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. 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 region.”.

(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 employees of the Group. 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

€ million 2017 2016
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
1
Excluding amortization of internally generated or separately acquired software.

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

€ million 2017 2016
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

€ million 2017 2016
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 employees of the Group. 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

 
€ million 2017 2016
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 result

22.5 KB EXCEL

 
€ million 2017 2016
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 tax

22 KB EXCEL

€ million 2017 2016
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 the Group 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”).

Tax reconciliation

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

€ million 2017 2016
Profit before income tax 2,224 2,154
 
Tax rate 31.7% 30.7%
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 credits 196 4
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

€ million 2017 20161
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
€ million Germany Abroad Total Germany Abroad Total
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
€ million Assets Liabilities Assets Liabilities
Intangible assets 111 1,555 71 2,727
Property, plant and equipment 23 98 25 114
Current and non-current financial assets 5 41 4 11
Inventories 554 14 589 14
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
1
Previous year’s figures have been adjusted, see Note (4) ‟Acquisitions and divestments”.

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 the Group. 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, Darmstadt, Germany, 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 shares of Merck KGaA, Darmstadt, Germany, 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 share grant of Merck KGaA, Darmstadt, Germany, 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.