, your right to exercise this stock option will be determined according to the terms in Section II.

Eligibility: Eligibility for grants is determined under the Merck & Co., Inc. 2010 Incentive Stock Plan for employees of the Company, its subsidiaries, its affiliates or its joint ventures if designated by the Compensation and Benefits Committee of Merck’s Board of Directors, or its delegate (the “Committee”).

II. TERMINATION OF EMPLOYMENT

A. General Rule. If your employment is terminated for any reason other than those specified in the following paragraphs, the portion of this stock option that is unvested will expire on the date your employment ends; the portion of this stock option that is vested will expire unless exercised before the New York Stock Exchange closes (the “Close of Business”) on the day before the same day of the third month (“Within Three Months”) after the date of the termination (but in no event after the expiration of the Option Period). Close of Business for any day on which the New York Stock Exchange is not open means the close of business prior to that date when the Exchange is open. Where there is no corresponding day of a month, the last day of the month is deemed to be the same day as a later day (e.g., November 28, 29 and 30 all correspond to February 28 in non leap years). If you are rehired by the Company or JV, this option nevertheless will expire unless exercised Within Three Months, or the original Expiration Date if earlier.

B. Retirement. If you retire from service with the Company the portion of this stock option that would have become exercisable according to its original schedule within one year of the date your employment terminates will vest and become exercisable on its applicable Vesting Date and the remainder

will expire immediately. Whether already vested on the date your employment terminates or vested as a result of such retirement, this option will expire on the earlier of (a) the day before the fifth anniversary of the termination date or (b) its original Expiration Date. For grantees who are employed in the U.S., “retirement” means a termination of employment after attaining the earliest of (a) age 55 with at least 10 years of service (b) such age and service that provides eligibility for subsidized retiree medical coverage or (c) age 65 without regard to years of service. For other grantees, “retire” is determined by the Company. If your employment is terminated as described in this paragraph and you are later rehired by the Company or JV, this option nevertheless will expire according to this paragraph notwithstanding such rehire.

C. Involuntary Termination. If your employment is terminated by the Company and the Company determines that such termination was involuntary, including the result of a restructuring or job elimination, but excluding non-performance of your duties and the reasons listed under paragraphs B or D through H, the portion of this stock option that is unvested will expire on the date your employment ends; the portion of this stock option that is vested will expire on the day before the one year anniversary of the date your employment ends, but in no event later than the original Expiration Date. If your employment is terminated as described in this paragraph and you are later rehired by the Company or JV, this option nevertheless will expire according to this paragraph notwithstanding such rehire.

D. Sale. If your employment is terminated and the Company determines that such termination resulted from the sale of your subsidiary, division or joint venture, the portion of this stock option that would have become exercisable within one year of the date your employment terminated according to the original schedule will vest immediately upon such termination. Whether already vested on the date your employment terminates or vested as a result of such sale, this stock option will expire the day before the first anniversary of the date your employment with the Company ends, but in no event later than the original Expiration Date. Notwithstanding the foregoing, the Committee may determine, for purposes of this stock option grant, whether employment with an entity that is established from the Company’s spin off, split off, split up or distribution of equity securities in connection with that entity constitutes a termination of employment, and may make adjustments, if any, as it deems appropriate, at the time of the distribution of such equity securities, in the kind and/or number of shares subject to this option, and/or in the option price of such option. If your employment is terminated as described in this paragraph and you are later rehired by the Company or JV, this option nevertheless will expire according to this paragraph notwithstanding such rehire.

 

 

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E. Misconduct. If your employment is terminated as a result of your deliberate, willful or gross misconduct, this stock option (whether vested or unvested) will expire immediately upon your receipt of notice of such termination.

F. Death. If your employment terminates as a result of your death, the portion of this stock option that is unvested will vest immediately upon your death. Whether already vested on the date of your death or vested as a result of your death, this stock option will expire on the day before the first anniversary of your death, even if such date is later than the Original Expiration date. This stock option will expire on such earlier date than otherwise specified in this paragraph as may be required under applicable non-U.S. law (e.g., in France, six months from the date of death).

G. Disability. If your employment is terminated and the Company determines that such termination resulted from your inability to perform the material duties of your role by reason of a physical or mental infirmity that is expected to last for at least six months or to result in your death, whether or not you are eligible for disability benefits from any applicable disability program, then this stock option will continue to become exercisable on applicable Vesting Dates and will expire on the earlier of (a) the day before the fifth anniversary of the day your employment terminates and (b) its original Expiration Date. If your employment is terminated as described in this paragraph and you are later rehired by the Company or JV, this option nevertheless will expire according to this paragraph notwithstanding such rehire.

H. Change in Control. If the Company involuntarily terminates your employment without Cause before the second anniversary after the closing of a change in control, each unvested Stock Option that is outstanding immediately prior to the change in control will immediately become fully vested and exercisable. All options, including options vested prior to such time, will expire on the day before the fifth anniversary of the termination of your employment following a change in control (but not beyond the Expiration Date). This extended exercise period does not apply in the case of termination by reasons of retirement, involuntary termination, sale, misconduct, death or disability, as described in paragraphs B, D, E, F and G above or termination prior to a change in control. If this stock option does not remain outstanding following the change in control and is not converted into a successor stock option, then you will be entitled to receive cash for this option in an amount at least equal to the difference between the price paid to stockholders in the change in control and the Option Price of this stock option. A “change in control” has the same meaning that it has under the Merck & Co., Inc. Change in Control Separation Benefits Plan (excluding an MSD Change in Control).

I. Joint Venture. Employment with a joint venture or other entity in which the Company has determined that it has a significant business or ownership interest (a “JV”) is not considered termination of employment for purposes of this stock option. If you transfer employment from the Company to a JV or from a JV to the Company, such employment must be approved by, and contiguous with employment by, the Company or the JV. The terms set out in paragraphs A through H above apply to this stock option while the option holder is employed by the JV.

III. TRANSFERABILITY

This stock option is not transferable and may not be assigned or otherwise transferred except, under specific terms, by executives who hold or who retired within the prior 12 months from a Section 16 officer position.

IV. ADMINISTRATION

The Committee is responsible for construing and interpreting this grant, including the right to construe disputed or doubtful plan provisions, and may establish, amend and construe such rules and regulations as it may deem necessary or desirable for the proper administration of this grant. Any decision or action taken or to be taken by the Committee, arising out of or in connection with the construction, administration, interpretation and effect of this grant shall, to the maximum extent permitted by applicable law, be within its absolute discretion (except as otherwise specifically provided herein) and shall be final, binding and conclusive upon the Company, all eligible employees and any person claiming under or through any eligible employee. All determinations by the Committee including, without limitation, determinations of the eligible employees, the form, amount and timing of incentives, the terms and provisions of incentives and the writings evidencing incentives, need not be uniform and may be made selectively among eligible employees who receive, or are eligible to receive, incentives hereunder, whether or not such eligible employees are similarly situated.

V. GRANTS NOT PART OF EMPLOYMENT CONTRACT

Notwithstanding reference to grants of incentives in letters offering employment or in specific employment agreements, incentives do not constitute part of any employment contract between the Company or JV and the grantee, whether the employment contract arises as a matter of agreement or applicable law. The value of any grant or of the proceeds of any exercise of Incentives are not included in calculating compensation for purposes of pension payments, separation pay, termination indemnities or other similar payments due upon termination of employment.

This stock option is subject to the provisions of the 2010 Incentive Stock Plan. For further information regarding your stock options, you may access the Merck Global Long-Term Incentives homepage via http://onemerck.com

Unless you notify the Company in writing that you do wish to refuse this grant within 60 days of the Grant Date, you will be deemed to acknowledge that you have read, understood and agree to all of the terms, conditions and provisions of this document and the Merck & Co., Inc. 2010 Incentive Stock Plan.

If you wish to reject this grant, you must send your written notice of rejection to the Company at:

Attention: Global Executive Compensation and Benefits

Merck & Co., Inc.

One Merck Drive, WS1F-38

Whitehouse Station, New Jersey, U.S.A. 08889

 

 

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Exhibit 10.20

FORM OF RSU QUARTERLY, ANNUAL GRANTS

RESTRICTED STOCK UNIT TERMS

STARTING 2013

UNDER THE MERCK & CO., INC 2010 INCENTIVE STOCK PLAN

This is a summary of the terms applicable to the Restricted Stock Unit (RSU) Award specified in this document. Different terms may apply to any prior or future RSU Awards.

 

Grant Type:      RSU—Quarterly
Grant Date:     
Vesting Date:      3 rd Anniversary

Eligibility : Eligibility for grants is determined under the Merck & Co., Inc. 2010 Incentive Stock Plan for employees of the Company, its subsidiaries, its affiliates or its joint ventures if designated by the Compensation and Benefits Committee of Merck’s Board of Directors, or its delegate (the “Committee”).

I. GENERAL INFORMATION

A. Restricted Period. The Restricted Period is the period during which this RSU Award is restricted and subject to forfeiture. The Restricted Period begins on the Grant Date and ends on the third anniversary of the Grant Date unless ended earlier under Article II below.

B. Dividend Equivalents. During the Restricted Period, dividend equivalents will be accrued for the holder (“you”) if and to the extent dividends are paid by the Company on Merck Common Stock. Payment of such dividends will be made, without interest or earnings, at the end of the Restricted Period. If any portion of this RSU Award lapses, is forfeited or expires, no dividend equivalents will be credited or paid on such portion. Any payment of dividend equivalents will be reduced to the extent necessary for the Company to satisfy any tax or other withholding obligations. No voting rights apply to this RSU Award.

C. Distribution. Upon the expiration of the Restricted Period if you are then employed, you will be entitled to receive a number of shares of Merck common stock equal to the number of RSUs that have become unrestricted and the dividend equivalents that accrued on that portion. Prior to distribution, you must deliver to the Company an amount the Company determines to be sufficient to satisfy any amount required to be withheld, including applicable taxes. The Company may, in its sole discretion, withhold from the RSU Award distribution a number of shares to pay applicable withholding (including taxes).

D. 409A Compliance. Anything to the contrary notwithstanding, no distribution of RSUs may be made unless in compliance with Section 409A of the Internal Revenue Code or any successor thereto. Specifically, distributions made due to a separation from service (as defined in Section 409A) to a “Specified Employee” as defined in Treas. Reg. Sec. 1.409A-1(i) or any successor thereto, to the extent required by Section 409A of the Code will not be made until administratively feasible following the first day of the sixth month following the separation from service, in the same form as they would have been made had this restriction not applied; provided further, that dividend equivalents that otherwise would have accrued will accrue during the period during which distribution is suspended.

 

II. TERMINATION OF EMPLOYMENT

If your employment with the Company is terminated during the Restricted Period, your right to this RSU Award will be determined according to the terms in this Section II.

A. General Rule. If your employment is terminated during the Restricted Period for any reason other than those specified in the following paragraphs, this RSU Award (and any accrued dividend equivalents) will be forfeited on the date your employment ends. If your employment is terminated as described in this paragraph and you are later rehired by the Company or JV, this grant nevertheless will expire according to this paragraph notwithstanding such rehire.

B. Sale. If your employment is terminated during the Restricted Period and the Company determines that such termination resulted from the sale of your subsidiary, division or joint venture, the following portion of your RSU Award and accrued dividend equivalents will be distributed to you at such time as it would have been paid if your employment had continued: one-third if employment terminates on or after the Grant Date but before the first anniversary thereof; two-thirds if employment terminates on or after the first anniversary of the Grant Date but before the second anniversary thereof; and all if employment terminates on or after the second anniversary of the Grant Date. The remainder will be forfeited on the date your employment ends. If your employment is terminated as described in this paragraph and you are later rehired by the Company or JV, this grant nevertheless will expire according to this paragraph notwithstanding such rehire.

C. Involuntary Termination. If your employment terminates during the Restricted Period and the Company determines that your employment was involuntarily terminated on or after the first anniversary of the Grant Date and during the Restricted Period, a pro rata portion (based on the number of completed months held prior to the date your employment terminated) of your RSU Award and accrued dividend equivalents will be distributed to you at such time as they would have been paid if your employment had continued. The remainder will be forfeited on the date your employment ends. An “involuntary termination” includes termination of your employment by the Company as the result of a restructuring or job elimination, but excludes non-performance of your duties and the reasons listed under paragraphs B, or D through H of this section. If your employment is terminated as described in this paragraph and you are later rehired by the Company or JV, this grant nevertheless will expire according to this paragraph notwithstanding such rehire.

D. Retirement. If you terminate employment during the Restricted Period by retirement then a pro-rata portion of this RSU Award will continue and be distributable in accordance with its terms as if employment had continued and will be distributed at the time active RSU Grantees receive distributions with respect to this Restricted Period. The pro-rata portion is the number of complete months of

 

 

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employment, beginning on the Grant Date and ending on the date employment terminates, divided by 36. The remainder of this RSU Award and any accrued dividends will terminate on the date employment terminates. For grantees who are employed in the U.S., “retirement” means a termination of employment after attaining the earliest of (a) age 55 with at least 10 years of service (b) such age and service that provides eligibility for subsidized retiree medical coverage or (c) age 65 without regard to years of service. For other grantees, “retirement” is determined by the Company. If your employment is terminated as described in this paragraph and you are later rehired by the Company or JV, this grant nevertheless will expire according to this paragraph notwithstanding such rehire.

E. Death. If your employment terminates due to your death during the Restricted Period, all of this RSU Award and accrued dividend equivalents will be distributed to your estate as soon as possible after your death.

F. Misconduct. If your employment is terminated as a result of your deliberate, willful or gross misconduct, this RSU Award and accrued dividend equivalents will be forfeited immediately upon your receipt of notice of such termination.

G. Disability. If your employment is terminated during the Restricted Period and the Company determines that such termination resulted from inability to perform the material duties of your role by reason of a physical or mental infirmity that is expected to last for at least six months or to result in your death, whether or not you are eligible for disability benefits from any applicable disability program, then this RSU Award will continue and be distributable in accordance with its terms as if employment had continued and will be distributed at the time active RSU Grantees receive distributions with respect to this RSU Award.

H. Change in Control. If the Company involuntarily terminates your employment during the Restricted Period without Cause before the second anniversary after the closing of any change in control, then this RSU Award will continue in accordance with its terms as if employment had continued and will be distributed at the time active RSU Grantees receive distributions with respect to this RSU Award. If this RSU does not remain outstanding following the change in control and is not converted into a successor RSU, then you will be entitled to receive cash for this RSU in an amount equal to the fair market value of the consideration paid to Merck stockholders for a share of Merck common stock in the change in control payable within 30 days of the closing of the change in control. On the second anniversary of the closing of the change in control, this paragraph shall expire. Change in control is defined in the Merck & Co., Inc. Change in Control Separation Benefits Plan (excluding an MSD Change in Control), but if RSUs are considered “deferred compensation” under Section 409A of the Internal Revenue Code, the definition of change in control will be modified to the extent necessary to comply with Section 409A.

I. Joint Venture. Employment with a joint venture or other entity in which the Company has a significant business or ownership interest is not considered termination of employment for purposes of this RSU Award. Such employment must be approved by, and contiguous with employment by, the Company. The terms set out in paragraphs A-H above apply to this RSU Award while you are employed by the joint venture or other entity.

III. TRANSFERABILITY

This RSU Award is not transferable and may not be assigned or otherwise transferred.

 

IV. ADMINISTRATION

The Committee is responsible for construing and interpreting this grant, including the right to construe disputed or doubtful plan provisions, and may establish, amend and construe such rules and regulations as it may deem necessary or desirable for the proper administration of this grant. Any decision or action taken or to be taken by the Committee, arising out of or in connection with the construction, administration, interpretation and effect of this grant shall, to the maximum extent permitted by applicable law, be within its absolute discretion (except as otherwise specifically provided herein) and shall be final, binding and conclusive upon the Company, all eligible employees and any person claiming under or through any eligible employee. All determinations by the Committee including, without limitation, determinations of the eligible employees, the form, amount and timing of incentives, the terms and provisions of incentives and the writings evidencing incentives, need not be uniform and may be made selectively among eligible employees who receive, or are eligible to receive, Incentives hereunder, whether or not such eligible employees are similarly situated.

V. GRANTS NOT PART OF EMPLOYMENT CONTRACT

Notwithstanding reference to grants of incentives in letters offering employment or in specific employment agreements, incentives do not constitute part of any employment contract between the Company or JV and the grantee, whether the employment contract arises as a matter of agreement or applicable law. The value of any grant or of the proceeds of any exercise of incentives are not included in calculating compensation for purposes of pension payments, separation pay, termination indemnities or other similar payments due upon termination of employment.

This RSU Award is subject to the provisions of the 2010 Incentive Stock Plan. For further information regarding your RSU Award, you may access the Merck Global Long-Term Incentives homepage via http://onemerck.com

Unless you notify the Company in writing that you wish to refuse this grant within 60 days of the Grant Date, you will be deemed to acknowledge that you have read, understood and agree to all of the terms, conditions and provisions of this document and the Merck & Co., Inc. 2010 Incentive Stock Plan.

If you wish to reject this grant, you must send your written notice of rejection to the Company at:

Attention: Global Executive Compensation and Benefits

Merck & Co., Inc.

One Merck Drive, WS1F-38

Whitehouse Station, New Jersey, U.S.A. 08889

 

 

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Exhibit 10.25

MERCK & CO. INC. U.S. SEPARATION BENEFITS PLAN

Effective as of January 1, 2013


MERCK & CO., INC., U.S. SEPARATION BENEFITS PLAN

SECTION 1

PREAMBLE

Merck Sharp & Dohme Corp. established the MSD Separation Benefits Plan (the “MSD Plan”), as amended from time to time, to provide benefits to eligible non-union employees whose employment with Merck Sharp & Dohme Corp. or a participating wholly owned subsidiary (collectively, “MSD”) was terminated under certain circumstances at the initiative of MSD.

Schering-Plough Corporation established the Schering-Plough Separation Benefits Plan (the “Schering Plan”), as amended from time to time, for the purpose of providing severance benefits to eligible union and non-union employees whose employment with Schering Corporation and certain of its U.S. affiliated companies was terminated under certain circumstances.

Effective January 1, 2012, the Schering Plan merged into the MSD Plan with the MSD Plan being renamed the Merck & Co., Inc. U.S. Separation Benefits Plan (the “Plan”). The Plan was amended and restated in its entirety at that time. Effective January 1, 2013, the Plan is again being amended and restated in its entirety as set forth herein.

The purpose of the Plan is to provide benefits to eligible employees whose employment with an Employer is terminated at the initiative of the Employer for reasons described below. This Plan is part of the MSD Separation Allowance Plan (Plan No. 514).

 

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SECTION 2

DEFINITIONS

For the purposes of this Plan, the following terms shall have the following meanings:

2.1      “ Annual Base Salary means

(a) With respect to a Participant who is exempt, his or her annualized base salary in effect as of his or her Separation Date, according to the Employer’s payroll records, without reduction for any contributions to Employer-sponsored benefit plans. For a Participant who is regularly scheduled to work less than full-time, Annual Base Salary is the reduced annual base salary applicable to the less than full-time position.

(b) With respect to a Participant who is non-exempt, the hourly rate according to the Employer’s payroll records in effect as of his or her Separation Date multiplied by the number of hours the Eligible Employee is regularly scheduled to work (up to a maximum of 2080 hours).

Annual Base Salary does not include bonuses, commissions, overtime pay, shift pay, premium pay, lump sum merit increases, cost of living allowances, income from stock options or other incentives under an Incentive Stock Plan of the Employer (or the Parent or any of its subsidiaries), stock grants or other incentives, or other pay not specifically included above.

2.2       Base Pay Rate ” means

(a)      With respect to an Eligible Employee who is exempt, his/her annual base pay according to the Employer’s payroll records in effect as of the date the Eligible Employee is offered a Qualified Alternative Position or a Negotiated Job Offer. For an Eligible Employee who is regularly scheduled to work less than full-time, annual base pay is the reduced annual base pay to the less than full-time position.

(b)      With respect to an Eligible Employee who is non-exempt, the hourly rate according to the Employer’s payroll records in effect as of the date the Eligible Employee is offered a Qualified Alternative Position or a Negotiated Job Offer multiplied by the number of hours the Eligible Employee is regularly scheduled to work (up to a maximum of 2080 hours).

Base Pay Rate is calculated without reduction for any contributions to Employer-sponsored benefit plans. Base Pay Rate includes applicable shift pay and premium pay but does not include bonuses, commissions, overtime pay, lump sum merit increases, cost of living allowances, income from awards granted under an Incentive Stock Plan of the Employer (or the Parent or its subsidiaries), or other pay not specifically included above.

2.3      “ Basic Life Insurance means life insurance provided to an Eligible Employee under a plan sponsored by Parent or a subsidiary of Parent equal to 1x “base pay” as defined under the life insurance plan in which the Eligible Employee participates, as it may be amended from time to time.

2.4      “ Benefits Continuation Period means the period of time, as set forth on Schedule B-2, during which a Participant is eligible to receive Separation Benefits, provided, however that the Participant may elect to end the period earlier than indicated on Schedule B-2 by notifying the

 

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Employer’s health and insurance plan administrator (i) within the later of thirty (30) days from the Participant’s Separation Date or the date by which the Participant is provided to review the Separation Letter so that the Benefit Continuation Period ends on the date it would have otherwise begun, or (ii) during the Employer’s annual open enrollment period for health and insurance benefits so that the Benefit Continuation Period ends the following January 1 (provided that date is not beyond the period set forth on Schedule B-2), or (iii) mid-year with a qualified status change that otherwise permits the Participant to make a change to the Participant’s healthcare coverage in accordance with the terms of the Employer’s healthcare plan so that the Benefits Continuation Period ends on the date the mid-year change would otherwise be effective under the terms of the Employer’s healthcare plan (provided that date is not beyond the period set forth on Schedule B-2).

2.5      “ Change in Control shall have the meaning set forth in the CIC Plan (and, for avoidance of doubt, a valid amendment of that definition under the CIC Plan shall constitute an amendment of this Plan without further action).

2.6      “ CIC Plan means the Merck & Co., Inc. Change in Control Separation Benefits Plan, as amended and restated effective January 1, 2013 and as it may be further amended from time to time, and any successor thereto.

2.7      “ Claims Reviewer means the Merck & Co., Inc. Employee Benefits Committee (or its delegate) whose members are appointed by the Parent’s Executive Vice President of Human Resources or his or her delegate; provided, however, for Section 16 Officers, Claims Reviewer means the Compensation and Benefits Committee of the Board of Directors of Parent or its delegate.

2.8      “ Code means the Internal Revenue Code of 1986, as amended and the regulations promulgated thereunder.

2.9       “ Complete Years of Continuous Service ” means (a) for a Legacy Schering Employee, a year from the Participant’s Most Recent Hire Date with a Legacy Schering Entity to its anniversary, and thereafter from each anniversary to the next, (b) for a Legacy Merck Employee, a year from the Participant’s Most Recent Hire Date with a Legacy Merck Entity to its anniversary, and thereafter from each anniversary to the next, (c) for a Legacy Inspire Employee, a year from the Participant’s Most Recent Hire Date with a Merck Entity to its anniversary, and thereafter from each anniversary to the next, and (d) for a Non-Legacy Company Employee, from the Participant’s Most Recent Hire Date with a Merck Entity, and thereafter from each anniversary to the next.

2.10      “ Continuous Service means (a) for a Legacy Schering Employee, the period of a Participant’s continuous employment with a Legacy Schering Entity commencing on the Participant’s Most Recent Hire Date with a Legacy Schering Entity and ending on the Separation Date as reflected on the Employer’s employee database, (b) for a Legacy Merck Employee, the period of a Participant’s continuous employment with a Legacy Merck Entity commencing on the Participant’s Most Recent Hire Date with a Legacy Merck Entity and ending on the Separation Date as reflected on the Employer’s employee database, (c) for a Legacy Inspire Employee, the period of a Participant’s continuous employment with a Merck Entity commencing on the Participant’s Most Recent Hire Date with a Merck Entity and ending on the Separation Date as reflected on the Employer’s employee database, and (d) for a Non-Legacy Company Employee, the period of a Participant’s continuous employment with a Merck Entity commencing on the Participant’s Most Recent Hire Date with a Merck Entity and ending on the Separation Date as

 

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reflected on the Employer’s employee database. For the avoidance of doubt, service prior to November 4, 2009 by a Legacy Schering Employee with a Legacy Merck Entity or a Legacy Merck Employee with a Legacy Schering Entity is excluded from “Continuous Service.” Notwithstanding anything contained in this Plan to the contrary, employment with a Legacy Schering Entity, Legacy Merck Entity or a Merck Entity as an Excluded Person does not count as “Continuous Service”.

2.11      “ Eligible Employee means (a) any regular full-time or regular part-time employee of an Employer who is on the Employer’s normal U.S. payroll and as to whom the terms and conditions of employment are not covered by a collective bargaining agreement unless the collective bargaining agreement specifically provides for coverage under the Plan; or (b) a U.S. Expatriate on an Employer’s normal U.S. payroll.

The term “Eligible Employee” shall not include:

(i) an employee (x) who is a party to an employment agreement with the Employer or with the Parent (or any of its subsidiaries) or (y) who is entitled, upon termination of employment with the Employer, to separation, severance, termination or other similar payments (1) under another plan or program sponsored by the Employer or Parent (or any of its subsidiaries); or (2) pursuant to a separate agreement with the Employer or Parent (or any of its subsidiaries) or (z) who is a party to an agreement with the Employer or Parent (or any of its subsidiaries) that provides that no payment or benefits are due to the employee in connection with his or her termination of employment; provided, however, in each case under the foregoing clauses (x), (y) and (z) unless the plan, program or agreement expressly provides for benefits under this Plan.

(ii) a participant in the CIC Plan (but this clause shall only apply during the Protection Period (as defined in Section 8.1));

(iii) temporary employees (including college coops, summer employees, high school coops, flexible workforce employees, post-doctorate research fellows and any other such temporary classifications ) and/or employees called by the Employer at any time for employment in the U.S. on a non-scheduled and non-recurring basis, and who becomes an employee of the Employer only after reporting to work for the period of time during which the person is working;

(iv) an Excluded Person;

(v) employees of a non-US subsidiary of an Employer (or who are dual employees of a non-US subsidiary of an Employer) who are on assignment in the US;

(vi) employees whose employment ends for any reason while on unapproved leaves of absence;

(vii) employees whose employment ends for any reason while on approved leaves of absence for a period equal to or more than six continuous months regardless of the reason(s) for the leave excluding the following approved leaves of absence: medical disability leaves, military leaves and family medical leaves under federal or state family medical leave laws and excluding Grandfathered Legacy Schering Employees;

 

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(viii) employees whose employment ends for any reason while on approved leaves of absence for medical disability for a period equal to or more than one year excluding Grandfathered Legacy Schering Employees; and/or.

(ix) Grandfathered Legacy Schering Employees who have not been medically cleared to return to work or who do not return to work within two years of their first day absent.

For purposes of the foregoing clauses (vii) and (viii), a series of leaves of absence is considered one continuous leave for purposes of calculating the six-month or one-year requirement if the employee does not return to active employment for any reason, including but not limited to because the employee’s former position is unavailable and the employee is unable to secure a new position.

Whether an individual is an Eligible Employee or not is determined as of the date of his/her Termination due to Workforce Restructuring or for Rebadged Employees as of the date of his/her termination of employment due to an outsource transaction or for Grandfathered Legacy Schering Employees as of the date of his/her Grandfathered Legacy Schering Termination.

2.12      “ Employer means individually and collectively, the entities identified on Schedule A attached hereto.

2.13      “ ERISA means the Employee Retirement Income Security Act of 1974, as amended, and the regulations promulgated thereunder.

2.14      “ Excluded Person means a person who (i) is an independent contractor, or agrees or has agreed that he/she is an independent contractor, or (ii) has any agreement or understanding with the Employer, or any of its affiliates that he/she is not an employee or an Eligible Employee, or (iii) is employed by a temporary or other employment agency, regardless of the amount of control, supervision or training provided by the Employer or its affiliates, or (iv) is a “leased employee” as defined under Section 414(n) of the Internal Revenue Code of 1986, as amended, or (v) is not treated by the Employer as an employee for purposes of withholding federal income taxes, regardless of any contrary Internal Revenue Service, governmental or judicial determination relating to such employment status or tax withholding. An Excluded Person is not eligible to participate in the Plan even if a court, agency or other authority rules that he/she is a common-law employee of the Employer or its affiliates.

2.15       “Grandfathered Legacy Schering Employees means Legacy Schering Employees who (i) were absent from work on December 31, 2011 on an approved medical leave of absence and receiving disability benefits under an Employer-sponsored disability plan and (ii) were notified on or prior to December 31, 2011 that their position was scheduled to be eliminated.

2.16      “ Grandfathered Legacy Schering Termination means the termination of employment by the Employer of a Grandfathered Legacy Schering Employee who is medically cleared to return to work within two years of his or her first day absent but does not return to work within such time period because he or she is unable to secure a Qualified Alternate Position.

2.17       Legacy Inspire Employee means an Eligible Employee who (a) as of December 31, 2012 is employed by a Merck Entity and either continues to be employed by such entity until his/her Separation Date or is rehired or transferred to such entity after December 31, 2012, and (b) as of his/her Separation Date is (i) employed by an Employer, and (ii) coded in the employee data

 

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base of Parent as S6 (Legacy Inspire) under infotype 35, and (iii) not covered by a collective bargaining agreement.

2.18      “ Legacy Merck Employee means an Eligible Employee who (a) as of December 31, 2012 is employed by a Merck Entity and either continues to be employed by such entity until his/her Separation Date or is rehired or transferred to such entity after December 31, 2012, and (b) as of his/her Separation Date is (i) employed by an Employer, and (ii) coded in the employee data base of Parent with a blank indicator under infotype 35, and (iii) not covered by a collective bargaining agreement.

2.19      “ Legacy Merck Entity means (a) for the period prior to November 4, 2009, Old Merck and its direct or indirect wholly owned subsidiaries and (b) for the period beginning November 4, 2009, New Merck and its direct or indirect wholly owned subsidiaries.

2.20        Legacy Schering Employee means an Eligible Employee who (a) as of December 31, 2012 is employed by a Merck Entity and either continues to be employed by such entity until his/her Separation Date or is rehired by or transferred to such entity after December 31, 2012, and (b) as of his/her Separation Date is (i) employed by an Employer, (ii) coded in the employee data base of Parent as S1 (Legacy Organon), S2 (Legacy Intervet) or S5 (Legacy Schering-Plough) under infotype 35, and (iii) not covered by a collective bargaining agreement unless that agreement specifically provides for benefits under this Plan.

2.21        Legacy Schering Entity means (a) for the period prior to November 9, 2009, Schering-Plough Corporation and its direct or indirect wholly owned subsidiaries and (b) for the period beginning November 4, 2009, New Merck and its direct or indirect wholly owned subsidiaries.

2.22      “ Merck Entity ” means for the period beginning November 4, 2009, New Merck and its direct or indirect wholly owned subsidiaries.

2.23      “ Misconduct means conduct which includes (a) falsification of an Employer’s or Parent’s records/misrepresentation; (b) theft; (c) acts or threats of violence; (d) refusal to carry out assigned work; (e) unauthorized possession of alcohol or illegal drugs on an Employer’s or Parent’s premises; (f) being under the influence of alcohol or illegal drugs during work hours; (g) willful intent to damage or destroy an Employer’s or Parent’s property; (h) violation of the Parent’s “Our Values and Standards”; (i) acts of discrimination/harassment; (j) conduct jeopardizing the integrity of the products of an Employer, Parent or one or more of its subsidiaries; (k) violation of rules, policies, and/or practices of an Employer or Parent; or (l) other conduct considered to be detrimental to an Employer, the Parent or one or more of its subsidiaries.

2.24      “ Most Recent Hire Date means (a) for a Legacy Schering Employee, his or her most recent hire date at a Legacy Schering Entity or an entity acquired by a Legacy Schering Entity as reflected on the Employer’s employee data system, (b) for a Legacy Merck Employee, his or her most recent hire date at a Legacy Merck Entity or an entity acquired by a Legacy Merck Entity as reflected on the Employer’s employee data system, (c) for a Legacy Inspire Employee, his or her most recent hire date at a Merck Entity or an entity acquired by a Merck Entity as reflected on the Employer’s employee data system, and (d) for a Non-Legacy Company Employee, his or her most recent hire date at a Merck Entity or an entity acquired by a Merck Entity as reflected on the Employer’s employee data system. Notwithstanding the foregoing, the most recent hire date for a Legacy Merck Employee who was employed by a Legacy Merck Entity on December 31, 1997, transferred from that entity to Merial as of January 1, 1998, remained continuously employed by Merial through the date he or she transferred employment from Merial to a Legacy Merck Entity

 

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and whose transfer to a Legacy Merck Entity occurred between October 1, 2000 and June 1, 2001, is his or her most recent hire date on the Employer’s employee data system at a Legacy Merck Entity prior to his or her transfer to Merial. Notwithstanding the foregoing, the most recent hire date for a Legacy Merck Employee who was employed by a Legacy Merck Entity on December 31, 2007, transferred from that entity to PRWT as of January 1, 2008, remained continuously employed by PRWT through September 3, 2010 and who was rehired by a Legacy Merck Entity as of September 3, 2010, is his or her most recent hire date on the Employer’s employee data system at a Legacy Merck Entity prior to his or her transfer to PRWT.

2.25        “Negotiated Job Offer means an offer of employment (or an offer of continued employment) with a successor employer or outsource vendor the terms and conditions of which are negotiated by an Employer, Parent or one of its subsidiaries or affiliates and may include, among other things, a reduction in Base Pay Rate.

2.26        New Merck means Merck & Co., Inc. (formerly known as Schering-Plough Corporation) on and after November 4, 2009

2.27      “ Non-Legacy Company Employee means an Eligible Employee who (a) is first hired by a Merck Entity on or after January 1, 2013, and (b) as of his/her Separation Date is (i) employed by an Employer, and (ii) coded in the employee data base of Parent with a blank indicator under infotype 35, and (iii) not covered by a collective bargaining agreement.

2.28       “ Offer Outside Geographic Parameters means a Negotiated Job Offer that results in the relocation of the Eligible Employee’s principal business location (x) more than 50 miles from the Eligible Employee’s principal business location at the time the Negotiated Job Offer is extended and not closer to the Eligible Employee’s residence at that time or (y) more than 75 miles from the Eligible Employee’s residence at the time the Negotiated Job Offer is extended and not closer to the Eligible Employee’s residence at that time. Whether a work location is more than 50 miles from an Eligible Employee’s principal business location or more than 75 miles from an Eligible Employee’s residence (and in each case not closer to the Eligible Employee’s residence) will be determined in accordance with the Employer’s relocation policy as in effect from time to time. For Eligible Employees who are field sales representatives/managers, the new principal business location is the geographic workload center of the new geography as determined by the Employer in its sole and absolute discretion.

2.29      “ Old Merck means Merck & Co., Inc. prior to November 4, 2009 (subsequently known as Merck Sharp & Dohme Corp).

2.30      “ Outplacement Benefits means benefits for outplacement counseling or other outplacement services made available to a Participant as provided pursuant to Section 4.4 of this Plan.

2.31      “ Parent means New Merck.

2.32      “Participant” means an Eligible Employee who has experienced a Termination due to Workforce Restructuring and who has signed, and, if a revocation period is applicable, not revoked, a Release of Claims in a form that is satisfactory to the Employer in its sole and absolute discretion.

 

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The term “Participant” shall also include, where and as applicable a Rebadged Employee and a Grandfathered Legacy Schering Employee who has experienced a Grandfathered Legacy Schering Termination, in each case, who has signed and, if a revocation period is applicable, not revoked a Release of Claims in a form that is satisfactory to the Employer in its sole and absolute discretion.

2.33      “ Plan means the Merck & Co., Inc., U.S. Separation Benefits Plan as set forth herein, and as may be amended from time to time.

2.34      “ Plan Administrator means the Parent or its delegate.

2.35      “ Plan Year means the calendar year January 1 through December 31 on which the records of the Plan are kept.

2.36      “ Qualified Alternative Position means a position with an Employer, the Parent or any of its subsidiaries which does not result in either of the following:

(i) a reduction in the Eligible Employee’s Base Pay Rate; or

(ii) relocation of the Eligible Employee’s principal business location (x) more than 50 miles from the Eligible Employee’s principal business location immediately prior to the relocation and not closer to the Eligible Employee’s residence at that time or (y) more than 75 miles from the Eligible Employee’s residence immediately prior to the relocation and not closer to the Eligible Employee’s residence at that time.

Whether a work location is more than 50 miles from an Eligible Employee’s principal business location or more than 75 miles from an Eligible Employee’s residence (and in each case not closer to the Eligible Employee’s residence) will be determined in accordance with the Employer’s relocation policy as in effect from time to time. For Eligible Employees who are field sales representatives/managers, the new principal business location is the geographic workload center of the new geography as determined by the Employer in its sole and absolute discretion.

Whether a position is a Qualified Alternative Position shall be determined at the time such position is offered or communicated to the Eligible Employee or to the Grandfathered Legacy Schering Employee.

2.37      “ Rebadged Employee means an Eligible Employee whose employment with the Employer is terminated by the Employer in connection with the outsourcing of work by the Employer in a transaction with a third-party vendor where the Eligible Employee is offered a Negotiated Job Offer and:

(a) (i) accepts the Negotiated Job Offer; or (ii) declines the Negotiated Job Offer, provided the Negotiated Job Offer is not an Offer Outside Geographic Parameters; and

(b) remains employed with the Employer through the date established by the Employer as the employee’s Separation Date unless the Employer expressly waives this provision.

Whether an Eligible Employee is a Rebadged Employee shall be determined by the Employer or Parent in its sole discretion. An Eligible Employee shall not be considered to be a Rebadged Employee if his or her employment with the Employer (i) does not end as set forth in this Section 2.32 (ii) ends due to the declination of a Negotiated Job Offer that is an Offer Outside Geographic Parameters, or (iii) ends as a result of any of the events described in Section 3.1(e).

 

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For the avoidance of doubt, a Rebadged Employee shall not be considered to have experienced a Termination due to Workforce Restructuring for purposes of the Plan.

2.38      “ Release of Claims means the agreement that an Eligible Employee must execute in order to become a Participant and to receive Separation Plan Benefits, which shall be prepared by the Employer or the Parent and shall contain such terms and conditions as determined by the Employer or the Parent, including but not limited to a general release of claims, known or unknown, that the Eligible Employee may have against the Employer (and the Parent and any of its subsidiaries and/or affiliates), including claims related to the employment and termination of employment of the Eligible Employee; such Release of Claims may also contain, in the Employer’s or the Parent’s discretion, other terms and conditions including, without limitation, cooperation in litigation, non-disclosure, confidentiality, non-disparagement, non-solicitation and/or non-competition provisions.

2.39      “ Section 16 Officer means an “officer” as such term is defined in Rule 16(a)-1(f) of the Securities Exchange Act of 1934 of the Parent who is also an Eligible Employee of an Employer.

2.40      “ Separation Benefits means the benefits provided pursuant to Sections 4.2 and 4.3 of this Plan.

2.41      “ Separation Date means the Eligible Employee’s last day of employment with the Employer due to a Termination due to Workforce Restructuring or, in the case of a Rebadged Employee, due to the outsourcing transaction. The Separation Date of an Eligible Employee who dies prior to his or her scheduled Separation Date but after he or she was notified of a scheduled Separation Date shall be deemed to have occurred on the day before his/her date of death. For Grandfathered Legacy Schering Employees, “Separation Date” means the last day of employment with the Employer due to a Grandfathered Legacy Schering Termination.

2.42      “ Separation Pay means the cash benefit payable under this Plan pursuant to Section 4.1 or to a Rebadged Employee pursuant to Section 4.5.

2.43      “ Separation Plan Benefits means, collectively, Separation Pay, Separation Benefits and Outplacement Benefits.

2.44       “Termination Due to Non-Performance means a termination of an Eligible Employee’s employment as determined and caused by the Employer due to the Eligible Employee’s failure to perform his or her job assignments in a satisfactory manner.

2.45      “ Termination due to Workforce Restructuring means the termination of an Eligible Employee’s employment as determined and caused by the Employer due to:

 

  (a) the elimination of an Eligible Employee’s job;

 

  (b) organizational changes; or

 

  (c) a general reduction of the workforce.

Whether an Eligible Employee’s job is eliminated is determined by the Employer but excludes the maintenance of the position with the elimination of a part-time or job share arrangement or other flexible work arrangement.

Organizational changes are determined by the Employer and include the following actions: discontinuance of operations, location closings, corporate restructuring but exclude a reduction in

 

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job title, grade or band level, Base Pay Rate, short term incentive opportunity (e.g., cash bonuses under any bonus or incentive plan or program of the Parent), long-term incentive compensation opportunity, equity compensation opportunity and/or other forms of remuneration of an Eligible Employee with or without a change in the Eligible Employee’s job duties where such reduction is due to (i) a general change in the Employer’s or the Parent’s compensation framework as it applies to similarly situated Eligible Employees, (e.g., a change in the general compensation framework applicable to similar jobs with the Employer, or an identifiable segment of the Employer such as a subsidiary, division or department); (ii) an action to align the Eligible Employee with the Employer’s or the Parent’s compensation and career framework as it applies to similarly situated Eligible Employees; or (iii) a demotion or other action taken as a result of the Eligible Employee’s performance or behaviors.

An Eligible Employee shall not be considered to have incurred a Termination due to Workforce Restructuring if his or her employment with the Employer (i) does not end due to this Section 2.40 (a), (b) or (c) or (ii) ends as a result of any of the events described in Section 3.1(d).

For the avoidance of doubt with respect to outsourcing transactions, (x) an Eligible Employee whose employment with the Employer is terminated by the Employer in connection with the outsourcing of work by the Employer in a transaction with a third-party vendor where the individual is offered a Negotiated Job Offer and declines the Negotiated Job Offer because it is an Offer Outside Geographic Parameters, is considered to have incurred a Termination due to Workforce Restructuring provided his or her employment with the Employer does not end as a result of any of the events described in Section 3.1 (d), and (y) a Rebadged Employee shall not be considered to have experienced a Termination due to Workforce Restructuring for purposes the Plan.

2.46      “ U.S. Expatriate means a U.S. citizen or individual with U.S. Permanent Resident status who is employed by the Employer and on assignment outside the U.S. and who is not an Excluded Person.

 

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SECTION 3

ELIGIBILITY FOR BENEFITS

3.1       Eligibility .

(a)      An Eligible Employee will be eligible for Separation Plan Benefits described in Section 4 (excluding Section 4.5) when he/she experiences a Termination due to Workforce Restructuring; provided, however, that a Legacy Inspire Employee will be eligible for Separation Plan Benefits described in Section 4 (excluding Section 4.5) only if he/she experiences a Termination due to Workforce Restructuring on or after May 17, 2013. A Grandfathered Legacy Schering Employee will be eligible for Separation Plan Benefits described in Section 4 (excluding Section 4.5) if he or she experiences a Grandfathered Legacy Schering Termination. Separation Plan Benefits shall be provided under this Plan to an Eligible Employee who experiences a Termination due to Workforce Restructuring or to a Grandfathered Legacy Schering Employee who experiences a Grandfathered Legacy Schering Termination, in each case only if the Eligible Employee or Grandfathered Legacy Schering Employee has executed and, if a revocation period is applicable, not revoked a Release of Claims in a form satisfactory to the Employer or Parent in its sole and nonreviewable discretion. An Eligible Employee or a Grandfathered Legacy Schering Employee who has executed and, if a revocation period is applicable, not revoked a Release of Claims is a Participant.

(b)      A Rebadged Employee will be eligible for Separation Pay described in Section 4.5; provided, however, that a Rebadged Employee who is a Legacy Inspire Employee will be eligible for Separation Pay described in Section 4.5 only if his/her employment with an Employer is terminated by the Employer in connection with the outsourcing of work on or after May 17, 2013. Separation Pay shall be provided under this Plan to a Rebadged Employee only if the Rebadged Employee has executed and, if a revocation period is applicable, not revoked a Release of Claims in a form satisfactory to the Employer or Parent in its sole and nonreviewable discretion. A Rebadged Employee who has executed and, if a revocation period is applicable, not revoked a Release of Claims is a Participant. A Rebadged Employee is not eligible for Separation Benefits or Outplacement Benefits.

(c)      An Eligible Employee will also be entitled to receive those pension benefits set forth in Schedule D (Change in Control/Pension) and retiree medical benefits set forth in Schedule E (Change in Control/Retiree Medical) if (i) a Change in Control has occurred and (ii) within two years thereafter, the Eligible Employee’s employment with the Employer (or successor employer) is terminated by the Employer (or successor employer) for any reason other than for Misconduct, death or “Permanent Disability” (as such term is defined in the CIC Plan), and (iii) the Eligible Employee signs and returns the release of claims in use under the CIC Plan and in accordance with the process established under the CIC Plan .

(d)      Notwithstanding anything herein to the contrary, an Eligible Employee shall not be considered to have incurred a Termination due to Workforce Restructuring under the Plan if his or her employment ends as a result of any of the following events:

(i)      a divestiture of a subsidiary, division or other identifiable segment of the Employer or Parent or a transfer of the Eligible Employee to a joint venture or other business entity in which the Employer or the Parent directly or indirectly will own some outstanding voting or other ownership interest, in each case where either

(x) the Eligible Employee is offered and accepts, or continues in, a Negotiated Job Offer; or

 

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(y) the Eligible Employee is offered and declines a Negotiated Job Offer, unless the Negotiated Job Offer is an Offer Outside Geographic Parameters with the acquiring entity or vendor;

(ii)      the Employer’s decision to outsource work to a third-party vendor where the Eligible Employee is a Rebadged Employee;

(iii)     the Eligible Employee’s voluntary resignation for any reason including after reaching early or normal retirement age under the retirement plan applicable to the Eligible Employee;

(iv)     a termination for Misconduct;

(v)      death (unless the Eligible Employee is not a Grandfathered Legacy Schering Employee and dies after he/she has been notified of his/her scheduled Separation Date but before the Separation Date occurs and a valid Release of Claims is executed by the Eligible Employee’s estate) in which case the Eligible Employee’s Separation Date shall be deemed to have occurred on the day before his/her date of death;

(vi)     the Eligible Employee terminating employment with the Employer prior to the date identified as the date the employee would experience a Termination due to Workforce Restructuring unless the Employer expressly agreed to waive this provision;

(vii)    failure by the Eligible Employee (other than a Legacy Schering Grandfathered Employee) to return to work at the Employer (or the Parent or any of its subsidiaries) for any reason, including, but not limited to the Eligible Employee’s failure to secure a position at the Employer (or the Parent or any of its subsidiaries) upon a return from a leave of absence for any reason; or

(viii)   failure by a Legacy Schering Grandfathered Employee to return to work at the Employer (or the Parent or any of its subsidiaries) within two years of his or her first day absent due to disability; or

(ix)     the Eligible Employee’s decision to decline a Qualified Alternative Position for any reason (including, but not limited to because the employee is a part-time employee and is offered a full-time position, is a shift-worker and the position offered is on a different shift or has a job share or other flexible work arrangement and the position offered is not a job share or does not include a flexible work arrangement) that is offered to the Eligible Employee prior to the Eligible Employee’s Separation Date; or

(x)      the Eligible Employee’s decision to accept an alternate position with the Employer, Parent or any of its subsidiaries (whether or not the position is a Qualified Alternative Position) and to later decline it; or

(xi)     Termination Due to Non-Performance.

(e)      Notwithstanding anything herein to the contrary, an Eligible Employee shall not be considered to be a Rebadged Employee under the Plan if his or her employment ends as a result of any of the following events:

(i)       a divestiture of a subsidiary, division or other identifiable segment of the Employer or Parent or a transfer of the Eligible Employee to a joint venture or other business entity in which the Employer or the Parent directly or indirectly will own some outstanding voting or other ownership interest;

(ii)      the Employer’s decision to outsource work to a third-party vendor where the Eligible Employee is offered a Negotiated Job Offer and declines it because it is an Offer Outside Geographic Parameters;

 

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(iii)      the Eligible Employee’s voluntary resignation for any reason including after reaching early or normal retirement age under the retirement plan applicable to the Eligible Employee;

(iv)      a termination for Misconduct;

(v)       death (unless the Eligible Employee is not a Grandfathered Legacy Schering Employee and dies after he/she has been notified of his/her scheduled Separation Date but before the Separation Date occurs and a valid Release of Claims is executed by the Eligible Employee’s estate) in which case the Eligible Employee’s Separation Date shall be deemed to have occurred on the day before his/her date of death;

(vi)      the Eligible Employee terminating employment with the Employer prior to the date identified by the Employer as the Separation Date unless the Employer expressly agreed to waive this provision;

(vii)     failure by the Eligible Employee (other than a Legacy Schering Grandfathered Employee) to return to work at the Employer (or the Parent or any of its subsidiaries) for any reason, including, but not limited to the Eligible Employee’s failure to secure a position at the Employer (or the Parent or any of its subsidiaries) upon a return from a leave of absence for any reason;

(viii)    failure by a Legacy Schering Grandfathered Employee to return to work at the Employer (or the Parent or any of its subsidiaries) within two years of his or her first day absent due to disability; or

(ix)      Termination Due to Non-Performance.

3.2       Termination of Eligibility for Benefits . A Participant shall cease to participate in the Plan, and all Separation Plan Benefits shall cease upon the occurrence of the earliest of:

(a) Termination of the Plan prior to, or more than two years following, a Change in Control;

(b) Inability of the Employer to pay Separation Plan Benefits when due;

(c) Completion of payment to the Participant of the Separation Plan Benefits for which the Participant is eligible; and

(d) The Claims Reviewer’s determination, in its sole discretion, of the occurrence of the Eligible Employee’s Misconduct, regardless of whether such determination occurs before or after the Eligible Employee’s Separation Date, unless the Claims Reviewer determines in its sole discretion that Misconduct shall not cause the cessation of Separation Plan Benefits in a particular case.

 

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SECTION 4

BENEFITS

4.1       Separation Pay . Separation Pay shall be payable under this Plan to a Participant who is not a Rebadged Employee as set forth on Schedule B-1. The terms of Schedule B-1 are hereby fully incorporated into and shall be considered as part of Section 4 of this Plan. For Separation Pay payable under this Plan to a Rebadged Employee, see Section 4.5 of this Plan.

4.2       Medical and Dental Benefits

(a)      A Participant who is covered under any of the Employer’s group active medical and dental plans as of his or her Separation Date shall be provided the opportunity to elect to continue such active coverage, as it may be amended from time to time, in accordance with the provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985, Section 4980B of the Code, and Section 601, et seq., of ERISA (“COBRA”) and in accordance with the Employer’s regular COBRA coverage payment practices, at active employee rates, as the same may be changed from time to time, for his or her Benefits Continuation Period, as determined in accordance with Schedule B-2. The terms of such Schedule B-2 are hereby fully incorporated into and shall be considered as part of Section 4 of this Plan.

(b)      A Participant who does not elect to continue active medical and/or dental coverage in accordance with COBRA shall not be eligible for active medical and/or dental benefit continuation coverage at active employee rates during his or her Benefits Continuation Period nor will he or she be eligible to continue such active coverage during the COBRA continuation period at the full COBRA premium.

(c)      A Participant who, prior to his or her Separation Date, had elected no active medical or dental coverage under the applicable medical or dental plan will not be permitted to change from no medical and/or dental coverage to coverage as a result of a Termination due to Workforce Restructuring or a Grandfathered Legacy Schering Termination.

(d)      Provided the Participant elects to continue coverage under COBRA, active medical and dental continuation coverage, as it may be amended from time to time, at active rates shall begin on the first day of the month coincident with or following the Participant’s Separation Date and shall end on the last day of the month in which the Benefits Continuation Period ends, provided the Participant pays the required contributions for coverage in the time and manner required under COBRA. If the Participant fails to pay the required contributions for coverage in the time and manner required under COBRA, or the Participant elects to terminate active medical and/or dental coverage, coverage will end as of the last day of the month for which the contribution was paid and it will not be reinstated. If the Participant has dental coverage on the last day of the Benefits Continuation Period, the Participant may be eligible to continue the dental coverage in effect at the end of the Benefits Continuation Period for the remaining COBRA period, if any, in accordance with COBRA by paying the full COBRA premium. If the Participant is eligible to participate in the retiree medical plan of an Employer (or Parent) as of his or her Separation Date at subsidized or unsubsidized retiree rates, see Section (e) below.

(e)      If, as of his or her Separation Date, a Participant is eligible to participate in a retiree medical plan of an Employer (or Parent) at subsidized or unsubsidized rates, then he or she (i) shall be eligible to continue active medical and dental benefits in accordance with this Section 4.2 and, (ii) if eligible for subsidized rates, following the completion of the Benefits Continuation

 

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Period, shall be eligible for retiree medical benefits at subsidized rates under the terms of retiree medical plan applicable to such Participant, as it may be amended from time to time, and (iii) if eligible for unsubsidized rates, following the completion of the Benefits Continuation Period and, if applicable, the COBRA period described in Section (f) below, shall be eligible for retiree medical benefits at unsubsidized rates under the terms of retiree medical plan applicable to such Participant, as it may be amended from time to time. If a Participant is not eligible to continue active medical coverage during the Benefits Continuation Period (e.g., because the Participant had no active coverage on his/her Separation Date or he/she failed to timely elect continuation coverage under COBRA) or the Participant’s active medical coverage ends during the Benefits Continuation Period (for any reason, including non-payment), the Participant cannot enroll for medical coverage as a retiree until the end of the Benefits Continuation Period. If the Participant elects to end the Benefits Continuation Period earlier than the period set forth on Schedule B-2 as permitted in Section 2.4, all active medical and/or dental benefit coverage that the Participant would otherwise have been eligible to receive during the maximum Benefits Continuation Period will be permanently and irrevocably forfeited. A Participant cannot be covered as an active employee and as a retiree (even under the retiree no coverage option, if available) in a medical plan of an Employer (or Parent) during the same period; provided, however, that a Participant may be covered through COBRA at full COBRA rates (for the remainder of the COBRA period only) for dental coverage even if during that period the Participant is also covered as a retiree for medical coverage.

(f)      If, as of his or her Separation Date, a Participant is not eligible to participate in a retiree medical plan of an Employer (or Parent) or is eligible to participate in a retiree medical plan of an Employer (or Parent) at unsubsidized rates, then following the completion of the Benefits Continuation Period (provided coverage has not terminated prior thereto for any reason, including failure to pay the required contribution) he or she may be eligible to continue coverage in effect at the end of the Benefits Continuation Period for the remaining COBRA period, if any, in accordance with COBRA by paying the full COBRA premium.

(g)      Rebadged Employees are not eligible for continuation of active medical and dental benefits at active contribution rates during the Benefits Continuation Period described in this Section 4.2.

4.3       Life Insurance Benefits

(a)      A Participant shall be eligible to continue Basic Life Insurance coverage at no cost to the Participant during his or her Benefits Continuation Period, as determined in accordance with Schedule B-2, subject to and in accordance with the terms of the applicable life insurance plan as they may be amended from time to time. The Participant is responsible for paying applicable tax on imputed income, if any, for Basic Life Insurance coverage during his or her Benefits Continuation Period. The terms of such Schedule B-2 are hereby fully incorporated into and shall be considered as part of Section 4 of this Plan.

(b)      Basic Life Insurance coverage shall end on the last day of the month in which the Benefits Continuation Period ends. If the Participant elects to end the Benefits Continuation Period earlier than the period set forth on Schedule B-2 as permitted in Section 2.4, all Basic Life Insurance coverage that the Participant would otherwise have been eligible to receive during the maximum Benefits Continuation Period will be permanently and irrevocably forfeited.

(c)      Rebadged Employees are not eligible for the life insurance benefits described in this Section 4.3.

 

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4.4       Outplacement Benefits . Benefits for outplacement counseling or other outplacement services, as set forth in Schedule C, will be made available to a Participant. The terms of such Schedule C are hereby fully incorporated into and shall be considered as part of Section 4 of this Plan. Outplacement benefits shall be provided in kind; cash shall not be paid in lieu of outplacement benefits nor will Separation Pay be increased if a Participant declines or does not use the outplacement benefits. Rebadged Employees are not eligible for outplacement benefits described in this Section 4.4.

4.5.       Separation Pay for Rebadged Employees . A Rebadged Employee who is a Participant shall be eligible for Separation Pay under this Plan in an amount equal to 50% of the Separation Pay that would be payable had he or she experienced a Termination due to Workforce Restructuring.

For the avoidance of doubt, a Rebadged Employee shall not be eligible for any Separation Plan Benefits other than the Separation Pay described in this Section 4.5.

4.6       Reduction of Benefits . Notwithstanding anything in this Plan to the contrary, a Participant’s Separation Pay (including Separation Pay described in Section 4.5) and Separation Benefits, if applicable, shall be reduced by:

(a)      any amount the Plan Administrator reasonably concludes the Participant owes the Employer (or the Parent or any subsidiary or affiliate of the Parent) including, without limitation, unpaid bills under the corporate credit card program, and for vacation used, but not earned;

(b)      any severance or severance type benefits that the Employer (or the Parent or any subsidiary or affiliate of the Parent) must pay to a Participant under applicable law;

(c)      where permitted by law, any payments received by the Participant pursuant to state workers compensation laws;

(d)      short-term disability benefits where state law does not permit Separation Pay to be offset from short-term disability benefits (or where the Employer in its sole and absolute discretion determines it is administratively easier for the Employer to reduce Separation Pay by short- term disability benefits in lieu of reducing short-term disability benefits by Separation Pay).

Notwithstanding anything in the Plan to the contrary, a Participant’s Separation Pay (including Separation Pay described in Section 4.5) and Separation Benefits are not meant to duplicate pay and benefits provided by the Employer (or the Parent or any of its subsidiaries) in connection with any Participant’s Termination due to Workforce Restructuring or in connection with a Participant’s termination due to the outsourcing of work to a third-party vendor, including pay and benefits under the federal Worker Adjustment Retraining and Notification Act and any state or local equivalent (collectively the “WARN Act”). If the Plan Administrator determines that a Participant is entitled to WARN Act damages or WARN Act notice, the Plan Administrator in its sole and absolute discretion may reduce the Participant’s Separation Pay and Separation Benefits under the Plan by the WARN Act damages or pay and benefits after receiving WARN Act notice, but not below $500, with the remaining Separation Pay and Separation Benefits provided to the Participant in accordance with the terms of the Plan in satisfaction of the Participant’s WARN Act notice rights or damages. In all other cases, Separation Pay paid under the Plan in excess of $500 will be treated as having been paid to satisfy any WARN Act damages, if applicable.

 

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SECTION 5

FORM AND TIMING OF BENEFITS; FORFEITURE

AND REPAYMENT OF BENEFITS

5.1       Form and Time of Payment

(a)      Except as otherwise provided in subsection (b), Separation Pay, less taxes and applicable deductions shall be paid in a lump sum as soon as practicable after the Participant’s Termination due to Workforce Restructuring (or in the case of a Rebadged Employee, after termination of employment due to the outsourcing transaction) and the expiration of any period during which the Participant may consider, sign and, if a revocation period is applicable, revoke the Release of Claims, but in no event later than March 15 of the calendar year following the year of a Participant’s Separation Date.

(b)      If it is determined by the Employer or Parent in its discretion, that (i) the Participant is, as of his or her Separation Date, a “specified employee” (as such term is defined in Section 409A(2)(B) of the Code); and (ii) the Separation Pay payable pursuant to the terms of the Plan constitutes nonqualified deferred compensation that would subject the Participant to “additional tax” under Section 409A(a)(1)(B) of the Code (the “409A Tax”), then the payment of Separation Pay will be postponed to the first business day of the seventh month following the Separation Date or, if earlier, the date of the Participant’s death.

5.1       Taxes . Separation Pay payable under this Plan shall be subject to the withholding of appropriate federal, state and local taxes.

Notwithstanding anything in this Plan to the contrary, the Employer or Parent will take such actions as it deems necessary, in its sole and absolute discretion, to avoid the imposition of a 409A Tax at such time and in such manner as permitted under Section 409A of the Code, including, but not limited to, reducing or eliminating benefits and changing the time or form of payment of benefits.

5.3       Forfeiture of Benefits . The Employer reserves the right, in its sole and absolute discretion, to cancel all Separation Plan Benefits and seek the return of Separation Pay in the event a Participant engages in any activity that the Employer considers detrimental to its interests (or the interests of the Parent or any of its subsidiaries) as determined by the Parent’s Executive Vice President and General Counsel and the Parent’s Executive Vice President, Human Resources. Activities that the Employer considers detrimental to its interest (or the interests of the Parent or any of its subsidiaries) include, but are not limited to:

(a)      breach of any obligations of the Participant’s terms and conditions of employment;

(b)      making false or misleading statements about the Employer, the Parent or any of its subsidiaries or their products, officers or employees to competitors, customers, potential customers of the Employer, the Parent or any of its subsidiaries or to current or former employees of the Employer, the Parent or any of its subsidiaries; and

(c)      breaching any terms of the Release of Claims, including any non-solicitation or non-competition provisions, if applicable.

 

17


5.4       Cessation of Separation Pay and Separation Benefits . Separation Pay, Outplacement Benefits and Separation Benefits shall cease in the event a Participant is rehired by the Employer, the Parent or one of its subsidiaries or affiliates other than Telerx Marketing, Inc.

5.5       Return of Separation Pay . Upon the occurrence of an event described in Section 5.3. or 5.4 of this Plan, the Participant shall repay to the Employer that portion of the lump sum amount that would not have been paid had the Separation Pay been paid in weekly installments from the Participant’s Separation Date. If the Participant receives short-term disability benefits from the Employer after his or her Separation Date, the Employer reserves the right to seek repayment by the Participant of that portion of the Separation Pay that would not have been paid in accordance with Section 4.6 had the Separation Pay been paid in installments.

5.6       Death of Participant . If a Participant dies following his or her Separation Date and a valid Release of Claims was signed by the Participant or is signed by the Participant’s estate then

(a) any unpaid Separation Pay will be paid to the Participant’s estate; and

(b) if the Participant was eligible to continue medical and/or dental coverage during the Benefits Continuation Period on the Participant’s date of death and the Participant’s surviving dependents were covered under the Participant’s medical and dental coverages (other than coverages applicable to retirees and their dependents) on that date, they may continue such active coverage for the balance of the Benefits Continuation Period, provided they continue to remain eligible dependents and they pay the applicable contributions at active employee rates, as they may change from time to time, to continue coverage. Thereafter, if, as of his or her Separation Date, such Participant (i) was eligible to participate in a retiree medical plan of an Employer (or Parent) at subsidized rates, then following the completion of the Benefits Continuation Period, surviving eligible dependents shall be eligible for retiree medical benefits at subsidized rates under the terms of retiree medical plan applicable to such Participant, as may be amended from time to time, or (ii) was not eligible to participate in a retiree medical plan of an Employer (or Parent) or is eligible to participate in a retiree medical plan of an Employer (or Parent) at unsubsidized rates, then following the completion of the Benefits Continuation Period the surviving dependents may be eligible to continue coverage in effect at the end of the Benefits Continuation Period for the remaining COBRA period, if any, in accordance with COBRA by paying the full COBRA premium. Medical and dental coverage under this Section 5.6 (b) shall be subject to and in accordance with the terms of the applicable plans as they may be amended from time to time.

The Separation Date of an Eligible Employee who dies prior to his or her scheduled Separation Date but after he or she was notified of a scheduled Separation Date shall be deemed to have occurred on the day before his/her date of death.

 

18


SECTION 6

PLAN ADMINISTRATION

6.1       Plan Administrator . Parent or its delegate is the Plan Administrator for purposes of ERISA.

6.2       Powers and Duties of Plan Administrator . The Plan Administrator or its delegate shall have the full discretionary power and authority to: (i) construe and interpret the Plan (including, without limitation, supplying omissions from, correcting deficiencies in, or resolving inconsistencies or ambiguities in, the language of the Plan); (ii) determine all questions of fact arising under the Plan, including questions as to eligibility for and the amount of benefits; (iii) establish such rules and regulations (consistent with the terms of the Plan) as it deems necessary or appropriate for administration of the Plan; (iv) delegate responsibilities to others to assist in administering the Plan; and (v) perform all other acts it believes reasonable and proper in connection with the administration of the Plan. The Plan Administrator or its delegate shall be entitled to rely on the records of the Employer in determining any Participant’s entitlement to and the amount of benefits payable under the Plan. Any determination of the Plan Administrator or its delegate, including interpretations of the Plan and determinations of questions of fact, shall be final and binding on all parties.

With respect to determining claims and appeals for benefits under this Plan, the Claims Reviewer (and its delegate) shall be deemed to be the delegate of the Plan Administrator and shall have all of the powers and duties of the Plan Administrator described above.

6.3       Additional Discretionary Authority . The Plan Administrator may, upon written approval of the Parent’s Executive Vice President, Human Resources (written approval of the Compensation and Benefits Committee of the Board of Directors of the Parent or its delegate with respect to Section 16 Officers), take the following actions under the Plan:

(a)      grant some, all or any portion of the benefits under this Plan to an employee who would not otherwise be eligible for such benefits under Section 3 above;

(b)      waive the requirement set forth in Section 3 for any individual Eligible Employee or group of Eligible Employees to execute a Release of Claims; and

(c)      grant additional Separation Plan Benefits to a Participant.

 

19


SECTION 7

CLAIMS AND APPEALS PROCEDURES

7.1       Claims .

(a)      Any request or claim for benefits under the Plan must be filed by a claimant or the claimant’s authorized representative within 60 days after the date claimant’s employment with an Employer ends; provided, however, for claims under Section 5.3, claims must be filed within 60 days after the date Separation Plan Benefits are cancelled.

(b)      Any request or claim for benefits under the Plan shall be deemed to be filed when a written request made by the claimant or the claimant’s authorized representative addressed to the Claims Reviewer at the address below is received by the Claims Reviewer.

   Claims Reviewer for the Separation Benefits Plan

   c/o Secretary of the Merck & Co., Inc. Employee Benefits Committee

   Merck & Co., Inc.

   One Merck Drive, WS3B-35

   P.O. Box 100

   Whitehouse Station, NJ 08889-0100

The claim for benefits shall be reviewed by, and a determination shall be made by, the Claims Reviewer, within the timeframe required for notice of adverse benefit determinations described below.

(c)      The Claims Reviewer shall provide written or electronic notification to the claimant or the claimant’s authorized representative of any “adverse benefit determination.” Such notice shall be provided within a reasonable time but not later than 90 days after the receipt by the Claims Reviewer of the claimant’s claim, unless the Claims Reviewer determines that special circumstances require an extension of time for processing the claim. If the Claims Reviewer determines that an extension of time for processing is required, written notice of the extension shall be furnished to the claimant before the expiration of the initial 90-day period indicating the special circumstances requiring an extension and the date by which the Claims Reviewer expects to render the benefit determination. No extension can exceed 90 days from the end of the initial 90-day period (i.e., 180 days from the receipt of the claim by the Claims Reviewer) without the consent of the claimant or the claimant’s authorized representative.

(d)      An “adverse benefit determination” is a denial, reduction, or termination of, or a failure to provide or make payment (in whole or part) for a benefit, including one that is based on a determination of a claimant’s eligibility to participate in the Plan.

(e)      The notice of adverse benefit determination shall be written in a manner calculated to be understood by the claimant and shall:

(i) set forth the specific reasons for the adverse benefit determination;

(ii) contain specific references to Plan provisions on which the determination is based;

(iii) describe any material or information necessary for the claim for benefits to be allowed and an explanation of why such information is necessary; and

 

 

20


(iv) describe the Plan’s appeal procedures and the time limits applicable to such procedures, including a statement of the claimant’s right to bring a civil action under section 502(a) of ERISA following an adverse benefit determination on review.

7.2       Appeals of Adverse Benefit Determinations .

(a)      Any request to review the Claims Reviewer’s adverse benefit determination under the Plan must be filed by a claimant or the claimant’s authorized representative in writing within 60 days after receipt by the claimant of written notification of adverse benefit determination by the Claims Reviewer. If the claimant or the claimant’s authorized representative fails to file a request for review of the Claims Reviewer’s adverse benefit determination in writing within 60 days after receipt by the claimant of written notification of adverse benefit determination, the Claims Reviewer’s determination shall become final and conclusive.

(b)      Any request to review an adverse benefit determination under the Plan shall be deemed to be filed when a written request is made by the claimant or the claimant’s authorized representative addressed to the Employee Benefits Committee at the address below is received by the Secretary of the Employee Benefits Committee.

    Merck & Co., Inc. Employee Benefits Committee

   c/o Secretary Employee Benefits Committee

   Merck & Co., Inc.

   One Merck Drive, WS3B-35

   P. O. Box 100

   Whitehouse Station, NJ 08889-0100

(c)      If the claimant or the claimant’s authorized representative timely files a request for review of the Claims Reviewer’s adverse benefit determination as specified in this Section 7.2, the Employee Benefits Committee shall re-examine all issues relevant to the original adverse benefit determination taking into account all comments, documents, records, and other information submitted by the claimant or the claimant’s authorized representative relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination. Any such claimant or his or her duly authorized representative may:

(i) upon request and free of charge have reasonable access to, and copies of, all documents, records, and other information relevant to the claimant’s claim for benefits; whether an item is relevant shall be determined by the Employee Benefits Committee in accordance with 29 CFR 2560.503-1 (m)(8); and

(ii) submit in writing any comments, documents, records, and other information relating to the claim for benefits.

(d)      The Claims Reviewer shall provide written or electronic notice to the claimant or the claimant’s authorized representative of its benefit determination on review. Such notice shall be provided within a reasonable time but not later than 60 days after the receipt by the Claims Reviewer of the claimant’s request for review, unless the Claims Reviewer determines that special circumstances require an extension of time for processing the request for review. If the Claims Reviewer determines that an extension of time for processing is required, written notice of the extension shall be furnished to the claimant before the expiration of the initial 60-day period indicating the special circumstances requiring an extension and the date by which the Claims Reviewer expects to render the benefit determination. No extension can exceed 60 days from the end of the initial 60-day period (i.e., 120 days from the date the request for review is received by

 

21


the Claims Reviewer) without the consent of the claimant or the claimant’s authorized representative.

(e)      If the claimant’s appeal is denied, the notice of adverse benefit determination on review shall be written in a manner calculated to be understood by the claimant and shall:

(i) set forth the specific reasons for the adverse benefit determination on review;

(ii) contain specific references to Plan provisions on which the benefit determination is based;

(iii) contain a statement that the claimant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records, and other information relevant to the claimant’s claim for benefits; whether an item is relevant shall be determined by the Claims Reviewer in accordance with 29 CFR 2560.503-1 (m)(8); and

(iv) include a statement of the claimant’s right to bring a civil action under section 502(a) of ERISA.

 

22


SECTION 8

AMENDMENT AND TERMINATION

8.1       Amendment and Termination .

(a)      Except as otherwise set forth in subsection (b) below, Parent or its delegate has the right to amend, suspend or terminate the Plan at any time without prior notice to or the consent of any employee; provided, however, that amendments that apply only to Section 16 Officers must also be approved by the Compensation and Benefits Committee of the Board of Directors of Parent or its delegate. No such amendment shall give the Employer or Parent the right to recover any amount paid to a Participant prior to the date of such amendment. Any such amendment, however, may cause the cessation and discontinuance of payments of Separation Plan Benefits to any person or persons under the Plan.

(b)      Except to the extent required by applicable law, for the entirety of the Protection Period, the material terms of the Plan, including this Section 8.1, shall not be modified in any manner that is materially adverse to a Qualifying Participant.

(c)      Parent or any such successor to Parent, shall pay all legal fees and related expenses (including the costs of experts, evidence and counsel) reasonably and in good faith incurred by a Qualifying Participant if the Qualifying Participant prevails on at least one material item of his or her claim for relief in an action (x) by the Qualifying Participant claiming that the provisions of this Section 8.1 have been violated (but, for the avoidance of doubt, excluding claims for plan benefits in the ordinary course) and (y) if applicable, by the Employer, Parent or its successor to enforce post-termination covenants against the Qualifying Participant.

(d)       Definitions . For purposes of this Section 8.1:

(i) “ Protection Period ” shall mean the period beginning on the date of the Change in Control and ending on the second anniversary of the date of the Change in Control; and

(ii) “ Qualifying Participant ” shall mean an individual who is an Eligible Employee or a Participant as of the date immediately prior to the Change in Control.

 

23


SECTION 9

GENERAL PROVISIONS

9.1       Unfunded Obligation . Separation Plan Benefits provided under this Plan shall constitute an unfunded obligation of the Employer. Payments shall be made, as due, from the general funds of the Employer. This Plan shall constitute solely an unsecured promise by the Employer to pay such benefits to Participants to the extent provided herein.

9.2       Applicable Law . It is intended that the Plan be an “employee welfare benefit plan” within the meaning of Section 3(1) of ERISA, and the Plan shall be administered in a manner consistent with such intent. The Plan and all rights thereunder shall be governed and construed in accordance with ERISA and, to the extent not preempted by federal law, with the laws of the state of New Jersey, wherein venue shall lie for any dispute arising hereunder.

9.3       Severability . If any provision of this Plan shall be held illegal or invalid for any reason, said illegality or invalidity shall not affect the remaining parts of this Plan, but this Plan shall be construed and enforced as if said illegal or invalid provision had never been included herein.

9.4       Employment at Will . Nothing contained in this Plan shall give an employee the right to be retained in the employment of the Employer or shall otherwise modify the employee’s at will employment relationship with the Employer. This Plan is not a contract of employment between the Employer and any employee.

9.5       Heirs, Assigns, and Personal Representatives . The Plan shall be binding upon the heirs, executors, administrators, successors, and assigns of the parties, including each Participant, present and future.

9.6       Payments to Incompetent Persons, Etc . Any benefit payable to or for the benefit of a minor, an incompetent person or other person incapable of receipting therefore shall be deemed paid when paid to such person’s guardian or to the party providing or reasonably appearing to provide for the care of such person, and such payment shall fully discharge the Employer, Parent, the Plan Administrator, the Claims Administrator and all other parties with respect thereto.

9.7       Lost Payees . Benefits shall be deemed forfeited if the Plan Administrator is unable to locate a Participant to whom Separation Plan Benefits are due. Such Separation Plan Benefits shall be reinstated if application is made by the Participant for the forfeited Separation Plan Benefits within one year of the Participant’s Separation Date and while the Plan is in operation.

 

24


SCHEDULE A

List of participating Employers:

From January 1, 2013 through May 16, 2013, all U. S. direct and indirect wholly owned subsidiaries of

Merck & Co. Inc. excluding the following:

Comsort, Inc.

Inspire Pharmaceuticals, Inc.

TELERx Marketing, Inc.

Vree Health LLC

From May 17, 2013, all U. S. direct and indirect wholly owned subsidiaries of Merck & Co. Inc.

excluding the following:

Comsort, Inc.

TELERx Marketing, Inc.

Vree Health LLC

 

25


SCHEDULE B-1

Separation Pay for Participants with a

Separation Date Occurring on or after January 1, 2013

Amount of Separation Pay in weeks (Annual Base Salary divided by 52)

 

Complete

Years of
Continuous
Service at
Separation

Date

   BAND LEVEL
  

 

Band 200

 

  

Band 300

 

  

Band 400

 

  

Band 500

 

  

Band 600

 

  

Band 700/800

 

0

   10    12    18    24    26    26

1

   10    12    18    24    32    40

2

   10    12    18    24    32    40

3

   10    12    18    24    32    40

4

   10    12    18    24    32    40

5

   12    14    20    26    34    42

6

   14    16    22    28    36    44

7

   16    18    24    30    38    46

8

   18    20    26    32    40    48

9

   20    22    28    34    42    50

10

   22    24    30    36    44    52

11

   24    26    32    38    46    54

12

   26    28    34    40    48    56

13

   28    30    36    42    50    58

14

   30    32    38    44    52    60

15

   32    34    40    46    54    62

16

   34    36    42    48    56    64

17

   36    38    44    50    58    66

18

   38    40    46    52    60    68

19

   40    42    48    54    62    70

20

   42    44    50    56    64    72

21

   44    46    52    58    66    74

22

   46    48    54    60    68    76

23

   48    50    56    62    70    78

24

   50    52    58    64    72    78

25

   52    54    60    66    74    78

26

   54    56    62    68    76    78

27

   56    58    64    70    78    78

28

   58    60    66    72    78    78

29

   60    62    68    74    78    78

30

   62    64    70    76    78    78

31

   64    66    72    78    78    78

32

   66    68    74    78    78    78

33

   68    70    76    78    78    78

34

   70    72    78    78    78    78

35

   72    74    78    78    78    78

36

   74    76    78    78    78    78

37

   76    78    78    78    78    78

38+

   78    78    78    78    78    78

 

26


SCHEDULE B-2

MEDICAL / DENTAL AND LIFE INSURANCE CONTINUATION

 

COMPLETE YEARS OF

CONTINUOUS SERVICE AT

SEPARATION DATE

   BENEFITS CONTINUATION PERIOD

< 5

   26 weeks

5 – 9.9

   39 weeks

10 – 19.9

   52 weeks

20+

   78 weeks

 

27


SCHEDULE C

OUTPLACEMENT BENEFITS

 

 

BAND LEVEL

 

  

BENEFIT

 

  

 

DURATION

 

           

Band 200

   Individual Career Transition   

 2 day Milestones Seminar

     Seminar and Counseling   

 Up to six (6) individual follow-up consulting sessions

         

 3 months access to Career Resource Network

                

Band 300

 

   Career Assistance Program   

3 Months

 

                

Band 400

 

   Career Transition Service   

6 Months

 

                

Band 600/500

 

   Executive Service   

12 Months

 

                

Band 800/700

 

   Senior Executive Service   

12 Months

 

The Outplacement Benefits are provided through a third party vendor. The vendor and/or the programs may change from time to time.

 

28


SCHEDULE D (Change in Control/Pension)

Description of Change-in-Control Benefits under the

Pension Plan

This Schedule describes benefits under the Pension Plan and the Supplemental Plan (as each is defined below) provided to an Eligible Employee under the Plan if such Eligible Employee signs and returns the release of claims in use under the CIC Plan and in accordance with the process established under the CIC Plan.

I.      If an Eligible Employee’s employment is terminated in circumstances entitling him or her to the benefits provided in Section 3.1 (c) of the Plan:

1.      For an Eligible Employee who participates in the Retirement Plan for Salaried Employees of MSD or its successor (the “MSD Pension Plan) and on his or her Separation Date is not at least age 55 with at least ten years of Credited Service under the MSD Pension Plan but would attain at least age 50 and have at least ten years of Credited Service under the MSD Pension Plan within two years following the date of the Change in Control (assuming continued employment during the entirety of such two-year period), then the Eligible Employee shall be deemed to be eligible for a subsidized early retirement benefit on his “Prior Plan Formula” (as defined in the MSD Pension Plan) under the MSD Pension Plan commencing in accordance with the terms of the MSD Plan.

2.      For an Eligible Employee who participates in the MSD Pension Plan or the Legacy Schering Retirement Plan, or their successors (collectively the “Pension Plan”) and on his or her Separation Date is not at least age 65 but would attain at least age 65 within two years following the date of the Change in Control (assuming continued employment during the entirety of such two-year period), then the Eligible Employee shall be deemed to be eligible for a Prior Plan Formula benefit unreduced for early commencement under the Pension Plan commencing in accordance with the terms of the Pension Plan.

3.      For an Eligible Employee who participates in the MSD Pension Plan and on his or her Separation Date is not eligible for the “Rule of 85 Transition Benefit” (as such term is defined in the MSD Pension Plan) but would have been eligible for the Rule of 85 Transition Benefit within two years following the date of the Change in Control (assuming continued employment during the entirety of such two-year period), then the Eligible Employee shall be deemed to be eligible for the Rule of 85 Transition Benefit upon commencement of his or her pension benefit under the MSD Pension Plan.

4.      For an Eligible Employee who participates in the Pension Plan on his or her Separation Date who is not vested in his or her accrued benefit under the Pension Plan, he or she shall be vested in his accrued benefit under the Pension Plan on his or her Separation Date.

II.      The benefits described in this Schedule D shall be payable from the Pension Plan and, to the extent that such benefits cannot be paid from the Pension Plan the Employer may, to the extent it deems necessary or appropriate (including to comply with applicable law and to preserve grandfathered status of arrangements subject to Section 409A of the Code), cause such benefits to be paid under a Supplemental Retirement Plan of MSD or the Legacy Schering Benefits Excess Plan, as applicable and any successors thereto (collectively the “Supplemental Plan”) or under new arrangements or from the Employer’s general assets.

 

29


SCHEDULE E (Change in Control/Retiree Medical)

Description of Change-in-Control Benefits under Health Plan

This Schedule describes benefits under the Health Plan provided to an Eligible Employee under the Plan if such Eligible Employee signs and returns the release of claims in use under the CIC Plan and in accordance with the process established under the CIC Plan.

I.      If an Eligible Employee’s employment is terminated in circumstances entitling him or her to the benefits provided in Section 3.1 (c) of the Plan:

If the Eligible Employee is eligible to participate in the Health Plan and on his or her Separation Date is not at least age 55 with the requisite amount of service with an Employer to satisfy the requirements to be considered a retiree eligible for subsidized retiree medical benefits under the Health Plan but would attain at least age 50 and meet the service requirements to be considered a retiree eligible for subsidized retiree medical benefits under the Health Plan within two years following the date of the Change in Control (assuming continued employment during the entirety of such two-year period), then the Eligible Employee shall be eligible for subsidized retiree medical benefits under the Health Plan on the date his or her Benefits Continuation Period Ends on the same terms and conditions applicable to salaried U.S.-based employees of the Employer whose employment terminated the last day of the month prior to the Eligible Employee’s Separation Date who were treated as retirees eligible for subsidized retiree medical benefits under the Health Plan as of that date.

II.      The Employer may, to the extent it deems necessary or appropriate (including to comply with applicable law and to preserve grandfathered status of arrangements subject to Section 409A of the Code), cause the benefits set forth in this Schedule E to be provided from insured arrangements, or pursuant to new arrangements, individual arrangements or otherwise. Further, notwithstanding anything to the contrary, to the extent any benefits to which an Eligible Employee is entitled under this Schedule E would reasonably be likely to constitute a discriminatory benefit under Section 105(h) of the Code or a similar law or regulation at the time the benefit is to be provided to the Eligible Employee, as determined in the sole discretion of the Parent, the Employer may, to the extent it deems necessary or appropriate (including to comply with applicable law), modify the benefit so that the benefit would no longer constitute a discriminatory benefit under Section 105(h) of the Code or such similar law, including, but not limited to, eliminating all subsidy from the Parent or the Employer, requiring that the Eligible Employee pay for participation in the benefit program with after-tax funds or causing the full employer and employee portions of the cost of the benefit to be imputed as gross income to the Eligible Employee.

III.      For purposes of this Schedule E, “Health Plan” means one or more plans sponsored by the Parent or one of its subsidiaries that provide medical benefits to Eligible Employees and to former Eligible Employees who are considered retirees thereunder and to the eligible dependents of each of the foregoing.

 

30

Exhibit 12

MERCK & CO., INC. AND SUBSIDIARIES

Computation of Ratios of Earnings to Fixed Charges

($ in millions except ratio data)

 

     Years Ended December 31,  
     2012     2011     2010     2009     2008  

Income Before Taxes

   $ 8,739      $ 7,334      $ 1,653      $ 15,290      $ 9,931   

Add (Subtract):

          

One-third of rents

     133        138        144        79        75   

Interest expense, gross

     714        749        715        460        251   

Interest capitalized, net of amortization

     (49     (2     3        27        42   

Equity (income) loss from affiliates, net of distributions

     (350     (394     (263     (511     (494
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings as defined

   $ 9,187      $ 7,825      $ 2,252      $ 15,345      $ 9,805   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

One-third of rents

   $ 133      $ 138      $ 144      $ 79      $ 75   

Interest expense, gross

     714        749        715        460        251   

Preferred stock dividends

     163        138        202        143        145   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed Charges

   $ 1,010      $ 1,025      $ 1,061      $ 682      $ 471   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of Earnings to Fixed Charges

     9        8        2        23        21   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For purposes of computing these ratios, “earnings” consist of income before taxes, one-third of rents (deemed by the Company to be representative of the interest factor inherent in rents), interest expense, interest capitalized, net of amortization and equity (income) loss from affiliates, net of distributions. “Fixed charges” consist of one-third of rents, interest expense as reported in the consolidated financial statements and dividends on preferred stock. Interest expense does not include interest related to uncertain tax positions.

Exhibit 21

MERCK & CO., INC. SUBSIDIARIES

as of 12/31/12

The following is a list of subsidiaries of the Company, doing business under the name stated.

 

Name

  

Country or State

of Incorporation

7728026 Canada Inc.    Canada
Aacifar-Produtos Quimicos e Farmaceuticos, Lda    Portugal
Abmaxis Inc.    Delaware
Aquaculture Holdings Limited    United Kingdom
Aquaculture Vaccines Limited    United Kingdom
Ark Products Limited    United Kingdom
AVL Holdings Limited    United Kingdom
Avondale Chemical Co. Limited    Ireland
Banyu Pharmaceutical Company, Ltd.    Japan
Beneficiadora E Industrializadora, S.A. de C.V.    Mexico
Brazil Holdings Ltd.    Bermuda
BRC Ltd.    Bermuda
Burgwedel Biotech GmbH    Germany
Canji, Inc.    Delaware
Charles E. Frosst (U.K.) Limited    United Kingdom
Chemibiotic (Ireland) Limited    Ireland
Cherokee Pharmaceuticals LLC    Delaware
Chibret pharmazeutische Gesellschaft mit beschränkter Haftung    Germany
Cloverleaf International Holdings S.a.r.l.    Luxembourg
Comsort, Inc.    Delaware
Continuum Professional Services Limited    United Kingdom
Cooper Veterinary Products (Proprietary) Limited    South Africa
Coopers Animal Health Limited    United Kingdom
Coopers Sáude Animal Indústria e Comércio Ltda.    Brazil
Cosmas B.V.    Netherlands
Crosswinds B.V.    Netherlands
Dashtag    United Kingdom
Desarrollos Farmaceuticos Y Cosmeticos, S.A.    Spain
Dieckmann Arzneimittel GmbH    Germany
Diosynth Apeldoorn B.V.    Netherlands
Diosynth France    France
Diosynth Holding B.V.    Netherlands
Diosynth International B.V.    Netherlands
Diosynth Limited    United Kingdom
Diosynth Produtos Farmo-quimicos Ltda.    Brazil
Essex Asia Limited    Hong Kong
Essex Beteiligungs GmbH & Co KG    Germany
Essex Chemie AG    Switzerland
Essex Farmaceutica, S.A.    Colombia
Essex Italia s.r.l.    Italy
Essex Pharma GmbH    Germany
Essex Pharmaceuticals, Inc.    Philippines
Essexfarm, S.A.    Ecuador
European Insurance Risk Excess Limited    Ireland
Farmaas B.V.    Netherlands
Farmacox-Companhia Farmaceutica, Lda    Portugal
Farmasix-Produtos Farmaceuticos, Lda    Portugal


Financiere MSD    France
Fontelabor-Produtos Farmaceuticos, Lda.    Portugal
Frosst Laboratories, Inc.    Delaware
Frosst Portuguesa - Produtos Farmaceuticos, Lda.    Portugal
Fulford (India) Limited 1    India
Global Animal Management, Inc.    Delaware
GlycoFi, Inc.    Delaware
Hangzhou MSD Pharmaceutical Company Limited 1    China
Hawk and Falcon L.L.C.    Delaware
Heptafarma - Companhia Farmacêutica, Sociedade Unipessoal, Lda.    Portugal
Horus B.V.    Netherlands
Hydrochemie GmbH    Germany
Inspire Pharmaceuticals, Inc.    Delaware
International Indemnity Ltd.    Bermuda
Intervet    France
Intervet (Hong Kong) Ltd    Hong Kong
Intervet (Ireland) Limited    Ireland
Intervet (Israel) Ltd.    Israel
Intervet (M) Sdn. Bhd.    Malaysia
Intervet (Proprietary) Ltd    South Africa
Intervet (Thailand) Ltd.    Thailand
Intervet AB    Sweden
Intervet Agencies B.V.    Netherlands
Intervet Animal Health Taiwan Limited    Taiwan (Republic of China)
Intervet Argentina S.A.    Argentina
Intervet Australia Pty Limited    Australia
Intervet Bulgaria EOOD    Bulgaria
Intervet Canada Corp.    Canada
Intervet Central America S. de R.L.    Panama
Intervet Colombia Ltda    Colombia
Intervet Danmark A/S    Denmark
Intervet Deutschland GmbH    Germany
Intervet do Brasil Veterinaria Ltda    Brazil
Intervet Ecuador S.A.    Ecuador
Intervet Egypt for Animal Health SAE    Egypt
Intervet GesmbH    Austria
Intervet Hellas A.E.    Greece
Intervet Holding B.V.    Netherlands
Intervet Holding Costa Rica SA    Costa Rica
Intervet Holding Iberia, S.L.    Spain
Intervet Holdings France    France
Intervet Hungaria Kft    Hungary
Intervet Inc.    Delaware
Intervet India Pvt. Ltd    India
Intervet International    France
Intervet International B.V.    Netherlands
Intervet International GmbH    Germany
Intervet Italia S.r.l.    Italy
Intervet K.K.    Japan
Intervet Korea Ltd.    Korea, Republic of
Intervet LLC    Russian Federation
Intervet Maroc    Morocco
Intervet Mexico S.A. de C.V.    Mexico
Intervet Middle East Ltd    Cyprus

 

2


Intervet Nederland B.V.    Netherlands
Intervet Norge AS    Norway
Intervet Oy    Finland
Intervet Philippines, Inc.    Philippines
Intervet Productions    France
Intervet Productions Srl    Italy
Intervet Romania SRL    Romania
Intervet Rural Co Pty. Ltd.    Australia
Intervet S.A.    Peru
Intervet Schering-Plough Animal Health Pty Ltd    Australia
Intervet South Africa (Proprietary) Limited    South Africa
Intervet Sp. z o.o.    Poland
Intervet UK Limited    United Kingdom
Intervet UK Production Limited    United Kingdom
Intervet Venezolana SA    Venezuela
Intervet Veterinaria Chile Ltda    Chile
Intervet Veteriner Ilaclari Pazarlama ve Ticaret Ltd. Sirketi    Turkey
Intervet Vietnam Ltd.    Viet Nam
Intervet, s.r.o.    Czech Republic
Interveterinaria SA de CV    Mexico
KBI Inc.    Delaware
KBI Sub Inc.    Delaware
KBI-E Inc.    Delaware
KBI-P Inc.    Delaware
Kirby-Warrick Pharmaceuticals Limited    United Kingdom
Laboratoires Merck Sharp & Dohme-Chibret    France
Laboratorios Abello, S.A.    Spain
Laboratorios Biopat, S.A.    Spain
Laboratorios Chibret, S.A.    Spain
Laboratorios Essex S.A.    Argentina
Laboratorios Frosst, S.A.    Spain
Laboratorios Organon S.A. de C.V.    Mexico
Laboratorios Quimico-Farmaceuticos Chibret, Lda.    Portugal
Livestock Nutrition Technologies Pty. Ltd.    Australia
Loftus Bryan Chemicals Limited    Ireland
LOSPAR Partnership 1    Delaware
Maple Leaf Holdings GmbH    Switzerland
Maya Tibbi Limited Sirketi    Turkey
MCM Vaccine Co. 1    Pennsylvania
Med-Nim (Proprietary) Limited    South Africa
Merck and Company, Incorporated    Delaware
Merck Canada Inc.    Canada
Merck Capital Ventures, LLC 1    Delaware
Merck Frosst Canada & Co.    Canada
Merck Frosst Company    Canada
Merck Frosst Finco LP    Canada
Merck Global Health Innovation Fund, LLC    Delaware
Merck HDAC Research, LLC    Delaware
Merck Holdings II Corp.    Delaware
Merck Holdings LLC    Delaware
Merck Lumira Biosciences Fund L.P.    Canada
Merck Registry Holdings, Inc.    New Jersey
Merck Respiratory Health Company    Nevada
Merck Retail Ventures, Inc.    Delaware

 

3


Merck SH Inc.    Delaware
Merck Sharp & Dohme (Argentina) Inc.    Delaware
Merck Sharp & Dohme (Asia) Limited    Hong Kong
Merck Sharp & Dohme (Australia) Pty. Limited    Australia
Merck Sharp & Dohme (Chile) Ltda.    Chile
Merck Sharp & Dohme (China) Limited    Hong Kong
Merck Sharp & Dohme (Enterprises) B.V.    Netherlands
Merck Sharp & Dohme (Europe) Inc.    Delaware
Merck Sharp & Dohme (Holdings) B.V.    Netherlands
Merck Sharp & Dohme (Holdings) Limited    United Kingdom
Merck Sharp & Dohme (Holdings) Pty Ltd    Australia
Merck Sharp & Dohme (I.A.) Corp.    Delaware
Merck Sharp & Dohme (International) Limited    Bermuda
Merck Sharp & Dohme (Israel - 1996) Company Ltd.    Israel
Merck Sharp & Dohme (Italia) S.p.A.    Italy
Merck Sharp & Dohme (Malaysia) SDN. BHD.    Malaysia
Merck Sharp & Dohme (New Zealand) Limited    New Zealand
Merck Sharp & Dohme (Sweden) A.B.    Sweden
Merck Sharp & Dohme (Switzerland) GmbH    Switzerland
Merck Sharp & Dohme Animal Health, S.L.    Spain
Merck Sharp & Dohme Asia Pacific Services Pte. Ltd.    Singapore
Merck Sharp & Dohme B.V.    Netherlands
Merck Sharp & Dohme BH d.o.o.    Bosnia
Merck Sharp & Dohme Bulgaria EOOD    Bulgaria
Merck Sharp & Dohme Colombia S.A.S.    Colombia
Merck Sharp & Dohme Comercializadora, S. de R.L. de C.V.    Mexico
Merck Sharp & Dohme Corp.    New Jersey
Merck Sharp & Dohme Cyprus Limited    Cyprus
Merck Sharp & Dohme d.o.o.    Croatia
Merck Sharp & Dohme d.o.o. Belgrade    Serbia
Merck Sharp & Dohme de Espana SAU    Spain
Merck Sharp & Dohme de Mexico S.A. de C.V.    Mexico
Merck Sharp & Dohme de Puerto Rico, Inc.    Delaware
Merck Sharp & Dohme Farmaceutica Ltda.    Brazil
Merck Sharp & Dohme Finance Europe Limited    United Kingdom
Merck Sharp & Dohme Gesellschaft m.b.H.    Austria
Merck Sharp & Dohme IDEA AG    Switzerland
Merck Sharp & Dohme inovativna zdravila d.o.o.    Slovenia
Merck Sharp & Dohme International Services B.V.    Netherlands
Merck Sharp & Dohme Ireland (Human Health) Ltd    Ireland
Merck Sharp & Dohme Limited    United Kingdom
Merck Sharp & Dohme Manufacturing    Ireland
Merck Sharp & Dohme Manufacturing Holdings    Bermuda
Merck Sharp & Dohme OU    Estonia
Merck Sharp & Dohme Peru SRL    Peru
Merck Sharp & Dohme Pharmaceutical Industrial and Commercial Societe Anonyme    Greece
Merck Sharp & Dohme Pharmaceuticals LLC    Russia
Merck Sharp & Dohme Quimica de Puerto Rico, Inc.    Delaware
Merck Sharp & Dohme Research GmbH    Switzerland
Merck Sharp & Dohme Romania SRL    Romania

 

4


Merck Sharp & Dohme S.A.    Morocco
Merck Sharp & Dohme s.r.o.    Czech Republic
Merck Sharp & Dohme SIA    Latvia
Merck Sharp & Dohme Singapore Trading Pte. Ltd.    Singapore
Merck Sharp & Dohme Tunisie SARL    Tunisia
Merck Sharp & Dohme, Limitada    Portugal
Merck Sharp & Dohme, S. de R.L. de C.V.    Mexico
Merck Sharp & Dohme, s.r.o.    Slovakia
Merck Sharp Dohme Ilaclari Limited Sirketi    Turkey
ML Holdings (Canada) Inc.    Canada
MSD (Italia) s.r.l.    Italy
MSD (L-SP) Unterstützungskasse GmbH    Germany
MSD (Nippon Holdings) BV    Netherlands
MSD (Norge) AS    Norway
MSD (Proprietary) Limited    South Africa
MSD (Shanghai) Pharmaceuticals Consultancy Co., Ltd.    China
MSD (Thailand) Ltd.    Thailand
MSD Animal Health BVBA    Belgium
MSD Animal Health GmbH    Switzerland
MSD Animal Health Innovation AS    Norway
MSD Animal Health Innovation GmbH    Germany
MSD Animal Health Innovation Pte. Ltd.    Singapore
MSD Animal Health Innovation SAS    France
MSD Animal Health Limited    United Kingdom
MSD Animal Health, Lda.    Portugal
MSD Argentina Holdings B.V.    Netherlands
MSD Asia Holdings Pte. Ltd.    Singapore
MSD Belgium BVBA/SPRL    Belgium
MSD Beteiligungs GmbH & Co KG    Germany
MSD BM 1 Ltd.    Bermuda
MSD BM 2 Ltd.    Bermuda
MSD Brazil (Investments) B.V.    Netherlands
MSD Central America Services S. de R.L.    Panama
MSD Chibropharm GmbH    Germany
MSD China (Investments) B.V.    Netherlands
MSD China B.V.    Netherlands
MSD China Holding Co., Ltd.    China
MSD Consumer Care Limited    United Kingdom
MSD Consumer Care, Inc.    Delaware
MSD Danmark ApS    Denmark
MSD Egypt LLC    Egypt
MSD EIC    Ireland
MSD Eurofinance    Bermuda
MSD Farmaceutica C.A.    Venezuela
MSD Finance 2 LLC    Delaware
MSD Finance B.V.    Netherlands
MSD Finance Company    Bermuda
MSD Finance Holding NL B.V.    Netherlands
MSD Finance Holdings    Ireland
MSD Finland Oy    Finland
MSD France    France

 

5


MSD Holdings G.K.    Japan
MSD Hong Kong Holdings Cooperatief U.A.    Netherlands
MSD Human Health Holding BV    Netherlands
MSD IDEA Pharmaceuticals Nigeria Limited    Nigeria
MSD International Finance LLC    Delaware
MSD International GmbH    Switzerland
MSD International Holdings GmbH    Switzerland
MSD International Holdings, Inc.    Delaware
MSD International Ventures B.V.    Netherlands
MSD Investment Holdings (Ireland)    Ireland
MSD Investments (Holdings) GmbH    Switzerland
MSD K.K.    Japan
MSD Korea Ltd.    Korea
MSD Laboratories India LLC    Delaware
MSD Latin America Services S. de R.L.    Panama
MSD Latin America Services S. de R.L. de C.V.    Mexico
MSD Limited    United Kingdom
MSD Luxembourg S.a.r.l.    Luxembourg
MSD Magyarország Kereskedelmi es Szolgaltato Kft    Hungary
MSD Merck Sharp & Dohme A.G.    Switzerland
MSD Mexico Investments B.V.    Netherlands
MSD Netherlands (Holding) B.V.    Netherlands
MSD NL 2 B.V.    Netherlands
MSD NL 4 B.V.    Netherlands
MSD Oss B.V.    Netherlands
MSD Overseas Manufacturing Co (Ireland)    Ireland
MSD Panama International Services S. de R.L.    Panama
MSD Participations B.V.    Netherlands
MSD Pharma (Singapore) Pte. Ltd.    Singapore
MSD Pharma Hungary Korlatolt Felelossegu Tarsasag    Hungary
MSD Pharmaceuticals Holdings    Ireland
MSD Pharmaceuticals Investments 1    Ireland
MSD Pharmaceuticals Investments 2    Ireland
MSD Pharmaceuticals Investments 3    Ireland
MSD Pharmaceuticals Ireland    Ireland
MSD Pharmaceuticals LLC    Russian Federation
MSD Pharmaceuticals Private Limited    India
MSD Polska Sp.z.o.o.    Poland
MSD R&D (China) Co., Ltd.    China
MSD Regional Business Support Center GmbH    Germany
MSD Registry Holdings, Inc.    New Jersey
MSD Shared Business Services EMEA Limited    Ireland
MSD Sharp & Dohme Gesellschaft mit beschränkter Haftung    Germany
MSD Stamford Singapore Pte Ltd    Singapore
MSD Supply Services Inc.    Puerto Rico
MSD Switzerland Investments 1    Ireland
MSD Switzerland Investments 2    Ireland
MSD Switzerland Investments 3    Ireland
MSD Switzerland Investments 4    Ireland
MSD Technology Singapore Pte. Ltd.    Singapore
MSD Tuas Singapore Pte. Ltd.    Singapore

 

6


MSD Ukraine Limited Liability Company    Ukraine
MSD Unterstutzungskasse GmbH    Germany
MSD Venezuela Holding GmbH    Switzerland
MSD Ventures (Ireland)    Ireland
MSD Ventures Singapore Pte. Ltd.    Singapore
MSD Verwaltungs GmbH    Germany
MSD Vietnam Holdings B.V.    Netherlands
MSD Vostok B.V.    Netherlands
MSD-SP Ltd.    United Kingdom
MSD-Sun FZ-LLC    United Arab Emirates
MSD-SUN, LLC 1    Delaware
MSP Singapore Company, LLC    Delaware
Multilan AG    Switzerland
Mycofarm International B.V.    Netherlands
Mycofarm Nederland B.V.    Netherlands
Mycofarm UK Limited    United Kingdom
N.V. Organon    Netherlands
Nanjing Organon Pharmaceutical Co., Ltd.    China
Nourifarma - Produtos Quimicos e Farmaceuticos Lda    Portugal
Nourypharma Nederland B.V.    Netherlands
NovaCardia, Inc.    Delaware
OBS Holdings B.V.    Netherlands
Orgachemia B.V.    Netherlands
Orgachemica Nigeria Ltd 1    Nigeria
Organon (Hong Kong) Ltd    Hong Kong
Organon (India) Pvt. Ltd. 1    India
Organon (Ireland) Ltd    Ireland
Organon (Malaysia) Sdn. Bhd.    Malaysia
Organon (Philippines) Inc.    Philippines
Organon A/O    Russian Federation
Organon Agencies B.V.    Netherlands
Organon API Inc.    Delaware
Organon Asia Pacific Sdn.Bhd.    Malaysia
Organon BioSciences International B.V.    Netherlands
Organon BioSciences Nederland B.V.    Netherlands
Organon BioSciences Reinsurance Limited    Ireland
Organon BioSciences Ventures B.V.    Netherlands
Organon China B.V.    Netherlands
Organon Dominicana SA    Dominican Republic
Organon Egypt Ltd    Egypt
Organon GmbH    Germany
Organon International B.V.    Netherlands
Organon Laboratories Limited    United Kingdom
Organon Latin America S.A.    Uruguay
Organon Middle East Ltd. Cyprus    Cyprus
Organon Middle East S.A.L. (Lebanon)    Lebanon
Organon Participations B.V.    Netherlands
Organon Slovakia spol. s.r.o.    Slovakia
Organon Teknika Corporation LLC    Delaware
Organon Teknika Holding B.V.    Netherlands
Organon USA Inc.    New Jersey
P.T. Merck Sharp & Dohme Indonesia    Indonesia

 

7


Pasteur Vaccins S.A. 1    France
Pharmaco Canada Inc.    Canada
Pitman-Moore Saude Animal Comercio e Distribuicao de Produtos Veterinarios    Brazil
Plough (U.K.) Limited    United Kingdom
Plough Consumer Products (Asia) Ltd.    Hong Kong
Plough Farma, Lda.    Portugal
Protein Transaction, LLC    Delaware
PT Intervet Indonesia    Indonesia
PT Organon Indonesia    Indonesia
PT Schering-Plough Indonesia Tbk. 1    Indonesia
Rosetta Biosoftware UK Limited    United Kingdom
Rosetta Inpharmatics LLC    Delaware
Sanofi Pasteur MSD A/S 1    Denmark
Sanofi Pasteur MSD AB 1    Sweden
Sanofi Pasteur MSD AG 1    Switzerland
Sanofi Pasteur MSD ApS 1    Denmark
Sanofi Pasteur MSD AS 1    Norway
Sanofi Pasteur MSD Gestion S.A. 1    France
Sanofi Pasteur MSD GmbH 1    Austria
Sanofi Pasteur MSD GmbH 1    Germany
Sanofi Pasteur MSD Ltd. 1    Ireland
Sanofi Pasteur MSD Limited 1    United Kingdom
Sanofi Pasteur MSD N.V./S.A. 1    Belgium
Sanofi Pasteur MSD Oy 1    Finland
Sanofi Pasteur MSD S.A. 1    Portugal
Sanofi Pasteur MSD S.A. 1    Spain
Sanofi Pasteur MSD S.p.A. 1    Italy
Sanofi Pasteur MSD SNC 1    France
Schering Holdings Mexico, S. de R.L. de C.V.    Mexico
Schering-Plough    France
Schering-Plough (Bray)    Ireland
Schering-Plough (China) Limited    Bermuda
Schering-Plough (India) Private Limited    India
Schering-Plough (Ireland) Company    Ireland
Schering-Plough (Proprietary) Limited    South Africa
Schering-Plough (Shanghai) Trading Company, Ltd.    China
Schering-Plough (Singapore) Pte. Ltd.    Singapore
Schering-Plough (Singapore) Research Pte. Ltd.    Singapore
Schering-Plough Animal Health Limited    Ireland
Schering-Plough Animal Health Limited    New Zealand
Schering-Plough Animal Health Operations Sdn. Bhd.    Malaysia
Schering-Plough Animal Health, Inc.    Philippines
Schering-Plough Bermuda Ltd.    Bermuda
Schering-Plough Canada Inc.    Canada
Schering-Plough Central East AG    Switzerland
Schering-Plough Clinical Trials, S.E.    United Kingdom
Schering-Plough Corporation    Philippines
Schering-Plough Corporation, U.S.A.    Delaware
Schering-Plough del Caribe, Inc.    New Jersey
Schering-Plough del Ecuador, S.A.    Ecuador
Schering-Plough del Peru S.A.    Peru
Schering-Plough Holdings (Ireland) Company    Ireland
Schering-Plough Holdings Limited    United Kingdom

 

8


Schering-Plough Indústria Farmacêutica Ltda.    Brazil
Schering-Plough Int Limited    United Kingdom
Schering-Plough International C.V.    Netherlands
Schering-Plough International Finance Company B.V.    Netherlands
Schering-Plough International LLC    Delaware
Schering-Plough Investments Cayman Ltd.    Cayman Islands
Schering-Plough Investments Ltd.    Delaware
Schering-Plough Israel AG    Switzerland
Schering-Plough Labo NV    Belgium
Schering-Plough Limited    Taiwan (Republic of China)
Schering-Plough Limited    United Kingdom
Schering-Plough Limited C.V.    Netherlands
Schering-Plough Luxembourg S.a.r.L.    Luxembourg
Schering-Plough Pensions Ireland Limited    Ireland
Schering-Plough Pharmaceuticals (Ireland) Limited    Ireland
Schering-Plough Products, L.L.C.    Delaware
Schering-Plough S.A.    Panama
Schering-Plough S.A.    Paraguay
Schering-Plough S.A.    Spain
Schering-Plough S.A.    Uruguay
Schering-Plough S.A. de C.V.    Mexico
Schering-Plough S.A. 1    Argentina
Schering-Plough s.r.l.    Italy
Schering-Plough Sante Animale    France
Schering-Plough Technologies Pte. Ltd.    Singapore
Sentipharm AG    Switzerland
Servicios Veterniarios Servet, Sociedad Anónima    Costa Rica
Shanghai MSD Pharmaceutical Trading Co., Ltd.    China
Shanghai Schering-Plough Pharmaceutical Company, Ltd.    China
Simcere MSD (Shanghai) Pharmaceuticals Co. Ltd. 1    China
Sinova AG 1    Switzerland
Sirna Therapeutics, Inc.    Delaware
SmartCells, Inc.    Delaware
SOL Limited    Bermuda
S-P Bermuda    Bermuda
SP Maroc S.a.R.L.    Morocco
S-P Ril Ltd.    United Kingdom
S-P Veterinary (UK) Limited    United Kingdom
S-P Veterinary Holdings Limited    United Kingdom
S-P Veterinary Limited    United Kingdom
S-P Veterinary Pensions Limited    United Kingdom
Supera Rx Medicamentos Ltda. 1    Brazil
Tasman Vaccine Laboratory (UK) Ltd    United Kingdom
TELERx Marketing Inc.    Pennsylvania
The Coppertone Corporation    Florida
The MSD Foundation Limited    United Kingdom
Theriak B.V.    Netherlands
Thomas Morson & Son Limited    United Kingdom
Transrow Manufacturing Ltd.    Bermuda
UAB Merck Sharp & Dohme    Lithuania
Undra, S.A. de C.V.    Mexico
VARIPHARM Arzneimittel GmbH    Germany
Venco Farmaceutica C.A.    Venezuela
Venco Holding GmbH    Switzerland

 

9


Vet Pharma Friesoythe GmbH    Germany
VetInvent, LLC    Delaware
Vetrex B.V.    Netherlands
Vetrex Egypt L.L.C.    Egypt
Vetrex Limited    United Kingdom
Vree Health Italia S.r.l.    Italy
Vree Health LLC    Delaware
Werthenstein Biopharma GmbH    Switzerland
Zoöpharm B.V.    Netherlands

 

 

1 own less than 100%

 

10

EXHIBIT 24.1

POWER OF ATTORNEY

Each of the undersigned does hereby appoint GERALYN S. RITTER and BRUCE N. KUHLIK and each of them, severally, his/her true and lawful attorney or attorneys to execute on behalf of the undersigned (whether on behalf of the Company, or as an officer or director thereof, or by attesting the seal of the Company, or otherwise) the Form 10-K Annual Report of Merck & Co., Inc. for the fiscal year ended December 31, 2012 under the Securities Exchange Act of 1934, including amendments thereto and all exhibits and other documents in connection therewith.

IN WITNESS WHEREOF, this instrument has been duly executed as of the 28 th day of February 2013.

 

MERCK & CO., INC.   

/s/ Kenneth C. Frazier

        Kenneth C. Frazier

  

Chairman, President and Chief Executive Officer

(Principal Executive Officer; Director)

/s/ Peter N. Kellogg

        Peter N. Kellogg

  

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

/s/ John Canan

        John Canan

  

Senior Vice President Finance—Global Controller

(Principal Accounting Officer)

  

DIRECTORS

 

/s/ Leslie A. Brun      

/s/ Carlos E. Represas

   
        Leslie A. Brun             Carlos E. Represas  
/s/ Thomas R. Cech      

/s/ Patricia F. Russo

   
        Thomas R. Cech             Patricia F. Russo  
/s/ Thomas H. Glocer    

/s/ Craig B. Thompson

 
        Thomas H. Glocer             Craig B. Thompson  
/s/ William B. Harrison, Jr.    

/s/ Wendell P. Weeks

 
        William B. Harrison, Jr.             Wendell P. Weeks  
/s/ C. Robert Kidder    

/s/ Peter C. Wendell

 
        C. Robert Kidder             Peter C. Wendell  
/s/ Rochelle B. Lazarus      
        Rochelle B. Lazarus      
     

EXHIBIT 24.2

I, Katie E. Fedosz, Senior Assistant Secretary of Merck & Co., Inc. (the “Company”), a corporation duly organized and existing under the laws of the State of New Jersey, do hereby certify that the following is a true copy of a resolution adopted at a meeting of the Board of Directors of said Company on February 26, 2013 in accordance with the provisions of the By-Laws of said Company:

“Special Resolution No. – 2012

RESOLVED, that the proposed form of Form 10-K Annual Report of the Company for the fiscal year ended December 31, 2012 attached hereto is hereby approved with such changes as the proper officers of the Company, with the advice of counsel, deem appropriate; and

RESOLVED, that each officer and director who may be required to execute the aforesaid Form 10-K Annual Report or any amendments thereto (whether on behalf of the Company or as an officer or director thereof, or by attesting the seal of the Company, or otherwise) is hereby authorized to execute a power of attorney appointing Geralyn S. Ritter and Bruce N. Kuhlik and each of them, severally, his/her true and lawful attorney or attorneys to execute in his/her name, place and stead (in any such capacity) such Form 10-K Annual Report and any and all amendments thereto and any and all exhibits and other documents necessary or incidental in connection therewith and to file the same with the Securities and Exchange Commission, each of said attorneys to have power to act with or without the others, and to have full power and authority to do and perform in the name and on behalf of each of said officers and directors, or both, as the case may be, every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as any such officer or director might or could do in person.”

IN WITNESS WHEREOF, I have hereunto subscribed my signature and affixed the seal of the Company this 28 th day of February 2013.

 

[Corporate Seal]      

/s/ Katie E. Fedosz

      Katie E. Fedosz
      Senior Assistant Secretary

EXHIBIT 31.1

CERTIFICATION

I, Kenneth C. Frazier, certify that:

1. I have reviewed this annual report on Form 10-K of Merck & Co., Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 28, 2013

By:   /s/ Kenneth C. Frazier
  Kenneth C. Frazier
  Chairman, President and Chief Executive Officer

Exhibit 31.2

CERTIFICATION

I, Peter N. Kellogg, certify that:

1. I have reviewed this annual report on Form 10-K of Merck & Co., Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 28, 2013

By:   /s/ Peter N. Kellogg
  Peter N. Kellogg
  Executive Vice President and Chief Financial Officer

EXHIBIT 32.1

Section 1350

Certification of Chief Executive Officer

Pursuant to 18 U.S.C. Section 1350, the undersigned officer of Merck & Co., Inc. (the “Company”), hereby certifies that the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Dated: February 28, 2013      

/s/ Kenneth C. Frazier

      Name: Kenneth C. Frazier
      Title:   Chairman, President and Chief Executive Officer

EXHIBIT 32.2

Section 1350

Certification of Chief Financial Officer

Pursuant to 18 U.S.C. Section 1350, the undersigned officer of Merck & Co., Inc. (the “Company”), hereby certifies that the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Dated: February 28, 2013      

/s/ Peter N. Kellogg

      Name: Peter N. Kellogg
      Title:   Executive Vice President and Chief Financial Officer