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Report on Expected Developments

The following report provides a forecast for fiscal 2017 of the development of the Merck Group and its three business sectors: Healthcare, Life Science and Performance Materials. The forecast covers our key performance indicators as in the previous year, namely net sales, EBITDA pre exceptionals and business free cash flow. Apart from the divestment of the business in Pakistan as well as the acquisition of BioControl Systems, Inc., USA, (BioControl) in the Life Science business sector, our forecast does not include any further portfolio changes. Merck is in advanced stages of negotiations to divest the Biosimilars business and the transaction is expected to close in 2017. The research and development expenses of this business amounted to around € 130 million in 2016.

Forecast for the Merck Group

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€ million Actual results 2016 Forecast for 2017 Key assumptions
Net sales 15,023.5 – Slight to moderate organic growth
– Neutral exchange rate effect
– Slight organic growth in Healthcare
– Solid organic growth of Life Science slightly above market growth
– Slight organic growth in Performance Materials
– Neutral exchange rate effect due to positive €/US$ development and negative exchange rate developments in various growth markets
EBITDA pre exceptionals 4,490.4 – About stable compared with 2016; this comprises
a slightly positive or negative percentage fluctuation around the previous year’s level
– In Healthcare rising research and development expenses
– Further realization of synergies from the integration of Sigma-Aldrich in Life Science
– Slight sales recovery and active cost management in Performance Materials
Business free cash flow 3,318.2 – Single-digit percentage decline – Higher investments in property, plant and equipment as well as in ­digitalization initiatives

Net sales

For the Group, we expect slight to moderate organic sales growth in 2017 compared with the previous year. Exchange rate changes are predicted to lead to a neutral exchange rate effect in 2017 for the Merck Group as a whole. This forecast is based on a €/US$ exchange rate in the range of 1.06 – 1.10, representing a positive currency effect for 2017 in comparison with 2016. By contrast, we continue to assume a further weakening of the currencies in several of our key growth markets, for instance in Latin America. Owing to the current political and macroeconomic developments, overall exchange rate volatility for 2017 is likely to remain high.

For the Healthcare business sector, we forecast a slight increase in organic sales in 2017. This will continue to be driven mainly by the strong dynamics in our growth markets, which should offset the market environment for Rebif®, which remains challenging, and continuous price pressure in numerous markets. In addition, we expect organic sales growth to benefit slightly from the full takeover of the commercialization of the antidiabetic agent ­Glucophage® in China from Bristol-Myers Squibb Company, USA, (BMS) as of the beginning of 2017.

In the Life Science business sector, for 2017 we predict solid organic growth of net sales slightly above expected market growth. Process Solutions should once again contribute to this to a considerable extent.

For the Performance Materials business sector, we expect slight organic growth of net sales in 2017 compared with 2016. We anticipate volume increases in all business units. In the Liquid Crystals business, however, we cannot rule out that the initial signs of a normalization in our market shares from the very high level of previous years will continue.

EBITDA pre exceptionals

EBITDA pre exceptionals is our key financial indicator to steer operating business. For the Merck Group as a whole, we assume that in 2017 EBITDA pre exceptionals will remain about stable compared with 2016; this encompasses a slightly positive or negative percentage fluctuation around the previous year’s level.

For the Healthcare business sector, we expect a high single-digit percentage decline in EBITDA pre exceptionals compared with 2016, particularly owing to further increases in research and development expenses for our pipeline.

For the Life Science business sector, in 2017 we expect growth of EBITDA pre exceptionals in the high single-digit to low teens percentage range compared with 2016 due to good organic sales performance. The continued realization of synergies as planned from the Sigma-Aldrich acquisition will also contribute to this.

The recovery in the display market, which became visible towards the end of 2016, as well as the broadened earnings base and high cost discipline in our Performance Materials business sector are factors which lead us to assume that in 2017 we will see slightly higher EBITDA pre exceptionals compared with the level of 2016.

In 2017, the expenses reported under Corporate and Other are expected to improve slightly in comparison with 2016.

Business free cash flow

For the business free cash flow of the Merck Group, we predict a single-digit percentage decline in 2017, driven by higher investments in property, plant and equipment and digitalization projects.

Forecast for the Healthcare business sector

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€ million Actual results 2016 Forecast for 2017 Key assumptions
Net sales 6,855.0 – Slight organic growth – Organic sales increases in growth markets offset continued decline in Rebif® sales
– Continued price pressure in Europe and also in the Asia-Pacific as well as Middle East and Africa regions
– Full takeover of the commercialization of the antidiabetic agent Glucophage® in China from BMS contributes slightly to sales growth
Low negative portfolio effect due to the divestment of the business in Pakistan, which generated sales in the mid double-digit million range in 2016
EBITDA pre exceptionals 2,127.9 High single-digit percentage decrease in EBITDA pre ­exceptionals compared with 2016 – Continued rise in research and development spending due to further pipeline development, particularly in immuno-oncology
– Negative product mix effect due to the decline in sales of Rebif®
– Absence of exceptional income recorded in 2016, such as the release of ­provisions for research projects discontinued in prior years and the divestment of a minority interest
Royalty income for Avonex®due to a patent granted in the United States in 2016
– Contractually agreed one-time payment as compensation for future royalty payments
Business free cash flow 1,648.1 – Low double-digit percentage decline – Decline in EBITDA pre exceptionals
– Continued investments in property, plant and equipment as well as ­digitalization within the scope of strategic initiatives

Net sales

For the Healthcare business sector, we forecast slight organic sales growth in 2017. Developments in our growth markets in the Latin America, Middle East and Africa, as well as Asia-Pacific regions are expected to contribute to this growth to a large extent. Likewise, we assume that the full takeover of the commercialization of the antidiabetic agent Glucophage® in China from BMS as of the beginning of 2017 will have a slightly positive influence on our sales. These positive effects should offset the continued expected decline in sales of Rebif® as well as sustained price pressure in Europe, Asia-Pacific, as well as in the Middle East and Africa region. Furthermore, we predict that our Consumer Health business will also contribute to the positive organic sales development. We assume that the divestment in the fourth quarter of 2016 of our business in Pakistan, which generated sales in the mid double-digit million range, will lead to a slight portfolio-related sales decline in 2017. Beyond this, our forecast does not reflect any further changes to our portfolio in 2017.

EBITDA pre exceptionals

For 2017, we forecast a decline in EBITDA pre exceptionals of the Healthcare business sector in the high single-digit percentage range compared with 2016. This will once again be mainly driven by research and development spending for the further development of our pipeline. Here we are investing heavily in our research projects in immuno-oncology, for example. We also expect further intensive research activities in other areas, for example in the four oncology research and development programs in-licensed in January 2017 from Vertex Pharmaceuticals Inc., USA. Moreover, we assume that our product mix will develop unfavorably owing to the expected decline in sales of our highly profitable product Rebif®. In 2017, there will be an absence of positive one-time effects that we realized in 2016. These include, among other things, the divestment of a minority interest as well as the release of provisions for research projects discontinued in previous years. In our estimation, royalty income from a patent granted in the interferon segment in the United States in 2016 will increase earnings. In addition, we entered into a contractual agreement in February 2017, under which we will receive a one-time payment of US$ 123 million (€ 114 million based on the exchange rate on February 6, 2017) as compensation for future royalty payments. Despite the resulting absence of regular license and royalty income, this will lead to an improvement in EBITDA pre exceptionals in the mid to high double-­digit million euro range in 2017. However, these positive effects will only partially offset the aforementioned negative developments.

Business free cash flow

In 2017, we expect a low double-digit percentage decline in the business free cash flow of the Healthcare business sector. Apart from the expected decline in EBITDA pre exceptionals, continued investments in property, plant and equipment as well as digitalization initiatives are likely to contribute to this.

Forecast for the Life Science business sector

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€ million Actual results 2016 Forecast for 2017 Key assumptions
Net sales 5,657.9 – Solid organic growth, and thus slightly above expected market growth of around + 4 % per year – Process Solutions likely to remain the strongest driver of growth
– Research Solutions and Applied Solutions also to contribute positively to organic sales growth albeit to a lesser extent
– Low positive portfolio effect due to the acquisition of BioControl, which ­generated sales of US$ 34 million in 2015
EBITDA pre exceptionals 1,652.3 – Growth over 2016 in the
high single-digit to low
teens percentage range
– Positive development due to the expected sales growth
– Realization of synergies as planned from the Sigma-Aldrich ­acquisition amounting to an additional € 80 million compared with 2016
Business free cash flow 1,144.0 – Increase in the twenties ­percentage range – Higher EBITDA pre exceptionals
– Improved management of inventories

Net sales

For the Life Science business sector, we forecast solid organic growth of net sales in 2017, thus slightly exceeding expected market growth of around 4% per year. We expect that all the business areas will contribute positively to this. The Process Solutions business area is likely to remain the strongest driver of organic growth in 2017. Yet the Research Solutions and Applied Solutions business areas should also contribute to the positive development. Additionally, we expect that initial sales synergies in the course of the advancing Sigma-Aldrich integration will make a positive contribution to organic sales growth. At the end of 2016 we acquired the company BioControl, which generated sales of around US$ 34 million in 2015. The first-time consolidation is likely to lead to a low, positive portfolio effect in 2017.

EBITDA pre exceptionals

EBITDA pre exceptionals of the Life Science business sector is forecast to grow in 2017 in a high single-digit to low teens percentage range compared with 2016. This is in line with the expected development of sales. Furthermore, in 2017 we will continue to pursue with high priority the realization of synergies as planned from the acquisition of Sigma-Aldrich. Having already realized cost synergies of around € 105 million in 2016, we expect additional synergies of around € 80 million in 2017.

Business free cash flow

For business free cash flow of our Life Science business sector, we forecast an increase in the twenties percentage range. In particular, the development of EBITDA pre exceptionals will contribute to this. Moreover, we expect that improved management of inventories will have a positive effect on business free cash flow.

Forecast for the Performance Materials business sector

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€ million Actual results 2016 Forecast for 2017 Key assumptions
Net sales 2,510.7 – Slight organic growth – Volume increases in all businesses driven, among other things, by a recovery in the display market visible since the end of 2016
– Continued price decline typical for the Liquid Crystals business
EBITDA pre exceptionals 1,106.4 – Slight increase – Recovery in the display market, broadened earnings base and active cost management could more than offset the continued price decline in liquid crystals
Business free cash flow 1,010.7 – Low double-digit
percentage decrease
– Higher investments in property, plant and equipment as well as in
digitalization initiatives

Net sales

We forecast slight organic sales growth in the Performance Materials business sector in 2017 compared with 2016. All businesses are likely to contribute positively to this through volume increases. The recovery in the display market, which became visible towards the end of 2016, should have a positive effect on the Liquid Crystals business. Here we cannot rule out, however, that the initial signs of a normalization in our market shares from the very high level of previous years will continue. In addition, the typical price pressure in the Liquid Crystals business is likely to continue also in 2017 and impact our organic sales growth.

EBITDA pre exceptionals

The recovery in the display market, which became visible towards the end of 2016, as well as the broadened earnings base with meanwhile four strong business units and active cost management should offset the continued price decline in liquid crystals. Consequently, for our Performance Materials business sector we forecast slightly higher EBITDA pre exceptionals in 2017 compared with the previous year’s level.

Business free cash flow

For the Performance Materials business sector, we forecast a low double-digit percentage decline in business free cash flow. In particular, we assume higher investments in plant, property and equipment as well as in digitalization initiatives.

Summary

For 2017, we expect the Merck Group to see slight to moderate organic sales growth, to which all business sectors are forecast to contribute. As regards exchange rates, overall we expect a neutral effect on our sales, with a slightly positive €/US$ development and negative exchange rate developments in various growth ­markets.

EBITDA pre exceptionals of the Merck Group should remain about stable compared with 2016; this encompasses a slightly positive or slightly negative percentage fluctuation around the previous year’s level. In the Healthcare business sector we continue to expect rising research and development expenses for the further development of the pipeline as well as a negative product mix effect. We estimate that the Life Science business sector will see organic growth slightly above the market and continue the realization of synergies from the acquisition of Sigma-Aldrich with high priority. In the Performance Materials business sector, the broadened earnings base and high cost discipline are expected to help offset the typical price decline in liquid crystals.

Business free cash flow of the Merck Group could decline in the single-digit percentage range owing to higher investments in property, plant and equipment as well as in digitalization projects.