MERCK & CO., INC., 10-K filed on 2/27/2018
Annual Report
Document and Entity Information (USD $)
In Millions, except Share data, unless otherwise specified
12 Months Ended
Dec. 31, 2017
Jan. 31, 2018
Jun. 30, 2017
Document And Entity Information [Abstract]
 
 
 
Document Type
10-K 
 
 
Amendment Flag
false 
 
 
Document Period End Date
Dec. 31, 2017 
 
 
Document Fiscal Year Focus
2017 
 
 
Document Fiscal Period Focus
FY 
 
 
Trading Symbol
MRK 
 
 
Entity Registrant Name
Merck & Co., Inc. 
 
 
Entity Central Index Key
0000310158 
 
 
Current Fiscal Year End Date
--12-31 
 
 
Entity Well-known Seasoned Issuer
Yes 
 
 
Entity Current Reporting Status
Yes 
 
 
Entity Voluntary Filers
No 
 
 
Entity Filer Category
Large Accelerated Filer 
 
 
Entity Common Stock, Shares Outstanding
 
2,696,190,502 
 
Entity Public Float
 
 
$ 174,700 
Consolidated Statement of Income (USD $)
In Millions, except Per Share data, unless otherwise specified
12 Months Ended
Dec. 31, 2017
Dec. 31, 2016
Dec. 31, 2015
Income Statement [Abstract]
 
 
 
Sales
$ 40,122 
$ 39,807 
$ 39,498 
Costs, Expenses and Other
 
 
 
Materials and production
12,775 
13,891 
14,934 
Marketing and administrative
9,830 
9,762 
10,313 
Research and development
10,208 
10,124 
6,704 
Restructuring costs
776 
651 
619 
Other (income) expense, net
12 
720 
1,527 
Total Costs, Expenses and Other
33,601 
35,148 
34,097 
Income Before Taxes
6,521 
4,659 
5,401 
Taxes on Income
4,103 
718 
942 
Net Income
2,418 
3,941 
4,459 
Less: Net Income Attributable to Noncontrolling Interests
24 
21 
17 
Net Income Attributable to Merck & Co., Inc.
$ 2,394 
$ 3,920 
$ 4,442 
Basic Earnings per Common Share Attributable to Merck & Co., Inc. Common Shareholders (in dollars per share)
$ 0.88 
$ 1.42 
$ 1.58 
Earnings per Common Share Assuming Dilution Attributable to Merck & Co., Inc. Common Shareholders (in dollars per share)
$ 0.87 
$ 1.41 
$ 1.56 
Consolidated Statement of Comprehensive Income (USD $)
In Millions, unless otherwise specified
12 Months Ended
Dec. 31, 2017
Dec. 31, 2016
Dec. 31, 2015
Statement of Comprehensive Income [Abstract]
 
 
 
Net Income Attributable to Merck & Co., Inc.
$ 2,394 
$ 3,920 
$ 4,442 
Other Comprehensive Income (Loss) Net of Taxes:
 
 
 
Net unrealized loss on derivatives, net of reclassifications
(446)
(66)
(126)
Net unrealized loss on investments, net of reclassifications
(58)
(44)
(70)
Benefit plan net gain (loss) and prior service credit (cost), net of amortization
419 
(799)
579 
Cumulative translation adjustment
401 
(169)
(208)
Other comprehensive income (loss), net of taxes
316 
(1,078)
175 
Comprehensive Income Attributable to Merck & Co., Inc.
$ 2,710 
$ 2,842 
$ 4,617 
Consolidated Balance Sheet (USD $)
In Millions, unless otherwise specified
Dec. 31, 2017
Dec. 31, 2016
Current Assets
 
 
Cash and cash equivalents
$ 6,092 
$ 6,515 
Short-term investments
2,406 
7,826 
Accounts receivable (net of allowance for doubtful accounts of $210 in 2017 and $195 in 2016)
6,873 
7,018 
Inventories (excludes inventories of $1,187 in 2017 and $1,117 in 2016 classified in Other assets - see Note 7)
5,096 
4,866 
Other current assets
4,299 
4,389 
Total current assets
24,766 
30,614 
Investments
12,125 
11,416 
Property, Plant and Equipment (at cost)
 
 
Land
365 
412 
Buildings
11,726 
11,439 
Machinery, equipment and office furnishings
14,649 
14,053 
Construction in progress
2,301 
1,871 
Property, plant and equipment (at cost)
29,041 
27,775 
Less: accumulated depreciation
16,602 
15,749 
Property, plant and equipment, net
12,439 
12,026 
Goodwill
18,284 
18,162 
Other Intangibles, Net
14,183 
17,305 
Other Assets
6,075 
5,854 
Total Assets
87,872 
95,377 
Current Liabilities
 
 
Loans payable and current portion of long-term debt
3,057 
568 
Trade accounts payable
3,102 
2,807 
Accrued and other current liabilities
10,427 
10,274 
Income taxes payable
708 
2,239 
Dividends payable
1,320 
1,316 
Total current liabilities
18,614 
17,204 
Long-Term Debt
21,353 
24,274 
Deferred Income Taxes
2,219 
5,077 
Other Noncurrent Liabilities
11,117 
8,514 
Merck & Co., Inc. Stockholders’ Equity
 
 
Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2017 and 2016
1,788 
1,788 
Other paid-in capital
39,902 
39,939 
Retained earnings
41,350 
44,133 
Accumulated other comprehensive loss
(4,910)
(5,226)
Stockholders' equity before deduction for treasury stock
78,130 
80,634 
Less treasury stock, at cost: 880,491,914 shares in 2017 and 828,372,200 shares in 2016
43,794 
40,546 
Total Merck & Co., Inc. stockholders’ equity
34,336 
40,088 
Noncontrolling Interests
233 
220 
Total equity
34,569 
40,308 
Total Liabilities and Equity
$ 87,872 
$ 95,377 
Consolidated Balance Sheet (Parenthetical) (USD $)
In Millions, except Share data, unless otherwise specified
Dec. 31, 2017
Dec. 31, 2016
Statement of Financial Position [Abstract]
 
 
Allowance for doubtful accounts
$ 210 
$ 195 
Inventories classified in other assets
$ 1,187 
$ 1,117 
Common stock, par value (in dollars per share)
$ 0.50 
$ 0.50 
Common stock, shares authorized (in shares)
6,500,000,000 
6,500,000,000 
Common stock, shares issued (in shares)
3,577,103,522 
3,577,103,522 
Treasury stock, shares (in shares)
880,491,914 
828,372,200 
Consolidated Statement of Equity (USD $)
In Millions, unless otherwise specified
Total
Common Stock
Other Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Loss
Treasury Stock
Non- controlling Interests
Beginning Balance at Dec. 31, 2014
$ 48,791 
$ 1,788 
$ 40,423 
$ 46,021 
$ (4,323)
$ (35,262)
$ 144 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
 
Net Income Attributable to Merck & Co., Inc.
4,442 
 
 
4,442 
 
 
 
Other comprehensive income (loss), net of taxes
175 
 
 
 
175 
 
 
Cash dividends declared on common stock ($1.89 per share in 2017, $1.85 per share in 2016 and $1.81 per share in 2015)
(5,115)
 
 
(5,115)
 
 
 
Treasury stock shares purchased
(4,186)
 
 
 
 
(4,186)
 
Changes in noncontrolling ownership interests
(75)
 
(20)
 
 
 
(55)
Net income attributable to noncontrolling interests
17 
 
 
 
 
 
17 
Distributions attributable to noncontrolling interests
(15)
 
 
 
 
 
(15)
Share-based compensation plans and other
733 
 
(181)
 
 
914 
 
Ending Balance at Dec. 31, 2015
44,767 
1,788 
40,222 
45,348 
(4,148)
(38,534)
91 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
 
Net Income Attributable to Merck & Co., Inc.
3,920 
 
 
3,920 
 
 
 
Other comprehensive income (loss), net of taxes
(1,078)
 
 
 
(1,078)
 
 
Cash dividends declared on common stock ($1.89 per share in 2017, $1.85 per share in 2016 and $1.81 per share in 2015)
(5,135)
 
 
(5,135)
 
 
 
Treasury stock shares purchased
(3,434)
 
 
 
 
(3,434)
 
Changes in noncontrolling ownership interests
124 
 
 
 
 
 
124 
Net income attributable to noncontrolling interests
21 
 
 
 
 
 
21 
Distributions attributable to noncontrolling interests
(16)
 
 
 
 
 
(16)
Share-based compensation plans and other
1,139 
 
(283)
 
 
1,422 
 
Ending Balance at Dec. 31, 2016
40,308 
1,788 
39,939 
44,133 
(5,226)
(40,546)
220 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
 
Net Income Attributable to Merck & Co., Inc.
2,394 
 
 
2,394 
 
 
 
Other comprehensive income (loss), net of taxes
316 
 
 
 
316 
 
 
Cash dividends declared on common stock ($1.89 per share in 2017, $1.85 per share in 2016 and $1.81 per share in 2015)
(5,177)
 
 
(5,177)
 
 
 
Treasury stock shares purchased
(4,014)
 
 
 
 
(4,014)
 
Changes in noncontrolling ownership interests
 
 
 
 
 
Net income attributable to noncontrolling interests
24 
 
 
 
 
 
24 
Distributions attributable to noncontrolling interests
(18)
 
 
 
 
 
(18)
Share-based compensation plans and other
729 
 
(37)
 
 
766 
 
Ending Balance at Dec. 31, 2017
$ 34,569 
$ 1,788 
$ 39,902 
$ 41,350 
$ (4,910)
$ (43,794)
$ 233 
Consolidated Statement of Equity (Parenthetical)
12 Months Ended
Dec. 31, 2017
Dec. 31, 2016
Dec. 31, 2015
Statement of Stockholders' Equity [Abstract]
 
 
 
Common stock, dividends declared (in dollars per share)
$ 1.89 
$ 1.85 
$ 1.81 
Consolidated Statement of Cash Flows (USD $)
In Millions, unless otherwise specified
12 Months Ended
Dec. 31, 2017
Dec. 31, 2016
Dec. 31, 2015
Cash Flows from Operating Activities
 
 
 
Net income
$ 2,418 
$ 3,941 
$ 4,459 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
4,637 
5,441 
6,375 
Intangible asset impairment charges
646 
3,948 
162 
Provisional charge for one-time transition tax related to the enactment of U.S. tax legislation
5,300 
Charge for future payments related to AstraZeneca collaboration license options
500 
Charge related to the settlement of worldwide Keytruda patent litigation
625 
Foreign currency devaluation related to Venezuela
876 
Net charge related to the settlement of Vioxx shareholder class action litigation
680 
Equity income from affiliates
(42)
(86)
(205)
Dividends and distributions from equity method affiliates
16 
50 
Deferred income taxes
(2,621)
(1,521)
(764)
Share-based compensation
312 
300 
299 
Other
269 
313 
874 
Net changes in assets and liabilities:
 
 
 
Accounts receivable
297 
(619)
(480)
Inventories
(145)
206 
805 
Trade accounts payable
254 
278 
(37)
Accrued and other current liabilities
(922)
(2,018)
(8)
Income taxes payable
(3,291)
124 
(266)
Noncurrent liabilities
(123)
(809)
(277)
Other
(1,091)
237 
(5)
Net Cash Provided by Operating Activities
6,447 
10,376 
12,538 
Cash Flows from Investing Activities
 
 
 
Capital expenditures
(1,888)
(1,614)
(1,283)
Purchases of securities and other investments
(10,739)
(15,651)
(16,681)
Proceeds from sales of securities and other investments
15,664 
14,353 
20,413 
Acquisition of Cubist Pharmaceuticals, Inc., net of cash acquired
(7,598)
Acquisitions of other businesses, net of cash acquired
(396)
(780)
(146)
Dispositions of businesses, net of cash divested
316 
Other
38 
482 
221 
Net Cash Provided by (Used in) Investing Activities
2,679 
(3,210)
(4,758)
Cash Flows from Financing Activities
 
 
 
Net change in short-term borrowings
(26)
(1,540)
Payments on debt
(1,103)
(2,386)
(2,906)
Proceeds from issuance of debt
1,079 
7,938 
Purchases of treasury stock
(4,014)
(3,434)
(4,186)
Dividends paid to stockholders
(5,167)
(5,124)
(5,117)
Proceeds from exercise of stock options
499 
939 
485 
Other
(195)
(118)
(61)
Net Cash Used in Financing Activities
(10,006)
(9,044)
(5,387)
Effect of Exchange Rate Changes on Cash and Cash Equivalents
457 
(131)
(1,310)
Net (Decrease) Increase in Cash and Cash Equivalents
(423)
(2,009)
1,083 
Cash and Cash Equivalents at Beginning of Year
6,515 
8,524 
7,441 
Cash and Cash Equivalents at End of Year
$ 6,092 
$ 6,515 
$ 8,524 
Nature of Operations
Nature of Operations
Nature of Operations
Merck & Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Company’s operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment.
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. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. Beginning in 2017, Merck is recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate.
The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Company’s Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients.
Summary of Accounting Policies
Summary of Accounting Policies
Summary of Accounting Policies
Principles of Consolidation — The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders’ interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis.
Acquisitions — In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Company’s intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Company’s consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded.
Foreign Currency Translation — The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) (AOCI) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net.
Cash Equivalents — Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months.
Inventories — Inventories are valued at the lower of cost or market. The cost of a substantial majority of domestic pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process.
Investments — Investments in marketable debt and equity securities classified as available-for-sale are reported at fair value. Fair values of the Company’s investments are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income (OCI). For declines in the fair value of equity securities that are considered other-than-temporary, impairment losses are charged to Other (income) expense, net. The Company considers available evidence in evaluating potential impairments of its investments, including the duration and extent to which fair value is less than cost and, for equity securities, the Company’s ability and intent to hold the investments. For debt securities, an other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net, is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI. Realized gains and losses for both debt and equity securities are included in Other (income) expense, net.
Revenue Recognition — Revenues from sales of products are recognized when title and risk of loss passes to the customer, typically upon delivery. Recognition of revenue also requires reasonable assurance of collection of sales proceeds and completion of all performance obligations. Domestically, sales discounts are issued to customers 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. Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates are recorded as current liabilities. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $198 million and $2.4 billion, respectively, at December 31, 2017 and $196 million and $2.7 billion, respectively, at December 31, 2016.
The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation, Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile. This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance.
Depreciation — Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings, and from 3 to 15 years for Machinery, equipment and office furnishings. Depreciation expense was $1.5 billion in 2017, $1.6 billion in 2016 and $1.6 billion in 2015.
Advertising and Promotion Costs — Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $2.2 billion, $2.1 billion and $2.1 billion in 2017, 2016 and 2015, respectively.
Software Capitalization — The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. Capitalized software costs are included in Property, plant and equipment and amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with projects that are being amortized over 6 to 10 years (including the Company’s on-going multi-year implementation of an enterprise-wide resource planning system) were $449 million and $452 million, net of accumulated amortization at December 31, 2017 and 2016, respectively. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred.
Goodwill — Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed.
Acquired Intangibles — Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 20 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows.
Acquired In-Process Research and Development — Acquired in-process research and development (IPR&D) that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company tests IPR&D for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPR&D intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPR&D intangible asset with its carrying value is performed. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results.
Contingent Consideration — Certain of the Company’s business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings.
Research and Development — Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPR&D impairment charges in all periods. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration.
Collaborative Arrangements — Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Cost reimbursements between the collaborative partners are recognized as incurred and included in Materials and production costs, Marketing and administrative expenses and Research and development expenses based on the underlying nature of the related activities subject to reimbursement. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, materials and production costs and marketing and administrative expenses on a gross basis. The Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales) and profit sharing amounts it pays to its collaborative partners within Materials and production costs. Terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Materials and production costs provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued when probable of being achieved and capitalized, subject to cumulative amortization catch-up. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Materials and production costs over its remaining useful life, subject to impairment testing.
Share-Based Compensation — The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards.
Restructuring Costs — The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period.
Contingencies and Legal Defense Costs — The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated.
Taxes on Income — Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income in the Consolidated Statement of Income.
Use of Estimates — The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on management’s best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPR&D, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates.
Reclassifications — Certain reclassifications have been made to prior year amounts to conform to the current year presentation.
Recently Issued Accounting Standards — In May 2014, the Financial Accounting Standards Board (FASB) issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. The new standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of adopting the guidance being recognized at the date of initial application (modified retrospective method). The new standard will be effective as of January 1, 2018 and will be adopted using the modified retrospective method. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by $5 million in 2018. The adoption of the new guidance will also result in some additional disclosures.
In January 2016, the FASB issued revised guidance for the accounting and reporting of financial instruments. The new guidance requires that equity investments with readily determinable fair values currently classified as available for sale be measured at fair value with changes in fair value recognized in net income. The new guidance also simplifies the impairment testing of equity investments without readily determinable fair values and changes certain disclosure requirements. The new standard will be effective as of January 1, 2018 and will be adopted using a modified retrospective approach. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by $8 million in 2018.
In August 2016, the FASB issued guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice. The new standard is effective as of January 1, 2018 and will be adopted using a retrospective application. The Company does not anticipate any changes to the presentation of its Consolidated Statement of Cash Flows as a result of adopting the new standard.
In October 2016, the FASB issued guidance on the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Under existing guidance, the recognition of current and deferred income taxes for an intra-entity asset transfer is prohibited until the asset has been sold to a third party. The new guidance will require the recognition of the income tax consequences of an intra-entity transfer of an asset (with the exception of inventory) when the intra-entity transfer occurs. The new standard will be effective as of January 1, 2018 and will be adopted using a modified retrospective approach. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by approximately $60 million in 2018 with a corresponding increase to deferred tax assets, subject to finalization.
In November 2016, the FASB issued guidance requiring that amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard is effective as of January 1, 2018 and will be adopted using a retrospective application. The adoption of the new guidance will not have a material effect on the Company’s Consolidated Statement of Cash Flows.
In March 2017, the FASB amended the guidance related to net periodic benefit cost for defined benefit plans that requires entities to (1) disaggregate the current service cost component from the other components of net benefit cost and present it with other employee compensation costs in the income statement within operations if such a subtotal is presented; (2) present the other components of net benefit cost separately in the income statement and outside of income from operations; and (3) only capitalize the service cost component when applicable. Entities must use a retrospective transition method to adopt the requirement for separate presentation in the income statement of service costs and other components and a prospective transition method to adopt the requirement to limit the capitalization of benefit costs to the service cost component. The Company will utilize a practical expedient that permits it to use the amounts disclosed in its pension and other postretirement benefit plan note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. The new standard is effective as of January 1, 2018. Net periodic benefit cost (credit) other than service cost was approximately $(510) million and $(530) million for the years ended December 31, 2017 and 2016, respectively, (see Note 14). Upon adoption, these amounts will be reclassified to Other (income) expense, net from their current classification within Materials and production costs, Marketing and administrative expenses and Research and development costs.
In May 2017, the FASB issued guidance clarifying when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The new standard is effective as of January 1, 2018 and will be applied to future share-based payment award modifications should they occur.
In February 2016, the FASB issued new accounting guidance for the accounting and reporting of leases. The new guidance requires that lessees recognize a right-of-use asset and a lease liability recorded on the balance sheet for each of its leases (other than leases that meet the definition of a short-term lease).  Leases will be classified as either operating or finance. Operating leases will result in straight-line expense in the income statement (similar to current operating leases) while finance leases will result in more expense being recognized in the earlier years of the lease term (similar to current capital leases). The new guidance will be effective for interim and annual periods beginning in 2019 and will be adopted using a modified retrospective approach which will require application of the new guidance at the beginning of the earliest comparative period presented. Early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
In August 2017, the FASB issued new guidance on hedge accounting that is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The new guidance makes more financial and nonfinancial hedging strategies eligible for hedge accounting, amends the presentation and disclosure requirements, and changes how companies assess effectiveness. The new guidance is effective for interim and annual periods beginning in 2019 on a modified retrospective basis. Early application is permitted in any interim period. The Company intends to early adopt this guidance as of January 1, 2018 on a modified retrospective basis. The Company anticipates recording a cumulative-effect adjustment upon adoption decreasing Retained earnings by $11 million in 2018.The adoption of the new guidance will result in some additional disclosures.
In February 2018, the FASB issued new guidance to address a narrow-scope financial reporting issue that arose as a consequence of the TCJA. Existing guidance requires that deferred tax liabilities and assets be adjusted for a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. That guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income (rather than in net income), such as amounts related to benefit plans and hedging activity. As a result, the tax effects of items within accumulated other comprehensive income do not reflect the appropriate tax rate (the difference is referred to as stranded tax effects). The new guidance allows for a reclassification of these amounts to retained earnings thereby eliminating these stranded tax effects. The new guidance is effective for interim and annual periods in 2019. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
In June 2016, the FASB issued amended guidance on the accounting for credit losses on financial instruments. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for interim and annual periods beginning in 2020, with earlier application permitted in 2019. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings in the beginning of the period of adoption. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
In January 2017, the FASB issued guidance that provides for the elimination of Step 2 from the goodwill impairment test. Under the new guidance, impairment charges are recognized to the extent the carrying amount of a reporting unit exceeds its fair value with certain limitations. The new guidance is effective for interim and annual periods in 2020. Early adoption is permitted. The Company does not anticipate that the adoption of the new guidance will have a material effect on its consolidated financial statements.
Acquisitions, Divestitures, Research Collaborations and License Agreements
Acquisitions, Divestitures, Research Collaborations and License Agreements
Acquisitions, Divestitures, Research Collaborations and License Agreements
The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Company’s financial results.
Recently Announced Transaction
In February 2018, Merck and Viralytics Limited (Viralytics) announced a definitive agreement pursuant to which Merck will acquire Viralytics, an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 1.75 per share. The proposed acquisition values the total issued shares in Viralytics at approximately AUD 502 million ($394 million). Upon completion of the transaction, Merck will gain full rights to Cavatax (CVA21), Viralytics’s investigational oncolytic immunotherapy. The transaction remains subject to a Viralytics’s shareholder vote and customary regulatory approvals. Merck anticipates the transaction will close in the second quarter of 2018.
2017 Transactions
In October 2017, Merck acquired Rigontec GmbH (Rigontec). Rigontec is a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontec’s lead candidate, RGT100, is currently in Phase I development evaluating treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of €119 million ($140 million) and may make additional contingent payments of up to €349 million (of which €184 million are related to the achievement of research milestones and regulatory approvals and €165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017.
In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZeneca’s Lynparza (olaparib) for multiple cancer types (see Note 4).
In March 2017, Merck acquired a controlling interest in Vallée S.A. (Vallée), a leading privately held producer of animal health products in Brazil. Vallée has an extensive portfolio of products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5% of the shares of Vallée for $358 million. Of the total purchase price, $176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $291 million related to currently marketed products, net deferred tax liabilities of $93 million, other net assets of $14 million and noncontrolling interest of $25 million. In addition, the Company recorded liabilities of $37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $37 million, representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $171 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The probability-adjusted future net cash flows of each product were discounted to present value utilizing a discount rate of 15.5%. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years. In the fourth quarter of 2017, Merck acquired an additional 4.5% interest in Vallée for $18 million, which reduced noncontrolling interest related to Vallée.
2016 Transactions
In July 2016, Merck acquired Afferent Pharmaceuticals (Afferent), a privately held pharmaceutical company focused on the development of therapeutic candidates targeting the P2X3 receptor for the treatment of common, poorly-managed, neurogenic conditions. Afferent’s lead investigational candidate, MK-7264 (formerly AF-219), is a selective, non-narcotic, orally-administered P2X3 antagonist being evaluated for the treatment of refractory, chronic cough. Total consideration transferred of $510 million included cash paid for outstanding Afferent shares of $487 million, as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Afferent. In addition, former Afferent shareholders are eligible to receive a total of up to an additional $750 million contingent upon the attainment of certain clinical development and commercial milestones for multiple indications and candidates, including MK-7264. This transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $223 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payment. Merck recognized an intangible asset for IPR&D of $832 million, net deferred tax liabilities of $258 million, and other net assets of $29 million (primarily consisting of cash acquired). The excess of the consideration transferred over the fair value of net assets acquired of $130 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPR&D was determined using an income approach. The asset’s probability-adjusted future net cash flows were discounted to present value using a discount rate of 11.5%. Actual cash flows are likely to be different than those assumed.
Also in July 2016, Merck, through its wholly owned subsidiary Healthcare Services & Solutions, LLC, acquired a majority ownership interest in The StayWell Company LLC (StayWell), a portfolio company of Vestar Capital Partners (Vestar). StayWell is a health engagement company that helps its clients engage and educate people to improve health and business results. Under the terms of the transaction, Merck paid $150 million for a majority ownership interest. Additionally, Merck provided StayWell with a $150 million intercompany loan to pay down preexisting third-party debt. Merck has an option to buy, and Vestar has an option to require Merck to buy, some or all of Vestar’s remaining ownership interest at fair value beginning three years from the acquisition date. This transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $238 million, deferred tax liabilities of $84 million, other net liabilities of $5 million and noncontrolling interest of $124 million. The excess of the consideration transferred over the fair value of net assets acquired of $275 million was recorded as goodwill and is largely attributable to anticipated synergies expected to arise after the acquisition. The goodwill was allocated to the Healthcare Services segment and is not deductible for tax purposes. The intangible assets recognized primarily relate to customer relationships, which are being amortized over a 10-year useful life, and medical information and solutions content, which are being amortized over a five-year useful life.
In June 2016, Merck and Moderna Therapeutics (Moderna) entered into a strategic collaboration and license agreement to develop and commercialize novel messenger RNA (mRNA)-based personalized cancer vaccines. The development program will entail multiple studies in several types of cancer and include the evaluation of mRNA-based personalized cancer vaccines in combination with Merck’s Keytruda. Pursuant to the terms of the agreement, Merck made an upfront cash payment to Moderna of $200 million, which was recorded in Research and development expenses. Following human proof of concept studies, Merck has the right to elect to make an additional payment to Moderna. If Merck exercises this right, the two companies will then equally share costs and profits under a worldwide collaboration for the development of personalized cancer vaccines. Moderna will have the right to elect to co-promote the personalized cancer vaccines in the United States. The agreement entails exclusivity around combinations with Keytruda. Moderna and Merck each have the ability to combine mRNA-based personalized cancer vaccines with other (non-PD-1) agents.
In January 2016, Merck acquired IOmet Pharma Ltd (IOmet), a privately held UK-based drug discovery company focused on the development of innovative medicines for the treatment of cancer, with a particular emphasis on the fields of cancer immunotherapy and cancer metabolism. The acquisition provides Merck with IOmet’s preclinical pipeline of IDO (indoleamine-2,3-dioxygenase 1), TDO (tryptophan-2,3-dioxygenase), and dual-acting IDO/TDO inhibitors. The transaction was accounted for as an acquisition of a business. Total purchase consideration in the transaction included a cash payment of $150 million and future additional milestone payments of up to $250 million contingent upon certain clinical and regulatory milestones being achieved. The Company determined the fair value of the contingent consideration was $94 million at the acquisition date utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment utilizing a discount rate of 10.5%. Merck recognized intangible assets for IPR&D of $155 million and net deferred tax assets of $32 million. The excess of the consideration transferred over the fair value of net assets acquired of $57 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPR&D were determined using an income approach. The assets’ probability-adjusted future net cash flows were discounted to present value also using a discount rate of 10.5%. Actual cash flows are likely to be different than those assumed. In July 2017, Merck made a $100 million payment as a result of the achievement of a clinical development milestone, which was accrued for at estimated fair value at the time of acquisition as noted above.

2015 Transactions
In December 2015, the Company divested its remaining ophthalmics portfolio in international markets to Mundipharma Ophthalmology Products Limited. Merck received consideration of approximately $170 million and recognized a gain of $147 million recorded in Other (income) expense, net in 2015.
In July 2015, Merck acquired cCAM Biotherapeutics Ltd. (cCAM), a privately held biopharmaceutical company focused on the discovery and development of novel cancer immunotherapies. Total purchase consideration in the transaction included an upfront payment of $96 million in cash and potential future additional payments associated with the attainment of certain clinical development, regulatory and commercial milestones. The transaction was accounted for as an acquisition of a business. Merck recognized an intangible asset for IPR&D of $180 million related to CM-24, a monoclonal antibody, as well as a liability for contingent consideration of $105 million, goodwill of $14 million and other net assets of $7 million. During 2016, as a result of unfavorable efficacy data, the Company determined that it would discontinue development of the pipeline program. Accordingly, the Company recorded an IPR&D impairment charge of $180 million related to CM-24 and reversed the related liability for contingent consideration, which had a fair value of $116 million at the time of program discontinuation. Both the IPR&D impairment charge and the income related to the reduction in the liability for contingent consideration were recorded in Research and development expenses in 2016.
Also in July 2015, Merck and Allergan plc (Allergan) entered into an agreement pursuant to which Allergan acquired the exclusive worldwide rights to MK-1602 and MK-8031, Merck’s investigational small molecule oral calcitonin gene-related peptide (CGRP) receptor antagonists, which are being developed for the treatment and prevention of migraine. Under the terms of the agreement, Allergan acquired these rights for upfront payments of $250 million, of which $125 million was paid in August 2015 upon closing of the transaction and the remaining $125 million was paid in April of 2016. The Company recorded a gain of $250 million within Other (income) expense, net in 2015 related to the transaction. Allergan is fully responsible for development of the CGRP programs, as well as manufacturing and commercialization upon approval and launch of the products. Under the agreement, Merck is entitled to receive potential development and commercial milestone payments and royalties at tiered double-digit rates based on commercialization of the programs. During 2016, Merck recognized gains of $100 million within Other (income) expense, net resulting from payments by Allergan for the achievement of research and development milestones.
In February 2015, Merck and NGM Biopharmaceuticals, Inc. (NGM), a privately held biotechnology company, entered into a multi-year collaboration to research, discover, develop and commercialize novel biologic therapies across a wide range of therapeutic areas. Under the terms of the agreement, Merck made an upfront payment to NGM of $94 million, which was included in Research and development expenses, and purchased a 15% equity stake in NGM for $106 million. Merck committed up to $250 million to fund all of NGM’s efforts under the initial five-year term of the collaboration, with the potential for additional funding if certain conditions are met. Prior to Merck initiating a Phase 3 study for a licensed program, NGM may elect to either receive milestone and royalty payments or, in certain cases, to co-fund development and participate in a global cost and revenue share arrangement of up to 50%. The agreement also provides NGM with the option to participate in the co-promotion of any co-funded program in the United States. Merck has the option to extend the research agreement for two additional two-year terms.
In January 2015, Merck acquired Cubist Pharmaceuticals, Inc. (Cubist), a leader in the development of therapies to treat serious infections caused by a broad range of bacteria. Total consideration transferred of $8.3 billion included cash paid for outstanding Cubist shares of $7.8 billion, as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Cubist. Share-based compensation payments to settle non-vested equity awards attributable to postcombination service were recognized as transaction expense in 2015. In addition, the Company assumed all of the outstanding convertible debt of Cubist, which had a fair value of approximately $1.9 billion at the acquisition date. Merck redeemed this debt in February 2015. The transaction was accounted for as an acquisition of a business.
The estimated fair value of assets acquired and liabilities assumed from Cubist is as follows:
Estimated fair value at January 21, 2015
 
Cash and cash equivalents
$
733

Accounts receivable
123

Inventories
216

Other current assets
55

Property, plant and equipment
151

Identifiable intangible assets:
 
Products and product rights (11 year weighted-average useful life)
6,923

IPR&D
50

Other noncurrent assets
184

Current liabilities (1)
(233
)
Deferred income tax liabilities
(2,519
)
Long-term debt
(1,900
)
Other noncurrent liabilities (1)
(122
)
Total identifiable net assets
3,661

Goodwill (2)
4,670

Consideration transferred
$
8,331

(1) 
Included in current liabilities and other noncurrent liabilities is contingent consideration of $73 million and $50 million, respectively.
(2) 
The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Pharmaceutical segment. The goodwill is not deductible for tax purposes.

The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The Company’s estimates of projected net cash flows considered historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the extent and timing of potential new product introductions by the Company’s competitors; and the life of each asset’s underlying patent. The net cash flows were probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product were then discounted to present value utilizing a discount rate of 8%. Actual cash flows are likely to be different than those assumed.
The Company recorded the fair value of incomplete research project surotomycin (MK-4261) which, at the time of acquisition, had not reached technological feasibility and had no alternative future use. During the second quarter of 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity for surotomycin, resulted in the discontinuation of the program and an IPR&D impairment charge (see Note 8).
In connection with the Cubist acquisition, liabilities were recorded for potential future consideration that is contingent upon the achievement of future sales-based milestones. The fair value of contingent consideration liabilities was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and a risk-adjusted discount rate of 8% used to present value the probability-weighted cash flows. Changes in the inputs could result in a different fair value measurement.
This transaction closed on January 21, 2015; accordingly, the results of operations of the acquired business have been included in the Company’s results of operations beginning after that date. During 2015, the Company incurred $324 million of transaction costs directly related to the acquisition of Cubist including share-based compensation costs, severance costs, and legal and advisory fees which are reflected in Marketing and administrative expenses.
The following unaudited supplemental pro forma data presents consolidated information as if the acquisition of Cubist had been completed on January 1, 2014:
Years Ended December 31
2015
Sales
$
39,584

Net income attributable to Merck & Co., Inc.
4,640

Basic earnings per common share attributable to Merck & Co., Inc. common shareholders
1.65

Earnings per common share assuming dilution attributable to Merck & Co., Inc. common shareholders
1.63


The unaudited supplemental pro forma data reflects the historical information of Merck and Cubist adjusted to include additional amortization expense based on the fair value of assets acquired, additional interest expense that would have been incurred on borrowings used to fund the acquisition, transaction costs associated with the acquisition, and the related tax effects of these adjustments. The pro forma data should not be considered indicative of the results that would have occurred if the acquisition had been consummated on January 1, 2014, nor are they indicative of future results.
Remicade/Simponi
In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson & Johnson (J&J) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Plough’s subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi, a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in February 2015 and the Company no longer has market exclusivity in any of its marketing territories. The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Merck’s distribution of the two products in these countries are equally divided between Merck and J&J.
Collaborative Arrangements
Collaborative Arrangement Disclosure
Collaborative Arrangements
Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Merck’s more significant collaborative arrangements are discussed below.

AstraZeneca
In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZeneca’s Lynparza (olaparib) for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda (pembrolizumab) and Imfinzi (durvalumab). The companies will also jointly develop and commercialize AstraZeneca’s selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications including thyroid cancer. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities.
Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies will be shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. AstraZenca is currently the principal on Lynparza sales transactions. Merck is recording its share of product sales of Lynparza, net of costs of sales and commercialization costs, as alliance revenue within the Pharmaceutical segment and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs.
As part of the agreement, Merck made an upfront payment to AstraZeneca of $1.6 billion and is making payments of $750 million over a multi-year period for certain license options ($250 million was paid in December 2017, $400 million will be paid in 2018 and $100 million will be paid in 2019). The Company recorded an aggregate charge of $2.35 billion in Research and development expenses in 2017 related to the upfront payment and future license options payments. In addition, Merck will pay AstraZeneca up to an additional $6.15 billion contingent upon successful achievement of future regulatory milestones of $2.05 billion and sales-based milestones of $4.1 billion for total aggregate consideration of up to $8.5 billion.
During the fourth quarter of 2017, based on the performance of Lynparza since the formation of the collaboration, Merck determined it was probable that annual sales of Lynparza in the future would exceed $250 million, which would trigger a $100 million sales-based milestone payment from Merck to AstraZeneca upon achievement of the sales milestone. Accordingly, in the fourth quarter of 2017, Merck recorded a $100 million liability and a corresponding intangible asset and also recognized $4 million of cumulative amortization expense within Materials and production costs. The remaining intangible asset will be amortized over its remaining estimated useful life of 11 years, subject to impairment testing. The remaining $4.0 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time.
Also, in January 2018, Lynparza received approval in the United States for the treatment of certain patients with metastatic breast cancer, triggering a $70 million milestone payment from Merck to AstraZeneca. This milestone payment will be capitalized and amortized over the remaining useful life of Lynparza.
Summarized information related to this collaboration is as follows:
Year Ended December 31
2017
Alliance revenues (net of commercialization costs)
$
20

 
 
Materials and production costs
4

Marketing and administrative expenses
1

Research and development expenses
2,419

 
 
Receivables from AstraZeneca
12

Payables to AstraZeneca
643

Expenses do not include all amounts attributed to activities related to the collaboration, rather only the amounts relating to payments between partners. Amounts in materials and production costs include amortization of related intangible assets.
Bayer AG
In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayer’s Adempas (riociguat), which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies equally share costs and profits from the collaboration and implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayer’s vericiguat, which is in Phase 3 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development by Bayer. Merck in turn made available its early-stage sGC compounds under similar terms. Under the agreement, Bayer leads commercialization of Adempas in the Americas, while Merck leads commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead commercialization in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017.
In 2016, the Company determined it was probable that annual sales of Adempas would exceed $500 million triggering a $350 million payment from Merck to Bayer. Accordingly, in 2016, the Company recorded a $350 million liability and a corresponding intangible asset and also recognized $50 million of cumulative amortization expense within Materials and production costs. The remaining intangible asset is being amortized over its then-remaining estimated useful life, subject to impairment testing. In 2017, annual sales of Adempas exceeded $500 million triggering the $350 million milestone payment from Merck to Bayer, which will be paid in the first quarter of 2018. There are $775 million of additional potential future sales-based milestone payments that have not yet been accrued as they are not deemed by the Company to be probable at this time.
Summarized information related to this collaboration is as follows:
Years Ended December 31
2017
 
2016
 
2015
Net product sales recorded by Merck
$
149

 
$
88

 
$

Merck’s profit share of sales in Bayer's marketing territories
151

 
81

 
30

Total sales
300

 
169

 
30

 
 
 
 
 
 
Materials and production costs
99

 
133

 
67

Marketing and administrative expenses
27

 
26

 
3

Research and development expenses
96

 
45

 
3

 
 
 
 
 
 
Receivables from Bayer
33

 

 
 
Payables to Bayer
352

 
353

 



Expenses do not include all amounts attributed to activities related to the collaboration, rather only the amounts relating to payments between partners. Amounts in materials and production costs include amortization of related intangible assets.
Restructuring
Restructuring
Restructuring
The Company incurs substantial costs for restructuring program activities related to Merck’s productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network.
The Company recorded total pretax costs of $927 million in 2017, $1.1 billion in 2016 and $1.1 billion in 2015 related to restructuring program activities. Since inception of the programs through December 31, 2017, Merck has recorded total pretax accumulated costs of approximately $13.5 billion and eliminated approximately 43,350 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company estimates that approximately two-thirds of the cumulative pretax costs are cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. While the Company has substantially completed the actions under these programs, approximately $500 million of additional pretax costs are expected to be incurred in 2018 relating to anticipated employee separations and remaining asset-related costs.
For segment reporting, restructuring charges are unallocated expenses.
The following table summarizes the charges related to restructuring program activities by type of cost:
 
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Year Ended December 31, 2017
 
 
 
 
 
 
 
Materials and production
$

 
$
52

 
$
86

 
$
138

Marketing and administrative

 
2

 

 
2

Research and development

 
6

 
5

 
11

Restructuring costs
552

 

 
224

 
776

 
$
552

 
$
60

 
$
315

 
$
927

Year Ended December 31, 2016
 
 
 
 
 
 
 
Materials and production
$

 
$
77

 
$
104

 
$
181

Marketing and administrative

 
8

 
87

 
95

Research and development

 
142

 

 
142

Restructuring costs
216

 

 
435

 
651

 
$
216


$
227


$
626


$
1,069

Year Ended December 31, 2015
 
 
 
 
 
 
 
Materials and production
$

 
$
78

 
$
283

 
$
361

Marketing and administrative

 
59

 
19

 
78

Research and development

 
37

 
15

 
52

Restructuring costs
208

 

 
411

 
619

 
$
208


$
174


$
728


$
1,110


Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Positions eliminated under restructuring program activities were approximately 2,450 in 2017, 2,625 in 2016 and 3,770 in 2015.
Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All of the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors.
Other activity in 2017, 2016 and 2015 includes $267 million, $409 million and $550 million, respectively, of asset abandonment, shut-down and other related costs. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 14) and share-based compensation. Other activity also reflects net pretax losses resulting from sales of facilities and related assets of $6 million in 2017, $151 million in 2016 and $117 million in 2015.
The following table summarizes the charges and spending relating to restructuring program activities:
 
Separation
Costs
 
Accelerated
Depreciation
 
Other
 
Total
Restructuring reserves January 1, 2016
$
592

 
$

 
$
53

 
$
645

Expenses
216

 
227

 
626

 
1,069

(Payments) receipts, net
(413
)
 

 
(347
)
 
(760
)
Non-cash activity

 
(227
)
 
(186
)
 
(413
)
Restructuring reserves December 31, 2016
395

 

 
146

 
541

Expenses
552

 
60

 
315

 
927

(Payments) receipts, net
(328
)
 

 
(394
)
 
(722
)
Non-cash activity

 
(60
)
 
61

 
1

Restructuring reserves December 31, 2017 (1)
$
619

 
$

 
$
128

 
$
747

(1) 
The remaining cash outlays are expected to be substantially completed by the end of 2020.
Financial Instruments
Financial Instruments
Financial Instruments
Derivative Instruments and Hedging Activities
The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments.
A significant portion of the Company’s revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Company’s foreign currency risk management program, as well as its interest rate risk management activities are discussed below.

Foreign Currency Risk Management
The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates.
The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options.
The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI, depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the effective portion of the unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. The hedge relationship is highly effective and hedge ineffectiveness has been de minimis. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes.
The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiary’s functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.
Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net. The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net. Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year.
The Company may also use forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates that are recorded in Other (income) expense, net. The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within OCI, and remains in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows.
Foreign exchange risk is also managed through the use of foreign currency debt. The Company’s senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI. Included in the cumulative translation adjustment are pretax losses of $520 million in 2017, and pretax gains of $193 million in 2016 and $304 million in 2015 from the euro-denominated notes.

Interest Rate Risk Management
The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk.
At December 31, 2017, the Company was a party to 26 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.
 
2017
Debt Instrument
Par Value of Debt
 
Number of Interest Rate Swaps Held
 
Total Swap Notional Amount
1.30% notes due 2018
$
1,000

 
4

 
$
1,000

5.00% notes due 2019
1,250

 
3

 
550

1.85% notes due 2020
1,250

 
5

 
1,250

3.875% notes due 2021
1,150

 
5

 
1,150

2.40% notes due 2022
1,000

 
4

 
1,000

2.35% notes due 2022
1,250

 
5

 
1,250


The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows.
Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31:
 
 
 
2017
 
2016
 
 
 
Fair Value of
Derivative
 
U.S. Dollar
Notional
 
Fair Value of
Derivative
 
U.S. Dollar
Notional
 
Balance Sheet Caption
 
Asset
 
Liability
 
Asset
 
Liability
 
Derivatives Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
Other assets
 
$
2

 
$

 
$
550

 
$
20

 
$

 
$
2,700

Interest rate swap contracts
Accrued and other current liabilities
 

 
3

 
1,000

 

 

 

Interest rate swap contracts
Other noncurrent liabilities
 

 
52

 
4,650

 

 
29

 
3,500

Foreign exchange contracts
Other current assets
 
51

 

 
4,216

 
616

 

 
6,063

Foreign exchange contracts
Other assets
 
38

 

 
1,936

 
129

 

 
2,075

Foreign exchange contracts
Accrued and other current liabilities
 

 
71

 
2,014

 

 
1

 
48

Foreign exchange contracts
Other noncurrent liabilities
 

 
1

 
20

 

 
1

 
12

 
 
 
$
91


$
127


$
14,386


$
765


$
31


$
14,398

Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
 
$
39

 
$

 
$
3,778

 
$
230

 
$

 
$
8,210

Foreign exchange contracts
Accrued and other current liabilities
 

 
90

 
7,431

 

 
103

 
2,931

 
 
 
$
39

 
$
90

 
$
11,209

 
$
230

 
$
103

 
$
11,141

 
 
 
$
130

 
$
217

 
$
25,595

 
$
995

 
$
134

 
$
25,539


As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Company’s derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31:
 
2017
 
2016
 
Asset
 
Liability
 
Asset
 
Liability
Gross amounts recognized in the consolidated balance sheet
$
130

 
$
217

 
$
995

 
$
134

Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet
(94
)
 
(94
)
 
(131
)
 
(131
)
Cash collateral (received) posted
(3
)
 

 
(529
)
 

Net amounts
$
33

 
$
123

 
$
335

 
$
3


The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a foreign currency cash flow hedging relationship, (iii) designated in a foreign currency net investment hedging relationship and (iv) not designated in a hedging relationship:
 
Years Ended December 31
2017
 
2016
 
2015
Derivatives designated in a fair value hedging relationship
 
 
 
 
 
Interest rate swap contracts
 
 
 
 
 
Amount of loss (gain) recognized in Other (income) expense, net on derivatives (1)
$
43

 
$
28

 
$
(14
)
Amount of (gain) loss recognized in Other (income) expense, net on hedged item (1)
(48
)
 
(29
)
 
7

Derivatives designated in foreign currency cash flow hedging relationships
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
Amount of gain reclassified from AOCI to Sales
(138
)
 
(311
)
 
(724
)
Amount of loss (gain) recognized in OCI on derivatives
561

 
(210
)
 
(526
)
 Derivatives designated in foreign currency net investment hedging relationships
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
Amount of gain recognized in Other (income) expense, net on derivatives (2)

 
(1
)
 
(4
)
Amount of loss (gain) recognized in OCI on derivatives

 
2

 
(10
)
Derivatives not designated in a hedging relationship
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
Amount of loss (gain) recognized in Other (income) expense, net on derivatives (3)
110

 
132

 
(461
)
Amount of gain recognized in Sales 
(3
)
 

 
(1
)
(1) 
There was $5 million, $1 million and $7 million of ineffectiveness on the hedge during 2017, 2016 and 2015, respectively.
(2) 
There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing.
(3) 
These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates.
At December 31, 2017, the Company estimates $184 million of pretax net unrealized losses on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales. The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity.
Investments in Debt and Equity Securities
Information on investments in debt and equity securities at December 31 is as follows:
 
 
2017
 
2016
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Amortized
Cost
 
Gross Unrealized
  
Gains
 
Losses
 
Gains
 
Losses
Corporate notes and bonds
$
9,806

 
$
9,837

 
$
9

 
$
(40
)
 
$
10,577

 
$
10,601

 
$
15

 
$
(39
)
U.S. government and agency securities
2,042

 
2,059

 

 
(17
)
 
2,232

 
2,244

 
1

 
(13
)
Asset-backed securities
1,542

 
1,548

 
1

 
(7
)
 
1,376

 
1,380

 
1

 
(5
)
Foreign government bonds
733

 
739

 

 
(6
)
 
519

 
521

 

 
(2
)
Mortgage-backed securities
626

 
634

 
1

 
(9
)
 
796

 
801

 
1

 
(6
)
Commercial paper
159

 
159

 

 

 
4,330

 
4,330

 

 

Equity securities
275

 
265

 
16

 
(6
)
 
349

 
281

 
71

 
(3
)
 
$
15,183

 
$
15,241

 
$
27

 
$
(85
)
 
$
20,179

 
$
20,158

 
$
89

 
$
(68
)

Available-for-sale debt securities included in Short-term investments totaled $2.4 billion at December 31, 2017. Of the remaining debt securities, $11.1 billion mature within five years. At December 31, 2017 and 2016, there were no debt securities pledged as collateral.
Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest:
Level 1 — Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 — Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below:
 
Fair Value Measurements Using
 
Fair Value Measurements Using
  
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
  
2017
 
2016
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate notes and bonds
$

 
$
9,678

 
$

 
$
9,678

 
$

 
$
10,389

 
$

 
$
10,389

U.S. government and agency securities
68

 
1,767

 

 
1,835

 
29

 
1,890

 

 
1,919

Asset-backed securities (1)

 
1,476

 

 
1,476

 

 
1,257

 

 
1,257

Foreign government bonds

 
732

 

 
732

 

 
518

 

 
518

Mortgage-backed securities (1)

 
547

 

 
547

 

 
628

 

 
628

Commercial paper

 
159

 

 
159

 

 
4,330

 

 
4,330

Equity securities
104

 

 

 
104

 
201

 

 

 
201

 
172

 
14,359

 

 
14,531

 
230

 
19,012

 

 
19,242

Other assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency securities

 
207

 

 
207

 

 
313

 

 
313

Corporate notes and bonds

 
128

 

 
128

 

 
188

 

 
188

Mortgage-backed securities (1)

 
79

 

 
79

 

 
168

 

 
168

Asset-backed securities (1)

 
66

 

 
66

 

 
119

 

 
119

Foreign government bonds

 
1

 

 
1

 

 
1

 

 
1

Equity securities
171

 

 

 
171

 
148

 

 

 
148

 
171


481




652


148


789




937

Derivative assets (3)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased currency options

 
80

 

 
80

 

 
644

 

 
644

Forward exchange contracts

 
48

 

 
48

 

 
331

 

 
331

Interest rate swaps

 
2

 

 
2

 

 
20

 

 
20

 

 
130

 

 
130

 

 
995

 

 
995

Total assets
$
343


$
14,970


$


$
15,313


$
378


$
20,796


$


$
21,174

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
$

 
$

 
$
935

 
$
935

 
$

 
$

 
$
891

 
$
891

Derivative liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward exchange contracts

 
162

 

 
162

 

 
93

 

 
93

Interest rate swaps

 
55

 

 
55

 

 
29

 

 
29

Written currency options

 

 

 

 

 
12

 

 
12

 

 
217

 

 
217

 

 
134

 

 
134

Total liabilities
$

 
$
217

 
$
935

 
$
1,152

 
$

 
$
134

 
$
891

 
$
1,025

(1) 
Primarily all of the asset-backed securities are highly-rated (Standard & Poor’s rating of AAA and Moody’s Investors Service rating of Aaa), secured primarily by auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies.
(2) 
Investments included in other assets are restricted as to use, primarily for the payment of benefits under employee benefit plans.
(3) 
The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Company’s own credit risk, the effects of which were not significant.
There were no transfers between Level 1 and Level 2 during 2017. As of December 31, 2017, Cash and cash equivalents of $6.1 billion include $5.2 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy).
Contingent Consideration
Summarized information about the changes in liabilities for contingent consideration is as follows:
 
2017
 
2016
Fair value January 1
$
891

 
$
590

Changes in estimated fair value (1)
141

 
(407
)
Additions
3

 
733

Payments
(100
)
 
(25
)
Fair value December 31 (2)
$
935

 
$
891


(1) Recorded in Research and development expenses, Materials and production costs and Other (income) expense, net. Includes cumulative translation adjustments.
(2) Includes $315 million recorded as a current liability for amounts expected to be paid within the next 12 months.
The changes in the estimated fair value of contingent consideration in 2017 primarily relate to changes in the liabilities recorded in connection with the termination of the SPMSD joint venture and the clinical progression of a program related to the Afferent acquisition. The changes in the estimated fair value of contingent consideration in 2016 were largely attributable to the reversal of liabilities related to programs obtained in connection with the acquisitions of cCAM, OncoEthix and SmartCells (see Note 8). The additions to contingent consideration reflected in the table above in 2016 relate to the termination of the SPMSD joint venture (see Note 9) and the acquisitions of IOmet and Afferent (see Note 3). The payments of contingent consideration in 2017 relate to the achievement of a clinical milestone in connection with the acquisition of IOmet (see Note 3) and in 2016 relate to the first commercial sale of Zerbaxa in the European Union.

Other Fair Value Measurements
Some of the Company’s financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature.
The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2017, was $25.6 billion compared with a carrying value of $24.4 billion and at December 31, 2016, was $25.7 billion compared with a carrying value of $24.8 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy.

Concentrations of Credit Risk
On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Company’s investment policy guidelines.
The majority of the Company’s accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. As of December 31, 2017, the Company’s total net accounts receivable outstanding for more than one year were approximately $130 million. The Company does not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on its financial position, liquidity or results of operations.
The Company’s customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation, Cardinal Health, Inc. and Zuellig Pharma Ltd. (Asia Pacific), which represented, in aggregate, approximately 40% of total accounts receivable at December 31, 2017. The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales.
Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Company’s financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Company’s credit rating, and the credit rating of the counterparty. As of December 31, 2017 and 2016, the Company had received cash collateral of $3 million and $529 million, respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities. The Company had not advanced any cash collateral to counterparties as of December 31, 2017 or 2016.
Inventories
Inventories
Inventories
Inventories at December 31 consisted of:
 
2017
 
2016
Finished goods
$
1,334

 
$
1,304

Raw materials and work in process
4,703

 
4,222

Supplies
201

 
155

Total (approximates current cost)
6,238

 
5,681

Increase to LIFO costs
45

 
302

 
$
6,283

 
$
5,983

Recognized as:
 
 
 
Inventories
$
5,096

 
$
4,866

Other assets
1,187

 
1,117


Inventories valued under the LIFO method comprised approximately $2.2 billion and $2.3 billion of inventories at December 31, 2017 and 2016, respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2017 and 2016, these amounts included $1.1 billion and $1.0 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $80 million at both December 31, 2017 and 2016, of inventories produced in preparation for product launches.
Goodwill and Other Intangibles
Goodwill and Other Intangibles
Goodwill and Other Intangibles
The following table summarizes goodwill activity by segment:
 
 
Pharmaceutical

 
All Other

 
Total

Balance January 1, 2016
$
15,862

 
$
1,861

 
$
17,723

Acquisitions
207

 
275

 
482

Impairments

 
(47
)
 
(47
)
Other (1) 
6

 
(2
)
 
4

Balance December 31, 2016 (2)
16,075

 
2,087

 
18,162

Acquisitions

 
177

 
177