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Group Structure

(4) Changes in the scope of consolidation

The scope of consolidation changed as follows in the reporting period:

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Consolidated subsidiaries as of December 31, 2017 314
Additions Establishment 5
Acquisitions 1
Materiality 10
Retirements Liquidations/mergers – 16
Divestments – 13
Immateriality
Loss of control
Consolidated subsidiaries as of December 31, 2018 301
Non-consolidated subsidiaries as of December 31, 2017 59
Non-consolidated subsidiaries as of December 31, 2018 44

Overall, the impact of subsidiaries not consolidated due to immateriality on net sales, profit after tax, assets and equity was less than 1% relative to the entire Group. Investments held in non-consolidated subsidiaries were disclosed under non-current financial assets (see Note (34) ‟Financial assets”). The list of non-consolidated subsidiaries mainly comprises non-operating shelf companies as well as entities subject to liquidation procedures, which are measured at fair value through other comprehensive income.

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, Darmstadt, Germany (see Note (70) ‟List of shareholdings”).

(5) Acquisitions and divestments

Divestment of Consumer Health business

On April 19, 2018, the Group signed an agreement on the divestment of its global Consumer Health business to The Procter & Gamble Company, United States, (P&G). The transaction was completed on December 1, 2018. The selling price was € 3.4 billion in cash before defined purchase price adjustments for transferred operating assets and borrowed capital, among other things. The purchase price adjustments will be made in the first half of 2019. The transaction was executed through the sale of shareholdings in multiple subsidiaries of the Group as well as by way of various asset sales. Apart from the commercial operations in 44 countries, the Consumer Health business also comprised two production facilities in Austria and India. Moreover, with respect to the transfer of the shareholdings in Merck Ltd., Mumbai, India, a former subsidiary of Merck KGaA, Darmstadt, Germany, the commercial operations of other business sectors were transferred as well, and immediately repurchased. About 3,300 employees transferred to P&G as part of the Consumer Health business divestment. In addition to the divestment agreement, the Group and P&G signed a number of manufacturing, supply and service agreements.

With the signing of the agreement to divest the Consumer Health business, in the opinion of the Executive Board the preconditions for classification as a discontinued operation pursuant to IFRS 5 were given. Until transaction closing, the parts of the Consumer Health business being transferred to P&G were disclosed in the consolidated balance sheet as assets held for sale and as liabilities directly related to assets held for sale.

In accordance with IFRS 5, the financial figures disclosed in these consolidated financial statements relate exclusively to continuing operations unless expressly stated otherwise. Supplies and services provided by the Group after the conclusion of the sale transaction according to contractual agreements were taken into account for the presentation of the reporting period and the prior-year period. The amounts of earnings contributions allocated to the Group’s continuing operations are based on the anticipated transactions that will be made with the disposed business after the divestment. In accordance with IFRS 5, the prior-year consolidated balance sheet was not adjusted. The cash flows from the discontinued operation are shown under separate items in the consolidated cash flow statement. A detailed reconciliation of the reporting components published in previous periods to the reporting components adjusted in accordance with IFRS 5 can be found in Note (49) ‟Effects from new accounting standards and other presentation and measurement changes”. The financial figures of discontinued operations are presented below:

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€ million 2018 2017
Net sales 748 809
Expenses – 680 – 709
Gain on the disposal of discontinued operation 2,614
Profit/loss of discontinued operation before income tax 2,682 101
Income tax on ordinary activities – 8 – 43
Income tax on the gain on the disposal of discontinued operation – 370
Proift/loss of discontinued operation after income tax 2,303 57
thereof: attributable to shareholders of Merck KGaA, Darmstadt, Germany 2,281 53
thereof: attributable to non-controlling interests 22 4

Neither net gains nor losses on fair value measurement less costs to sell were recognized for fiscal 2018 or the previous year.

The following table provides the reconciliation from the disposal proceeds to the preliminary net gain from the disposal of discontinued operation before tax:

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€ million 2018
Disposal proceeds 3,364
less: net assets divested – 606
Subtotal 2,758
 
Transaction costs related to the disposal – 103
Realized currency translation effects on equity – 41
Disposal gain before tax 2,614

Net assets divested comprised the following items:

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€ million Carrying amounts on the disposal date
Non-current assets
Goodwill 251
Property, plant and equipment 84
Deferred tax assets 48
Other non-current assets 8
391
 
Current assets
Cash and cash equivalents 241
Inventories 43
Receivables 115
Other current assets 38
436
 
Total assets 827
 
Non-current liabilities
Provisions for pensions and other post-employment benefits 46
Other non-current liabilities and provisions 7
54
 
Current liabilities
Trade accounts payable 60
Other current liabilities and provisions 14
75
 
Total liabilities 128
 
Net assets divested (including non-controlling interests) 699
thereof: non-controlling interests 93
Net assets divested 606

Significant management judgments and sources of estimation uncertainty – assets held for sale, disposal groups and discontinued operations

The assessment as to when a non-current asset, disposal group or discontinued operation meets the prerequisites of IFRS 5 for classification as ”held for sale” is subject to significant discretionary judgment. Even in the case of an existing management decision to review a disposal, an assessment subject to uncertainties has to be made as to the probability that a corresponding disposal will occur during the year or not.

Regarding the divestment of the Consumer Health business, material information was made available to potential buyers first in fiscal 2018, using electronic data rooms. It was only on the basis of this information that potential buyers were able to submit binding offers that were analyzed by the Group based on its price expectations. During the subsequent negotiations with potential buyers, the negotiating parties were able to define the transaction in more specific terms, i.e. material changes to the disposal plan were not unlikely at the balance sheet date (December 31, 2017). Against this background at December 31, 2017, the Executive Board did not consider the divestment of the Consumer Health business within the next twelve months as highly probable.

Divestment of flow cytometry business

On October 18, 2018, the Group signed an agreement with Luminex Corporation, United States, concerning the divestment of the flow cytometry business. These business activities comprised the flow cytrometry platforms Amnis® and Guava® as well as the associated reagents under these brands. The disposal proceeds amounted to € 66 million (US$ 75 million), of which € 61 million (US$ 70 million) was paid in fiscal 2018. The remaining € 5 million will be paid in fiscal 2019. The transaction was completed on December 31, 2018. The business activities assigned to the Life Science business sector primarily consisted of the allocated goodwill as well as intangible assets and inventories. This divestment generated a disposal gain of € 9 million which was recognized in other operating income.

Divestment of Biosimilars business in previous year

On August 31, 2017, the Group completed the divestment of the Biosimilars business to subsidiaries of Fresenius SE & Co. KGaA. In addition to the divestment of the business activities, the contract parties entered into supply and services agreements, which include drug development support and manufacturing services. As compensation for the sale of the business activities, the Group received an upfront payment of € 156 million. According to the agreed terms of the transaction, the Group was entitled to future milestone payments of up to € 497 million, which were partly covered by services to be performed, as well as tiered royalties on product sales. The disposal gain amounted to € 319 million and was recorded under other operating income. Further information regarding the fair values determined in 2017 by an external expert for the contingent consideration components and the sensitivity analysis can be found in Note (39) ‟Information on fair value measurement”.

In addition to the aforementioned consideration components, the Group received an advance payment of € 45 million for services to be performed at short notice which was recognized in the period in which the services were provided. Proceeds from the provision of services were mainly recognized as part of net sales.

Acquisitions in the previous year

On May 8, 2017, the Group acquired all of the shares in Grzybowski Scientific Inventions Ltd. (GSI) headquartered in Evanston, United States. GSI developed Chematica, a computer-aided retro-synthesis tool. The software uses advanced reaction rules and proprietary algorithms to identify synthesis pathways that meet user-defined requirements. GSI was integrated into the Life Science business sector. The purchase price comprised fixed compensation of US$ 7 million (€ 7 million) as well as milestone payments of up to US$ 1 million (€ 1 million).

On September 15, 2017, the Group acquired a 100% interest in Natrix Separations, Inc. (Natrix). The company, which is headquartered in Burlington, Canada, supplies hydrogel membrane products for single-use chromatography. Natrix was integrated into the Life Science business sector. The purchase price comprised fixed compensation of around US$ 14 million (€ 12 million) as well as milestone payments of up to US$ 8 million (€ 7 million).

The purchase price allocations for GSI and Natrix remained unchanged compared to December 31, 2017. The most significant impact from the purchase price allocations resulted, in both cases, from the remeasurement of technology-related intangible assets.

(6) Collaborations of material significance

Strategic alliance with Pfizer Inc., United States, to co-develop and co-commercialize active ingredients in immunooncology

On November 17, 2014, the Group formed a global strategic alliance with Pfizer Inc., United States, (Pfizer) to co-develop and co-commercialize the anti-PD-L1 antibody avelumab and an anti-PD-1 antibody contributed by Pfizer. In 2017, avelumab was approved for the first time under the trade name Bavencio® for the treatment of patients with metastatic Merkel cell carcinoma as well as patients with locally advanced or metastatic urothelial cancer. This antibody is also being studied in multiple broad-based clinical trials as a potential treatment for further tumor types. The active ingredient is to be developed as a single agent as well as in various combinations with a broad portfolio of approved and investigational active ingredients. The overriding objective of the strategic alliance is sharing the development risks and to accelerate the two companies’ presence in immuno-oncology.

According to the collaboration agreement, during the development period each company bears one-half of the development expenses. In the commercialization phase, the Group realizes the vast majority of sales from the commercialization of Bavencio® while the Group and Pfizer evenly split the net amount of sales less defined expense components. The execution of the collaboration agreement is not being structured through a separate vehicle.

Upon entry into the agreement in 2014, Pfizer made an upfront cash payment of US$ 850 million (€ 678 million) to the Group. Pfizer also committed to make further payments of up to US$ 2 billion to the Group subject to the achievement of defined regulatory and commercial milestones. Based on the collaboration agreement, the Group additionally received the right to co-promote for multiple years Xalkori® (crizotinib), a kinase inhibitor indicated for the treatment of patients with metastatic non-small cell lung cancer (NSCLC) whose tumors are anaplastic lymphoma kinase (ALK)-positive or whose tumors are metastatic ROS1-positive. During co-promotion of Xalkori®, the Group receives from Pfizer a profit share, which is reported in net sales. In 2018, this profit share income amounted to € 58 million (2017: € 72 million). At initial recognition, the right was measured at fair value by an independent external expert using the multi-period excess earnings method. The right was capitalized when it was granted and is being amortized over the term of the agreement. The residual book value of this intangible asset as of December 31, 2018, was € 68 million (December 31, 2017: € 93 million). An impairment loss of € 33 million was recognized for rights to Xalkori® in 2017.

On the date the collaboration agreement was entered into, both the upfront payment received and the value of the right to co-promote Xalkori® were recognized in the balance sheet as deferred income under other liabilities. Both amounts are being recognized as income on a pro rata basis over the expected period during which the Group is to meet certain obligations and will be presented under other operating income (2018: € 191 million/2017: € 191 million). In fiscal 2018, the Group generated sales of € 69 million with Bavencio® (2017: € 21 million) and recorded research and development expenses of € 313 million (2017: € 264 million). In addition, the Group recognized income in a mid double-digit million euro amount in return for waiving rights to Pfizer’s anti-PD-1 antibody, which had previously been included in the collaboration agreement; this income was reported under other operating income (2017: income of € 124 million for milestone payments for regulatory approvals received).

Significant management judgments and sources of estimation uncertainty – collaboration agreements

In the past, the Group occasionally recognized income for upfront and milestone payments as well as license fees received under collaboration agreements.

In this context, the Group had to assess the extent to which the requirements of IFRS 15 had to be applied directly or indirectly.

If so, the Group had to determine whether the Group’s contractually promised goods or services contained in the collaboration agreement could be separated or not.

For the immuno-oncology collaboration agreement entered into with Pfizer Inc., United States, in November 2014, the various promises to transfer goods or services could not be separated, meaning that the promises had to be accounted for in their entirety as a single performance obligation – as is customary for collaboration agreements in the pharmaceutical industry.

Furthermore, for identified performance obligations, the Group had to determine whether income had to be recognized over time or at a point in time. If income is recognized over time, management judgments are required as to the appropriate revenue recognition method and the period over which income is to be recognized.

In the case of the collaboration agreement with Pfizer, income had to be recognized over time, i.e. the upfront payment received had to be allocated over the period in which the main development activities were conducted. If the consideration received in this context and deferred as a liability had been recognized in the income statement over a shorter period reduced by six months, in fiscal 2018 this would have increased other operating income, and profit before income tax would therefore have increased by € 64 million (2017: € 38 million). Recognition over a period extended by six months would have lowered other operating income and profit before income tax by € 38 million (2017: € 27 million).

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

In December 2012, the Group established an agreement with Bristol-Myers Squibb Company, United States, (BMS) for the co-commercialization of the antidiabetic agent Glucophage® (active ingredient: metformin hydrochloride) for the treatment of type 2 diabetes in China. Based on this agreement, as of fiscal 2017 the Group took over the exclusive distribution of Glucophage® in China. Since then, the Group has recorded sales of Glucophage® in China and pays license fees to BMS. In fiscal 2018, sales generated with Glucophage® in China amounted to € 329 million (2017: € 279 million) and license payments to BMS were € 53 million (2017: € 44 million).

Agreement with Intrexon Corporation, United States, on the joint development and commercialization of CAR-T cancer therapies

In March 2015, the Group and Intrexon Corporation, United States, (Intrexon) entered into a strategic collaboration and license agreement to develop and commercialize chimeric antigen receptor T-cell (CAR-T) cancer therapies. The agreement provided the Group exclusive access to Intrexon’s proprietary and complementary suite of technologies to engineer T-cells with optimized and inducible gene expression. Based on this agreement, Intrexon was responsible for all platform and product developments until the investigational new drug application was submitted for regulatory approval. In 2015, the Group made an upfront cash payment of US$ 115 million to Intrexon, which was recognized as part of intangible assets not yet available for use (carrying amount as of December 31, 2017: € 104 million).

Effective December 28, 2018, the Group transferred the above-mentioned exclusive rights back to Intrexon on the basis of a contractual agreement. At the time the contract was signed, the Group was entitled to receive Intrexon common stock worth US$ 150 million in return for the assignment of rights. Due to the intention to hold the shares for the long term, the shares were classified as equity instruments subsequently measured at fair value through other comprehensive income. Furthermore, the agreement contained another investment by the Group, amounting to US$ 25 million, in Intrexon’s subsidiary Precigen, Inc., United States, (Precigen) which is involved in the development of T-cell cancer therapies. In return, the Group received a convertible note in an amount of US$ 25 million, with the option, under certain conditions, to acquire shares in either Intrexon or Precigen. The convertible note was classified as a debt instrument measured at fair value through profit or loss.

The closing conditions for the transaction to take effect, including the waiting period pursuant to the Hart-Scott-Rodino Antitrust Improvements Act (U.S. antitrust law) were met in fiscal 2018. The transaction led to the disposal of the intangible asset in an amount of € 104 million and to the recognition of a disposal gain, which was reported under other operating income.

Development agreement with Avillion LLP, United Kingdom, to develop anti-IL-17-A/F Nanobody®

On March 30, 2017, the Group announced an agreement with a subsidiary of Avillion LLP, United Kingdom, (Avillion) to develop the anti-IL-17-A/F Nanobody® M1095. The Group acquired full, exclusive rights to anti-IL-17-A/F Nanobody® through a global development and commercialization license from Ablynx nv, Belgium, in 2013. This Nanobody® is an investigational therapy which has completed Phase I development. As part of the cooperation, Avillion will be responsible for developing this anti-IL-17-A/F Nanobody® from Phase II through Phase III in plaque psoriasis. Avillion will also finance the clinical program through to regulatory submission. The drug candidate is currently in a Phase IIb trial that started on schedule in August 2018. During the development phase, the Group recognizes a financial liability for potential repayment obligations to Avillion and records a corresponding expense as research and development costs. Research and development costs in the low single-digit million euro range were incurred in fiscal 2018.

Immuno-oncology collaboration with F-star Delta Ltd., United Kingdom

On June 4, 2017, the Group announced a strategic collaboration with F-star Delta Ltd, United Kingdom, (F-star) for the development and commercialization of bispecific immuno-oncology antibodies. The Group has the option, upon delivery of pre-defined data packages by F-star, to fully acquire the company that owns five bispecific development programs, including F-star’s lead asset FS118. In return, the Group made upfront payments to F-star and its shareholders totaling € 60 million, which were capitalized in 2017. Until the option can be exercised, the Group finances F-star’s research and development activities and reports the corresponding expenses under research and development costs. In addition, since the collaboration began, the Group has made performance-related milestone payments of € 14 million, which have been capitalized. If the option is exercised and defined milestones are reached, the Group will incur further payment obligations.

Development agreement with the SFJ Pharmaceuticals Group, United States, to develop abituzumab

On May 2, 2018, the Group announced that it had signed an agreement with the SFJ Pharmaceuticals Group, United States, (SFJ) to develop abituzumab. Abituzumab is an investigational monoclonal antibody with potential for treating solid tumors such as colorectal cancer (mCRC). In a Phase II study of a patient population with KRAS wild-type mCRC, a subgroup of patients was identified as potentially benefiting from treatment with abituzumab in combination with Erbitux® and chemotherapy. SFJ will be responsible for Phase II and III development of abituzumab. During the development stages, the Group recognizes a financial liability for potential repayment obligations to SFJ and records a corresponding expense as research and development costs. No significant clinical development expenses were incurred in the 2018 reporting period.