AstraZeneca Annual Report and Form 20-F Information 2011

Financial Statements25 Commitments and contingent liabilities continuedAdvance PaymentThe merger between Astra and Zeneca in 1999 triggered the first stepin the termination arrangements. Merck relinquished all rights, includingcontingent payments on future sales, to potential Astra products withno existing or pending US patents at the time of the merger. As a result,AstraZeneca now has rights to such products and is relieved ofpotential obligations to Merck and restrictions in respect of thoseproducts (including annual contingent payments), affording AstraZenecasubstantial freedom to exploit the products as it sees fit.At the time of the merger, the Advance Payment was paid. It wascalculated as the then net present value of $2.8bn discounted from2008 to the date of merger at a rate of 13% per annum and amountedto $967m. It was subject to a true-up in 2008 (as discussed underTrue-Up below).Partial RetirementIn March 2008, there was a partial retirement of Merck’s limitedpartnership interest by payment to Merck of an amount calculatedas a multiple of the average annual contingent payments from 2005 to2007 on the relevant products, plus $750m. The payment was $4,271m.Upon the Partial Retirement, Merck’s rights in respect of certain ofthe agreement products ended. The products covered by the PartialRetirement include Toprol-XL, Pulmicort, Rhinocort and Symbicort.True-UpIn 2008, in accordance with the Agreements, there was a True-Up ofthe Advance Payment. The True-Up amount was based on a multipleof the average annual contingent payments from 2005 to 2007 inrespect of all the agreement products with the exception of Prilosec andNexium (subject to a minimum of $6.6bn), plus other defined amounts(totalling $912m). In accordance with the Agreements, the calculatedamount was then reduced by the Appraised Value (as discussed underFirst Option below), the Partial Retirement payment and the AdvancePayment (at its undiscounted amount of $2.8bn). This True-Up amountwas settled in an amount equal to $241m paid by Merck to AstraZeneca.Loan Note ReceivableIncluded in the assets and liabilities covered by the Restructuring wasa loan note receivable by AstraZeneca from Merck with a face valueof $1.38bn. In 2008, at the same time as the settlement of the PartialRetirement and the True-Up, Merck settled the loan note receivableby paying AstraZeneca $1.38bn.If Merck had exercised the First Option in 2008, the net minimumpayment that would have been made to Merck would have been $3.3bn,being the minimum combined payments of $4.7bn specified in theAgreements on the Partial Retirement, the True-Up and First Option,less the repayment of the loan note of $1.38bn. In accounting for theRestructuring in 1998, the loan note was included in the determinationof the fair values of the assets and liabilities to be acquired. At that time,the loan note was ascribed a fair value of zero on acquisition and onthe balance sheet, because it was estimated that the net minimumpayment of $3.3bn equated to the fair value of the rights to be acquiredunder the Partial Retirement, True-Up and First Option.First OptionIn accordance with the Agreements, in 2008 a calculation was made ofthe Appraised Value, being the net present value of the future contingentpayments in respect of all agreement products not covered by thePartial Retirement, other than Prilosec and Nexium. The AppraisedValue was calculated in 2008 as $647m.Payment of the Appraised Value to Merck in March 2008 would havetaken place only if Merck had exercised the First Option in 2008. Merckdid not exercise this option. Under the Agreements AstraZeneca couldexercise the First Option in the first two months of 2010 for a sum equalto the 2008 Appraised Value.In 2010, AstraZeneca exercised the First Option. Payment of $647mto Merck was made on 30 April 2010. This payment resulted inAstraZeneca acquiring Merck’s interests in products covered by theFirst Option including Entocort, Atacand, Plendil and the authorisedgeneric version of felodipine, and certain products then still indevelopment (principally Brilinta and lesogaberan). On 30 April 2010,contingent payments on these products (except for the authorisedgeneric version of felodipine) ceased with respect to periods after thisdate and AstraZeneca obtained the ability to exploit these products andother opportunities in the Cardiovascular and Neuroscience therapyareas. (Contingent payments on the authorised generic version offelodipine will continue until AstraZeneca’s third party distributionarrangement ends, which is currently expected to occur in June 2012.)As detailed in Note 9, the intangible asset relating to lesogaberan of$128m was subsequently impaired to a value of nil following a decisionto terminate further development of this compound.Second OptionAstraZeneca may exercise a Second Option to purchase Merck’sinterests in the Merck affiliates that hold the limited partner and otherrights referred to above. Exercise of the Second Option would resultin the repurchase by AstraZeneca of Merck’s interests in Prilosec andNexium in the US. This option is exercisable by AstraZeneca in Mayto October of 2012, or in 2017, or if combined annual sales of the twoproducts fall below a minimum amount. If AstraZeneca exercises theSecond Option, consummation of the transaction will occur five to sixmonths later. AstraZeneca’s consummation of the Second Option willend the contingent payments in respect of Prilosec and Nexium andwill effectively end AstraZeneca’s relationship with, and obligationsto, Merck (other than some residual manufacturing arrangements).In September 2010, AstraZeneca and Merck reached an agreementwith respect to the treatment of Vimovo under the Agreements,pursuant to which AstraZeneca will pay Merck certain amounts withrespect to Vimovo only if it exercises the Second Option and as partof the exercise price for the Second Option.The exercise price for the Second Option is the sum of the net presentvalue of the future annual contingent payments on Nexium and Prilosecas determined at the time of exercise and the net present value of up to5% of future US sales of Vimovo, with the precise amount dependenton the level of annual sales and the timing of the option exercise, aswell as 13 times Merck’s average annual 1% profit allocation in thePartnership for the prior three years. The exercise price of the SecondOption cannot be determined at this time.Accounting treatment of termination arrangementsAstraZeneca considers that the termination arrangements describedabove represent the acquisition, in stages, of Merck’s interests inthe Partnership and agreement products (including Merck’s rights tocontingent payments) and depend, in part, on the exercise of the Firstand Second Options. The effects will only be reflected in the financialstatements as these stages are reached. If and when all such paymentsare made, AstraZeneca will have unencumbered discretion in itsoperations in the US market.AstraZeneca anticipates that the benefits that accrue under all of thetermination arrangements arise:> > Currently, from the substantial freedom over products acquired ordiscovered post-merger.> > On occurrence of each stage of such arrangements, from enhancedcontributions from, and substantial freedom over, those productsthat have already been launched (for example, Prilosec, Nexium,Brilinta, Pulmicort, Symbicort, Rhinocort and Atacand), and thosethat are in development.Economic benefits include relief from contingent payments, anticipatedcost savings from cessation of manufacturing arrangements and othercost efficiencies, together with the strategic advantages of increasedfreedom to operate.182 Financial StatementsAstraZeneca Annual Report and Form 20-F Information 2011