Report on Expected Developments

The following report provides a forecast for fiscal 2018 of the development of Merck KGaA, Darmstadt, Germany, and its three business sectors: Healthcare, Life Science and Performance Materials. The forecast again covers our key performance indicators as in the previous year, namely net sales, EBITDA pre and business free cash flow. On September 5, 2017, we announced that strategic options for the Consumer Health business are being examined. This analysis of strategic options had not yet been completed when this report was prepared, and on December 31, 2017 the Executive Board came to the conclusion that a divestment of the Consumer Health business within 12 months is not to be considered as very likely. Therefore, our forecast is based on an unchanged portfolio compared with fiscal 2017.

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forecast for the group

€ million Actual results 2017 Forecast for 2018 Key assumptions
Net sales 15,326.6
  • Moderate organic growth
  • Moderately negative foreign exchange effect
  • Moderate organic growth in Healthcare due to strong dynamics in growth ­markets as well as increasing sales of Mavenclad® and Bavencio®
  • Solid organic growth in Life Science, slightly above expected market growth
  • Slight to moderate organic decrease in Performance Materials owing to the ongoing adjustment processes in the Liquid Crystals business
  • Negative foreign exchange effect, driven primarily by the exchange rate of the U.S. dollar and currencies of various growth markets
EBITDA pre 4,414.5
  • Slight organic decline
  • Negative foreign exchange effect of 4% to 6%
  • In Healthcare continued high investments in research and development as well as in marketing and sales; absence of positive one-time effects from the ­previous year
  • Organic sales growth and continued realization of planned synergies from the ­integration of Sigma-Aldrich in Life Science business sector
  • Ongoing adjustment processes in the Liquid Crystals business that will not be ­offset despite the enhanced diversification of Performance Materials and active cost ­management
  • Negative foreign exchange effect, particularly owing to the development of the U.S. dollar and currencies of various growth markets
Business free cash flow 3,318.0
  • Low double-digit percentage decline
  • Lower EBITDA pre and investments in property, plant and equipment as well as digitalization initiatives, higher inventory levels due to a changed product mix and volume increases

Net sales

For the Group, in 2018 we expect moderate organic sales growth in comparison with the previous year. With regard to foreign exchange rates, we continue to expect a volatile environment due to political and macroeconomic developments. For the full year, we forecast a moderately negative exchange rate effect on our net sales compared with the previous year, with a greater impact in the first half than in the second half of the year. The estimation for 2018 is based on a €/US$ exchange rate in the range of 1.18 – 1.22 and further declines in the value of the currencies of various growth markets.

For our Healthcare business sector, we forecast a moderate organic increase in net sales in 2018. Again in 2018, this is expected to be driven mainly by strong dynamics in our growth markets, which should offset the still challenging market environment for Rebif® and continued price pressure in numerous markets. Furthermore, we expect sales of Mavenclad® in the high double-digit million range and of Bavencio® in the mid double-digit million range.

In our Life Science business sector, for 2018 we again predict solid organic growth of net sales, which should be slightly above expected market growth. We see medium-term growth at around 4% per year. We assume that Process Solutions will be the largest growth driver. The expected topline synergies from the Sigma-Aldrich acquisition will contribute to sales growth as planned.

We forecast a slight to moderate organic decline in net sales for our Performance Materials business sector in 2018 compared with 2017. The adjustment processes in our Liquid Crystals business will, as expected, also continue in 2018, leading to significant sales declines. We assume that the expected good sales growth of the other business units will not be able to compensate for this development.

EBITDA pre

EBITDA pre is our key financial indicator to steer operating business. On a currency-adjusted basis, we forecast a slight percentage decline in EBITDA pre for the Group in 2018 compared with 2017. In addition, based on the above-described currency scenario, however, foreign exchange rates are expected to impact our EBITDA pre by approximately – 4% to – 6% compared with 2017, which will affect all three business sectors.

For our Healthcare business sector, we forecast a slight percentage decline in organic EBITDA pre; the foreign exchange environment is expected to have a moderately negative impact on EBITDA pre. Owing to the continuous further development of our research pipeline, we are budgeting higher research and development costs compared with 2017. However, this is subject to the development of clinical data and prioritization decisions. Furthermore, the absence of positive one-time effects from the previous year amounting to approximately € 200 million (milestone payments for Bavencio®; one-time payment for future license payments) will have a negative impact.

For our Life Science business sector, in fiscal 2018 we expect a similar dynamic for currency-adjusted growth of EBITDA pre as in the previous year (2017: + 8%). Both the expected sales development and the further planned realization of synergies from the Sigma-­Aldrich acquisition will contribute to this. However, organic EBITDA pre growth of our Life Science business sector is likely to be lowered by a moderately negative foreign exchange effect.

We assume that in our Performance Materials business sector, the expected good development of the other business units as well as disciplined cost management will once again in 2018 not be able to offset the expected sales and earnings decline in the highly profitable Liquid Crystals business. Consequently, we expect that organic EBITDA pre will decline in the mid-teens percentage range in comparison with 2017. The difficult foreign exchange environment, which hits the Performance Materials business especially hard due to its regional positioning, will have an additional negative impact on the earnings situation.

In our estimation, negative EBITDA pre of Corporate and Other will increase in the low double-digit percentage range in 2018. This development relates to investments in innovation and digitalization initiatives. Previously, these costs were incurred in the business sectors and are now recorded centrally under Corporate and Other. By contrast, expected currency hedging gains should have a compensating effect in 2018.

Business free cash flow

For the business free cash flow of the Group in 2018, we forecast a decline in the low double-digit percentage range, driven by lower EBITDA pre, continued high investments in property, plant and equipment, and higher inventories owing to a changed product mix and higher volumes.

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forecast for our healthcare business sector

€ million Actual results 2017 Forecast for 2018 Key assumptions
Net sales 6,999.0
  • Moderate organic growth
  • Moderately negative foreign exchange effect
  • Organic sales growth in growth markets will compensate for the organic decline in Rebif® sales, which is expected to be in the high single-digit percentage range
  • Continued price pressure in Europe and also in the Asia-Pacific as well as Middle East and Africa regions
  • Bavencio® and Mavenclad® will contribute visibly to sales growth
  • Solid organic growth of our Consumer Health business
  • Negative foreign exchange effect, driven primarily by the exchange rate of the U.S. dollar and currencies of various growth markets
EBITDA pre 1,949.3
  • Slight organic decline
  • Moderately negative foreign exchange effect
  • Continued rise in research and development spending due to expected further pipeline development, particularly in immuno-oncology
  • Increasing marketing and selling expenses
  • Negative product mix effect due to a decline in sales of Rebif®
  • Absence of positive one-time effects from 2017 amounting to approximately € 200 million (milestone payments for Bavencio®; one-time payment received for future license payments)
  • Cost savings owing to the divestment of our Biosimilars business
  • Increasing earnings contributions from Bavencio® and Mavenclad®
  • Negative foreign exchange effect, driven primarily by the exchange rate of the U.S. dollar and currencies of various growth markets
Business free cash flow 1,447.9
  • Single-digit percentage ­decline
  • Decline in EBITDA pre
  • Increase in working capital due to product mix effects

Net sales

For our Healthcare business sector, we expect moderate organic sales growth in 2018. The development of our growth markets in the Latin America, Middle East and Africa, as well as Asia-Pacific regions is expected to contribute to this growth to a large extent. We also assume that the products newly approved in 2017, namely Bavencio® and Mavenclad®, will contribute significantly to growth with sales in the mid double-digit million range and high double-digit million range, respectively. These positive effects should be able to more than offset the expected decline in sales of Rebif® as well as continued price pressure in key markets in Europe, Asia-Pacific, as well as Middle East and Africa. Furthermore, we assume that our Consumer Health business will also contribute to the positive organic sales development. In particular, the U.S. dollar exchange rate and foreign exchange developments in various growth markets should lead to a moderately negative exchange rate effect.

EBITDA pre

For 2018, we forecast currency-adjusted EBITDA pre of our Healthcare business sector to see a slight percentage decline compared with the previous year. However, the expected negative foreign exchange environment will additionally adversely affect EBITDA pre. Positive one-time effects amounting to approximately € 200 million, which we realized in 2017, will not be incurred in 2018. This includes Bavencio® milestone payments from Pfizer and a one-time payment for future license payments. Continuously rising research and develop­ment costs for further pipeline development, particularly in immuno-oncology, will be an additional key driver of the forecast organic development of EBITDA pre. However, this budgeted cost increase will be further updated in the course of the year depending on clinical data and prioritization decisions. We also expect our market­ing and selling costs to increase further. In addition, we assume that our product mix will develop unfavorably owing to the expected decline in sales of Rebif®. The divestment of our Biosimilars business in 2017 and the resulting absence of research and development costs as well as increasing contributions from our newly approved products Bavencio® and Mavenclad® will partly offset the expected decline in organic EBITDA pre.

Business free cash flow

In 2018, we expect business free cash flow of our Healthcare business sector to show a single-digit percentage decline. This will be primarily driven by the expected decline in EBITDA pre and the increase in working capital due to product mix effects.

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forecast for our life science business sector

€ million Actual results 2017 Forecast for 2018 Key assumptions
Net sales 5,881.5
  • Solid organic growth, ­slightly above expected market growth
  • Moderately negative foreign exchange effect
  • Process Solutions is likely to remain the strongest growth driver, followed by ­Applied Solutions
  • Research Solutions will also contribute positively to organic sales development, albeit to a smaller extent
  • No significant portfolio effect from the acquisition of Natrix Separations
  • Negative foreign exchange effect, particularly owing to the development of the U.S. dollar
EBITDA pre 1,785.8
  • Organic earnings growth with a similar dynamic as in 2017
  • Moderately negative foreign exchange effect
  • Positive development resulting from expected sales growth
  • Continuation of the planned realization of synergies from the Sigma-Aldrich ­acquisition
  • Negative foreign exchange effect, particularly owing to the development of the U.S. dollar
Business free cash flow 1,401.7
  • Slightly below the prior-year level
  • Improved EBITDA pre
  • Higher inventories reflect the expected sales growth and changed product mix

Net sales

For our Life Science business sector, compared with 2017 we forecast further solid organic net sales growth in 2018, which should be slightly above expected market growth. In the medium term, we see annual market growth at approximately 4%. We assume that all business units will contribute positively to organic growth. In 2018, the Process Solutions business unit is again likely to remain the strongest driver of organic growth, followed by Applied Solutions. The Research Solutions business unit should also contribute to the positive sales development, yet to a lesser extent. Additionally, the topline synergies from the Sigma-Aldrich acquisition will contribute to growth as planned. At the end of 2017, we acquired Natrix Separations. The consolidation will not lead to a significant portfolio effect. We assume a moderately negative foreign exchange effect primarily owing to the development of the U.S. dollar.

EBITDA pre

EBITDA pre of our Life Science business sector in 2018 is likely to see dynamic growth similar to 2017 on a currency-adjusted basis (2017: + 8%). This development is in line with the expected development of sales. Furthermore, in 2018 we will assign high priority to continuing the planned realization of cost and sales synergies from the Sigma-­Aldrich acquisition. After already having realized synergies of around € 185 million up until 2017, for 2018 we expect further synergies as planned that are likely to have an additional effect of around € 95 million on earnings. We assume that in 2018 we will achieve our planned synergy target of € 280 million for the Sigma-­Aldrich acquisition. However, in 2018 organic growth of EBITDA pre of our Life Science business sector is expected to be lowered by moderately negative foreign exchange effects.

Business free cash flow

We expect our Life Science business free cash flow to be slightly below the previous year’s level. The higher EBITDA pre will be more than offset by higher inventory levels. These result primarily from expected dynamic sales growth and a changed product mix.

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forecast for our performance materials business sector

€ million Actual results 2017 Forecast for 2018 Key assumptions
Net sales 2,446.0
  • Organically slightly to ­moderately below the year-earlier level
  • Moderately negative foreign exchange effect
  • Volume increase in all businesses; strong dynamics particularly in Advanced ­Technologies and IC Materials
  • Market share adjustment and price decline in the Liquid Crystals business
  • Negative exchange rate effect, especially due to the forecast development of the U.S. dollar and currencies in key Asian markets
EBITDA pre 979.8
  • Organic percentage decline in the mid teens range
  • Moderately negative foreign exchange effect
  • The decline in market shares and prices in the Liquid Crystals business cannot be offset by growth of the other businesses and active cost management
  • Negative foreign exchange effect, particularly owing to the development of the U.S. dollar and currencies in key Asian markets
Business free cash flow 905.8
  • Double-digit percentage ­decline
  • Decline in EBITDA pre, sustained high investments in property, plant and ­equipment higher inventory levels due to volume increases

Net sales

We forecast a slight to moderate organic sales decline in our Performance Materials business sector in 2018 compared with 2017. In our estimation, the adjustment processes in our Liquid Crystals business will continue unabated in 2018. This is attributable to the normalization of our market shares, especially in China, which had been unusually high in recent years. This has been recognizable since 2017. Therefore, it is to be expected that the pricing pressure customary in this industry will once again not be offset by the corresponding volume growth in 2018. Despite the meanwhile high degree of diversification of our Performance Materials business sector, in our estimation this development will not be offset by good organic growth in our other business fields. OLED technology (Advanced Technologies) and the semiconductor materials business are expected to show a dynamic development. Due to unfavorable foreign exchange developments, in Performance Materials in 2018 we expect to see a moderately negative foreign exchange effect stemming mainly from the U.S. dollar exchange rate, as well as declines in the value of key Asian currencies.

EBITDA pre

In 2018, our Performance Materials business sector will probably again be unable to compensate for the expected sales decline in the highly profitable Liquid Crystals business despite the expected good performance of the other business fields as well as high cost discipline. Consequently, we expect that organic EBITDA pre will decline in the mid-teens percentage range in comparison with 2017. The difficult foreign exchange environment, which hits the Performance Materials business especially hard due to its regional positioning, will additionally have a moderately negative impact on the earnings situation.

Business free cash flow

For our Performance Materials business sector, we forecast a decline in business free cash flow in the mid double-digit percentage range. Besides the negative development of EBITDA pre, we expect higher investments in property, plant and equipment as well as high inventory levels due to volume increases.

Summary

For 2018, we expect moderate organic growth of net sales for the Group, which is likely to be driven by the Healthcare and Life Science business sectors. In addition, we assume a moderately negative foreign exchange effect due to the current weakness of the U.S. dollar as well as the development forecast for various currencies in our growth markets. EBITDA pre of the Group is expected to decrease slightly on a currency-adjusted basis in comparison with the previous year. In our Healthcare business sector, we expect a slight organic percentage decline in EBITDA pre. For our Life Science business sector, on a currency-adjusted basis we expect similar growth dynamics of EBITDA pre as in the previous year. For our Performance Materials business sector, we forecast EBITDA pre to decline in the mid-teens percentage range on a currency-adjusted basis. We assume that the currently difficult foreign exchange environment in all three business sectors will lead to a decline in EBITDA pre of between – 4% and – 6%.

Business free cash flow of the Group is expected to decline in the low double-digit percentage range, above all due to lower EBITDA pre, continuing investments in property, plant and equipment and in digitalization initiatives, as well as higher inventories.