Merck KGaA

A development and license agreement with Merck KGaA (Merck) with respect to Erbitux granted Merck exclusive rights to market Erbitux outside of the U.S. and Canada, and co-exclusive rights with BMS and us in Japan. Merck also has rights to manufacture Erbitux for supply in its territory. In 2009, we manufactured and provided a portion of Merck's requirements for API, which was included in net product sales. We also receive a royalty on the sales of Erbitux outside of the U.S. and Canada, which is included in collaboration and other revenue as earned. Collaborative reimbursements received for supply of product; for research and development; and marketing, selling, and administrative expenses are recorded as a reduction to the respective expense line items on the consolidated statement of operations. Royalty expense paid to third parties, net of any royalty reimbursements received, is recorded as a reduction of collaboration and other revenue.

Exenatide

We are in a collaborative arrangement with Amylin Pharmaceuticals (Amylin) for the joint development, marketing, and selling of Byetta (exenatide injection) and other forms of exenatide such as exenatide once weekly (proposed tradename Bydureon). Byetta is presently approved as an adjunctive therapy to improve glycemic control in patients with type 2 diabetes who have not achieved adequate glycemic control using metformin, a sulfonylurea, or a combination of metformin and sulfonylurea; and in the U.S. only, as an adjunctive therapy in patients using a thiazolidinedione (with or without metformin) and as a monotherapy. Lilly and Amylin are co-promoting Byetta in the U.S. Amylin is responsible for manufacturing and primarily utilizes third-party contract manufacturers to supply Byetta. However, we are manufacturing Byetta pen delivery devices for Amylin. We are responsible for development and commercialization costs outside the U.S.

Under the terms of our arrangement, we report as collaboration and other revenue our 50 percent share of gross margin on Amylin's net product sales in the U.S. We report as net product sales 100 percent of sales outside the U.S. and our sales of Byetta pen delivery devices to Amylin. The following table summarizes the revenue recognized with respect to Byetta:

We pay Amylin a percentage of the gross margin of exenatide sales outside of the U.S., and these costs are recorded in cost of sales. Under the 50/50 profit-sharing arrangement for the U.S., in addition to recording as revenue our 50 percent share of exenatide's gross margin, we also record 50 percent of U.S. research and development costs and marketing and selling costs in the respective line items on the consolidated statements of operations.

A NDA has been submitted to the FDA for Bydureon. In October 2010, we received a complete response letter from the FDA that requested a safety study to measure the potential for heart rhythm disturbances when exenatide is used at higher than average doses. Our goal is to submit a reply to the complete response letter in the second half of 2011. Based on the requirements for additional data, this will likely be considered a Class 2 resubmission requiring a six-month review. We have also submitted Bydureon for review by the European Medicines Agency and we anticipate action in the first half of 2011.

Amylin is constructing and will operate a manufacturing facility for Bydureon, and we have entered into a supply agreement in which Amylin will supply Bydureon product to us for sales outside the U.S. The estimated total cost of the facility is approximately  $550 million. In 2008, we paid  $125.0 million to Amylin, which we will amortize to cost of sales over the estimated life of the supply agreement beginning with product launch. We would be required to reimburse Amylin for a portion of any future impairment of this facility, recognized in accordance with GAAP. A portion of the  $125.0 million payment we made to Amylin would be creditable against any amount we would owe as a result of impairment. We have also agreed to loan up to  $165.0 million to Amylin at an indexed rate. No amounts have been loaned pursuant to this arrangement. Draws must be made by June 30, 2011,and any borrowings must be repaid by June 30, 2014. We have also agreed to cooperate with Amylin in the development, manufacturing, and marketing of Bydureon in a dual-chamber cartridge pen configuration. We will contribute 60 percent of the total initial capital costs of the project, our portion of which will be approximately  $130 million. As of December 31, 2010, we have contributed approximately  $90 million.

TPG-Axon Capital

In 2008, we entered into an agreement with an affiliate of TPG-Axon Capital (TPG) whereby both we and TPG were obligated to fund the Phase III development of semagacestat and solanezumab, our two lead molecules for the treatment of mild to moderate Alzheimer's disease. In the third quarter of 2010, we halted the development of semagacestat based on preliminary results of Phase III clinical trials which resulted in a charge to research and development of approximately  $80 million. In February 2011, we amended this agreement. Under the amended agreement, TPG's remaining obligation to fund solanezumab costs incurred subsequent to 2010 will not be material and will not extend beyond the first half of 2011. In exchange for their funding, TPG may receive success-based sales milestones totaling approximately  $70.0 million and mid-single digit royalties that are contingent upon the successful development of solanezumab. The royalties relating to solanezumab would be paid for approximately eight years after launch of a product. Reimbursements received from TPG for its portion of research and development costs incurred related to the Alzheimer's treatments are recorded as a reduction to the research and development expense line item on the consolidated statements of operations. The reimbursement from TPG has not been and is not expected to be material in any period.

Summary of Collaboration-Related Commission and Profit Share Payments

The aggregate amount of commissions and profit share payments included in marketing, selling, and administrative expense pursuant to the collaborations described above was  $174.5 million,  $319.2 million, and  $307.6 million in 2010, 2009, and 2008, respectively.

Performance Award Program

PAs are granted to officers and management and are payable in shares of our common stock.  The number of PA shares actually issued, if any, varies depending on the achievement of certain pre-established earnings-per-share targets over a two-year period.  In 2009, we granted both a one-year and a two-year award to all global management as a transition to a two-year performance period for all PAs granted beginning in 2010.  PA shares are accounted for at fair value based upon the closing stock price on the date of grant and fully vest at the end of the measurement periods.  The fair values of PAs granted in 2010 and 2008 were  $30.88 and  $51.22, respectively.  The fair values of PAs granted in 2009 were  $36.17 for the one-year award and  $34.12 for the two-year award.  The number of shares ultimately issued for the PA program is dependent upon the earnings achieved during the vesting period.  Pursuant to this plan, approximately 3.8 million shares, 2.8 million shares, and 2.5 million shares were issued in 2010, 2009, and 2008, respectively.  Approximately 3.8 million shares are expected to be issued in 2011.  As of December 31, 2010, the total remaining unrecognized compensation cost related to nonvested PAs amounted to  $31.5 million, which will be amortized over the weighted-average remaining requisite service period of 12 months.

A summary of the SVA activity is presented below:

Restricted Stock Unit

RSUs are granted to certain employees and are payable in shares of our common stock. RSU shares are accounted for at fair value based upon the closing stock price on the date of grant.  The corresponding expense is amortized over the vesting period, typically three years.  The fair values of RSU awards granted in 2010, 2009, and 2008 were  $34.78,  $38.12, and  $51.22, respectively.  The number of shares ultimately issued for the RSU program remains constant with the exception of forfeitures.  Pursuant to this plan, 1.5 million, 0.5 million and 0.4 million shares were granted in 2010, 2009, and 2008, respectively, and approximately 0.2 million shares were issued in 2010.  Approximately 0.2 million shares are expected to be issued in 2011.  As of December 31, 2010, the total remaining unrecognized compensation cost related to nonvested RSUs amounted to  $40.6 million, which will be amortized over the weighted-average remaining requisite service period of 23 months.

Stock Option Program

Stock options were granted prior to 2007 to officers and management at exercise prices equal to the fair market value of our stock price at the date of grant.  No stock options were granted subsequent to 2007.  Options fully vest three years from the grant date and have a term of 10 years.

Stock option activity during 2010 is summarized below:

All options were vested as of December 31, 2010.

The intrinsic value of options exercised during 2010, 2009, and 2008 amounted to  $0.1 million,  $0.3 million, and  $4.8 million, respectively.  The total grant date fair value of options vested during 2009, and 2008 amounted to  $68.5 million, and  $84.1 million, respectively.  We received cash of  $0.1 million,  $0.2 million, and  $2.9 million from exercises of stock options during 2010, 2009, and 2008, respectively.  The recognized related tax benefits for all three years were not material.

Note 14:  Retirement Benefits

We use a measurement date of December 31 to develop the change in benefit obligation, change in plan assets, funded status, and amounts recognized in the consolidated balance sheets at December 31 for our defined benefit pension and retiree health benefit plans, which were as follows:

The unrecognized net actuarial loss and unrecognized prior service cost (benefit) have not yet been recognized in net periodic pension costs and are included in accumulated other comprehensive loss at December 31, 2010.

In 2011, we expect to recognize from accumulated other comprehensive loss as components of net periodic benefit cost,  $220.4 million of unrecognized net actuarial loss and  $6.3 million of unrecognized prior service benefit related to our defined benefit pension plans, and  $83.3 million of unrecognized net actuarial loss and  $40.1 million of unrecognized prior service benefit related to our retiree health benefit plans.  We do not expect any plan assets to be returned to us in 2011.

The following represents our weighted-average assumptions as of December 31:

In evaluating the expected return on plan assets annually we consider numerous factors, including; our historical assumptions compared with actual results, an analysis of current and future market conditions, our current and expected asset allocations, historical returns and the views of leading financial advisers and economists for future asset class returns.  As noted, historical returns are just one of several factors considered and are not the starting point for determining the expected return.  Our 20-year annualized rate of return on our U.S. defined benefit pension plans and retiree health benefit plan was approximately 9.4 percent as of December 31, 2010.  Health-care-cost trend rates are assumed to increase at an annual rate of 7.8 percent in 2011, decreasing by approximately 0.4 percent per year to an ultimate rate of 5.3 percent by 2018.

The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:

The total accumulated benefit obligation for our defined benefit pension plans was  $7.23 billion and  $6.67 billion at December 31, 2010 and 2009, respectively.  The projected benefit obligation and fair value of the plan assets for the defined benefit pension plans with projected benefit obligations in excess of plan assets were  $7.12 billion and  $5.93 billion, respectively, as of December 31, 2010, and  $7.55 billion and  $6.01 billion, respectively, as of December 31, 2009.  The accumulated benefit obligation and fair value of the plan assets for the defined benefit pension plans with accumulated benefit obligations in excess of plan assets were  $1.10 billion and  $136.3 million, respectively, as of December 31, 2010, and  $1.01 billion and  $107.4 million, respectively, as of December 31, 2009.

Net pension and retiree health benefit expense included the following components:

If the health-care-cost trend rates were to be increased by one percentage point each future year, the December 31, 2010, accumulated postretirement benefit obligation would increase by  $182.5 million (8.8 percent) and the aggregate of the service cost and interest cost components of the 2010 annual expense would increase by  $14.4 million (8.1 percent).  A one percentage point decrease in these rates would decrease the December 31, 2010, accumulated postretirement benefit obligation by  $164.1 million (  7.9 percent) and the aggregate of the 2010 service cost and interest cost by  $11.7 million (6.6 percent).

The following represents the amounts recognized in other comprehensive income (loss) in 2010:

We have defined contribution savings plans that cover our eligible employees worldwide.  The purpose of these defined contribution plans is generally to provide additional financial security during retirement by providing employees with an incentive to save.  Our contributions to the plan are based on employee contributions and the level of our match.  Expenses under the plans totaled  $119.8 million,  $127.6 million, and  $114.1 million for the years 2010, 2009, and 2008, respectively.

We provide certain other postemployment benefits primarily related to disability benefits and accrue for the related cost over the service lives of employees.  Expenses associated with these benefit plans in 2010, 2009, and 2008 were not significant.

Benefit Plan Investments

Our benefit plan investment policies are set with specific consideration of return and risk requirements in relationship to the respective liabilities.  U.S. plans represent 83 percent of our global investments.  Given the long-term nature of our U.S. liabilities, the U.S. plans have the flexibility to manage an above average degree of risk in the asset portfolios.  At the investment policy level, there are no specifically prohibited investments.  However, within individual investment manager mandates, restrictions and limitations are contractually set to align with our investment objectives, ensure risk control, and limit concentrations.

We manage our portfolio to minimize any concentration of risk by allocating funds within asset categories.  In addition, within a category we use different managers with various management objectives to eliminate any significant concentration of risk.

Our global benefit plans may enter into contractual arrangements (derivatives) to implement the local investment policy or manage particular portfolio risks.  Derivatives are principally used to increase or decrease exposure to a particular public equity, fixed income, commodity or currency market more rapidly or less expensively than could be accomplished through the use of the cash markets.  The plans utilize both exchange traded and over-the-counter instruments.  The maximum exposure to either a market or counterparty credit loss is limited to the carrying value of the receivable, and is managed within contractual limits.  We expect all of our counterparties to meet their obligations.  The gross values of these derivative receivables and payables are not material to the global asset portfolio, and their values are reflected within the tables below.

The U.S. defined benefit pension and retiree health benefit plan allocation strategy is currently comprised of approximately 80 percent growth investments and 20 percent fixed income investments.  The growth investment allocation encompasses U.S. and international public equity securities, hedge funds, and private equity-like investments.  These portfolio allocations are intended to reduce overall risk by providing diversification, while seeking moderate to high returns over the long term. 

Public equity securities are well diversified and invested in U.S. and international small-to-large companies across various asset managers and styles.  The remaining portion of the growth portfolio is invested in private alternative investments. 

Fixed income investments primarily consist of fixed income securities in U.S. Treasuries and Agencies, emerging market debt obligations, corporate bonds, mortgage-backed securities and commercial mortgage-backed obligations. 

Hedge funds are privately owned institutional investment funds that generally have moderate liquidity.  Hedge funds seek specified levels of absolute return regardless of overall market conditions, and generally have low correlations to public equity and debt markets.  Hedge funds often invest substantially in financial market instruments (stocks, bonds, commodities, currencies, derivatives, etc.) using a very broad range of trading activities to manage portfolio risks.  Hedge fund strategies focus primarily on security selection and seek to be neutral with respect to market moves.  Common groupings of hedge fund strategies include relative value, tactical, and event driven.  Relative value strategies include arbitrage, when the same asset can simultaneously be bought and sold at different prices, achieving an immediate profit.  Tactical strategies often take long and short positions to reduce or eliminate overall market risks while seeking a particular investment opportunity. Event strategy opportunities can evolve from specific company announcements such as mergers and acquisitions, and typically have little correlation to overall market directional movements.  Our hedge fund investments are made through limited partnership interests primarily in fund of funds structures to ensure diversification across many strategies and many individual managers.   Plan holdings in hedge funds are valued based on net asset values (NAVs) calculated by each fund or general partner, as applicable, and we have the ability to redeem these investments at NAV.

Private equity-like investment funds typically have low liquidity and are made through long-term partnerships or joint ventures that invest in pools of capital invested in primarily non-publicly traded entities. Underlying investments include venture capital (early stage investing), buyout, and special situation investing.  Private equity management firms typically acquire and then reorganize private companies to create increased long term value.  Private equity-like funds usually have a limited life of approximately 10-15 years, and require a minimum investment commitment from their limited partners.  Our private investments are made both directly into funds and through fund of funds structures to ensure broad diversification of management styles and assets across the portfolio.  Plan holdings in private equity-like investments are valued using the value reported by the partnership, adjusted for known cash flows and significant events through our reporting date. Values provided by the partnerships are primarily based on analysis of and judgments about the underlying investments. Inputs to these valuations include underlying NAVs, discounted cash flow valuations, comparable market valuations, and may also include adjustments for currency, credit, liquidity and other risks as applicable. The vast majority of these private partnerships provide us with annual audited financial statements including their compliance with fair valuation procedures consistent with applicable accounting standards.

Other assets include cash and cash equivalents and mark-to-market value of derivatives.

The cash value of the trust-owned insurance contract is invested in investment grade publicly traded equity and fixed income securities.

Other than hedge funds and private equity-like investments, which are discussed above, we determine fair values based on a market approach using quoted market values, significant other observable inputs for identical or comparable assets or liabilities, or discounted cash flow analyses.

The fair values of our defined benefit pension plan and retiree health plan assets as of December 31, 2010 by asset category are as follows:

The activity in the Level 3 investments during 2010 was as follows: