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

The management report of Merck KGaA, Darmstadt, Germany, has been combined with the Group management report. The annual financial statements and the combined management report of the Group and Merck KGaA, Darmstadt, Germany, for 2018 are being filed with the electronic German Federal Gazette (elektronischer Bundesanzeiger) and are available on the website of the German company register.

Merck KGaA, Darmstadt, Germany, headquartered in Darmstadt, is the parent company of the Group. In addition to its function of a holding company, Merck KGaA, Darmstadt, Germany, generated sales in the Healthcare, Life Science and Performance Materials business sectors. Merck KGaA, Darmstadt, Germany, bears a significant portion of the Group-wide research and development costs, and employs the majority of the 11,000-plus workforce in Darmstadt.

The financial statements of Merck KGaA, Darmstadt, Germany, have been prepared in accordance with the provisions of the German Commercial Code (HGB), as amended by the German Accounting Directive Implementation Act (BilRUG), and the German Stock Corporation Act (AktG). The full version of the annual financial statements together with the unqualified auditor’s opinion has been submitted to the operator of the electronic Federal Gazette (elektronischer Bundesanzeiger), where they are published and forwarded to the Company Register.

Statement on Corporate Governance

The Statement of Corporate Governance according to section 289a of the German Commercial Code (HGB) is contained in the ‟Corporate Governance” section of the Annual Group Report.

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

SPIN-OFF OF OPERATING BUSINESS ACTIVITIES OF THE BUSINESS SECTORS AND TEMPORARY LEASEBACK OF THE SPUN-OFF BUSINESS ACTIVITIES

As part of the strategic development of Merck KGaA, Darmstadt, Germany, the existing operating activities of the Healthcare, Life Science and Performance Materials business sectors within Merck KGaA, Darmstadt, Germany, together with the relevant assets and liabilities (hereinafter: ‟operating sectors”) were spun off at their carrying values into three separate companies (hereinafter: ‟OpCo” or plural ‟OpCos”) with the legal form of a GmbH or German limited liability corporation (operating spin-off). This operating spin-off is based on the spin-off and takeover agreement concluded between Merck KGaA, Darmstadt, Germany, and the OpCos in notarized form on March 2, 2018. Following approval by the 2018 Annual General Meeting, the operating spin-off took place with economic effect as of 0:00 hours on January 1, 2018.

Immediately after the spin-off took effect, all shares held by Merck KGaA, Darmstadt, Germany, in the respective OpCos were transfered to holding companies via a further spin-off (holding company spin-off), as a result of which the OpCos are each indirectly held by Merck KGaA, Darmstadt, Germany, via an intermediate holding company. The acquiring legal entities within the scope of the holding company spin-off were Merck Healthcare Holding GmbH, a subsidiary of Merck KGaA, Darmstadt, Germany, for the business shares of Healthcare OpCo, Merck Life Science Holding GmbH, a subsidiary of Merck KGaA, Darmstadt, Germany, for the business shares of Life Science OpCo and Merck Performance Materials Holding GmbH, a subsidiary of Merck KGaA, Darmstadt, Germany, for the business shares of Performance Materials OpCo (referred to individually as ‟HoldCo”, independently of the sector, and jointly as ‟HoldCos”). To this end, Merck KGaA, Darmstadt, Germany, and the HoldCos signed a notarized spin-off and takeover agreement on March 2, 2018. The holding company spin-off took place with economic effect as of 0:00 hours on January 1, 2018.

Since the technical system requirements for the introduction of the sector-specific ERP systems as regards the OpCos were not in place at the time of the spin-off, the business activities spun off to the OpCos have been temporarily leased back by the relevant OpCos to Merck KGaA, Darmstadt, Germany, until the introduction of the sector-specific ERP systems. For this purpose, also on March 2, 2018, Merck KGaA, Darmstadt, Germany, entered into a business leasing contract with the respective OpCo with economic effect as of 0:00 hours on January 1, 2018, to lease back all the operating business previously spun off to the OpCo. Under the terms of the respective business leasing contract, Merck KGaA, Darmstadt, Germany, leases the entire operation from the respective OpCo, as well as all fixed assets in this context; it acquires the current assets as well as certain liabilities and provisions at their carrying amounts under German commercial law. The business lease allowed the spin-off measures to be implemented for all OpCos with economic effect at a uniform time, 0:00 hours on January 1, 2018, while retaining the flexibility of transitioning the management of the relevant operating business in accordance with the sector-specific ERP introduction at an individual time to the OpCo in question in a targeted manner. On the basis of the operating lease contract, Merck KGaA, Darmstadt, Germany, will temporarily continue to operate the spun-off business as a leaseholder in its own name and for its own account. Once the relevant ERP systems have been introduced for the respective OpCo, the business lease with this OpCo will be terminated and the business previously leased out will pass to the OpCo.

The aforementioned spin-off and business leasing contracts form part of an overall entrepreneurial concept. They were submitted to the General Meeting of Merck KGaA, Darmstadt, Germany, for approval on April 27, 2018 (2018 Annual General Meeting) as a coherent restructuring measure and approved by it. The gradual implementation of the measures is due to be completed in 2020. In 2018, the Healthcare OpCo changed its legal form to that of a German corporation with general partners (‟Kommanditgesellschaft auf Aktien”) and has since been trading under the name of Merck Healthcare KGaA, Darmstadt, Germany, a subsidiary of Merck KGaA, Darmstadt, Germany.

The table below shows the balance sheet of Merck KGaA, Darmstadt, Germany, after the operating spin-off, holding company spin-off and temporary leaseback as of 0:00 hours on January 1, 2018. The impact in fiscal 2018 of the spin-offs was mainly lower depreciation, amortization and write-downs of fixed assets and lower pension expenses. On the other hand, business lease expenses and the passing-on of costs for personnel-related provisions led to an increase in other operating expenses.

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€ million Merck KGaA,
Darmstadt,
Germany
Dec. 31, 2017
Merck KGaA,
Darmstadt,
Germany
Jan. 1, 20181
ASSETS
A. Fixed assets
Intangible assets 489.7 191.8
Tangible assets 1,173.0 821.6
Financial assets 16,485.7 17,510.7
18,148.4 18,524.2
B. Current assets
Inventories 688.3 688.3
Trade accounts receivable 181.3 181.3
Other receivables and other assets 891.6 591.6
Cash and cash equivalents 1.4 1.4
1,762.6 1,462.6
 
C. Prepaid expenses 28.5 28.5
Total ASSETS 19,939.5 20,015.3
 
EQUITY AND LIABILITIES
A. Net equity
Subscribed capital 168.0 168.0
General partner’s equity 397.2 397.2
Capital reserves 3,813.7 3,813.7
Retained earnings 701.6 701.6
Profit carried forward E. Merck KG, Darmstadt, Germany 60.3 60.3
Net retained profit: shareholders 187.1 187.1
5,327.9 5,327.9
B. Provisions
Provisions for pensions and other post-employment benefits 200.4 110.7
Other provisions 1,112.1 946.1
1,312.5 1,056.8
C. Liabilities
Financial liabilities 1,500.0 1,500.0
Trade accounts payable 292.1 292.1
Other liabilities 11,489.1 11,820.7
13,281.3 13,612.8
 
D. Deferred income 17.9 17.9
Total LIABILITIES 19,939.5 20,015.3
1
After operating spin-off, holding company spin-off and temporary leaseback.

Business development

Net sales of Merck KGaA, Darmstadt, Germany, decreased slightly in 2018. The decline of € 22 million resulted primarily from the Healthcare and Performance Materials business sectors, offset mainly by an increase in other sales.

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Change
€ million 2018 2017 € million in %
Healthcare 2,310 2,404 – 94 – 3.9%
Life Science 780 777 3 0.4%
Performance Materials 1,386 1,399 – 13 – 0.9%
Other sales 309 228 82 35.8%
Total 4,785 4,807 – 22 – 0.5%

Other sales mainly included intragroup cross-charging for IT services, rent and other administrative services.

The share of sales with other Group companies (Group sales) amounted to 93.6% in 2018 (2017: 93.6%).

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Change
€ million 2018 2017 € million in %
Group sales 4,477 4,500 – 23 – 0.5%
Sales to third parties 308 307 1 0.3%
Total 4,785 4,807 – 22 – 0.5%

At 86.7% (2017: 90.3%), the share of exports in 2018 was below the previous year’s level.

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Change
€ million 2018 2017 € million in %
Outside Germany 4,148 4,341 – 193 – 4.4%
Germany 637 467 170 36.5%
Total 4,785 4,807 – 22 – 0.5%

The decline in net sales of the Healthcare business sector was attributable to a one-time payment for future license payments in the previous year, which had increased sales. By contrast, net sales of products rose slightly in 2018. Business with cardiovascular medications (+ 5.1%), the oncology drug Erbitux® (+ 1.0%) and with thyroid medications (+ 3.8%) showed a moderate increase. All told, the business sector recorded declining sales in particular in the Middle East and Africa region, while sales rose especially in the Asia-Pacific region.

In the Performance Materials business sector, the previous year’s sales level was not reached by the Display Solutions business unit (– 0.8%). In addition, the Surface Solutions business unit recorded a slight drop in sales (– 2.0%) mainly affecting sales in the Middle East and Africa region. From a regional perspective, sales in Asia-Pacific were flat, while Europe recorded moderate losses and North America generated sales growth.

Net sales of the Life Science business sector were slightly above the previous year’s figure. The Research Solutions (– 3.0%) and Applied Solutions (– 5.0%) business units showed a slight decline in sales, which was offset by the increase in net sales in the Process Solutions business unit (+ 4.4%). Sales growth was generated in the North America and Asia-Pacific regions. By contrast, a slight fall was recorded in particular in the Europe and Middle East and Africa regions.

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Results of operations

Change
€ million 2018 2017 € million in %
Sales 4,785 4,807 – 22 – 0.5%
Other income 172 212 – 40 – 18.9%
Cost of materials – 1,776 – 1,505 – 271 18.0%
Personnel expenses – 1,305 – 1,258 – 47 3.7%
Depreciation, amortization and write-downs – 112 – 183 71 – 38.8%
Other operating expenses – 2,152 – 1,801 – 351 19.5%
Investment income/Write-downs of financial assets 1,234 847 387 45.7%
Financial result – 262 – 201 – 61 30.3%
Profit before profit transfers and taxes 584 917 – 334 – 36.4%
Profit transfers – 454 – 553 99 – 17.9%
Taxes 32 – 193 225 – 116.3%
Profit after profit transfers and taxes 162 171 – 9 – 5.3%

The decline in other income was mainly the result of lower gains from the release of provisions.

The increase in cost of materials was due to a higher amount of intragroup cross-charging and increased sales volume with declining prices in some cases; the cost of materials in relation to sales amounted to 37.1% (2017: 31.3%).

The rise in personnel expenses was due to higher wages and salaries as a result of the collectively agreed pay increase and the higher number of employees.

Depreciation, amortization and write-downs fell by 38.8% as a result of the decline in fixed assets following the spin-off.

The increase in other operating expenses was due to increased consulting costs and higher expenses in connection with the business lease as well as an increase in the passing-on of costs for personnel-related provisions; see section ‟Effects of material company agreements on the net assets, financial position and results of operations”.

Investment income rose essentially on account of higher profit transfers by OpCo companies; see section ‟Effects of material company agreements on the net assets, financial position and results of operations”. However, the reduced dividend payment by the Merck Holding GmbH, Gernsheim, Germany, a subsidiary of Merck KGaA, Darmstadt, Germany, had an offsetting effect.

The Financial result deteriorated due to lower fair values of plan assets.

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Assets

Change
€ million Dec. 31, 2018 Dec. 31, 2017 € million in %
Fixed assets 18,670 18,148 522 2.9%
Intangible assets 239 490 – 251 – 51.2%
Tangible assets 899 1,173 – 274 – 23.4%
Financial assets 17,532 16,486 1,046 6.3%
Current assets 2,336 1,763 573 32.5%
Inventories 725 688 37 5.3%
Trade accounts receivable 315 181 134 73.7%
Other receivables and other assets 1,293 892 401 45.0%
Cash and cash equivalents 3 1 2 142.9%
Prepaid expenses 34 28 6 21.1%
21,040 19,940 1,100 5.5%
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Equity and Liabilities

Change
€ million Dec. 31, 2018 Dec. 31, 2017 € million in %
Net equity 5,329 5,328 1 0.0%
Provisions 1,119 1,312 – 193 – 14.7%
Provisions for pensions and other post-employment benefits 288 200 87 43.2%
Other provisions 832 1,112 – 280 – 25.2%
Liabilities 14,575 13,281 1,295 9.8%
Financial liabilities 1,500 1,500
Trade accounts payable 446 292 154 52.7%
Other liabilities 12,629 11,489 1,141 9.9%
Deferred income 17 18 – 1 – 6.1%
21,040 19,940 1,100 5.5%

The net assets and financial position of Merck KGaA, Darmstadt, Germany, changed only slightly in comparison with the previous year. With a 5.5% increase in total assets, the equity ratio amounted to 25.3% (2017: 26.7%).

The operating spin-off led to a decline in intangible and tangible assets, while financial assets increased; see section ‟Effects of material company agreements on the net assets, financial position and results of operations”.

The increase in current assets (€ + 573 million) was mainly attributable to higher receivables from affiliates for profit transfers and other group cross-charging.

The drop in other provisions (€ – 280 million) resulted primarily from the operating spin-off; see section ‟Effects of material company agreements on the net assets, financial position and results of operations”.

The rise in other liabilities resulted primarily from the clearing account with the Merck Financial Services GmbH, Darmstadt, Germany, a subsidiary of Merck KGaA, Darmstadt, Germany.

Research and development

In 2018, research and development spending on projects of Merck KGaA, Darmstadt, Germany, and other Group companies totaled € 923 million (2017: € 685 million). A large portion was also incurred by companies outside the Group. In Darmstadt, Healthcare mainly focuses on research in the areas of oncology as well as autoimmune and inflammatory diseases. The rise of € 196 million in R&D spending by the Healthcare business sector was reflected in the increase of € 238 million in overall R&D spending (34.7%). At the same time, the Healthcare business sector accounted for 65.4% (2017: 59.6%) and thus the largest share 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, for innovative OLED applications and for materials for the production of integrated circuits. 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 the promotion of new developments. Improved test kits, chromatography methods, substrates for separating active substances, and innovations continue to be in the focus in the fields of microbiology and hygiene monitoring.

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Research and development costs

Change
€ million 2018 2017 € million in %
Healthcare 604 408 196 48.0%
Life Science 46 35 11 31.4%
Performance Materials 260 220 40 18.2%
Other R&D spending that cannot be allocated to the individual business sectors 13 22 – 9 – 40.9%
Total 923 685 238 34.7%

The ratio of research and development spending to sales was 19.3% (2017: 14.3%). Overall, the average number of employees working in research and development was 2,674. Merck KGaA, Darmstadt, Germany, is one of the main research sites of the Group, accounting for a share of 41.6% (2017: 32.0%) of total Group research and development spending.

Dividend

For 2018, we are proposing to the General Meeting the payment of a dividend of € 1.25 per share.

Personnel

As of December 31, 2018, Merck KGaA, Darmstadt, Germany, had 11,133 employees, representing an increase over the previous year (2017: 10,677).

Average number of employees by functional area:

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Personnel

Average number of employees during the year 2018 2017
Production 3,756 3,536
Administration 3,213 3,072
Research 2,674 2,515
Logistics 671 648
Sales and marketing 590 574
Other 79 128
Total 10,983 10,473

Risks and opportunities

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

Forecast for Merck KGaA, Darmstadt, Germany

DEVIATIONS OF ACTUAL BUSINESS DEVELOPMENT IN 2018 FROM THE PREVIOUSLY REPORTED GUIDANCE:

In the 2017 combined management report, net sales were forecast to increase slightly in the Life Science and Healthcare business sectors in fiscal 2018. A slight drop in net sales was forecast for the Performance Materials business sector.

The sales decline in the Healthcare business sector (– 3.9%) resulted primarily from lower license income. Sales of products were slightly above the previous year’s level. Sales growth was generated in the Oncology (+ 2.1%) and Fertility (+ 11.9%) business units. This sales growth was offset by declining sales in the other business units (Neurology & Immunology).

In 2018, sales in the Life Science business sector were flat overall. Declining sales in the Research Solutions (– 3.0%) and Applied Solutions (– 5.0%) business units were offset by rising sales in Process Solutions (+ 4.4%).

Continued high competitive pressure in the Display Solutions business unit (– 0.8%) led to a slight fall in Performance Materials net sales (– 0.9%). The Surface Solutions business unit additionally recorded a slight drop in sales (– 2.0%).

Net income was down compared to the previous year (– 5.3%). Higher other operating expenses (19.5%) contrast, in particular, with improved investment income (45.7%) and a reduction in tax expenses. Investment income rose primarily due to profit transfers of the newly established OpCo companies. However, the reduced dividend payment by the Merck Holding GmbH, Gernsheim, Germany, a subsidiary of Merck KGaA, Darmstadt, Germany, had an offsetting effect.

Forecast 2019

For fiscal 2019, a decline in net sales is expected overall due to the planned termination of the business leasing contract with Merck Healthcare KGaA, a subsidiary of Merck KGaA, Darmstadt, Germany, and the resulting transfer of the Healthcare business sector’s operating business.

A slight decline in net sales is forecast for the Performance Materials business sector. In the Life Science business sector, we expect a slight increase in net sales for fiscal 2019.

As in 2017, 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.

The Merck Financial Services GmbH, Darmstadt, Germany, a subsidiary of Merck KGaA, Darmstadt, Germany, will provide the company with sufficient financial resources and thus ensure liquidity.

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