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 2016 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 section “Corporate Governance” of this Annual Report. It is also published on our website (www.merckgroup.com ➞ investors ➞ corporate governance).
Changes to accounting and measurement principles and disclosure changes
Due to the first-time application of the provisions of the German Accounting Directive Implementation Act (BilRUG), an adjustment was made to certain items of the previous year’s income statement. This applies to net sales and the corresponding cost of materials, as well as other operating income and expenses. The previous year’s figures in the income statement have been adjusted accordingly and are presented in the following table:
32 KB EXCEL| € million |
2015 Pre adjustment |
Adjustment |
2015 Adjusted |
|---|---|---|---|
| Sales | 3,888 | 778 | 4,666 |
| Other income | 966 | – 778 | 188 |
| Cost of materials | – 956 | – 464 | – 1,420 |
| Personnel expenses | – 1,123 | – | – 1,123 |
| Depreciations, amortization, write-downs and impairment losses | – 280 | – | – 280 |
| Other operating expenses | – 2,050 | 464 | – 1,586 |
| Investment result / Write-downs of financial assets | 339 | – | 339 |
| Financial result | – 175 | – | – 175 |
| Profit from ordinary activities | 609 | – | 609 |
| Profit transfers | – 373 | – | – 373 |
| Taxes | – 116 | – | – 116 |
| Profit after profit transfers and taxes / Net income | 120 | – | 120 |
Business Development
In 2016, Merck KGaA sales declined to € 4,465 million (2015: € 4,666 million). The decrease of € 201 million was due to the Performance Materials business sector. By contrast, the Healthcare and Life Science business sectors slightly increased their sales:
31 KB EXCEL| Change | ||||||
|---|---|---|---|---|---|---|
| € million | 2016 | 20151 | € million | in % | ||
| Healthcare | 2,232 | 2,217 | 15 | 0.7% | ||
| Life Science | 710 | 698 | 12 | 1.7% | ||
| Performance Materials | 1,407 | 1,637 | – 230 | – 14.1% | ||
| Other sales | 116 | 114 | 2 | 1.8% | ||
| Total sales | 4,465 | 4,666 | – 201 | – 4.3% | ||
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Other sales mainly included intragroup cross-charging for IT services and other administration services.
The share of sales with other Group companies (Group sales) declined in 2016 to 91.0% (2015: 93.6%).
30.5 KB EXCEL| Change | ||||||
|---|---|---|---|---|---|---|
| € million | 2016 | 20151 | € million | in % | ||
| Group sales | 4,063 | 4,366 | – 303 | – 6.9% | ||
| Sales to third parties | 402 | 300 | 102 | 34.0% | ||
| Total | 4,465 | 4,666 | – 201 | – 4.3% | ||
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At 89.4% (2015: 89.2%), the share of exports in 2016 was nearly at the previous year’s level.
30.5 KB EXCEL| Change | ||||||
|---|---|---|---|---|---|---|
| € million | 2016 | 20151 | € million | in % | ||
| Outside Germany | 3,990 | 4,163 | – 173 | – 4.2% | ||
| Germany | 475 | 502 | – 27 | – 5.4% | ||
| Total | 4,465 | 4,666 | – 201 | – 4.3% | ||
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The increase in sales by the Healthcare business sector was primarily attributable to the cross-charging of research and development services to Group companies. Excluding intragroup cross-charging, net sales would have declined. This was mainly attributable to declines in the sales of cardiovascular medicines (– 25.3%) and the oncology drug Erbitux® (– 2.5%). Net sales of cardiovascular medicines decreased mainly in the Asia-Pacific and Latin America regions. This was primarily the result of intensive inventory build-ups by customers in the fourth quarter of 2015. Net sales of products for the treatment of thyroid disorders were flat (+ 0.9%) in nearly all regions.
In 2016, sales of the Performance Materials business sector were lower than in the previous year. The decrease was due to weaker business of the Display Materials business unit, which generated lower sales particularly in the Asia-Pacific region. The Advanced Technologies (+ 13.7%) and Pigments & Functional Materials (+ 3.5%) business units maintained their level of sales primarily in Europe and expanded their sales in Asia-Pacific.
All the business areas of the Life Science business sector generated sales growth. The increases were mainly attributable to the Asia-Pacific region, whereas slight sales declines were registered in Latin America. In particular, the Applied Solutions business area generated higher sales (+ 3.4%), with sales in Europe increasing by 3.9%.
Results of operations
34 KB EXCEL| Change | ||||||
|---|---|---|---|---|---|---|
| € million | 2016 | 20151 | € million | in % | ||
| Sales | 4,465 | 4,666 | – 201 | – 4.3% | ||
| Other income | 185 | 188 | – 3 | – 1.6% | ||
| Cost of materials | – 1,488 | – 1,420 | – 68 | 4.8% | ||
| Personnel expenses | – 1,055 | – 1,123 | 68 | – 6.1% | ||
| Depreciation, amortization, write-downs and impairment losses | – 176 | – 280 | 104 | – 37.1% | ||
| Other operating expenses | – 1,726 | – 1,586 | – 140 | 8.8% | ||
| Investment result / Write-downs of financial assets | 659 | 339 | 320 | 94.4% | ||
| Financial result | – 243 | – 175 | – 68 | – 38.9% | ||
| Profit from ordinary activities | 621 | 609 | 12 | 2.0% | ||
| Profit transfers | – 400 | – 373 | – 27 | 7.2% | ||
| Taxes | – 65 | – 116 | 51 | 44.0% | ||
| Profit after profit transfers and taxes/ Net income | 156 | 120 | 36 | 30.0% | ||
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In comparison with 2015, other income reflected higher income from increases in inventories of internally generated production materials and lower gains from disposals of fixed assets and exchange rate changes.
The cost of materials increased slightly in relation to sales (33.3%; 2015: 30.4%).
Despite the increase in the headcount, personnel expenses declined. The main reason for this were lower pension expenses in comparison with 2015 as a result of applying the amended, legally stipulated discount rate for the calculation of pension provisions. The difference resulting from this change amounted to € 224 million and is barred from distribution by law.
Depreciation, amortization, write-downs and impairment losses decreased mainly owing to the decline of € 97 million in impairment losses. In 2015, impairment losses amounting to € 105 million were recognized on intangible assets owing to the termination of development projects. In 2016, impairment losses of this magnitude were not required.
Other operating expenses increased mainly as a result of the intensification of IT activities as well as from the disposal of an intragroup investment.
The investment result improved mainly due to a higher dividend payment amounting to € 500 million (2015: € 270 million) from Merck Holding GmbH, Gernsheim.
The majority of the funds required for the Sigma-Aldrich acquisition were borrowed at the end of 2015. The interest expenses incurred thereby were paid over the full fiscal year, thus increasing the negative financial result.
Net assets and financial position
32.5 KB EXCELAssets
| Change | ||||
|---|---|---|---|---|
| € million | Dec. 31, 2016 | Dec. 31, 2015 | € million | in % |
| Fixed assets | 17,563 | 17,770 | – 207 | – 1.2% |
| Intangible assets | 250 | 227 | 23 | 10.1% |
| Tangible assets | 1,003 | 921 | 82 | 8.9% |
| Financial assets | 16,310 | 16,622 | – 312 | – 1.9% |
| Current assets | 1,504 | 1,280 | 224 | 17.5% |
| Inventories | 635 | 617 | 18 | 2.9% |
| Trade accounts receivable | 291 | 213 | 78 | 36.6% |
| Receivables and other assets | 576 | 450 | 126 | 28.0% |
| Cash and cash equivalents | 2 | – | 2 | – |
| Prepaid expenses | 28 | 27 | 1 | 3.7 % |
| 19,095 | 19,077 | 18 | 0.1 % | |
Liabilities
| Change | ||||
|---|---|---|---|---|
| € million | Dec. 31, 2016 | Dec. 31, 2015 | € million | in % |
| Net equity | 5,290 | 5,268 | 22 | 0.4% |
| Provisions | 1,034 | 930 | 104 | 11.2% |
| Provisions for pensions and other post-employment benefits | 80 | 5 | 75 | – |
| Other provisions | 954 | 925 | 29 | 3.1% |
| Liabilities | 12,769 | 12,878 | – 109 | – 0.8% |
| Financial obligations | 1,500 | 1,500 | – | – |
| Trade accounts payable | 260 | 289 | – 29 | – 10.0% |
| Other liabilities | 11,009 | 11,089 | – 80 | – 0.7% |
| Deferred income | 2 | 1 | 1 | 100.0% |
| 19,095 | 19,077 | 18 | 0.1% | |
The net assets and financial position of Merck KGaA barely changed in comparison with the previous year. With total assets remaining almost constant, the equity ratio of 27.7% did not change.
An intragroup divestment of Merck Performance Materials Co. Ltd., Taiwan, led to a decline in financial assets in 2016.
At the Darmstadt site, the One Global Headquarters construction project made notable progress. This significantly contributed to the increase in tangible assets.
Current assets rose by € 224 million mainly owing to higher receivables from intragroup supply relationships with affiliates as well as higher tax receivables.
The increase in other provisions by € 29 million was primarily attributable to higher provisions for outstanding invoices. This compared with lower provisions for financial risks from development projects. Pension provisions rose owing to the increase in the present value of defined benefit obligations and the greater number of employees. At the same time, however, they were lowered by the effect of the statutory requirement to adjust the discount rate.
The decrease in other liabilities resulted primarily from intragroup profit transfers pursuant to profit and loss transfer agreements.
Research and Development
In 2016, research and development spending on projects for Merck KGaA and other Group companies totaled € 751 million (2015: € 782 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 € 126 million in R&D spending by the Healthcare business sector was reflected in the decline of € 31 million in overall R&D spending (– 4.0%). At the same time, the Healthcare business sector accounted for 64.3% (2015: 77.8%) 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.
31 KB EXCEL| Change | ||||
|---|---|---|---|---|
| € million | 2016 | 2015 | € million | in % |
| Healthcare | 483 | 609 | – 126 | – 20.7% |
| Life Science | 39 | 38 | 1 | 2.6% |
| Performance Materials | 223 | 130 | 93 | 71.5% |
| Other R&D spending that cannot be allocated to the individual business sectors | 6 | 5 | 1 | 20.0% |
| Total | 751 | 782 | – 31 | – 4.0% |
The ratio of research and development spending to sales was 16.8% (2015: 16.8%). Overall, the average number of employees working in research and development was 2,320. Merck KGaA is one of the main research sites of the Merck Group, accounting for 38.0% (2015: 45.7%) of total Group research and development spending. This decrease 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 2016, we are proposing to the General Meeting the payment of a dividend of € 1.20 per share.
Personnel
As of December 31, 2016, Merck KGaA had 9,988 employees,
a slight increase over the previous year (2015: 9,537).
Average number of employees by functional area:
30 KB EXCEL| Average number of employees during the year | 2016 | 2015 |
|---|---|---|
| Production | 3,270 | 3,114 |
| Administration | 2,359 | 2,254 |
| Research | 2,320 | 2,186 |
| Logistics | 624 | 583 |
| Engineering | 619 | 555 |
| Sales and marketing | 434 | 409 |
| Other | 118 | 348 |
| Total | 9,744 | 9,449 |
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 2016 from the previously reported guidance:
In the forecast for 2016 given in the annual financial statements of Merck KGaA for 2015, we expected sales to be at the previous year’s level. The effects of BilRUG were not included in the forecast. With the exception of the Healthcare business sector, the reclassifications pursuant to BilRUG were not of material significance to the development of sales.
For the Healthcare and Performance Materials business sectors we anticipated a slight decline in sales.
The cross-charging of research and development costs to Group companies led to an increase in sales by the Healthcare business sector. The expected decline in 2016 occurred with sales of the oncology drug Erbitux® (– 2.5%) and with cardiovascular medicines (– 25.3%). Sales of products to treat thyroid disorders were at the level we had forecast (+ 0.9%).
For the Performance Materials business sector, we anticipated a decline in sales owing to continued high competitive pressure on liquid crystals. This development occurred and led to a significant decline in sales of the Display Materials business unit (– 23.3%). The Advanced Technologies (+ 13.7%) and Pigments & Functional Materials (+ 3.5%) business units increased their respective sales; however, the sales of the Performance Materials business sector declined overall by 14.1%.
In contrast to expectations, the increase in sales by the Life Science business sector (+ 1.7%) could not compensate for the decrease in sales by the other business sectors.
In the annual financial statements for 2015, a decline in net income for 2016 was forecast.
Net income was mainly impacted by a decline in sales and higher financing costs in connection with the acquisition of Sigma-Aldrich. By contrast, pension expenses, which declined owing to the application of the legally stipulated discount rate for the measurement of pension provisions, had a positive effect on net income. Overall, net income increased owing to higher investment income. The financial resources for the company continue to be provided by Merck Financial Services GmbH, Darmstadt.
Forecast 2017
For fiscal 2017, slight increases in sales are expected for all three business sectors: Healthcare, Performance Materials and Life Science.
The financing costs of the Sigma-Aldrich acquisition will continue to adversely affect net income. Nevertheless, owing to positive investment income and dividend payments from subsidiaries, we expect net income to increase slightly. The financial resources for the company will be provided by Merck Financial Services GmbH, Darmstadt.
Currently no risks can be identified that could jeopardize the continued existence of Merck KGaA.
The internal control system for the accounting process in accordance with section 289 (5) of the German Commercial Code (HGB)
The annual financial statements of Merck KGaA are prepared by Merck Accounting Solutions & Services Europe GmbH, Darmstadt, an independent legal entity within the Merck Group. The financial statement process of Merck KGaA is based on the accounting provisions of the German Commercial Code (HGB) with due consideration of key processes and uniform deadlines. The objective of the internal control system for the accounting process is to implement controls that will provide the security needed to ensure that financial statements are prepared in compliance with the relevant accounting laws and standards. It covers measures designed to ensure the complete, correct and timely conveyance and presentation of information that is relevant for the preparation of the financial statements. The accounting processes are monitored via a stringent internal control system that ensures accounting accuracy as well as compliance with the relevant legal regulations.
The main rules and tools used are as follows:
- Accounting guidelines based on Group-wide guidelines. These Group-wide accounting guidelines are the responsibility of Group Accounting and are available to all employees of the relevant units via the Merck intranet. Detailed account allocation instructions are provided here for all major transactions. These guidelines include, for example, clear requirements for the inventory valuation process and transfer pricing within intragroup supply relationships.
- Clearly defined segregation of tasks and assignment of responsibilities to the units involved in the accounting process. Through corresponding organizational measures, we ensure that in the accounting system duties are segregated between the booking of transactions and the review and approval of transactions. These measures include the power of disposition approved by the Executive Board in relation to authorizing contracts and credit notes, as well as consistently implementing a dual-control principle.
- Involvement of external experts as needed, for example for the valuation of pension obligations
- Use of suitable, largely uniform IT finance systems and the application of detailed authorization concepts to limit user rights on a need-to-have basis, taking into account principles concerning the segregation of duties
- System-based IT controls as well as manual, process-integrated controls, particularly within the scope of the accounting process
- Consideration of risks recorded and assessed by the risk management system in the annual financial statements insofar as this is required by existing accounting rules
The management of the respective department is responsible for the implementation of these rules and utilization of the tools.
The annual financial statements of Merck KGaA are the responsibility of the Chief Financial Officer, who is a member of the Executive Board of Merck KGaA. This responsibility is laid down in the rules of procedure of the Executive Board.
All the structures and processes described are subject to constant review by Group Internal Auditing. The Executive Board determines the structures and processes that are to be audited in an annual audit plan.
The results of these audits are dealt with regularly in meetings of the Executive Board, the Supervisory Board, as well as the Finance Committee of E. Merck KG.