Notes to the Consolidated Income Statement
(7) Net sales
Net sales were generated primarily from the sale of goods and to a limited degree also included revenues from services rendered, commission income as well as profit-sharing from collaborations. Merck Group net sales totaled € 15,327 million in 2017 (2016: € 15,024 million), which represented an increase of 2.0% compared with 2016. The breakdown of net sales is presented in the Segment Reporting in Note (32) ‟Information by business sector/country and regions”.
(8) Cost of sales
Cost of sales primarily included the cost of manufactured products sold as well as merchandise sold. Cost comprises overheads and, if necessary, inventory write-downs, in addition to directly attributable costs, such as the cost of materials, personnel and energy, as well as depreciation/amortization. On the occasion of the 350th anniversary of the company in 2018, a promise of a one-time bonus was made to Merck employees. This led to an expense of € 13 million within cost of sales.
(9) Marketing and selling expenses
Marketing and selling expenses comprised the following:22.5 KB EXCEL
|Sales force||– 1,033||– 1,063|
|Internal sales services||– 852||– 903|
|Sales promotion||– 630||– 598|
|Logistics||– 680||– 614|
|Amortization of intangible assets1||– 1,017||– 1,032|
|Royalty and license expenses||– 227||– 177|
|Other marketing and selling expenses||– 263||– 140|
|Marketing and selling expenses||– 4,702||– 4,526|
Amortization of intangible assets was mainly attributable to customer relationships, marketing authorizations, licenses and similar rights, brands and trademarks, which could be functionally allocated to Marketing and Selling.
€ 90 million (2016: € 97 million) of royalty, license and commission expenses related to the commercialization of Erbitux® outside the United States and Canada, while € 44 million of the license expenses arose in connection with the amended commercialization structure for Glucophage® in China with the distribution partner Bristol-Myers Squibb (see Note (5) ‟Collaborations of material significance”).
(10) Research and development costs
Research and development costs totaled € 2,140 million in 2017 (2016: € 1,976 million).
Reimbursements for research and development amounting to € 29 million (2016: € 84 million) were offset against research and development costs. This figure also included government subsidies of € 6 million (2016: € 3 million). As in the previous year, the reimbursements were mainly from the strategic alliance with Pfizer Inc., USA, in the field of immuno-oncology.
The breakdown of research and development costs by region is presented in the Segment Reporting (see Note (32) ‟Information by business sector/country and region”).
(11) Other operating income
Other operating income was as follows:22 KB EXCEL
|Income from milestone payments, rights and royalties||568||317|
|Gains on disposal of businesses and non-current assets||352||483|
|Reversals of allowances for receivables||97||59|
|Reversals of impairment losses on non-current assets||87||1|
|Income from miscellaneous services||12||18|
|Gains from the release of provisions for litigation||10||23|
|Remaining other operating income||101||95|
|Other operating income||1,227||996|
The income from milestone payments, rights and royalties of € 568 million (2016: € 317 million) primarily resulted from the collaboration agreement entered into with Pfizer Inc., USA, in 2014 in the field of immuno-oncology. This related to milestone payments received in the amount of € 124 million due to the marketing authorizations of Bavencio® in 2017 as well as to the pro rata recognition of deferred income from the upfront payment as well as the value of the right to co-promote Xalkori® in the amount of € 191 million (2016: € 191 million) (see Note (5) ‟Collaborations of material significance”). Income from royalties was mainly due to an agreement about a one-off payment of € 116 million as settlement for license payments due in the future as well as due to a license for interferon beta products (Biogen Inc., USA) in the amount of € 87 million.
The gains on disposal of businesses and non-current assets of € 352 million (2016: € 483 million) were mainly attributable to the sale of the Biosimilars business activities (€ 319 million). The gains in the prior year related to the sale of the rights to Kuvan® (€ 330 million), the deconsolidation of the Venezuelan entities (€ 50 million) as well as the disposal of other equity investments.
The reversals of allowances for receivables in the amount of € 97 million (2016: € 59 million) included receivables from Mylan Inc., USA, in the amount of € 20 million in connection with the sales of the Generics business in 2007. Moreover, in fiscal 2017, the improved solvency, above all in relation to customers from the Middle East, resulted in reversals of allowances for receivables.
The reversals of impairment losses on non-current assets of € 87 million (2016: € 1 million) were attributable to the biopharmaceutical production plant in Corsier-sur-Vevey, Switzerland, due to improved expectations as regards capacity utilization, primarily owing to the marketing authorizations for Bavencio® (€ 69 million), as well as to the intangible asset for cladribine as a result of the marketing authorization of Mavenclad® (€ 17 million).
The remaining other operating income included, among other things, gains in the amount of € 47 million (2016: € 0 million) from the reclassification of foreign exchange differences from equity to profit or loss due to capital decreases at subsidiaries.
(12) Other operating expenses
The breakdown of other operating expenses was as follows:23.5 KB EXCEL
|Integration costs/IT costs||– 160||– 193|
|Litigation||– 108||– 104|
|Impairment losses||– 86||– 134|
|Restructuring costs||– 77||– 22|
|Non-income-related taxes||– 55||– 68|
|Premiums, fees and contributions||– 41||– 65|
|Employee bonus for the 350-year anniversary||– 40||–|
|Allowances for receivables||– 39||– 52|
|Profit share expenses||– 27||– 39|
|Losses on disposal of businesses and non-current assets||– 25||– 22|
|Costs of examining strategic options for the Consumer Health business||– 24||–|
|Expenses for miscellaneous services||– 14||– 15|
|Project costs||– 7||– 11|
|Acquisition costs||– 6||– 7|
|Exchange rate differences from operating activities (net)||– 3||– 57|
|Remaining other operating expenses||– 225||– 192|
|Other operating expenses||– 937||– 981|
Integration and IT costs amounting to € 160 million (2016: € 193 million) were incurred for the global harmonization of the IT landscape and in connection with the integration of acquired and existing businesses. In 2016, this related mainly to the Sigma-Aldrich integration.
Litigation expenses amounting to € 108 million (2016: € 104 million) arose primarily in connection with the antitrust review proceedings for the Sigma-Aldrich acquisition (see Note (50) ‟Subsequent Events”).
The restructuring costs amounting to € 77 million (2016: € 22 million) arose mainly in connection with the planned closure of German sites of the Life Science business sector as well as the relocation of the shared service organization. These related mainly to personnel measures. In addition, restructuring costs arose in connection with the reorganization of businesses in the Healthcare business sector. In 2016, restructuring costs were primarily incurred in connection with the ‟Fit for 2018” transformation and growth program and also related mainly to personnel measures.
On the occasion of the 350th anniversary of the company in 2018, a promise of a one-time bonus was made to Merck employees. This led to an expense of € 40 million in other operating expenses.
Additionally, other operating expenses also included special environmental protection costs as well as personnel expenses not allocable to the functional areas.
The restructuring costs and impairment losses as well as personnel expenses for the one-time bonus as part of the company’s 350th anniversary contained in other operating expenses were allocable to functional costs as follows:23 KB EXCEL
|Restructuring costs||– 77||– 22|
|thereof: marketing and selling expenses||– 30||– 3|
|thereof: administration expenses||– 43||– 19|
|thereof: research and development costs||–||–|
|thereof: other operating expenses||– 3||–|
|Impairment losses||– 86||– 134|
|thereof: cost of sales||– 6||– 19|
|thereof: marketing and selling expenses||– 33||– 93|
|thereof: administration expenses||–||– 2|
|thereof: research and development costs||– 33||– 14|
|thereof: other operating expenses||– 14||– 5|
|Employee bonus for the 350-year anniversary||– 40||–|
|thereof: marketing and selling expenses||– 12||–|
|thereof: administration expenses||– 22||–|
|thereof: research and development costs||– 5||–|
|thereof: other operating expenses||– 1||–|
(13) Financial result22.5 KB EXCEL
|Interest income and similar income||26||20|
|Interest expenses and similar expenses||– 283||– 277|
|Interest expenses from interest rate derivatives||– 13||– 13|
|Interest result||– 271||– 270|
|Interest component of the additions to pension provisions and other non-current provisions||– 52||– 52|
|Currency differences from financing activities||22||– 4|
|Financial result||– 300||– 326|
Currency differences from financing activities mainly included gains or losses from hedging intragroup transactions in foreign currency.
(14) Income tax22 KB EXCEL
|Current income taxes in the period||– 780||– 671|
|Income taxes for previous periods||– 12||– 19|
|Deferred taxes in the period||1,179||168|
|Income tax||386||– 521|
Impact of tax reform in the United States
On December 22, 2017, extensive changes in tax legislation were enacted in the United States as a result of the U.S. tax reform ‟Tax Cuts and Jobs Act”. The changes resulting from the U.S. tax reform are very complex and extensive and relate to both current taxes and the measurement of deferred taxes in fiscal 2017. They were analyzed by Merck and had the following material effects:
- The remeasurement of deferred taxes resulting from measurement differences of assets and liabilities using the changed Federal Tax Rate of 21% (previously 35%) led to deferred tax income of € 619 million. This was mainly the result of measurement differences in relation to intangible assets recognized primarily in connection with the acquisition of Sigma-Aldrich Corporation, USA, in fiscal 2015 in the United States.
- The reversal of deferred tax liabilities from outside basis differences for planned dividend payouts resulted in tax income in the amount of € 401 million.
- The new rules for the taxation of gains from foreign subsidiaries (tax toll charge) led to additional taxes to be paid on prior-period income which had not been subject to taxes and increased current tax expenses by € 114 million (see Note (29) ‟Other liabilities”).
The following table presents the tax reconciliation from theoretical income tax expense to income tax expense according to the consolidated income statement. The theoretical income tax expense is determined by applying the statutory tax rate of a corporation headquartered in Darmstadt. As a result of the increase in the trade tax rate of the city of Darmstadt to 454% in 2017 (2016: 425%), the tax rate increased by one percentage point to 31.7% (2016: 30.7%).24.5 KB EXCEL
|Profit before income tax||2,224||2,154|
|Theoretical income tax expense||– 705||– 661|
|Tax rate differences||248||235|
|Tax effect of companies with a negative contribution to consolidated profit||– 72||– 38|
|Income taxes for previous periods||– 12||– 19|
|Tax effect on tax loss carryforwards||1||1|
|Tax effect of non-deductible expenses/Tax-free income/Other tax effects||730||– 43|
|thereof: from the U.S. tax reform (deferred taxes on temporary differences)||619||–|
|thereof: from the U.S. tax reform (deferred taxes on outside basis differences)||401||–|
|thereof: from the U.S. tax reform (one-time transition tax on foreign earnings)||– 114||–|
|Income tax expense according to consolidated income statement||386||– 521|
|Effective tax rate according to consolidated income statement||– 17.3%||24.2%|
Income taxes consisted of corporation and trade taxes for the companies domiciled in Germany as well as comparable income taxes for foreign companies.
The higher tax credits arose primarily in the United States due to the consideration of dividend income. However, this dividend income was also taxable in the United States; the related tax expense of € 227 million was included under ‟Tax effect of non-deductible expenses/Tax-free income/Other tax effects.” This item also includes the effects of U.S. tax reform on deferred taxes.
After eliminating the effects of U.S. tax reform, the effective tax rate for the Group was in the lower range of the expected bandwidth between 23% and 25%.
Deferred taxes as reportedin the consolidated income statement
The reconciliation between deferred taxes in the consolidated balance sheet and deferred taxes in the consolidated income statement is presented in the following table:23 KB EXCEL
|Change in deferred tax assets (consolidated balance sheet)||93||– 37|
|Change in deferred tax liabilities (consolidated balance sheet)||1,235||202|
|Change in deferred taxes credited/debited to equity||15||– 85|
|Changes in scope of consolidation/currency translation/other changes||– 164||88|
|Deferred taxes (consolidated income statement)||1,179||168|
Deferred taxes for remeasurements of the net liability from defined benefit pension plans and other benefit commitments recognized in other comprehensive income led to an increase in equity of € 2 million (2016: increase in equity of € 79 million). Fair value changes of available-for-sale financial assets and of derivatives used for hedging purposes recognized in other comprehensive income resulted in a decrease in equity from deferred taxes in the amount of € 32 million (2016: increase in equity of € 11 million). The aforementioned effects on equity are reported in the statement of comprehensive income.
The item ‟Changes in scope of consolidation / currency translation / other changes” primarily includes currency translation effects of € –196 million (2016: € 9 million) that mainly result from exchange rate changes between the euro and the U.S. dollar.
Changes in tax loss carryforwards
Tax loss carryforwards were structured as follows:25.5 KB EXCEL
|Dec. 31, 2017||Dec. 31, 2016|
|Tax loss carryforwards||117||1,054||1,171||88||959||1,047|
|Tax loss carryforwards for whicha deferred tax asset is recognized||56||160||216||13||322||335|
|Tax loss carryforwards for which no deferred tax asset is recognized||61||894||955||75||637||712|
|Recognized deferred tax assets||19||269||288||13||230||243|
|Recognized deferred tax assetson tax loss carryforwards||7||25||32||2||74||76|
|Not recognized deferred tax assetson tax loss carryforwards||12||244||256||11||156||167|
The vast majority of the tax loss carryforwards either has no expiry date or can be utilized for up to 20 years. In 2017, the income tax expense was reduced by € 1 million (2016: € 1 million) due to the utilization of tax loss carryforwards from prior years for which no deferred tax asset had been recognized in prior periods.
Deferred taxes as reportedin the consolidated balance sheet
Deferred tax assets and liabilities correspond to the following balance sheet items:27 KB EXCEL
|Dec. 31, 2017||Dec. 31, 20161|
|Property, plant and equipment||23||98||25||114|
|Current and non-current financial assets||5||41||4||11|
|Current and non-current receivables/Other assets||21||2||27||2|
|Provisions for pensions and other post-employment benefits||485||92||460||85|
|Current and non-current other provisions||190||35||355||41|
|Current and non-current liabilities||69||9||106||13|
|Tax loss carryforwards||32||–||76||–|
|Tax refund claims/Other||58||86||50||467|
|Deferred taxes (before offsetting)||1,548||1,931||1,764||3,475|
|Offset deferred tax assets and liabilities||– 442||– 442||– 751||– 751|
|Deferred taxes (consolidated balance sheet)||1,106||1,489||1,013||2,724|
In addition to deferred tax assets on tax loss carryforwards amounting to € 32 million (December 31, 2016: € 76 million), deferred tax assets of € 1,074 million were recognized for temporary differences (December 31, 2016: € 937 million).
The significant decline in deferred tax liabilities in the item ‟Tax refund claims/other” resulted from planned dividend payouts in the United States that will generally be tax-exempt in future pursuant to the U.S. tax reform and will therefore no longer represent a future tax burden for Merck. Deferred tax liabilities from outside basis differences for planned dividend payouts were recorded in the amount of € 17 million (December 31, 2016: € 466 million).
Temporary differences relating to the retained earnings of subsidiaries, for which no deferred taxes are recognized, amounted to € 2,856 million (December 31, 2016: € 5,669 million).
(15) Earnings per share
Basic earnings per share are calculated by dividing the profit after tax (net income of the Group) attributable to the shareholders of Merck KGaA by the weighted average number of theoretical shares outstanding. The use of a theoretical number of shares takes into account the fact that the general partner’s capital is not represented by shares. The share capital of € 168 million was divided into 129,242,252 shares. Accordingly, the general partner’s capital of € 397 million was divided into 305,535,626 theoretical shares. Overall, the total capital thus amounted to € 565 million or 434,777,878 theoretical shares outstanding. The weighted average (basic) number of shares in 2017 was likewise 434,777,878.
The calculation of diluted earnings per share has to take into account a potential dilution effect arising from the announced free grant of Merck shares to eligible employees on the occasion of the 350th anniversary of the company in 2018. While the necessary shares will be purchased in 2018 on the market and an issue of new shares is not planned, the announced Merck share grant led to an increase in the weighted average (diluted) number of shares by 1,149 shares to 434,779,027 shares in accordance with IAS 33. However, this did not lead to an arithmetical dilution effect on the indicator so that diluted earnings per share were equivalent to basic earnings per share.