[50] Provisions 

Provisions developed as follows:

As a pharmaceutical, chemical and life science company, Merck is exposed to a multitude of litigation risks. These include in particular risks in the areas of product liability, competition and antitrust law, pharmaceutical law, patent law, tax law, and environmental protection. We are engaged in legal proceedings and government investigations, the outcome of which is currently uncertain. A provision is set up for a proceeding if it can be assumed that an obligation from a proceeding is likely to lead to future cash outflows. Provisions comprise the estimated payment obligation as well as potential attorney fees and other legal costs. The individual provisions are reviewed on each balance sheet date. The actual cash outflows may deviate from the provisions set up since experience has shown that decisions by courts of law or government agencies involve uncertainties.

As of December 31, 2012, provisions amounted to € 678.9 million (2011: € 473.7 million). Provisions for litigation took into account the material litigation risks described in the following. As of the balance sheet date, provisions existed in connection with the legal dispute with Israel Bio-Engineering Project Limited Partnership (IBEP), in which IBEP claims intellectual property rights and license fees in connection with the funding and development of Rebif® and other products.

Existing provisions for a patent dispute with the company Biogen Idec in connection with the product Rebif® in the United States were adjusted owing to a revised risk assessment.

Our former generics subsidiary Dey Inc., USA, is alleged to have falsely reported price information. Although Dey Inc. was divested within the scope of the sale of the Generics business to Mylan Inc., PA (USA) in 2007, Merck continues to be liable for costs incurring from the aforementioned legal disputes since the mentioned risk was not transferred to Mylan. In this connection, claims were settled in a number of U.S. states as well as with the U.S. Department of Justice in previous years.

In connection with the divested Generics business, the European Commission opened administrative fine proceedings against Merck. It is alleged that Merck engaged in anticompetitive behavior in connection with the market launch of the product citalopram. A corresponding provision was set up.

As of the balance sheet date, provisions also existed for litigation with the federal state of São Paulo, Brazil. The federal state of São Paulo is demanding compensation from the Brazilian company Merck S.A., Brazil, in connection with the marketing of the product Raptiva®. Merck withdrew Raptiva® from the market globally in early 2009.

For various smaller pending legal disputes against companies of the Merck Group, provisions that are considered appropriate have been set up.

Provisions for restructuring mainly include provisions for severance payments for employees in connection with restructuring projects and provisions for onerous contracts. These were recognized once detailed restructuring plans had been prepared and communicated.

In 2012, provisions related to the “Fit for 2018” efficiency improvement and cost reduction program were set up. The aim of this program is to secure the competitiveness and the growth of the Merck Group over the long term. The provisions recognized in this connection mainly included future commitments to employees such as severance payments and € 14.7 million from partial retirement arrangements. In addition, commitments from the closure of sites were included here.

Provisions for employee benefits include obligations from long-term variable compensation programs. In 2012, the previous variable compensation program (Merck Long-Term Incentive Plan – LTIP) was replaced by a new long-term variable compensation plan aligned not only with target achievement based on key performance indicators, but above all with a sustainable performance of Merck shares. With the new Merck Long-Term-Incentive-Plan, certain executives and employees could be eligible to receive a certain number of virtual shares – Merck Share Units (MSUs) – at the end of a three-year performance cycle. The number of MSUs that could be received depends on the total value defined for the respective person and the average closing price of Merck shares in Xetra trading during the last 60 trading days prior to January 1 of the respective fiscal year (reference price). In order for members of top management to receive payment, they must personally own an investment in Merck shares dependent on their respective fixed annual compensation. When the three-year performance cycle ends, the number of MSUs to then be granted is determined based on the development of two key performance indicators (KPIs). These are on the one hand the performance of the Merck share price compared to the performance of the DAX® with a weighting of 70% and on the other hand the development of the EBITDA pre margin, during the performance cycle as a proportion of a defined target value with a weighting of 30%.

Depending on the development of the KPIs, at the end of the respective performance cycle the eligible participants are granted between 0% and 150% of the MSUs they could be eligible to receive. Based on the MSUs granted, the eligible participants receive a cash payment at a specified point in time in the year after the three-year performance cycle has ended.

The value of a granted MSU, which is relevant for payment, corresponds to the average closing price of Merck shares in Xetra trading during the last 60 trading days prior to January 1 after the performance cycle. The payment amount is limited to three times the reference price.

The fair value of the obligations is recalculated on each balance sheet date using a Monte Carlo simulation based on the previously described KPIs. The expected volatilities are based on the implicit volatility of Merck shares and the DAX® index in accordance with the remaining term of the LTIP tranche. The dividend payments incorporated into the valuation model orient towards medium-term dividend expectations. The value of the provision for the vesting period already completed was € 17.8 million as of December 31, 2012. The net expense for fiscal 2012 was likewise € 17.8 million.

The Executive Board members have their own Long-Term Incentive Plan, the conditions of which largely correspond to the Long-Term Incentive Plan described here. A description of the plan for the Executive Board can be found in the compensation report, which is part of the Statement on Corporate Governance.

Moreover, obligations from the previously valid, non-share-price-based LTIP tranches 2010 – 2011 exist totaling € 50.7 million (2011: € 33.7 million). The amount paid from these tranches depends on the achievement of the two performance indicators “Underlying Free Cash Flow on Revenues (FCR)” and “Return on Sales (ROS)” at the end of a three-year period. The plan has caps on potential future payments in the event of high degree of target achievement. By contrast, if the level of target of achievement is too low, no payments are made. The Executive Board was excluded from participating in the earlier LTIP tranches.

Provisions for employee benefits also include obligations for the partial retirement program and other severance pay that were not set up in connection with the “Fit for 2018” program as well as obligations in connection with long-term working hour accounts and anniversary bonuses.

With respect to provisions for defined-benefit pensions and other post-employment benefits, see Note [51].

Provisions for environmental protection existed in Germany and the United States and were mainly set up for obligations assumed from soil remediation and groundwater protection in connection with the discontinued crop protection business.

Other provisions include provisions for purchase commitments, subsequent contract costs stemming from discontinued research projects, other guarantees, and provisions for uncertain commitments from contributions, duties and fees.