Annual Report 2014 Annual Report 2014

Scope of consolidation

(3) Changes in the scope of consolidation

Including the parent company Merck KGaA, Darmstadt, 218 (2013: 191) companies were fully consolidated in the annual financial statements of the Merck Group. 189 (2013: 165) are located abroad. No companies were consolidated using the equity method as of the balance sheet date. Four newly established companies, 27 companies of the acquired AZ Electronic Materials S.A. Group, as well as four further companies, which were previously not consolidated due to immateriality, were included in the consolidated financial statements for the first time. A total of eight companies were deconsolidated as a result of liquidation, mergers or disposals.

Due to secondary importance, 28 (2013: 22) subsidiaries were not consolidated. Overall, the impact of these subsidiaries on sales, profit after tax, assets and equity was less than 1 % relative to the entire Merck Group. The interests in subsidiaries not consolidated due to secondary importance were classified as available-for-sale financial assets and presented under non-current financial assets. The list of shareholdings presents all of the companies included in the consolidated financial statements as well as all of the shareholdings of Merck KGaA (see Note [70]).

(4) Acquisitions and divestments as well as assets held for sale and disposal groups

Acquisition of AZ Electronic Materials S.A.

Obtainment of control following the public offer

Within the scope of a public takeover offer, on May 2, 2014 Merck had received valid acceptances of the offer in respect of 81.3 % of the share capital and thus obtained control of the publicly listed company AZ Electronic Materials S.A., Luxembourg (AZ). The payments for the obtainment of control were as follows:

Show table
shareholding (in %)
€ million
Purchase price for the obtainment of control 81.3 1,523.4
Acquired cash and cash equivalents – 104.1
Payments for the obtainment of control less acquired cash and cash equivalents 81.3 1,419.3

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By June 27, 2014, Merck’s shareholding in AZ had increased to 99.8 % and was then able to initiate a squeeze-out, which was completed on July 2, 2014 with the acquisition of the remaining shareholding of 0.2 %. The acquisition of non-controlling interests after May 2, 2014 was recognized in equity as a transaction without a change of control. Above and beyond the purchase price to obtain control, the following purchase price was paid in order to increase the shareholding:

Show table
shareholding (in %)
€ million
Purchase price for the obtainment of control 81.3 1,523.4
Purchase price/Payments for the acquisition of further shares after obtainment of control 18.7 351.3
Total purchase price before the deduction of acquired cash and cash equivalents 100.0 1,874.7

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Business activities as well as sales and earnings contribution of AZ

AZ is a leading global producer of specialty chemical materials that generated sales of US$ 730.3 million (2012: US$ 793.9 million) and profit after tax of US$ 57.3 million (2012: US$ 83.3 million) in 2013. Around 67.5 % of sales were attributable to the IC Materials division, which supplies process chemicals used to manufacture integrated circuits in the highly differentiated premium segment. The Optronics division accounted for approximately 32.5 % of sales in 2013. This division’s portfolio includes light-sensitive processing materials, or photoresists, for the manufacture of flat panel displays, as well as silicon-chemistry-based products for optoelectronics. As of the end of 2013, AZ had a total of 1,131 employees.

After May 2, 2014, Merck began to integrate AZ into the Performance Materials division. The aim of the acquisition was to further strengthen Merck’s materials and specialty chemicals business by joining forces with one of the leading suppliers of high-tech materials for the electronics industry.

The impact of the consolidation of AZ on sales as well as net income after taxes between May 2, 2014 and December 31, 2014 amounted to € 374.7 million and € – 52.5 million, respectively. This result takes into account higher cost of sales owing to the step-up of the acquired inventories to fair values.

Assuming the first-time consolidation of AZ had already taken place as of January 1, 2014, sales of the Merck Group for the period from January 1 to December 31, 2014 would have amounted to € 11,471.3 million (compared with reported sales of € 11,291.5 million) and net income after taxes would have been € 1,155.5 million (compared with reported net income of € 1,164.8 million). The determination of these figures assumed that the adjustments of the book values as a result of the purchase price allocation would have been identical.

Purchase price allocation

The acquired assets and liabilities were recognized at the following fair values on the date of the first-time consolidation. The possibility of measuring non-controlling interests at fair values on the acquisition date (full goodwill method) was not applied. The purchase price allocation was completed as of the reporting date.

Show table
€ million Fair values on the
acquisition date
Current assets
Cash and cash equivalents 104.1
Inventories 119.5
Receivables 130.3
Other current assets 7.1
Non-current assets
Intangible assets (excluding goodwill) 1,051.1
Property, plant and equipment 185.7
Other non-current assets 65.4
Assets 1,663.2
Current liabilities
Current financial liabilities 144.1
Other current liabilities and provisions 184.5
Non-current liabilities
Non-current financial liabilities 122.7
Other non-current liabilities and provisions 24.0
Deferred tax liabilities 321.0
Liabilities 796.3
Net assets 866.9
Non-controlling interests on the acquisition date (18.7 %) – 161.9
Net assets acquired 705.0
Purchase price for the acquisition of shares (81.3 %) 1,523.4
Positive difference (goodwill) 818.4

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The positive difference of € 818.4 million was recognized as goodwill. This results in particular from intangible assets that are not recognizable, for example the ability of AZ to develop new solutions and products in its technologically innovative industry as well as from anticipated synergy effects expected from the integration of AZ into the Merck Group.

The development of goodwill during the period from first-time recognition and December 31, 2014 was as follows:

Show table
€ million Development
of goodwill
Goodwill on May 2, 2014 818.4
Exchange rate effects 111.6
Goodwill on December 31, 2014 930.0

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Within the scope of the acquisition, no contingent consideration was agreed upon which Merck would possibly have to pay in the future. The selling shareholders did not contractually indemnify Merck for the outcome of a contingency or uncertainty related to the acquired assets or liabilities. Costs of € 7.7 million directly related to the acquisition of the company were recorded under other operating expenses in 2014.

The most significant impact of the purchase price allocation resulted from the remeasurement of intangible assets, property, plant and equipment, as well as work in progress and finished goods included in inventories at fair value. Since work in progress and finished goods were sold within 2014, this led to additional cost of sales offset by the sales achieved. As a result, the sale of these inventories did not generate any additional income. The intangible assets identified during the purchase price allocation and recognized on the date of first-time consolidation were to the largest extent attributable to technology-related intangible assets and brand rights. The multi-period excess earnings method was used for the valuation of technology-related intangible assets. The relief from royalty method was used for the valuation of the brand rights.

No contingent liabilities were identified in the course of the purchase price allocation. The gross amounts of the acquired receivables on the acquisition date were € 130.3 million. The best possible estimate of the irrecoverable receivables amounted to less than € 0.1 million.

Planned acquisition of the Sigma-Aldrich Corporation

Merck and the Sigma-Aldrich Corporation, a life science and high-tech enterprise headquartered in St. Louis, (USA) (Sigma-Aldrich), announced on September 22, 2014 that they had entered into a merger agreement under which Merck will acquire Sigma-Aldrich for a total purchase price of approximately US$ 17.0 billion or approximately € 13.1 billion (based on the exchange rate on September 22, 2014). Sigma-Aldrich shareholders approved the acquisition at an extraordinary shareholders’ meeting on December 5, 2014.

Merck received antitrust clearance of the planned acquisition from the U.S. Federal Trade Commission (FTC) on December 23, 2014. U.S. antitrust clearance satisfies a condition to closing the transaction, which remains subject to certain other closing conditions, including regulatory approval in other jurisdictions. Merck expects the transaction to close by mid-2015.

The purchase price will be financed through a combination of cash on Merck’s balance sheet, bank loans and bonds. The vast majority of the currency risk stemming from the payment of the purchase price in U.S. dollars has been hedged using standard derivatives (forward exchange transactions and currency options) in line with the requirements for cash flow hedge accounting.

Divestment of the Discovery and Development Solutions business field

Effective March 31, 2014, the Discovery and Development Solutions business field of the Merck Millipore division was sold to Eurofins Scientific S.A., Luxembourg. The assets sold were reported as a disposal group in the consolidated financial statements as of December 31, 2013 and included property, plant and equipment, inventories, and goodwill allocated to the business field. The selling price was € 22.6 million. In accordance with the contractual agreement, € 20.9 million of this amount was received as of the end of the reporting period.

(5) Joint arrangements of material significance

Strategic alliance with Pfizer Inc., USA, to co-develop and co-commercialize active ingredients in immuno-oncology

On November 17, 2014 Merck announced that it had entered into a global strategic alliance with Pfizer Inc., USA, (Pfizer) to develop and commercialize the anti-PD-L1 antibody avelumab (also known as MSB0010718C). This antibody is currently in clinical development by Merck Serono in a Phase I trial as a potential treatment for various tumor types. A Phase II study in patients with Merkel cell carcinoma was initiated in July 2014. The compound will be developed as a single agent as well as in various combinations with Pfizer’s and Merck’s broad portfolio of approved and investigational pipeline candidates. As part of the strategic alliance, the two companies will also combine resources and expertise to advance Pfizer’s anti-PD-1 antibody into Phase I trials with the potential to co-develop and co-commercialize this asset in the future. The overriding objective of the strategic alliance is to share the risks of development and to accelerate the two companies’ presence in immuno-oncology.

According to the collaboration agreement, during the development period the two partners will equally share the development expenses. In a potentially later commercialization phase, Merck will recognize the vast majority of sales from the anti-PD-L1 antibody while the net result of the sales and certain defined expense components will be shared equally among Pfizer and Merck.

The implementation of the collaboration agreement will not be structured through a separate vehicle. This means that the assets, and obligations for the liabilities attributable to the contractual arrangement are owned by the two contracting companies. Decisions about the relevant activities require unanimous consent in accordance with the collaboration agreement. Therefore, the accounting rules governing joint operations pursuant to IFRS 11 are applied and Merck records the assets, liabilities, revenues and expenses attributable to the collaboration in accordance with the respectively valid IFRS.

Under the terms of the agreement, Pfizer made an upfront cash payment of US$ 850 million (€ 678.3 million) to Merck after the closing. Pfizer also committed to make development and commercial milestone payments of up to US$ 2 billion to Merck. Based on the collaboration agreement, Merck and Pfizer will also co-promote Xalkori® (crizotinib), a drug for the treatment of non small cell lung cancer in the United States and certain other major markets, over a multi-year period. During co-promotion of the product, Merck will receive from Pfizer cost reimbursements and a share of the profits. The fair value of the right was determined by an independent external appraiser by applying the multi-period excess earnings method (MEEM) and amounts to US$ 369 million (€ 294.4 million). The entitlement to the right was capitalized on the date it was granted and will be amortized over the term of the agreement.

On the date of the closing of the collaboration agreement, both the upfront payment received and the value of the right to co-promote Xalkori® were recognized in the balance sheet as deferred income within other liabilities. Both amounts will be recognized as income over the expected period in which Merck is to meet certain obligations during the development phase and will be disclosed under royalty, license and commission income. More information on the exercise of management judgments and estimation uncertainties can be found in Note [7].

Apart from the aforementioned accounting impact, the agreement had no material effect on the net assets, financial position and results of operations in the reporting period.

Agreement with Threshold Pharmaceuticals Inc., USA, to co-develop and commercialize evofosfamide

In February 2012, Merck Serono entered into a global agreement with Threshold Pharmaceuticals, Inc., USA, (Threshold) to co-develop and commercialize evofosfamide (also known as TH-302), a chemical molecule for use in oncology. Evofosfamide is currently being investigated in two Phase III clinical trials in patients with advanced unresectable or metastatic soft issue sarcoma and advanced pancreatic cancer.

Under the terms of the agreement, Merck received co-development rights as well as exclusive global commercialization rights. Threshold has an option to co-commercialize the compound in the United States. In fiscal 2012, Merck made an upfront payment in the amount of € 18.7 million and since then has made additional milestone payments for development activities in the amount of € 64.0 million. Merck bears 70 % of worldwide development costs for evofosfamide. The assets, liabilities, income and expenses in connection with the agreement are recognized by Merck in accordance with the relevant IFRSs.

Agreement with Eli Lilly and Company, USA, and Bristol-Myers Squibb Company, USA, on the co-commercialization of Erbitux® in Japan

In October 2007, Merck Serono entered into an agreement with ImClone Systems Inc., USA (which has now merged into Eli Lilly and Company, USA) and Bristol-Myers Squibb Company, USA (BMS) on the co-development and co-commercialization of Erbitux® (cetuximab), a drug indicated for the treatment of metastatic colorectal cancer, as well as for other cancers, in Japan. Pursuant to the agreement, Merck Serono distributes the product and books the sales for the collaboration. Merck receives 50 % of the profit or loss from sales of Erbitux® in Japan, while Eli Lilly and BMS each receive 25 %. In addition, Eli Lilly receives a royalty equal to 4.75 % of total net sales of Erbitux® in Japan from Merck. Merck records the assets, liabilities, revenues and expenses related to the agreement in accordance with the respectively valid IFRS. In 2014, Merck received sales of € 113.2 million from the commercialization of Erbitux® in Japan (2013: € 115.1 million). On February 13, 2015, Merck announced that full promotional responsibiltiy for Erbitux® in Japan will be transferred to Merck as of May 1, 2015.

Agreement with Bristol-Myers Squibb Company, USA, for the co-commercialization of Glucophage® in China

In March 2013, Merck Serono entered into an agreement with Bristol-Myers Squibb, USA, on the co-commercialization of the antidiabetic agent Glucophage® (active ingredient: metformin hydrochloride) for the treatment of type 2 diabetes in China. Merck records the assets, liabilities, revenues and expenses related to the agreement in accordance with the respectively valid IFRS. In 2014, Merck received commission income of € 58.4 million for the co-commercialization of Glucophage® (2013: € 12.8 million).

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