Additional information on Merck KGaA in accordance with the German Commercial Code (HGB)

The management report of Merck KGaA has been combined with the Group management report. The annual financial statements and the combined management reports of the Merck Group and Merck KGaA for 2017 are being filed with the electronic German Federal Gazette (elektronischer Bundesanzeiger) and are available on the website of the German company register.

Statement on Corporate Governance

The Statement on Corporate Governance according to section 289a HGB is contained in the Corporate Governance section of this report.

Effects of company agreements on the net assets, financial position and results of operations

Operating activities of the business sectors

As part of the strategic further development of Merck KGaA, it is planned to spin off the existing operating activities of the Healthcare, Performance Materials and Life Science business sectors into three separate companies with the legal form of a GmbH or German limited liability corporation (hereinafter: ‟OpCo” or plural ‟OpCos”). The spin-off of the business sectors to these OpCo target companies domiciled in Darmstadt must be approved by the General Meeting of Merck KGaA in April 2018. Following approval by the General Meeting, the three business sectors are to be spun off with retroactive effect from January 1, 2018.

Combined control and profit and loss transfer agreements already exist between the respective OpCos. Going forward, these agreements are to remain in effect. Consequently, in the future there will still be one company for corporation tax, trade tax and turnover tax purposes. In the future, each OpCo will be owned by a business-­sector-­relevant intermediate holding company, each of which is a wholly owned subsidiary of Merck KGaA.

Since the technical system requirements to report the business sectors spun off as regards the OpCos are not yet in place, the business sectors spun off are to be temporarily leased back to Merck until the ERP systems of the respective OpCos are introduced. For this purpose, Merck KGaA is entering into a business leasing contract with the respective OpCo with retrospective effect from January 1, 2018. Until the technical system requirements have been implemented, owing to the business lease Merck KGaA will record business transactions in its own name and on its own behalf. Once the ERP systems have been introduced for each OpCo, the business lease will be terminated and the business will be taken over in full.

Business split and transfer to Merck Real Estate GmbH, Darmstadt

The real estate and properties of Merck KGaA are rented based on a general rental agreement with effect on December 15, 2017 from Merck KGaA to Merck Real Estate GmbH. A combined control and profit and loss transfer agreement exists between Merck KGaA and Merck Real Estate GmbH. Therefore, Merck Real Estate GmbH is one of the companies in fiscal unity with Merck KGaA.

Within the scope of this reorganization, 111 employees of Merck KGaA were taken on by Merck Real Estate GmbH. The transferred assets and liabilities are presented in the overview at the end of this section. The impact on the income statement of Merck KGaA was only immaterial in 2017.

Separation of the Consumer Health business

By way of the transfer agreement dated August 31, 2017, Merck KGaA transferred to Merck Consumer Health GmbH, Darmstadt, with retroactive effect from January 1, 2017 and via Merck Consumer Health Holding Germany GmbH, its Consumer Health business along with all the allocable business assets, rights and duties in the course of a so-called chain transfer. The separation serves to prepare the strategic repositioning of the Consumer Health business within the Merck Group.

The operations of Merck Consumer Health GmbH were immediately leased back to Merck KGaA after the transfer to Merck KGaA. The lease fee amounted to € 1.3 million in 2017. Additionally, the effects on the income statement of the company are not material. Employees were not transferred to Merck Consumer Health GmbH.

The following overview presents the assets and liabilities transferred from Merck KGaA to Merck Consumer Health GmbH with retroactive effect from January 1, 2017.

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€ million Merck Consumer Health Merck Real Estate
Transferred assets    
A. Tangible assets    
Software 0.0
Buildings 1.4
Plant and machinery, other facilities 4.6 0.4
Construction in progress 1.5
7.5 0.4
B. Current assets    
Inventories 4.4
Trade accounts receivable 0.5
Other receivables and other assets 1.4
6.3
   
Total assets 13.8 0.4
   
Transferred liabilities    
A. Provisions    
Provisions for pensions and other post-employment benefits 0.6
Other provisions 1.5 1.4
1.5 2.0
B. Liabilities    
Trade accounts payable 1.0
Other liabilities
1.0
   
Total liabilities 2.5 2.0
   
Total transferred assets less liabilities 11.3 – 1.6

Business development

In 2017, Merck KGaA sales increased by € 342 million. The increase resulted from the Healthcare and Life Science business sectors as well as other sales. By contrast, sales of the Performance Materials business sector declined slightly:

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Change
€ million 2017 2016 € million in %
Healthcare 2,404 2,232 172 7.7%
Life Science 777 710 67 9.4%
Performance Materials 1,399 1,407 – 8 – 0.6%
Other sales 228 116 112 96.5%
Total sales 4,807 4,465 342 7.7%

Other sales mainly included intragroup cross-charging for IT services and other administration services. The increase was due to higher ongoing costs for IT projects.

The share of sales with other Group companies (Group sales) amounted to 93.6% in 2017 (2016: 91.0%).

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Change
€ million 2017 2016 € million in %
Group sales 4,500 4,063 437 10.8%
Sales to third parties 307 402 – 95 – 23.6%
Total 4,807 4,465 342 7.7%

At 90.3% (2016: 89.4%), the share of exports in 2017 was slightly above the previous year’s level.

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Change
€ million 2017 2016 € million in %
Outside Germany 4,341 3,990 351 8.8%
Germany 467 475 – 8 – 1.7%
Total 4,807 4,465 342 7.7%

In the Healthcare business sector, the increase in sales was primarily due to an agreement on a one-time payment for future license payments. Sales of products, on the other hand, remained almost unchanged. The increase in sales of cardiovascular therapies (+ 14.8%) was approximately offset by a decline in sales of the oncology drug Erbitux (– 7.5%). Thyroid therapies generated a slight rise in sales (+ 2.5%). Overall, the business sector recorded sales declines in the region of Europe, offset by a sales increase in the Asia-Pacific region.

In Performance Materials, sales by the Display Materials business unit did not reach the previous year’s level. The sales increases in the other two business units Pigments & Functional Materials (+ 10.6%) and Advanced Technologies (+ 8.3%) did not compensate for this. Sales declines were recorded particularly in the Asia-Pacific region. This was offset by a slight increase in the regions of Europe and North and Latin America.

In 2017, sales by the Life Science business sector increased by 9.4%. Growth was generated by all three business units, whereby Process Solutions accounted for the largest share of growth (+ 14%). The largest sales increases were recorded in the regions of Europe, North and Latin America, as well as Asia-Pacific.

Results of operations

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Change
€ million 2017 2016 € million in %
Sales 4,807 4,465 343 7.7%
Other income 212 185 27 14.3%
Cost of materials – 1,505 – 1,488 – 17 1.1%
Personnel expenses – 1,258 – 1,055 – 203 19.2%
Depreciation, amortization, write-downs and impairment losses – 183 – 176 – 7 4.2%
Other operating expenses – 1,801 – 1,726 – 75 4.3%
Investment income/Write-downs of financial assets 847 659 188 28.6%
Financial result – 201 – 243 41 – 17.1%
Profit before profit transfers and taxes 917 621 296 47.7%
Profit transfers – 533 – 400 – 153 38.2%
Taxes – 193 – 65 – 128 196.9%
Profit after profit transfers and taxes/Net income 171 156 15 9.8%

The increase in other income was mainly attributable to higher income from increased inventories of work in progress and finished goods.

The cost of materials increased slightly. The cost of materials in relation to sales amounted to 31.3% (2016: 33.3%).

The increase in personnel expenses was due to higher pension expenses, on the one hand. The increase in pension expenses resulted from an adjustment in 2016 of the actuarial interest rate used for the measurement of pension provisions. Due to the law on implementation of the directive on credit agreements relating to residential immovable property and on the amendment of provisions of commercial law, in 2016 the specified period for measurement of the average market interest rate was extended from seven to ten years. This resulted in lower pension expenses in 2016. On the other hand, wages and salaries increased as a result of the collectively agreed pay increase and the higher number of employees.

Depreciation, amortization, write-downs and impairment losses increased slightly by 4.2% as a result of higher fixed assets.

The rise in other operating expenses was due to increased sales and marketing activities as well as higher expenses in connection with provisions for litigation risks.

Investment income improved mainly as a result of a higher dividend payment from Merck Holding GmbH, Gernsheim.

The financial result improved overall owing to higher interest income from plan assets, which are offset against the interest component of the addition to pension provisions.

Net assets and financial position

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Assets

Change
€ million Dec. 31, 2017 Dec. 31, 2016 € million in %
Fixed assets 18,148 17,563 585 3.3%
Intangible assets 490 250 240 95.9%
Tangible assets 1,173 1,003 170 16.9%
Financial assets 16,486 16,310 176 1.1%
Current assets 1,763 1,504 259 17.2%
Inventories 688 635 53 8.4%
Trade accounts receivable 181 291 – 110 – 37.7%
Receivables and other assets 892 576 316 54.8%
Cash and cash equivalents 1 2 – 1 – 50.0%
Prepaid expenses 28 28 0 0.0%
19,940 19,095 845 4.4%
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Liabilities

Change
€ million Dec. 31, 2017 Dec. 31, 2016 € million in %
Net equity 5,328 5,290 38 0.7%
Provisions 1,312 1,034 278 26.9%
Provisions for pensions and other post-employment benefits 200 80 120 150.5%
Other provisions 1,112 954 158 16.6%
Liabilities 13,281 12,769 512 4.0%
Financial obligations 1,500 1,500 0.0%
Trade accounts payable 292 260 32 12.3%
Other liabilities 11,489 11,009 480 4.4%
Deferred income 18 2 16 800.0%
19,940 19,095 845 4.4%

The net assets and financial position of Merck KGaA changed only slightly in comparison with the previous year. With a 4.4% increase in total assets, the equity ratio amounted to 26.7% (2016: 27.7%).

At the Darmstadt site, the construction project to expand global headquarters made further progress. This significantly contributed to the increase in tangible assets.

The increase in financial assets was due to a payment made to the capital reserve of Merck 12. Allgemeine Beteiligungs-GmbH in 2017.

The increase in current assets (+ € 259 million) was mainly attributable to higher receivables from affiliates for short-term loans. By contrast, tax receivables declined.

The increase in other provisions (+ € 158 million) was mainly due to higher provisions for income taxes and for legal risks.

The rise in other liabilities resulted primarily from the clearing account with Merck Financial Services GmbH, Darmstadt.

Research and development

In 2017, research and development spending on projects of Merck KGaA and other Group companies totaled € 685 million (2016: € 751 million). A large portion was also incurred by companies outside the Merck Group. In Darmstadt, Healthcare mainly focuses on oncology as well as autoimmune and inflammatory diseases. The decline of € 75 million in R&D spending by the Healthcare business sector was reflected in the decline of € 66 million in overall R&D spending (– 8.8%). At the same time, the Healthcare business sector accounted for 59.6% (2016: 64.3%) and thus the largest proportion of research and development spending. The Performance Materials business sector focuses its research activities on developing new and improved basic materials and mixtures for LC displays, as well as for innovative OLED applications. To strengthen the Pigments business, new effect pigments for the automotive, cosmetics and printing ink sectors have been developed. In the Life Science business sector, research activities focused in particular on technologies for laboratory and life science applications, and new developments were driven forward. These included improved test kits, chromatography methods, substrates for separating active substances, and innovations in the fields of microbiology and hygiene monitoring.

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Change
€ million 2017 2016 € million in %
Healthcare 408 483 – 75 – 15.5%
Life Science 35 39 – 4 – 10.3%
Performance Materials 220 223 – 3 – 1.3%
Other R&D spending that cannot be allocated to the individual business sectors 22 6 16 266.7%
Total 685 751 – 66 – 8.8%

The ratio of research and development spending to sales was 14.3% (2016: 16.8%). Overall, the average number of employees working in research and development was 2,515. Merck KGaA is one of the main research sites of the Merck Group, accounting for a share of 32.0% (2016: 38.0%) of total Group research and development spending. The decrease in this share was due on the one hand to lower research and development costs of Merck KGaA and on the other hand to higher research and development costs of the Merck Group.

Dividend

For 2017, we are proposing to the General Meeting the payment of a dividend of € 1.25 per share.

Personnel

As of December 31, 2017, Merck KGaA had 10,677 employees, which was an increase over the previous year (2016: 9,988).

Average number of employees by functional area:

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PERSONNEL

Average number of employees during the year 2017 2016
Production 3,536 3,270
Administration 3,072 2,881
Research 2,515 2,320
Logistics 648 624
Sales and marketing 574 531
Other 128 118
Total 10,473 9,744

Risks and opportunities

Merck KGaA is largely subject to the same opportunities and risks as the Merck Group. More information can be found in the Report on Risks and Opportunities.

Forecast for Merck KGaA

Deviations of actual business developments in 2017 from the previously reported guidance:

In 2016, sales were forecast to increase slightly in all three business sectors in fiscal 2017.

The sales increase in the Healthcare business sector (+ 7.7%) was mainly the result of higher license income. Sales of products increased slightly over the previous year’s level as additional sales of cardiovascular therapies (+ 14.8%) offset the decline in sales of the oncology drug Erbitux (– 7.5%).

Sales by the Life Science business sector increased significantly (+ 9.4%). All business units, Research Solutions (+ 6.6%), Applied Solutions (+ 6.7%) and Process Solutions (+ 14.0%), contributed to sales growth.

Continued high competitive pressure in the Liquid Crystals business led to a slight decline in Performance Materials sales (– 0.6%). The decline in the Display Materials business unit (– 4.8%) was not fully offset by sales increases in the Pigments & Functional Materials (+ 10.6%) and Advanced Technologies (+ 8.3%) business units.

A further rise in net income was mainly due to higher sales and improved investment income. The increase in investment income was mainly attributable to a higher dividend payment from Merck Holding GmbH, Gernsheim. On the expenses side, this was offset by higher expenses in connection with legal risks, resulting in an overall increase in net income of 9.8%.

The financial resources for the company continue to be provided by Merck Financial Services GmbH, Darmstadt.

Forecast 2018

For fiscal 2018, slight sales increases are expected for the Life ­Science and Healthcare business sectors. Sales by the Performance Materials business sector, however, are expected to decline slightly.

As in 2016, the financing costs of the Sigma-­Aldrich acquisition continue to adversely affect net income. Nevertheless, positive investment income and dividend payments from subsidiaries will lead again to a slight increase in net income. Merck Financial Services GmbH, Darmstadt, will provide the company with sufficient financial resources and thus ensure liquidity.

Currently no risks can be identified that could jeopardize the continued existence of the company.