MERCK & CO., INC. The following section of this Form 10-K generally discusses 2020 and 2019 results and year-to-year comparisons between 2020 and 2019. Discussion of 2018 results and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 filed onFebruary 26, 2020 . Description ofMerck 's BusinessMerck & Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Company's operations are principally managed on a products basis and include two operating segments, which are thePharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities.The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Company's relationship withAstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off ofWomen's Health , Biosimilars and Established Brands into aNew Company InFebruary 2020 ,Merck announced its intention to spin-off products from its women's health, biosimilars and established brands businesses into a new, independent, publicly traded company namedOrganon & Co. (Organon) through a distribution of Organon's publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders forU.S. federal income tax purposes. The established brands included in the transaction consist of dermatology, non-opioid pain management, respiratory, and select cardiovascular products including Zetia and Vytorin, as well as the rest ofMerck 's diversified brands franchise.Merck 's existing research pipeline programs will continue to be owned and developed withinMerck as planned. Organon will have development capabilities initially focused on late-stage development and life-cycle management and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed late in the second quarter of 2021, subject to market and certain other conditions. 47 --------------------------------------------------------------------------------
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Overview
Financial Highlights
% Change
Excluding
Foreign
($ in millions) 2020 % Change Exchange 2019
Sales $ 47,994 2 % 4 % $ 46,840
Net Income Attributable to Merck & Co., Inc. 7,067 (28) % (25) % 9,843
Non-GAAP Net Income Attributable to
13 % 16 % 13,382
Earnings per Common Share Assuming Dilution Attributable
to
$2.78 (27) % (24) %$3.81
Non-GAAP Earnings per Common Share Assuming Dilution
Attributable to
14 % 17 % $5.19
(1) Non-GAAP net income and non-GAAP earnings per share (EPS) exclude
acquisition and divestiture-related costs, restructuring costs and certain other
items. For further discussion and a reconciliation of GAAP to non-GAAP net
income and EPS (see "Non-GAAP Income and Non-GAAP EPS" below).
Executive Summary
Worldwide sales were $48.0 billion in 2020, an increase of 2% compared with
2019, or 4% excluding the unfavorable effect from foreign exchange. The sales
increase was driven primarily by oncology, certain hospital acute care products
and animal health. Growth in these areas was largely offset by the negative
effects of the coronavirus disease 2019 (COVID-19) pandemic as discussed below,
the effects of generic competition, particularly in the diversified brands and
women's health franchises, competitive pressure in the virology franchise and
pricing pressure in the diabetes franchise.
During 2020, Merck continued executing on its strategic priorities reporting
year-over-year sales growth despite the business challenges posed by the
COVID-19 pandemic. Roughly two-thirds of Merck 's Pharmaceutical segment revenue
is comprised of physician-administered products, sales of which were negatively
affected in 2020 by patients' inability to access health care providers, fewer
well visits, and social distancing measures. However, in the latter part of the
year, the Company experienced a partial recovery in the underlying demand for
products across its key growth pillars. Despite the pandemic, Merck employees
across the organization continued their important work, enrolling and
maintaining clinical studies, progressing the pipeline and ensuring the supply
of and patient access to the Company's portfolio of medically important
medicines and vaccines. The Company also executed on Merck 's capital allocation
priorities by completing business development transactions and investing in its
pipeline. Additionally, the Company remains on track to complete the spin-off of
Organon late in the second quarter of 2021 thereby creating two companies, each
focused on their strengths and portfolios allowing them to pursue their
respective market opportunities and business strategies. In 2020, the products
that will comprise Organon had total sales of $6.5 billion .
Merck actively monitors the business development landscape for growth
opportunities that meet the Company's strategic criteria. To expand its oncology
presence, Merck completed the acquisitions of ArQule, Inc. (ArQule ), a
biopharmaceutical company focused on kinase inhibitor discovery and development
for the treatment of cancer and other diseases; and VelosBio Inc. (VelosBio), a
clinical-stage biopharmaceutical company committed to developing first-in-class
cancer therapies targeting receptor tyrosine kinase-like orphan receptor 1
(ROR1) currently being evaluated for the treatment of patients with hematologic
malignancies and solid tumors. Additionally, Merck entered into strategic
collaboration agreements with Seagen to gain access to ladiratuzumab vedotin, an
investigational antibody-drug conjugate targeting LIV-1, and Tukysa (tucatinib),
a small molecule tyrosine kinase inhibitor for the treatment of human epidermal
growth factor receptor 2 (HER2)-positive cancers. To augment Merck 's animal
health business, the Company acquired the U.S. rights to Sentinel Flavor Tabs
and Sentinel Spectrum Chews.
As part of industry-wide efforts to develop solutions to the pandemic, the
Company acquired OncoImmune, a company developing a therapeutic candidate for
the treatment of patients hospitalized with COVID-19; and Themis Bioscience GmbH
(Themis), a company focused on vaccines and immune-modulation therapies for
infectious diseases, including a COVID-19 vaccine candidate. Additionally, Merck
entered into
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strategic collaborations with Ridgeback Biotherapeutics LP (Ridgeback Bio) to
develop an orally available antiviral candidate in clinical development for the
treatment of patients with COVID-19; and with the International AIDS Vaccine
Initiative, Inc. (IAVI) to develop an investigational vaccine against SARS-CoV-2
being studied for the prevention of COVID-19. In January 2021 , the Company
announced it was discontinuing development of the COVID-19 vaccine candidates
(see Note 3 to the consolidated financial statements).
During 2020, the Company received numerous regulatory approvals within oncology.
Keytruda received approval in the United States as monotherapy in the
therapeutic areas of cutaneous squamous cell carcinoma (cSCC), metastatic
microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR)
colorectal cancer, non-muscle invasive bladder cancer (NMIBC) and tumor
mutational burden-high (TMB-H) solid tumors, as well as in combination with
chemotherapy for the treatment of triple-negative breast cancer (TNBC). Merck
also received approval in the United States for an every six weeks (Q6W) dosing
regimen across all adult indications. Additionally, Keytruda received approval
in China for the treatment of certain patients with head and neck squamous cell
carcinoma (HNSCC) and in both China and Japan for the treatment of certain
patients with esophageal squamous cell carcinoma (ESCC). Lynparza, which is
being developed in collaboration with AstraZeneca PLC (AstraZeneca), received
approval in the United States : in combination with bevacizumab as a first-line
maintenance treatment of certain adult patients with advanced epithelial
ovarian, fallopian tube or primary peritoneal cancer who are in complete or
partial response to first-line platinum-based chemotherapy; and for the
treatment of certain adult patients with metastatic castration-resistant
prostate cancer (mCRPC) following progression on prior treatment. Additionally,
Lynparza was approved in the European Union (EU): as monotherapy for the
treatment of adult patients with mCRPC and BRCA1/2 mutations who have progressed
following a prior therapy; and for the maintenance treatment of certain adult
patients with metastatic adenocarcinoma of the pancreas. Lynparza was also
approved in Japan for the treatment of three types of advanced cancer: ovarian,
prostate and pancreatic cancer. Lenvima, which is being developed in
collaboration with Eisai Co., Ltd. (Eisai), received approval in China as
monotherapy for the treatment of differentiated thyroid cancer.
Also in 2020, Gardasil 9 was approved for use in women and girls in Japan where
it is marketed as Silgard 9. Additionally, in 2020, the U.S. Food and Drug and
Administration (FDA) granted accelerated approval for an expanded indication for
Gardasil 9 for the prevention of oropharyngeal and other head and neck cancers
caused by certain HPV types. In January 2021 , the Company received FDA approval
for Verquvo (vericiguat), to reduce the risk of cardiovascular death and heart
failure hospitalization following a hospitalization for heart failure or need
for outpatient intravenous diuretics in adults. Verquvo is being jointly
developed with Bayer AG (Bayer).
In addition to the recent regulatory approvals discussed above, the Company
advanced its late-stage pipeline with several regulatory submissions. Keytruda
is under review in United States and/or internationally for the treatment of
certain patients with TNBC, classical Hodgkin Lymphoma (cHL), colorectal cancer,
cSCC, esophageal and gastric cancer. Lenvima is under review in Japan as
monotherapy for the treatment of thymic cancer. V114, an investigational
15-valent pneumococcal conjugate vaccine, is under priority review by the FDA
for the prevention of invasive pneumococcal disease in adults 18 years of age
and older. The European Medicines Agency (EMA) is also reviewing an application
for licensure of V114 in adults. The Company is involved in litigation
challenging the validity of several Pfizer Inc. patents that relate to
pneumococcal vaccine technology in the United States and several foreign
jurisdictions.
The Company's Phase 3 oncology programs include Keytruda in the therapeutic
areas of biliary tract, cervical, cutaneous squamous cell, endometrial, gastric,
hepatocellular, mesothelioma, ovarian, prostate and small-cell lung cancers;
Lynparza as monotherapy for colorectal cancer and in combination with Keytruda
for non-small-cell lung and small-cell lung cancers; and Lenvima in combination
with Keytruda for bladder, endometrial, gastric, head and neck, melanoma and
non-small-cell lung cancers. Also within oncology, MK-6482, belzutifan, an
investigational hypoxia-inducible factor-2 alpha (HIF-2?) inhibitor being
evaluated for the treatment of patients with von Hippel-Lindau
disease-associated renal cell carcinoma (RCC), received Breakthrough Therapy
designation from the FDA. Additionally, the Company has candidates in Phase 3
clinical development in several other therapeutic areas, including MK-7264,
gefapixant, a selective, non-narcotic, orally-administered, investigational
P2X3-receptor antagonist being developed for the treatment of refractory,
chronic cough; MK-7110, an investigational treatment for patients hospitalized
with COVID-19; MK-8591A, islatravir, an investigational nucleoside reverse
transcriptase translocation inhibitor (NRTTI) in combination with doravirine for
the treatment of HIV-1 infection; and V114, which is being evaluated for the
prevention of pneumococcal disease in pediatric patients.
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The Company is allocating resources to support its commercial opportunities in
the near term while making the necessary investments to support long-term
growth. Research and development expenses in 2020 reflect higher costs related
to business development activity, higher clinical development spending and
increased investment in discovery research and early drug development.
In November 2020 , Merck 's Board of Directors approved an increase to the
Company's quarterly dividend, raising it to $0.65 per share from $0.61 per share
on the Company's outstanding common stock. During 2020, the Company returned
$7.5 billion to shareholders through dividends and share repurchases.
Management
In February 2021 , Merck announced that Kenneth C. Frazier , chairman and chief
executive officer, will retire as chief executive officer, effective June 30,
2021 . Mr. Frazier will continue to serve on Merck 's Board of Directors as
executive chairman, for a transition period to be determined by the board. The
Merck Board of Directors has unanimously elected Robert M. Davis , Merck 's
current executive vice president, global services and chief financial officer,
as chief executive officer, as well as a member of the board, effective July 1,
2021 . Mr. Davis will become president of Merck , effective April 1, 2021 , at
which time the Company's operating divisions-Human Health, Animal Health ,
Manufacturing, and Merck Research Laboratories (MRL)-will begin reporting to Mr.
Davis .
COVID-19
Overall, in response to the COVID-19 pandemic, Merck remains focused on
protecting the safety of its employees, ensuring that its supply of medicines
and vaccines reaches its patients, contributing its scientific expertise to the
development of antiviral approaches, and supporting health care providers and
Merck 's communities. Although COVID-19-related disruptions to patients' ability
to access health care providers negatively affected results in 2020, Merck
remains confident in the fundamental underlying demand for its products and its
prospects for long-term growth.
In 2020, the estimated negative impact of the COVID-19 pandemic to Merck 's sales
was approximately $2.5 billion , largely attributable to the Pharmaceutical
segment, with approximately $50 million attributable to the Animal Health
segment. Roughly two-thirds of Merck 's Pharmaceutical segment revenue is
comprised of physician-administered products, which, despite strong underlying
demand, have been affected by social distancing measures, fewer well visits and
delays in elective surgeries due to the COVID-19 pandemic. These impacts, as
well as the prioritization of COVID-19 patients at health care providers, have
resulted in reduced administration of many of the Company's human health
products, in particular for its vaccines, including Gardasil 9, as well as for
Keytruda and Implanon/Nexplanon. In addition, declines in elective surgeries
negatively affected the demand for Bridion. However, sales of Pneumovax 23
increased due to heightened awareness of pneumococcal vaccination.
Operating expenses were positively affected in 2020 by approximately $600
million primarily due to lower promotional and selling costs, as well as lower
research and development expenses, net of investments in COVID-19-related
antiviral and vaccine research programs.
Merck believes that global health systems and patients have largely adapted to
the impacts of COVID-19, but the Company's assumption is that ongoing residual
negative impacts will persist, particularly during the first half of 2021 and
most notably with respect to vaccine sales, with the impact expected to be more
acute in the United States . For the full year of 2021, Merck assumes an
unfavorable impact to revenue of approximately 2% due to the COVID-19 pandemic,
all of which relates to Pharmaceutical segment sales. In addition, for the full
year of 2021, with respect to the COVID-19 pandemic, Merck expects a net
negative impact to operating expenses, as spending on the development of its
COVID-19 antiviral programs is expected to exceed the favorable impact of lower
spending in other areas due to the COVID-19 pandemic.
Pricing
Global efforts toward health care cost containment continue to exert pressure on
product pricing and market access worldwide. Changes to the U.S. health care
system as part of health care reform, as well as increased purchasing power of
entities that negotiate on behalf of Medicare, Medicaid, and private sector
beneficiaries, have contributed to pricing pressure. In several international
markets, government-mandated pricing actions have reduced prices of generic and
patented drugs. In addition, the Company's revenue performance in 2020 was
negatively
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affected by other cost-reduction measures taken by governments and other
third-parties to lower health care costs. The Company anticipates all of these
actions and additional actions in the future will continue to negatively affect
revenue performance.
Operating Results
Sales
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
United States $ 21,027 2 % 2 % $ 20,519 12 % 12 % $ 18,346
International 26,967 2 % 5 % 26,321 10 % 13 % 23,949
Total $ 47,994 2 % 4 % $ 46,840 11 % 13 % $ 42,294
U.S. plus international may not equal total due to rounding.
Worldwide sales grew 2% in 2020 due to higher sales in the oncology franchise
reflecting strong growth of Keytruda, as well as increased alliance revenue from
Lynparza and Lenvima. Also contributing to revenue growth were higher sales of
certain vaccines, including Gardasil/Gardasil 9 and Pneumovax 23, as well as
increased sales of certain hospital acute care products, including Prevymis and
Bridion. Higher sales of animal health products also drove revenue growth in
2020.
Sales growth in 2020 was partially offset by the effects of generic competition
for certain products including women's health product NuvaRing, hospital acute
care products Noxafil and Cubicin, oncology products Emend/Emend for Injection,
cardiovascular products Zetia and Vytorin, and products within the diversified
brands franchise, particularly Singulair. The diversified brands franchise
includes certain products that are approaching the expiration of their marketing
exclusivity or that are no longer protected by patents in developed markets.
Lower sales of pediatric vaccines, including ProQuad, M-M-R II, and Varivax, as
well as lower sales of diabetes products Januvia and Janumet, and virology
products Zepatier and Isentress/Isentress HD also partially offset revenue
growth in 2020. As discussed above, the COVID-19 pandemic negatively affected
sales in 2020.
Sales in the United States grew 2% in 2020 primarily driven by higher sales of
Keytruda, increased alliance revenue from Lynparza and Lenvima, and higher sales
of animal health products. Revenue growth was largely offset by lower sales of
NuvaRing, Januvia, Noxafil, Emend/Emend for Injection, M-M-R II, Janumet,
Varivax and Implanon/Nexplanon.
International sales grew 2% in 2020. The increase in international sales
primarily reflects growth in Keytruda, Gardasil/Gardasil 9, increased alliance
revenue from Lynparza, as well as higher sales of Pneumovax 23, Prevymis,
Januvia and animal health products. Sales growth was partially offset by lower
sales of Zepatier, Vytorin, Noxafil, Zetia, Remicade, Emend/Emend for Injection
and products within the diversified brands franchise, particularly Singulair and
Nasonex. International sales represented 56% of total sales in both 2020 and
2019.
See Note 18 to the consolidated financial statements for details on sales of the
Company's products. A discussion of performance for select products in the
franchises follows.
Pharmaceutical Segment
Oncology
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Keytruda $ 14,380 30 % 30 % $ 11,084 55 % 58 % $ 7,171
Alliance Revenue - Lynparza
(1) 725 63 % 62 % 444 137 % 141 % 187
Alliance Revenue - Lenvima (1) 580 44 % 43 % 404 171 % 173 % 149 Emend 145 (63) % (62) % 388 (26) % (24) % 522
(1) Alliance revenue represents
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Keytruda is an anti-PD-1 (programmed death receptor-1) therapy that has been
approved as monotherapy for the treatment of certain patients with cervical
cancer, cHL, cSCC, ESCC, gastric or gastroesophageal junction adenocarcinoma,
HNSCC, hepatocellular carcinoma (HCC), non-small-cell lung cancer (NSCLC),
small-cell lung cancer (SCLC), melanoma, Merkel cell carcinoma, MSI-H or dMMR
cancer including MSI-H/dMMR colorectal cancer, primary mediastinal large B-cell
lymphoma (PMBCL), TMB-H cancer, and urothelial carcinoma including NMIBC.
Keytruda is also approved for the treatment of certain patients: in combination
with chemotherapy for metastatic squamous and nonsquamous NSCLC, in combination
with chemotherapy for HNSCC, in combination with chemotherapy for TNBC, in
combination with axitinib for RCC, and in combination with Lenvima for
endometrial carcinoma. The Keytruda clinical development program includes
studies across a broad range of cancer types.
Global sales of Keytruda grew 30% in 2020 driven by higher demand as the Company
continues to launch Keytruda with multiple new indications globally, although
the COVID-19 pandemic had a dampening effect on growing demand. Sales in the
United States continue to build across the multiple approved indications, in
particular for the treatment of advanced NSCLC as monotherapy, and in
combination with chemotherapy for both nonsquamous and squamous metastatic
NSCLC, along with uptake in the RCC, adjuvant melanoma, HNSCC, bladder cancer
and endometrial carcinoma indications. Uptake of the every six weeks (Q6W) adult
dosing regimen in the United States benefited sales in 2020. Keytruda sales
growth in international markets was driven by continued uptake in approved
indications, particularly in the EU. Sales growth was partially offset by
declines in Japan due to pricing. Pursuant to a re-pricing rule, the Japanese
government reduced the price of Keytruda by 17.5% effective February 2020 .
Additionally, Keytruda was subject to another price reduction of 20.9% in April
2020 under a provision of the Japanese pricing rules.
In January 2020 , the FDA approved Keytruda as monotherapy for the treatment of
certain patients with Bacillus Calmette-Guerin (BCG)-unresponsive, high-risk,
NMIBC based on the results of the KEYNOTE-057 trial.
In April 2020 , the FDA granted accelerated approval for an additional
recommended dosage of 400 mg every six weeks (Q6W) for Keytruda across all adult
indications, including monotherapy and combination therapy. This new dosage
option is available in addition to the current dose of 200 mg every three weeks
(Q3W).
In June 2020 , the FDA granted accelerated approval for Keytruda as monotherapy
for the treatment of adult and pediatric patients with unresectable or
metastatic TMB-H solid tumors, as determined by an FDA-approved test, that have
progressed following prior treatment and who have no satisfactory alternative
treatment options based in part on the results of the KEYNOTE-158 trial.
Also in June 2020 , the FDA approved Keytruda as monotherapy for the treatment of
patients with recurrent or metastatic cSCC that is not curable by surgery or
radiation based on data from the KEYNOTE-629 trial.
Additionally in June 2020 , the FDA approved Keytruda as monotherapy for the
first-line treatment of patients with unresectable or metastatic MSI-H or dMMR
colorectal cancer based on results from the KEYNOTE-177 trial.
In October 2020 , the FDA approved an expanded label for Keytruda as monotherapy
for the treatment of adult patients with relapsed or refractory cHL based on
results from the KEYNOTE-204 trial. The FDA also approved an updated pediatric
indication for Keytruda for the treatment of pediatric patients with refractory
cHL or cHL that has relapsed after two or more lines of therapy. Keytruda was
previously approved under the FDA's accelerated approval process for the
treatment of adult and pediatric patients with refractory cHL, or who have
relapsed after three or more prior lines of therapy based on data from the
KEYNOTE-087 trial. In accordance with accelerated approval regulations,
continued approval was contingent upon verification and description of clinical
benefit; these accelerated approval requirements have been fulfilled with the
data from KEYNOTE-204.
In November 2020 , the FDA granted accelerated approval for Keytruda in
combination with chemotherapy for the treatment of patients with locally
recurrent unresectable or metastatic TNBC whose tumors express PD-L1 (Combined
Positive Score [CPS] ?10) as determined by an FDA-approved test. The approval is
based on results from the KEYNOTE-355 trial.
In June 2020 , Keytruda was approved by the National Medical Products
Administration (NMPA) in China as monotherapy for the second-line treatment of
patients with locally advanced or metastatic ESCC whose
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tumors express PD-L1 (CPS ?10). This indication was granted based on the
KEYNOTE-181 trial, including data from an extension of the global study in
Chinese patients. In December 2020 , China's NMPA approved Keytruda as
monotherapy for the first-line treatment of patients with metastatic or with
unresectable, recurrent HNSCC whose tumors express PD-L1 (CPS ?20) as determined
by a fully validated test.
In August 2020 , Keytruda was approved by Japan's Pharmaceuticals and Medical
Devices Agency (PMDA) as monotherapy for the treatment of patients whose tumors
are PD-L1-positive, and have radically unresectable, advanced or recurrent ESCC
who have progressed after chemotherapy. The approval was based on results from
the KEYNOTE-181 trial. Additionally, Keytruda was approved by Japan's PMDA for
use at an additional recommended dosage of 400 mg Q6W, including monotherapy and
combination therapy. This new dosage option is available in addition to the
current dose of 200 mg Q3W.
In January 2021 , Keytruda was approved by the European Commission (EC) as a
first-line treatment in adult patients with MSI-H or dMMR colorectal cancer
based on the results of the KEYNOTE-177 study.
The Company is a party to certain third-party license agreements pursuant to
which the Company pays royalties on sales of Keytruda. Under the terms of the
more significant of these agreements, Merck pays a royalty of 6.5% on worldwide
sales of Keytruda through 2023 to one third party; this royalty will decline to
2.5% for 2024 through 2026 and will terminate thereafter. The Company pays an
additional 2% royalty on worldwide sales of Keytruda to another third party, the
termination date of which varies by country; this royalty will expire in the
United States in 2024 and in major European markets in 2025. The royalties are
included in Cost of sales.
Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed
as part of a collaboration with AstraZeneca (see Note 4 to the consolidated
financial statements), is approved for the treatment of certain types of
advanced ovarian, breast, pancreatic and prostate cancers. Alliance revenue
related to Lynparza grew 63% in 2020 due to continued uptake across the multiple
approved indications in the United States , the EU, China and Japan .
In May 2020 , the FDA approved Lynparza in combination with bevacizumab as a
first-line maintenance treatment of certain adult patients with advanced
epithelial ovarian, fallopian tube or primary peritoneal cancer who are in
complete or partial response to first-line platinum-based chemotherapy. In
November 2020 , Lynparza was approved in the EU for the maintenance treatment of
adult patients with advanced high-grade epithelial ovarian, fallopian tube or
primary peritoneal cancer who are in complete or partial response following
completion of first-line platinum-based chemotherapy in combination with
bevacizumab and whose cancer is associated with homologous recombination
deficiency (HRD)-positive status. These approvals were based on the results from
the PAOLA-1 trial.
Also in May 2020 , the FDA approved Lynparza for the treatment of adult patients
with deleterious or suspected deleterious germline or somatic homologous
recombination repair (HRR) gene-mutated mCRPC who have progressed following
prior treatment. In November 2020 , Lynparza was approved in the EU as
monotherapy for the treatment of adult patients with mCRPC and BRCA1/2 mutations
(germline and/or somatic) who have progressed following a prior therapy. These
approvals were based on the results from the PROfound trial.
In July 2020 , Lynparza was approved in the EU as a monotherapy for the
maintenance treatment of adult patients with germline BRCA1/2 mutations who have
metastatic adenocarcinoma of the pancreas and have not progressed after a
first-line chemotherapy regimen. This approval was based on the results from the
POLO trial.
In December 2020 , Lynparza was approved in Japan for the treatment of three
types of advanced cancer: ovarian, prostate and pancreatic cancer. The three
approvals authorize Lynparza for use as maintenance treatment after first-line
chemotherapy containing bevacizumab (genetical recombination) in patients with
HRD ovarian cancer; the treatment of patients with BRCA gene-mutated (BRCAm)
mCRPC; and maintenance treatment after platinum-based chemotherapy for patients
with BRCAm curatively unresectable pancreas cancer. The concurrent approvals by
the Japanese Ministry of Health , Labor, and Welfare are based on results from
the PAOLA-1, PROfound and POLO trials.
Lenvima, an oral receptor tyrosine kinase inhibitor being developed as part of a
collaboration with Eisai (see Note 4 to the consolidated financial statements),
is approved for the treatment of certain types of thyroid cancer, HCC, in
combination with everolimus for certain patients with RCC, and in combination
with Keytruda for the
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treatment of certain patients with endometrial carcinoma. Alliance revenue
related to Lenvima grew 44% in 2020 due to higher demand in the United States ,
China and the EU.
In November 2020 , China's NMPA approved Lenvima as a monotherapy for the
treatment of differentiated thyroid cancer.
Global sales of Emend, for the prevention of certain chemotherapy-induced nausea
and vomiting, declined 63% in 2020 primarily due to lower demand and pricing in
the United States due to generic competition for Emend for Injection following
U.S. patent expiry in September 2019 . Also contributing to the Emend sales
decline was lower demand in the EU and Japan as a result of generic competition
for the oral formulation of Emend following loss of market exclusivity in May
2019 and December 2019 , respectively. U.S. market exclusivity for the oral
formulation of Emend previously expired in 2015.
In April 2020 , the FDA approved Koselugo (selumetinib) for the treatment of
pediatric patients two years of age and older with neurofibromatosis type 1
(NF1) who have symptomatic, inoperable plexiform neurofibromas (PN). The FDA
approval is based on positive results from the National Cancer Institute (NCI)
Cancer Therapy Evaluation Program (CTEP)-sponsored Phase 2 SPRINT Stratum 1
trial coordinated by the NCI's Center for Cancer Research , Pediatric Oncology
Branch. This is the first regulatory approval of a medicine for the treatment of
NF1 PN, a rare and debilitating genetic condition. Koselugo is being jointly
developed and commercialized with AstraZeneca globally (see Note 4 to the
consolidated financial statements).
Vaccines
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Gardasil/Gardasil 9 $ 3,938 5 % 6 % $ 3,737 19 % 21 % $ 3,151
ProQuad 678 (10) % (10) % 756 27 % 29 % 593
M-M-R II 378 (31) % (31) % 549 28 % 29 % 430
Varivax 823 (15) % (15) % 970 25 % 28 % 774
Pneumovax 23 1,087 17 % 18 % 926 2 % 3 % 907
Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers
and other diseases caused by certain types of HPV, grew 5% in 2020 primarily due
to higher volumes in China and the replenishment in 2020 of doses borrowed from
the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine
Stockpile in 2019. The replenishment resulted in the recognition of sales of
$120 million in 2020, which, when combined with the reduction of sales of $120
million in 2019 due to the borrowing, resulted in a favorable impact to sales of
$240 million in 2020. Lower demand in the United States and Hong Kong , SAR, PRC
attributable to the COVID-19 pandemic partially offset the increase in sales of
Gardasil/Gardasil 9.
In June 2020 , the FDA approved an expanded indication for Gardasil 9 for the
prevention of oropharyngeal and other head and neck cancers caused by HPV Types
16, 18, 31, 33, 45, 52, and 58. The oropharyngeal and head and neck cancer
indication was approved under accelerated approval based on effectiveness in
preventing HPV-related anogenital disease.
In July 2020 , Gardasil 9 was approved by the PMDA in Japan for use in women and
girls nine years and older for the prevention of cervical cancer, certain
cervical, vaginal and vulvar precancers, and genital warts caused by the HPV
types covered by the vaccine. In December 2020 , Silgard 9 was also approved in
Japan for the prevention of anal cancer and precursor lesions caused by HPV
types 6, 11, 16 and 18 for individuals nine years and older and for genital
warts for men nine years and older. Gardasil 9 is marketed in Japan as Silgard
9.
The Company is a party to certain third-party license agreements pursuant to
which the Company pays royalties on sales of Gardasil/Gardasil 9. Under the
terms of the more significant of these agreements, Merck pays a 7% royalty on
worldwide sales of Gardasil/Gardasil 9 to one third party (royalty obligations
under this agreement expire in December 2023 ) and an additional 7% royalty on
sales of Gardasil/Gardasil 9 in the United States to another third party (these
royalty obligations expire in December 2028 ). The royalties are included in Cost
of sales.
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Global sales of ProQuad, a pediatric combination vaccine to help protect against
measles, mumps, rubella and varicella, declined 10% in 2020 driven primarily by
lower demand in the United States resulting from fewer measles outbreaks in 2020
compared with 2019, coupled with the unfavorable impact of the COVID-19
pandemic, partially offset by higher pricing.
Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps
and rubella, declined 31% in 2020 driven primarily by lower demand in the United
States resulting from fewer measles outbreaks in 2020 compared with 2019,
coupled with the unfavorable impact of the COVID-19 pandemic. Lower demand in
Brazil also contributed to the M-M-R II sales decline in 2020.
Global sales of Varivax, a vaccine to help prevent chickenpox (varicella),
declined 15% in 2020 driven primarily by lower demand in the United States
resulting from the COVID-19 pandemic, partially offset by higher pricing. The
Varivax sales decline was also attributable to lower government tenders in
Brazil .
Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease,
grew 17% in 2020 primarily due to higher volumes in the EU and in the United
States attributable in part to heightened awareness of pneumococcal vaccination.
Higher pricing in the United States also contributed to Pneumovax 23 sales
growth in 2020.
Hospital Acute Care
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Bridion $ 1,198 6 % 7 % $ 1,131 23 % 26 % $ 917
Noxafil 329 (50) % (50) % 662 (11) % (7) % 742
Prevymis 281 70 % 69 % 165 128 % 131 % 72
Cubicin 152 (41) % (40) % 257 (30) % (28) % 367
Zerbaxa 130 8 % 10 % 121 39 % 42 % 87
Global sales of Bridion, for the reversal of two types of neuromuscular blocking
agents used during surgery, grew 6% in 2020 due to higher demand globally,
particularly in the United States . However, fewer elective surgeries as a result
of the COVID-19 pandemic unfavorably affected demand in 2020.
Worldwide sales of Noxafil, an antifungal agent for the prevention of certain
invasive fungal infections, declined 50% in 2020 due to generic competition in
the United States and in the EU. The patent that provided U.S. market
exclusivity for certain forms of Noxafil representing the majority of U.S.
Noxafil sales expired in July 2019 . Additionally, the patent for Noxafil expired
in a number of major European markets in December 2019 . As a result, the Company
is experiencing volume and pricing declines in Noxafil sales in these markets as
a result of generic competition and expects the declines to continue.
Worldwide sales of Prevymis, a medicine for prophylaxis (prevention) of
cytomegalovirus (CMV) infection and disease in adult CMV-seropositive recipients
of an allogenic hematopoietic stem cell transplant, grew 70% in 2020 due to
continued uptake since launch in the EU and in the United States . Prevymis was
approved by the EC in January 2018 and by the FDA in November 2017 .
Global sales of Cubicin for injection, an antibiotic for the treatment of
certain bacterial infections, declined 41% in 2020 primarily due to ongoing
generic competition in the EU and in the United States .
In December 2020 , the Company temporarily suspended sales of Zerbaxa, a
combination antibacterial and beta-lactamase inhibitor for the treatment of
certain bacterial infections, and subsequently issued a product recall,
following the identification of product sterility issues. As a result, the
Company recorded an intangible asset impairment charge related to Zerbaxa (see
Note 8 to the consolidated financial statements). The Company does not
anticipate that Zerbaxa will return to the market before 2022.
In June 2020 , the FDA approved a supplemental New Drug Application (NDA) for
Recarbrio (imipenem, cilastatin, and relebactam) for the treatment of patients
18 years of age and older with hospital-acquired
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bacterial pneumonia and ventilator-associated bacterial pneumonia caused by
certain susceptible Gram-negative microorganisms.
Immunology
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Simponi $ 838 1 % 1 % $ 830 (7) % (2) % $ 893
Remicade 330 (20) % (20) % 411 (29) % (25) % 582
Sales of Simponi, a once-monthly subcutaneous treatment for certain inflammatory
diseases (marketed by the Company in Europe , Russia and Turkey ), were nearly
flat in 2020. Sales of Simponi are being unfavorably affected by the launch of
biosimilars for a competing product. The Company expects this competition will
continue to unfavorably affect sales of Simponi.
Sales of Remicade, a treatment for inflammatory diseases (marketed by the
Company in Europe , Russia and Turkey ), declined 20% in 2020 driven by ongoing
biosimilar competition in the Company's marketing territories in Europe . The
Company lost market exclusivity for Remicade in major European markets in 2015
and no longer has market exclusivity in any of its marketing territories. The
Company is experiencing pricing and volume declines in these markets as a result
of biosimilar competition and expects the declines to continue.
The Company's marketing rights with respect to these products will revert to
Janssen Pharmaceuticals, Inc. in the second half of 2024.
Virology
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Isentress/Isentress HD $ 857 (12) % (11) % $ 975 (15) % (10) % $ 1,140
Zepatier 167 (55) % (54) % 370 (19) % (16) % 455
Worldwide sales of Isentress/Isentress HD, an HIV integrase inhibitor for use in
combination with other antiretroviral agents for the treatment of HIV-1
infection, declined 12% in 2020 primarily due to competitive pressure in the
United States and in the EU. The Company expects competitive pressures for
Isentress/Isentress HD to continue.
Global sales of Zepatier, a treatment for adult patients with chronic hepatitis
C virus genotype (GT) 1 or GT4 infection, declined 55% in 2020 driven by lower
demand globally due to competition and declining patient volumes, coupled with
the impact of the COVID-19 pandemic.
Cardiovascular
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Zetia/Vytorin $ 664 (24) % (24) % $ 874 (35) % (34) % $ 1,355
Atozet 453 16 % 16 % 391 13 % 18 % 347
Rosuzet 130 8 % 9 % 120 107 % 115 % 58
Alliance revenue - Adempas (1) 281 38 % 38 % 204 47 % 47 % 139
Adempas 220 3 % 2 % 215 13 % 17 % 190
(1) Alliance revenue represents Merck 's share of profits from sales in Bayer's
marketing territories, which are product sales net of cost of sales and
commercialization costs (see Note 4 to the consolidated financial statements).
Combined global sales of Zetia (marketed in most countries outside the United
States as Ezetrol) and Vytorin (marketed outside the United States as Inegy),
medicines for lowering LDL cholesterol, declined 24% in 2020 driven primarily by
lower sales of Ezetrol in Japan and Ezetrol and Inegy in the EU. The patent that
provided market exclusivity for Ezetrol in Japan expired in September 2019 and
generic competition began in June 2020 . The
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EU patents for Ezetrol and Inegy expired in April 2018 and April 2019 ,
respectively. Accordingly, the Company is experiencing sales declines in these
markets as a result of generic competition and expects the declines to continue.
The sales decline in 2020 was also attributable to lower pricing following loss
of exclusivity in Australia . Higher demand for Ezetrol in China partially offset
the sales decline in 2020. Merck lost market exclusivity in the United States
for Zetia in 2016 and Vytorin in 2017 and subsequently lost nearly all U.S.
sales of these products as a result of generic competition.
Sales of Atozet (marketed outside of the United States ), a medicine for lowering
LDL cholesterol, grew 16% in 2020, primarily driven by higher demand in most
markets, particularly in the EU, Japan and other countries in the Asia Pacific
region.
Zetia, Vytorin, Atozet and Rosuzet will be contributed to Organon in connection
with the spin-off (see Note 1 to the consolidated financial statements).
Adempas, a cardiovascular drug for the treatment of pulmonary arterial
hypertension, is part of a worldwide collaboration with Bayer to market and
develop soluble guanylate cyclase (sGC) modulators including Adempas (see Note 4
to the consolidated financial statements). Revenue from Adempas includes Merck 's
share of profits from the sale of Adempas in Bayer's marketing territories,
which grew 38% in 2020, as well as sales in Merck 's marketing territories, which
grew 3% in 2020.
In January 2021 , the FDA approved Verquvo (vericiguat), an sGC stimulator, to
reduce the risk of cardiovascular death and heart failure hospitalization
following a hospitalization for heart failure or need for outpatient intravenous
diuretics in adults with symptomatic chronic heart failure and reduced ejection
fraction. The approval was based on the results of the pivotal Phase 3 VICTORIA
trial and follows a priority regulatory review. Verquvo is part of the same
worldwide clinical development collaboration with Bayer that includes Adempas
referenced above.
Diabetes
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Januvia/Janumet $ 5,276 (4) % (4) % $ 5,524 (7) % (4) % $ 5,914
Worldwide combined sales of Januvia and Janumet, medicines that help lower blood
sugar levels in adults with type 2 diabetes, declined 4% in 2020 as a result of
continued pricing pressure in the United States , partially offset by higher
demand in certain international markets, particularly in China . The Company
expects U.S. pricing pressure to continue. Januvia and Janumet will lose market
exclusivity in the United States in January 2023 . The supplementary patent
certificates that provide market exclusivity for Januvia and Janumet in the EU
expire in September 2022 and April 2023 , respectively. The Company anticipates
sales of Januvia and Janumet in these markets will decline substantially after
loss of market exclusivity.
Women's Health
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Implanon/Nexplanon 680 (14) % (13) % 787 12 % 14 % 703
NuvaRing 236 (73) % (73) % 879 (3) % (2) % 902
Worldwide sales of Implanon/Nexplanon, a single-rod subdermal contraceptive
implant, declined 14% in 2020, primarily driven by lower demand in the United
States and in the EU resulting from the COVID-19 pandemic.
Worldwide sales of NuvaRing, a vaginal contraceptive product, declined 73% in
2020 due to generic competition in the United States . The patent that provided
U.S. market exclusivity for NuvaRing expired in April 2018 and generic
competition began in December 2019 . Accordingly, the Company is experiencing a
rapid and substantial decline in U.S. NuvaRing sales and expects the decline to
continue.
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Implanon/Nexplanon and NuvaRing will be contributed to Organon in connection
with the spin-off (see Note 1 to the consolidated financial statements).
Biosimilars
% Change
Excluding % Change
Foreign Excluding Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Biosimilars $ 330 31 % 31 % $ 252 * * $ 64
* Calculation not meaningful.
Biosimilar products are marketed by the Company pursuant to an agreement with
Samsung Bioepis Co., Ltd. (Samsung) to develop and commercialize multiple
pre-specified biosimilar candidates. Currently, the Company markets Renflexis
(infliximab-abda), a biosimilar to Remicade (infliximab) for the treatment of
certain inflammatory diseases; Ontruzant (trastuzumab-dttb), a biosimilar to
Herceptin (trastuzumab) for the treatment of HER2-positive breast cancer and
HER2 overexpressing gastric cancer; Brenzys (etanercept biosimilar), a
biosimilar to Enbrel for the treatment of certain inflammatory diseases; and
Aybintio (bevacizumab) for the treatment of certain types of cancer. Merck 's
commercialization territories under the agreement vary by product. Sales growth
of biosimilars in 2020 was primarily due to continued post-launch uptake of
Renflexis in the United States and Canada and the launch of Ontruzant in Brazil
in 2020.
In August 2020 , the EC granted marketing authorization for Aybintio for the
treatment of metastatic carcinoma of the colon or rectum, metastatic breast
cancer, NSCLC, advanced and/or metastatic RCC, epithelial ovarian, fallopian
tube and primary peritoneal cancer and cervical cancer. An application seeking
approval of Aybintio in the United States was filed in September 2019 .
The above biosimilar products will be contributed to Organon in connection with
the spin-off (see Note 1 to the consolidated financial statements).
Animal Health Segment
% Change % Change
Excluding Excluding
Foreign Foreign
($ in millions) 2020 % Change Exchange 2019 % Change Exchange 2018
Livestock $ 2,939 6 % 9 % $ 2,784 6 % 11 % $ 2,630
Companion Animal 1,764 10 % 11 % 1,609 2 % 5 % 1,582
Sales of livestock products grew 6% in 2020 predominantly due to an additional
five months of sales in 2020 related to the April 2019 acquisition of Antelliq,
a leader in digital animal identification, traceability and monitoring solutions
(see Note 3 to the consolidated financial statements). Sales of companion animal
products grew 10% in 2020 driven primarily by higher demand for the Bravecto
line of products for parasitic control, as well as higher demand for companion
animal vaccines.
Costs, Expenses and Other
($ in millions) 2020 % Change 2019 % Change 2018
Cost of sales $ 15,485 10 % $ 14,112 4 % $ 13,509
Selling, general and administrative 10,468 (1) % 10,615 5 % 10,102
Research and development 13,558 37 % 9,872 1 % 9,752
Restructuring costs 578 (9) % 638 1 % 632
Other (income) expense, net (886) * 139 * (402)
$ 39,203 11 % $ 35,376 5 % $ 33,593
* Calculation not meaningful.
58-------------------------------------------------------------------------------- Table of Content s Cost of Sales Cost of sales was$15.5 billion in 2020 compared with$14.1 billion in 2019. Cost of sales includes the amortization of intangible assets recorded in connection with acquisitions, collaborations, and licensing arrangements, which totaled$1.8 billion in 2020 compared with$2.0 billion in 2019, respectively. Additionally, costs in 2020 and 2019 include intangible asset impairment charges of$1.6 billion and$705 million related to marketed products and other intangibles (see Note 8 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. Costs in 2020 also include a charge of$260 million in connection with the discontinuation of COVID-19 vaccine development programs (see Note 3 to the consolidated financial statements) and inventory write-offs of$120 million related to a recall for Zerbaxa (see Note 8 to the consolidated financial statements). Also included in cost of sales are expenses associated with restructuring activities which amounted to$175 million in 2020 compared with$251 million in 2019, primarily reflecting 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 67.7% in 2020 compared with 69.9% in 2019. The gross margin decline in 2020 reflects the unfavorable effects of higher impairment charges (noted above), pricing pressure, a charge related to the discontinuation of COVID-19 vaccine development programs, and higher inventory write-offs related to the recall of Zerbaxa (noted above), partially offset by the favorable effects of product mix, lower amortization of intangible assets and lower restructuring costs. Selling, General and Administrative Selling, general and administrative (SG&A) expenses were$10.5 billion in 2020, a decline of 1% compared with 2019. The decline was driven primarily by lower administrative, selling and promotional costs, including lower travel and meeting expenses, due in part to the COVID-19 pandemic, and the favorable effect of foreign exchange, partially offset by higher costs related to the spin-off of Organon and a contribution to theMerck Foundation . SG&A expenses in 2020 include$710 million of costs related to the spin-off of Organon. SG&A expenses in 2020 and 2019 include restructuring costs of$47 million and$34 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. Research and Development Research and development (R&D) expenses were$13.6 billion in 2020, an increase of 37% compared with 2019. The increase was driven primarily by higher upfront payments related to acquisitions and collaborations, including a$2.7 billion charge in 2020 related to the acquisition of VelosBio (see Note 3 to the consolidated financial statements), as well as higher expenses related to clinical development and increased investment in discovery research and early drug development. Higher restructuring costs also contributed to the increase in R&D expenses in 2020. The increase in R&D expenses in 2020 was partially offset by lower in-process research and development (IPR&D) impairment charges and lower costs resulting from the COVID-19 pandemic, net of spending on COVID-19-related vaccine and antiviral research programs. R&D expenses are comprised of the costs directly incurred by MRL, the Company's research and development division that focuses on human health-related activities, which were$6.6 billion in 2020 compared with$6.1 billion in 2019. Also included in R&D expenses areAnimal Health research costs, licensing costs and costs incurred by other divisions in support of R&D activities, including depreciation, production and general and administrative, which in the aggregate were$2.7 billion in 2020 and$2.6 billion in 2019. Additionally, R&D expenses in 2020 include a$2.7 billion charge for the acquisition of VelosBio (noted above), a$462 million charge for the acquisition of OncoImmune and charges of$826 million related to transactions with Seagen. R&D expenses in 2019 include a$993 million charge for the acquisition of Peloton. See Note 3 to the consolidated financial statements for more information on these transactions. R&D expenses also include IPR&D impairment charges of$90 million and$172 million in 2020 and 2019, respectively (see Note 8 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such 59 -------------------------------------------------------------------------------- Table of Content s charges could be material. In addition, R&D expenses in 2020 include$83 million of costs associated with restructuring activities, primarily relating to accelerated depreciation. R&D expenses also include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with business acquisitions. During 2020 and 2019, the Company recorded a net reduction in expenses of$95 million and$39 million , respectively, related to changes in these estimates. Restructuring Costs In early 2019,Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Company's manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Company's plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of Organon. As the Company continues to evaluate its global footprint and overall operating model, it subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately$3.0 billion . The Company expects to record charges of approximately$700 million in 2021 related to the Restructuring Program. The Company anticipates the actions under the Restructuring Program to result in annual net cost savings of approximately$900 million by the end of 2023. Actions under previous global restructuring programs have been substantially completed. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were$578 million in 2020 and$638 million in 2019. Separation costs incurred were 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. Also included in restructuring costs are asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Company's restructuring activities are included in Cost of sales, Selling, general and administrative expenses and Research and development costs. The Company recorded aggregate pretax costs of$883 million in 2020 and$927 million in 2019 related to restructuring program activities (see Note 5 to the consolidated financial statements). Other (Income) Expense, Net Other (income) expense, net, was$886 million of income in 2020 compared with$139 million of expense in 2019, primarily due to higher income from investments in equity securities, net, largely related to Moderna, Inc. For details on the components of Other (income) expense, net, see Note 14 to the consolidated financial statements. Segment Profits ($ in millions) 2020 2019 2018
Pharmaceutical segment profits
1,650 1,609 1,659
Other non-reportable segment profits 1 (7) 103
Other (22,582) (18,462) (17,932)
Income Before Taxes $ 8,791 $ 11,464 $ 8,701
Pharmaceutical segment profits are comprised of segment sales less standard
costs, as well as SG&A expenses directly incurred by the segment. Animal Health
segment profits are comprised of segment sales, less all cost of sales, as well
as SG&A and R&D expenses directly incurred by the segment. For internal
management reporting presented to the chief operating decision maker, Merck does
not allocate the remaining cost of sales not included in segment profits as
described above, research and development expenses incurred by MRL, or general
and administrative expenses, nor the cost of financing these activities.
Separate divisions maintain responsibility for
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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 are
costs related to restructuring activities and acquisition and
divestiture-related costs, including the amortization of purchase accounting
adjustments, intangible asset impairment charges, and changes in the estimated
fair value measurement of liabilities for contingent consideration.
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.
Pharmaceutical segment profits grew 5% in 2020 compared with 2019 driven
primarily by higher sales, as well as lower selling and promotional costs.
Animal Health segment profits grew 3% in 2020 driven primarily by higher sales
and lower promotional and selling costs, partially offset by higher R&D costs
and the unfavorable effect of foreign exchange.
Taxes on Income
The effective income tax rates of 19.4% in 2020 and 14.7% in 2019 reflect the
impacts of acquisition and divestiture-related costs and restructuring costs,
partially offset by the beneficial impact of foreign earnings, including product
mix. The effective income tax rate in 2020 reflects the unfavorable impact of a
charge for the acquisition of VelosBio for which no tax benefit was recognized.
The effective income tax rate in 2019 reflects the favorable impact of a $364
million net tax benefit related to the settlement of certain federal income tax
matters (see Note 15 to the consolidated financial statements) and the reversal
of tax reserves established in connection with the 2014 divestiture of Merck 's
Consumer Care (MCC) business due to the lapse in the statute of limitations. In
addition, the effective income tax rate in 2019 reflects the unfavorable impacts
of a charge for the acquisition of Peloton for which no tax benefit was
recognized and charges of $117 million related to the finalization of treasury
regulations for the transition tax associated with the 2017 enactment of U.S.
tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 15 to the
consolidated financial statements).
Net Income (Loss) Attributable to Noncontrolling Interests
Net income (loss) attributable to noncontrolling interests was $15 million in
2020 compared with $(66) million in 2019. The loss in 2019 was driven primarily
by the portion of goodwill impairment charges related to certain businesses in
the Healthcare Services segment that were attributable to noncontrolling
interests.
Net Income and Earnings per Common Share
Net income attributable to Merck & Co., Inc. was $7.1 billion in 2020 and $9.8
billion in 2019. EPS was $2.78 in 2020 and $3.81 in 2019.
Non-GAAP Income and Non-GAAP EPS
Non-GAAP income and non-GAAP EPS are alternative views of the Company's
performance that Merck is providing because management believes this information
enhances investors' understanding of the Company's results as it permits
investors to understand how management assesses performance. Non-GAAP income and
non-GAAP EPS exclude certain items because of the nature of these items and the
impact that they have on the analysis of underlying business performance and
trends. The excluded items (which should not be considered non-recurring)
consist of acquisition and divestiture-related costs, restructuring costs and
certain other items. These excluded items are significant components in
understanding and assessing financial performance.
Non-GAAP income and non-GAAP EPS are important internal measures for the
Company. Senior management receives a monthly analysis of operating results that
includes non-GAAP EPS. Management uses these measures internally for planning
and forecasting purposes and to measure the performance of the Company along
with other metrics. In addition, senior management's annual compensation is
derived in part using non-GAAP pretax income. Since non-GAAP income and
non-GAAP EPS are not measures determined in accordance with GAAP, they have no
standardized meaning prescribed by GAAP and, therefore, may not be comparable to
the calculation of similar measures of other companies. The information on
non-GAAP income and non-GAAP EPS should be considered in addition to, but not as
a substitute for or superior to, net income and EPS prepared in accordance with
generally accepted accounting principles in the United States (GAAP).
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A reconciliation between GAAP financial measures and non-GAAP financial measures
is as follows:
($ in millions except per share amounts) 2020 2019 2018
Income before taxes as reported under GAAP $ 8,791 $ 11,464 $ 8,701
Increase (decrease) for excluded items:
Acquisition and divestiture-related costs (1) 3,704 2,681 3,066
Restructuring costs 883 927 658
Other items:
Charge for the acquisition of VelosBio 2,660 - -
Charges for the formation of collaborations (2) 1,076 - 1,400
Charge for the acquisition of OncoImmune 462 - -
Charge for the discontinuation of COVID-19 vaccine development programs
305 - -
Charge for the acquisition of Peloton - 993 -
Charge related to the termination of a collaboration with Samsung -
- 423
Charge for the acquisition of Viralytics Limited - - 344
Other (20) 55 (57)
Non-GAAP income before taxes 17,861 16,120 14,535
Taxes on income as reported under GAAP 1,709 1,687 2,508
Estimated tax benefit on excluded items (3) 1,122 695 535
Adjustment to tax benefits recorded in conjunction with the 2015
(67) - -
Net tax benefit from the settlement of certain federal income tax matters
- 364 -
Tax benefit from the reversal of tax reserves related to the divestiture of MCC
- 86 -
Net tax charge related to the finalization of treasury regulations related to the enactment of the TCJA
- (117) (160) Non-GAAP taxes on income 2,764 2,715 2,883 Non-GAAP net income 15,097 13,405 11,652
Less: Net income (loss) attributable to noncontrolling interests as reported under GAAP
15 (66) (27)
Acquisition and divestiture-related costs attributable to noncontrolling interests
- (89) (58)
Non-GAAP net income attributable to noncontrolling interests 15 23 31
Non-GAAP net income attributable to Merck & Co., Inc. $ 15,082 $ 13,382 $ 11,621
EPS assuming dilution as reported under GAAP $ 2.78 $ 3.81 $ 2.32
EPS difference 3.16 1.38 2.02
Non-GAAP EPS assuming dilution $
5.94
(1)Amount in 2020 includes a$1.6 billion intangible asset impairment charge related to Zerbaxa. Amount in 2019 includes a$612 million intangible asset impairment charge related to Sivextro. See Note 8 to the consolidated financial statements. (2)Amount in 2020 includes$826 million related to transactions with Seagen (see Note 3 to the consolidated financial statements). Amount in 2018 represents charge for the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements). (3) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation 62 -------------------------------------------------------------------------------- Table of Content s 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 asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items These items are adjusted for after evaluating them on an individual basis considering their quantitative and qualitative aspects. Typically, these consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2020 are charges for the acquisitions of VelosBio and OncoImmune, charges related to collaborations, including transactions with Seagen (see Note 3 to the consolidated financial statements), a charge for the discontinuation of COVID-19 vaccine development programs, and an adjustment to tax benefits recorded in conjunction with the 2015Cubist Pharmaceuticals, Inc. acquisition. Excluded from non-GAAP income and non-GAAP EPS in 2019 is a charge for the acquisition of Peloton (see Note 3 to the consolidated financial statements), tax charges related to the finalization ofU.S. treasury regulations related to the TCJA, a net tax benefit related to the settlement of certain federal income tax matters, and a tax benefit related to the reversal of tax reserves established in connection with the 2014 divestiture of MCC (see Note 15 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2018 is a charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), a charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements), a charge for the acquisition ofViralytics (see Note 3 to the consolidated financial statements), and measurement-period adjustments related to the provisional amounts recorded for the TCJA (see Note 15 to the consolidated financial statements). Beginning in 2021, the Company will be changing the treatment of certain items for the purposes of its non-GAAP reporting. Historically,Merck 's non-GAAP results excluded the amortization of intangible assets recognized in connection with business acquisitions (reflected as part of acquisition and divestiture-related costs) but did not exclude the amortization of intangibles originating from collaborations, asset acquisitions or licensing arrangements. Beginning in 2021,Merck 's non-GAAP results will no longer differentiate between the nature of the intangible assets being amortized and will exclude all amortization of intangible assets. Also, beginning in 2021,Merck 's non-GAAP results will exclude gains and losses on investments in equity securities. Prior period amounts will be recast to conform to the new presentation. Research and Development Research Pipeline The Company currently has several candidates under regulatory review inthe United States and internationally, as well as in late-stage clinical development. A chart reflecting the Company's current research pipeline as ofFebruary 22, 2021 and related discussion is set forth in Item 1. "Business - Research and Development" above.Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. AtDecember 31, 2020 , the balance of IPR&D was$3.2 billion (see Note 8 to the consolidated financial statements). 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 63 -------------------------------------------------------------------------------- Table of Content s the acquisition date. 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. In 2020, 2019, and 2018 the Company recorded IPR&D impairment charges within Research and development expenses of$90 million ,$172 million and$152 million , respectively (see Note 8 to the consolidated financial statements). 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. Acquisitions, Research Collaborations and License AgreementsMerck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain recent transactions are summarized below; additional details are included in Note 3 to the consolidated financial statements.Merck is actively monitoring the landscape for growth opportunities that meet the Company's strategic criteria. InJanuary 2020 ,Merck acquiredArQule , a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases for$2.7 billion .ArQule's lead investigational candidate, MK-1026 (formerly ARQ 531), is a novel, oral Bruton's tyrosine kinase (BTK) inhibitor currently being evaluated for the treatment of B-cell malignancies. The transaction was accounted for as an acquisition of a business. The Company recorded IPR&D of$2.3 billion (related to MK-1026), goodwill of$512 million and other net liabilities of$102 million . InJuly 2020 ,Merck and Ridgeback Bio, a closely held biotechnology company, closed a collaboration agreement to develop molnupiravir (MK-4482, also known as EIDD-2801), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19.Merck gained exclusive worldwide rights to develop and commercialize molnupiravir and related molecules. Under the terms of the agreement, Ridgeback Bio received an upfront payment and also is eligible to receive future contingent payments dependent upon the achievement of certain developmental and regulatory approval milestones, as well as a share of the net profits of molnupiravir and related molecules, if approved. Molnupiravir is currently being evaluated in Phase 2/3 clinical trials in both the hospital and outpatient settings. The primary completion date for the Phase 2/3 studies isJune 2021 . The Company anticipates interim efficacy data in the first quarter of 2021. InSeptember 2020 ,Merck and Seagen announced an oncology collaboration to globally develop and commercialize Seagen's ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials for breast cancer and other solid tumors. Under the terms of the agreement,Merck made an upfront payment of$600 million and a$1.0 billion equity investment in 5 million shares of Seagen common stock at a price of$200 per share.Merck recorded$616 million in Research and development expenses in 2020 related to this transaction. Seagen is also eligible to receive future contingent milestone payments dependent upon the achievement of certain developmental and sales-based milestones. Concurrent with the above transaction, Seagen grantedMerck an exclusive license to commercialize Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers, inAsia , theMiddle East andLatin America and other regions outside ofthe United States ,Canada andEurope . Under the terms of the agreement,Merck made upfront payments aggregating$210 million , which were recorded as Research and development expenses in 2020. Seagen is also eligible to receive future contingent regulatory approval milestones and tiered royalties based on annual sales levels of Tukysa inMerck 's territories. InDecember 2020 ,Merck acquired OncoImmune, a privately held, clinical-stage biopharmaceutical company, for an upfront payment of$423 million . In addition, OncoImmune shareholders will be eligible to receive future contingent regulatory approval milestone payments and tiered royalties. OncoImmune's lead therapeutic candidate MK-7110 (also known as CD24Fc) is being evaluated for the treatment of patients hospitalized with COVID-19. Topline results from a pre-planned interim efficacy analysis from a Phase 3 study of MK-7110 were released inSeptember 2020 . Full results from this Phase 3 study, which were consistent with the topline results, were received inFebruary 2021 and will be submitted for publication in the future. The transaction was accounted 64 -------------------------------------------------------------------------------- Table of Content s for as an acquisition of an asset. Under the agreement, prior to the completion of the acquisition, OncoImmune spun-out certain rights and assets unrelated to the MK-7110 program to a new entity owned by the existing shareholders of OncoImmune. In connection with the closing of the acquisition,Merck invested$50 million for a 20% ownership interest in the new entity, which was valued at$33 million resulting in a$17 million premium.Merck also recognized other net liabilities of$22 million . The Company recorded Research and development expenses of$462 million in 2020 related to this transaction. InDecember 2020 ,Merck announced it had entered into an agreement with theU.S. Government to support the development, manufacture and initial distribution of MK-7110 upon approval or Emergency Use Authorization (EUA) from the FDA byJune 30, 2021 . Under the agreement,Merck was to receive up to approximately$356 million for manufacturing and supply of approximately 60,000-100,000 doses of MK-7110 to theU.S. government byJune 30, 2021 to help meet the government's pandemic response goals. Following the execution of this agreement,Merck received feedback from the FDA that additional data, beyond the study conducted by OncoImmune, would be needed to support a potential EUA application. Based on this FDA feedback,Merck no longer expects to supply theU.S. government with MK-7110 in the first half of 2021.Merck is actively working with FDA to address the agency's comments. InDecember 2020 ,Merck acquired VelosBio, a privately held clinical-stage biopharmaceutical company, for$2.8 billion . VelosBio's lead investigational candidate is MK-2140 (formerly known as VLS-101), an antibody-drug conjugate targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) that is currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. The transaction was accounted for as an acquisition of an asset.Merck recorded net assets of$180 million (primarily cash) and Research and development expenses of$2.7 billion in 2020 related to the transaction. InFebruary 2021 ,Merck and Pandion Therapeutics, Inc. (Pandion) entered into a definitive agreement under whichMerck will acquire Pandion, a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases, for$60 per share in cash representing an approximate total equity value of$1.85 billion . Pandion is advancing a pipeline of precision immune modulators targeting critical immune control nodes. Under the terms of the acquisition agreement,Merck , through a subsidiary, will initiate a tender offer to acquire all outstanding shares of Pandion. The closing of the tender offer is subject to certain conditions, including the tender of shares representing at least a majority of the total number of Pandion's shares of fully-diluted common stock, the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act and other customary conditions. The transaction is expected to close in the first half of 2021. Capital Expenditures Capital expenditures were$4.7 billion in 2020,$3.5 billion in 2019 and$2.6 billion in 2018. Expenditures inthe United States were$2.7 billion in 2020,$1.9 billion in 2019 and$1.5 billion in 2018. The increased capital expenditures in 2020 and 2019 reflect investment in new capital projects focused primarily on increasing manufacturing capacity forMerck 's key products. The increased capital expenditures in 2020 also reflect the purchase of a manufacturing facility in Dunboyne,Ireland to support upcoming product launches (see Note 3 to the consolidated financial statements). The Company plans to invest more than$20 billion in new capital projects from 2020-2024. Depreciation expense was$1.7 billion in 2020,$1.7 billion in 2019 and$1.4 billion in 2018, of which$1.2 billion in 2020,$1.2 billion in 2019 and$1.0 billion in 2018, related to locations inthe United States . Total depreciation expense in 2020 and 2019 included accelerated depreciation of$268 million and$233 million , respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). 65 -------------------------------------------------------------------------------- Table of Content s Analysis of Liquidity and Capital ResourcesMerck 's strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) 2020 2019 2018 Working capital$ 437 $ 5,263 $ 3,669
Total debt to total liabilities and equity 34.7 % 31.2 % 30.4 % Cash provided by operations to total debt 0.3:1 0.5:1 0.4:1
The decline in working capital in 2020 compared with 2019 is primarily related to increased short-term debt supporting the funding of business development activities and capital expenditures. Cash provided by operating activities was$10.3 billion in 2020 compared with$13.4 billion in 2019, reflecting higher payments related to collaborations which were$2.9 billion in 2020 compared with$805 million in 2019. 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. Cash used in investing activities was$9.4 billion in 2020 compared with$2.6 billion in 2019. The increase was driven primarily by lower proceeds from the sales of securities and other investments, higher use of cash for acquisitions and higher capital expenditures, partially offset by lower purchases of securities and other investments. Cash used in financing activities was$2.8 billion in 2020 compared with$8.9 billion in 2019. The lower use of cash in financing activities was driven primarily by a net increase in short-term borrowings in 2020 compared with a net decrease in short-term borrowing in 2019, as well as lower purchases of treasury stock, partially offset by higher payments on debt (see below), lower proceeds from the issuance of debt (see below), higher dividends paid to shareholders and lower proceeds from the exercise of stock options. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable (see Note 6 to the consolidated financial statements). The Company factored$2.3 billion and$2.7 billion of accounts receivable in the fourth quarter of 2020 and 2019, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. AtDecember 31, 2020 and 2019 the Company had collected$102 million and$256 million , respectively, on behalf of the financial institutions, which was remitted to them inJanuary 2021 and 2020, respectively. The net cash flows from these collections are reported as financing activities in the Consolidated Statement of Cash Flows. 66 -------------------------------------------------------------------------------- Table of Content s The Company's contractual obligations as ofDecember 31, 2020 are as follows: Payments Due by Period ($ in millions) Total 2021 2022-2023 2024-2025 Thereafter Purchase obligations (1)$ 3,458 $ 977 $ 1,232 $ 668 $ 581 Loans payable and current portion of long-term debt 6,432 6,432 - - - Long-term debt 25,437 - 4,000 3,863 17,574 Interest related to debt obligations 10,779 759 1,431 1,254 7,335 Unrecognized tax benefits (2) 305 305 - - - Transition tax related to the enactment of the TCJA (3) 3,006 390 736 1,880 - Milestone payments related to collaborations (4) 200 200 - - - Leases (5) 1,778 335 521 342 580$ 51,395 $ 9,398 $ 7,920 $ 8,007 $ 26,070 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) As of December 31, 2020, the Company's Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, including interest and penalties, of$1.8 billion , including$305 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 2021 cannot be made. (3) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years through 2025 as permitted under the TCJA (see Note 15 to the consolidated financial statements). (4) Reflects payments under collaborative agreements for sales-based milestones that were achieved in 2020 (and therefore deemed to be contractual obligations) but not paid until 2021 (see Note 4 to the consolidated financial statements). (5) Amounts exclude reasonably certain lease renewals that have not yet been executed (see Note 9 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts do not include contingent milestone payments related to collaborative arrangements or acquisitions as they are not considered contractual obligations until the successful achievement of developmental, regulatory approval or commercial milestones. AtDecember 31, 2020 , the Company has recognized liabilities for contingent sales-based milestone payments related to collaborations with AstraZeneca and Eisai where payment remains subject to the achievement of the related sales milestone aggregating$1.0 billion (see Note 4 to the consolidated financial statements). Excluded from research and development obligations are potential future funding commitments of up to approximately$52 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects$73 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2021 relating to the Company's pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately$300 million to itsU.S. pension plans,$170 million to its international pension plans and$35 million to its other postretirement benefit plans during 2021. InJune 2020 , the Company issued$4.5 billion principal amount of senior unsecured notes consisting of$1.0 billion of 0.75% notes due 2026,$1.25 billion of 1.45% notes due 2030,$1.0 billion of 2.35% notes due 2040 and$1.25 billion of 2.45% notes due 2050.Merck used the net proceeds from the offering for general corporate purposes, including without limitation the repayment of outstanding commercial paper borrowings and other indebtedness with upcoming maturities. InMarch 2019 , the Company issued$5.0 billion principal amount of senior unsecured notes consisting of$750 million of 2.90% notes due 2024,$1.75 billion of 3.40% notes due 2029,$1.0 billion of 3.90% notes due 2039, and$1.5 billion of 4.00% notes due 2049. The Company used the net proceeds from the offering for general corporate purposes, including the repayment of outstanding commercial paper borrowings. The Company has a$6.0 billion credit facility that matures inJune 2024 . The facility provides backup liquidity for the Company's commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. 67 -------------------------------------------------------------------------------- Table of Content s InMarch 2018 , the Company filed a securities registration statement with theU.S. 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 ofNovember 3, 2009 , the Company executed a full and unconditional guarantee of the then existing debt of its subsidiaryMerck 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. 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. 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. InNovember 2020 ,Merck 's Board of Directors declared a quarterly dividend of$0.65 per share on the Company's outstanding common stock that was paid inJanuary 2021 . InJanuary 2021 , the Board of Directors declared a quarterly dividend of$0.65 per share on the Company's common stock for the second quarter of 2021 payable inApril 2021 . InOctober 2018 ,Merck 's Board of Directors authorized purchases of up to$10 billion ofMerck 's common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. The Company spent$1.3 billion to purchase 16 million shares of its common stock for its treasury during 2020 under this program. InMarch 2020 , the Company temporarily suspended its share repurchase program. As ofDecember 31, 2020 , the Company's remaining share repurchase authorization was$5.9 billion . The Company purchased$4.8 billion and$9.1 billion of its common stock during 2019 and 2018, respectively, under authorized share repurchase programs. In 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (the Dealers). Under the ASR agreements,Merck agreed to purchase$5 billion ofMerck 's common stock, in total, with an initial delivery of 56.7 million shares ofMerck 's common stock, based on the then-current market price, made by the Dealers toMerck , and payments of$5 billion made byMerck to the Dealers in 2018, which were funded with existing cash and investments, as well as short-term borrowings. Upon settlement of the ASR agreements in 2019,Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price ofMerck 's common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received byMerck under this program to 64.4 million. 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 of the Company's foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect theU.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the 68 -------------------------------------------------------------------------------- Table of Content s future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other Comprehensive Income (Loss) (OCI), depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in Accumulated Other Comprehensive Income (Loss) (AOCI) and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. BecauseMerck principally sells foreign currency in its revenue hedging program, a uniform weakening of theU.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value ofMerck 's hedges would have declined by an estimated$593 million and$456 million atDecember 31, 2020 and 2019, respectively, from a uniform 10% weakening of theU.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes inMerck 's major foreign currency exposures relative to theU.S. dollar. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiary's functional currency from the effects of volatility in foreign exchange. In these instances,Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. A sensitivity analysis to changes in the value of theU.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if theU.S. dollar uniformly weakened by 10% against all currency exposures of the Company atDecember 31, 2020 and 2019, Income before taxes would have declined by approximately$99 million and$110 million in 2020 and 2019, respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of theU.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to theU.S. dollar would not affect other foreign currencies relative to theU.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes inMerck 's major foreign currency exposures relative to theU.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The economy ofArgentina was determined to be hyperinflationary in 2018; consequently, in accordance withU.S. GAAP, the Company began remeasuring its monetary assets and liabilities for those operations in earnings. The impact to the Company's results was immaterial. The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI, and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative 69 -------------------------------------------------------------------------------- Table of Content s instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI. The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Company's senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI. 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. AtDecember 31, 2020 , the Company was a party to 14 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) 2020 Par Value of Number of Interest Total Swap Debt Instrument Debt Rate Swaps Held Notional Amount 3.875% notes due 2021 (1)$ 1,150 5$ 1,150 2.40% notes due 2022 1,000 4 1,000 2.35% notes due 2022 1,250 5 1,250 (1) These interest rate swaps matured inJanuary 2021 . The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The 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 inU.S. interest rates. Changes in medium- to long-termU.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 ofMerck 's investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates atDecember 31, 2020 and 2019 would have positively affected the net aggregate market value of these instruments by$2.6 billion and$2.0 billion , respectively. A one percentage point decrease atDecember 31, 2020 and 2019 would have negatively affected the net aggregate market value by$3.1 billion and$2.2 billion , respectively. The fair value ofMerck 's debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values ofMerck 's investments were determined using a combination of pricing and duration models. Critical Accounting Estimates 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 acquisitions, including initial fair value determinations of assets and liabilities (primarily IPR&D, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including 70 -------------------------------------------------------------------------------- Table of Content s those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Company's intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Company's consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPR&D, are determined utilizing information available near the 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 determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Company's business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. 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 71 -------------------------------------------------------------------------------- Table of Content s 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 also 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. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPR&D with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations.Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Company's contracts related to thePharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. For certain services in theAnimal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Company's business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. Inthe United States , sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. TheU.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Company's wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly 72 -------------------------------------------------------------------------------- Table of Content s basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2020, 2019 or 2018. Summarized information about changes in the aggregate customer discount accrual related toU.S. sales is as follows: ($ in millions) 2020 2019 Balance January 1$ 2,436 $ 2,630 Current provision 13,144 11,999 Adjustments to prior years (16) (230) Payments (12,454) (11,963) Balance December 31$ 3,110 $ 2,436 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$249 million and$2.9 billion , respectively, atDecember 31, 2020 and were$233 million and$2.2 billion , respectively, atDecember 31, 2019 . Outside ofthe United States , variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the government's total unbudgeted spending and the Company's specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows itsU.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision forU.S. pharmaceutical sales as a percentage ofU.S. net pharmaceutical sales was 0.6% in 2020, 1.1% in 2019 and 1.6% in 2018. Outside ofthe United States , returns are only allowed in certain countries on a limited basis.Merck 's payment terms forU.S. pharmaceutical customers are typically 36 days from receipt of invoice and forU.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda, have longer payment terms, some of which are up to 90 days. Outside ofthe United States , payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs withU.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs 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. 73 -------------------------------------------------------------------------------- Table of Content s Inventories Produced in Preparation for Product LaunchesThe 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 3 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 atDecember 31, 2020 and 2019 were$279 million and$168 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 certain additional matters including governmental and environmental matters (see Note 10 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 ofDecember 31, 2020 and 2019 of approximately$250 million and$240 million , respectively, represents the Company's best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. 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 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 accruing 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. 74 -------------------------------------------------------------------------------- Table of Content s 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$11 million in 2020 and are estimated at$46 million in the aggregate for the years 2021 through 2025. In management's opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled$67 million at bothDecember 31, 2020 and 2019. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately$65 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Company's financial condition, results of operations or liquidity for any year. 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. Total pretax share-based compensation expense was$475 million in 2020,$417 million in 2019 and$348 million in 2018. AtDecember 31, 2020 , there was$678 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted-average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled$454 million in 2020,$137 million in 2019 and$195 million in 2018. Net periodic benefit (credit) for other postretirement benefit plans was$(59) million in 2020,$(49) million in 2019 and$(45) million in 2018. 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 changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. 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. The discount rates for the Company'sU.S. pension and other postretirement benefit plans ranged from 2.10% to 2.80% atDecember 31, 2020 , compared with a range of 3.20% to 3.50% atDecember 31, 2019 . 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, current market conditions and 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. For 2021, the expected rate of return for the Company'sU.S. pension and other postretirement benefit plans will range from 6.50% to 6.70%, compared to a range of 7.00% to 7.30% in 2020. The Company has established investment guidelines for itsU.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'sU.S. pension and other postretirement benefit plans is allocated 30% to 45% inU.S. equities, 15% to 30% in international equities, 35% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolio's equity weighting is consistent with the long-term nature of the plans' benefit obligations. The expected annual standard 75 -------------------------------------------------------------------------------- Table of Content s deviation of returns of the target portfolio, which approximates 11%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For 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 inU.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 had an estimated$80 million favorable (unfavorable) impact on the Company's net periodic benefit cost in 2020. A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated$40 million favorable (unfavorable) impact onMerck 's net periodic benefit cost in 2020. Required funding obligations for 2021 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 primarily reflect 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. 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. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Company's cost structure. 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 termination 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 Cost of sales, Selling, general 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.Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired.Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic 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. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). 76 -------------------------------------------------------------------------------- Table of Content s Other acquired intangible assets (excluding IPR&D) are initially recorded at fair value, assigned an estimated useful life, and 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 that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. The Company evaluates IPR&D for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPR&D intangible asset with its carrying value. 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 in operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Company's results of operations. Impairments of Investments The Company reviews its investments in marketable debt securities 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 in marketable debt securities, including the duration and extent to which fair value is less than cost. Changes in fair value that are considered temporary are reported net of tax in OCI. An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net, is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI. Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net. Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net. Realized gains and losses for equity securities are included in Other (income) expense, net. 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 77
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Table of Content s 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 15 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. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. 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, or negative variations of any of the foregoing. 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 approvals, product potential, development programs and include statements related to the expected impact of the COVID-19 pandemic. 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 theSecurities 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.
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