[48] Provisions Audited

Provisions developed as follows:

Litigation

As of December 31, 2013, the provisions for legal disputes amounted to € 772.3 million (2012: € 678.9 million). Many of the legal disputes and official proceedings currently pending relate to the Merck Serono division. The legal matters described below represent the most significant legal risks.

Product-related and patent disputes
Rebif®

In Israel, Merck is party to three legal disputes with Israel Bio-Engineering Project Limited Partnership (“IBEP”). IBEP is asserting claims for intellectual property rights and the payment of license fees in the past and in the future. The legal disputes are connected to the financing of the development of Rebif®, a drug for the treatment of multiple sclerosis, and other products in the early 1980s. Merck has taken appropriate accounting measures.

Merck is also involved in a patent dispute in the United States with Biogen IDEC Inc., USA (“Biogen”). Biogen claims that the sale of Rebif® in the United States infringes on a Biogen patent. The disputed patent was granted to Biogen in 2009 in the United States. Subsequently, Biogen sued Merck and other pharmaceutical companies for infringement of this patent. Merck defended itself against all allegations and brought a countersuit claiming that the patent was invalid and not infringed on by Merck’s actions. A “Markman hearing” was held in January 2012. The parties are currently engaged in court-ordered mediation proceedings. Merck has taken appropriate accounting measures.

Antitrust proceedings
Raptiva®

In December 2011, the Brazilian federal state of São Paulo sued Merck for damages because of alleged collusion between various pharmaceutical companies and an association of patients suffering from psoriasis and vitiligo. The collusion is alleged to have aimed at an increase in the sales of the involved companies’ drugs to the detriment of patients and state coffers. Moreover, in connection with the product Raptiva®, patients have filed suit to receive compensatory damages. Merck has taken appropriate accounting measures for these legal disputes in the financial statements.

Drug pricing by the divested Generics Group

Merck continues to bear the risk of having to defend against certain litigation brought against the Generics Group, which was sold to Mylan, Inc. (USA) in 2007. In this context, Merck remains responsible for risks from cases in the United States which relate to drug pricing. Merck has taken appropriate accounting measures.

Paroxetine: In connection with the divested generics business, Merck is subject to antitrust investigations by the British Office of Fair Trading (“OFT”) in the United Kingdom. In March 2013, the OFT informed Merck of the assumption that a settlement agreement entered into in 2002 between Generics (UK) Ltd. and several GlaxoSmithKline companies in connection with the antidepressant drug paroxetine violates British and European competition law. As the owner of Generics (UK) Ltd. at the time, Merck was allegedly involved in the settlement negotiations and is therefore liable. The investigations into Generics (UK) Ltd. started in 2011, without Merck being aware of this. It is considered probable that the OFT will impose a fine on Merck. Merck has recognized appropriate provisions in this connection.

Citalopram: In June 2013, the European Commission imposed a fine on Merck for various agreements between its former subsidiary Generics (UK) Ltd. and the Danish company Lundbeck, which related to the antidepressant citalopram, patented by Lundbeck. The provision recognized in 2012 was partially utilized or released. For the remaining risks, appropriate accounting measures were taken. Merck has filed an appeal with the European Court.

In addition to provisions for the mentioned litigation, adequate provisions existed as of the balance sheet date for various smaller pending legal disputes.

Restructuring

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 2013, additional provisions related to the “Fit for 2018” transformation and growth program were set up. The aim of this program, which was established in 2012, 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 € 31.8 million (2012: € 14.7 million) from partial retirement arrangements. In addition, commitments from the closure of sites were included here. The advance payments made in 2013 in the amount € 202.6 million are primarily due to severance payments to employees.

Provisions for employee benefits/Share-based payment

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 the long-term 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® 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 € 63.5 million as of December 31, 2013 (2012: € 17.8 million). The net expense for fiscal 2013 was € 45.7 million (2012: € 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 tranche 2011 exist totaling € 37.3 million (2012: € 50.7 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 tranche.

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” transformation and growth 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 [49].

Environmental protection

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

Other provisions

Other provisions mainly 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.

A provision recognized for contingent consideration in connection with the acquisition of the microbiology business of Biotest AG, Dreieich, in the amount of € 15.0 million was paid in 2013. Also, in connection with discontinued research projects, recognized provisions were utilized, and a provision recognized for claims from the discontinued businesses was released.