Notes to the Interim Consolidated Financial Statements as of June 30, 2014

These consolidated financial statements have been prepared with Merck KGaA, Frankfurter Strasse 250, 64293 Darmstadt, Germany, which manages the operations of the Merck Group, as parent company.

Accounting policies

The interim financial statements of the Merck Group dated June 30, 2014 comply with IAS 34. They have been prepared in accordance with the International Reporting Standards (IFRS) in force on the reporting date and adopted by the European Union as well as in accordance with section 37w of the German Securities Trading Act (WpHG). In accordance with IAS 34, a condensed scope of reporting as compared with the consolidated financial statements as of December 31, 2013 was selected.

With the exception of the disclosure changes described in the following, there were no material changes to accounting policies in comparison with the previous year.

Effective January 1, 2014, two product groups, Neurobion® (a vitamin B-based analgesic) and Floratil® (a probiotic antidiarrheal), were transferred from the Merck Serono division to the Consumer Health division. A detailed presentation of the resulting disclosure changes in segment reporting can be found in the information on segment reporting.

The notes to the consolidated financial statements of the Merck Group for 2013, particularly the accounting policies, apply accordingly.

Income tax include the taxes on taxable profit levied in the individual countries plus changes in deferred taxes recognized in income. The income tax in the interim financial statements is calculated based on the income of the consolidated companies and the currently valid tax rate as a best possible estimate.

The preparation of the interim financial statements requires that assumptions and estimates be made to a certain extent. The assumptions and estimates are based on the current state of knowledge and the data available on the balance sheet date.

The following standards take effect as of fiscal 2014:

• IFRS 10 “Consolidated Financial Statements”
• IFRS 11 “Joint Arrangements”
• IFRS 12 “Disclosure of Interests in Other Entities”
• Amendments to IAS 27 “Separate Financial Statements”
• Amendment to IAS 28 “Investments in Associates and Joint Ventures”
• Amendment to IAS 32 “Financial Instruments: Presentation”
• Amendment to IAS 36 “Impairment of Assets”
• Amendment to IAS 39 “Financial Instruments: Recognition and Measurement”
• Amendments to IFRS 10 “Consolidated Financial Statements”
• Amendment to IFRS 11 “Joint Arrangements”
• Amendments to IFRS 12 “Disclosure of Interests in Other Entities”

The new rules do not have any material effects on the interim consolidated financial statements.

Merck applied the amendment to IAS 36 “Impairment of Assets” in advance in the consolidated financial statements as of December 31, 2013.

Scope of consolidation

As of June 30, 2014, 222 (December 31, 2013: 191) companies were fully consolidated. No companies were consolidated using either the proportionate consolidation method or the equity method as of the balance sheet date. Since the beginning of 2014, one merger took place. Three newly established companies, 28 entities of the AZ Electronic Materials S.A. Group as well as one further and to date immaterial company were included in the consolidated financial statements for the first time.

Acquisition of AZ Electronic Materials S.A.

Obtainment of control following the public offer

Within the scope of a public takeover offer, on May 2, 2014 Merck had received valid acceptances of the offer in respect of 81.3% of the share capital and thus obtained control of the publicly listed company AZ Electronic Materials S.A., Luxembourg (AZ). The purchase price as well as the payments made to obtain control were as follows:

By June 27, 2014, Merck’s shareholding in AZ had increased to 99.8%. On this date, Merck initiated a squeeze-out, which was completed on July 2, 2014 with the acquisition of the remaining shareholding of 0.2%. The acquisition of non-controlling interests after May 2, 2014 was recognized in equity as a transaction without a change of control. Above and beyond the purchase price to obtain control, the following purchase prices were paid in order to increase the shareholding:

Business activities as well as sales and earnings contribution of AZ

AZ is a leading global producer of specialty chemical materials that generated sales of US$ 730.3 million (2012: $ 793.9 million) and profit after tax of US$ 57.3 million (2012: US$ 83.3 million) in 2013. Around 67.5% of sales were attributable to the IC Materials division, which supplies specialty process chemicals used to manufacture integrated circuits in the highly differentiated premium segment. The Optronics division accounted for approximately 32.5% of sales in 2013. This division’s portfolio includes light-sensitive processing materials, or photoresists, for the manufacture of flat panel displays, as well as silicon-chemistry-based products for optoelectronics. As of the end of 2013, AZ had a total of 1,131 employees.

After May 2, 2014, Merck began to integrate AZ into the Performance Materials division. The aim of the acquisition is to further strengthen Merck’s materials and specialty chemicals business by joining forces with one the leading suppliers of high-tech materials for the electronics industry.

The impact of the consolidation of AZ on sales as well as net income after taxes between May 2, 2014 and June 30, 2014 amounted to € 88.5 million and € -19.9 million, respectively. This result takes into account higher cost of sales owing to the step-up of the acquired inventories to fair values.

Assuming the first-time consolidation of AZ had already taken place as of January 1, 2014, sales of the Merck Group for the period from January 1 to June 30, 2014 would have amounted to € 5,580.7 million (compared with reported sales of € 5,409.4 million) and net income after taxes would have been € 635.8 million (compared with reported net income after taxes of € 633.4 million). The determination of these figures assumed that the adjustments of the book values as a result of the purchase price allocation would have been identical.

Purchase price allocation

The acquired assets and liabilities were recognized at the following fair values on the date of the first-time consolidation. The possibility of measuring non-controlling interests at fair values on the acquisition date (full goodwill method) was not applied. Owing to takeover law restrictions, Merck could only gain access to the information needed to perform the purchase price allocation on the date on which it obtained control of AZ. For this reason, the purchase price allocation could not be entirely completed as of the report date. Therefore, the fair values presented in the following are to be considered preliminary.

The positive difference of € 840.8 million was recognized as goodwill. This results in particular from intangible assets that are not recognizable, for example the ability of AZ to develop new solutions and products in its technologically innovative industry as well as from synergy effects expected from the integration of AZ into the Performance Materials division.

The development of goodwill during the period from first-time recognition and June 30, 2014 was as follows:

Within the scope of the acquisition, no contingent consideration was agreed upon which Merck would possibly have to pay in the future. The selling shareholders did not contractually indemnify Merck for the outcome of a contingency or uncertainty related to the acquired assets or liabilities. Costs of € 6.7 million directly related to the acquisition of the company were recorded under other operating expenses in the first half of 2014.

The most significant impact of the purchase price allocation resulted from the remeasurement of intangible assets, property plant and equipment, as well as inventories at fair value. Since some of the acquired inventories were sold by June 30, 2014, this led to additional cost of sales that were offset by the sales achieved. As a result, the sale of these inventories did not generate any additional income. The intangible assets identified during the purchase price allocation and recognized on the date of first-time consolidation were to the largest extent attributable to technology-related intangible assets as well as to brand rights. The multi-period excess earnings method was used for the valuation of technology-related intangible assets. The relief from royalty method was used for the valuation of the brand rights.

No contingent liabilities were identified in the course of the purchase price allocation. The gross amounts of the acquired receivables on the acquisition date were € 130.5 million. The best possible estimate of the irrecoverable receivables amounted to less than € 0.1 million.

Divestment of the Discovery and Development Solutions business field

Effective March 31, 2014, the Discovery and Development Solutions business field of the Merck Millipore division was sold to Eurofins Scientific S.A., Luxembourg. The assets sold were reported as a disposal group in the consolidated financial statements as of December 31, 2013 and included property, plant and equipment, inventories, and goodwill allocated to the business field. The selling price amounted to € 22.6 million, payment of which had largely been received by the end of the second quarter of 2014.

License rights to ceralifimod returned

In October 2011, Merck had acquired exclusive global development and marketing rights to ceralifimod (ONO-4641) in multiple sclerosis (MS) outside Japan, South Korea and Taiwan from Ono Pharmaceutical Co., Ltd., Osaka, Japan (Ono). The drug candidate is currently in Phase II of clinical development. On June 17, 2014, Merck announced that it had reached a mutual agreement with Ono to terminate the license agreement and to return the license rights to Ono since the compound does not meet Merck’s criteria for further investment. The return of the license rights led in the second quarter to an impairment loss amounting to the full value of the relevant intangible asset of € 14.0 million. In addition, adequate provisions were set up for unavoidable subsequent costs that are likely to be incurred since under the terms of the agreement no further economic benefits are expected to flow to Merck.

Segment Reporting

Segmentation was performed in accordance with the internal organization and reporting structure of the Merck Group. The fields of activity of the individual divisions are described in detail in the sections about the divisions in the interim management report.

The column “Corporate and Other” includes assets and liabilities as well as income and expenses that cannot be directly allocated to the reportable segments. These mainly relate to Group functions. Moreover, the column serves the reconciliation to the Group numbers. The cash flows from the financial result and income taxes are also disclosed under “Corporate and Other”.

Apart from sales, the success of a segment is mainly determined by EBITDA pre one-time items (segment result) and business free cash flow. EBITDA pre one-time items and business free cash flow are performance indicators not defined by International Financial Reporting Standards. However, they represent important variables used to steer the Merck Group. To permit a better understanding of operational performance, EBITDA pre one-time items excludes depreciation and amortization in addition to specific income and expenses of a one-time nature presented in the following. Among other things, business free cash flow is used for internal target agreements and individual incentive plans.

Transfer prices for intragroup sales are determined on an arm’s-length basis. There were no significant intercompany relations between the business segments.

The following table presents the reconciliation of EBITDA pre one-time items of all operating businesses to the profit before income tax of the Merck Group.

Business free cash flow comprised the following:

One-time items were as follows:

The restructuring costs amounting to € 35.6 million in the first six months of 2014 (year-earlier period: € 46.7 million) mainly related to the “Fit for 2018” transformation and growth program. Asset impairments amounting to € 3.8 million (year-earlier period: € 30.5 million) were also attributable to the program, which together with the restructuring costs resulted in total expenses of € 36.7 million (year-earlier period: € 77.1 million) in connection with “Fit for 2018”.

The reconciliation of operating assets presented in the Segment Reporting to the total assets of the Merck Group was as follows:

Other operating expenses and income include the investment result of € 1.2 million for the first half (year-earlier period: € 1.4 million), which was attributable to Corporate and Other, as in 2013.

The adjustments of the previous year’s figures for the Merck Serono and Consumer Health divisions owing to the transfer as of January 1, 2014 of the two product groups Neurobion® (a vitamin B-based analgesic) and Floratil® (a probiotic antidiarrheal) from the Merck Serono division to the Consumer Health division are presented in the following table.

Earnings per share

Basic earnings per share are calculated by dividing the profit after tax attributable to the shareholders of Merck KGaA by the weighted average number of theoretical shares outstanding. The calculation of the theoretical number of shares is based on the fact that the general partner’s equity capital is not represented by shares. Subsequent to the resolution passed by the Annual General Meeting of Merck KGaA on May 9, 2014 approving a share split in a ratio of 1:2, the no-par-value shares with a pro rata amount of the share capital of € 2.60 each were divided into two shares with a pro rata amount of the share capital of € 1.30 each. In accordance with the redivision of the share capital of € 168.0 million into 129,242,252 shares, the general partner’s capital of € 397.2 million was divided into 305,535,626 theoretical shares. Overall, the total capital thus amounted to € 565.2 million or 434,777,878 theoretical shares outstanding. Taking the share split into account, the weighted average number of shares in the second quarter and in the first half of 2014 was likewise 434,777,878.

As of June 30, 2014, there were no potentially dilutive shares. Diluted earnings per share corresponded to basic earnings per share.

The calculation of basic and diluted earnings per shares was retroactively adjusted for all the reporting periods presented owing to the share split as of June 30, 2014.

Information on the measurement of fair value

On the reporting date, assets classified as available-for-sale financial assets and derivative financial instruments were measured at fair value.

Derivative financial instruments are used exclusively to hedge and reduce the risks of interest rate and foreign exchange positions.

The following derivative financial instruments were held as of the balance sheet date:

The maturity structure of the hedging transactions (nominal volume) is as follows as of the balance sheet date:

The forward exchange contracts and currency options entered into to reduce the exchange rate risk primarily served to hedge intercompany financing in foreign currency as well as to hedge future cash flows.

The following table presents the reconciliation of the balance sheets items to the classes of financial instruments in accordance with IFRS 7 and provides information on fair value measurement.

The fair value of financial assets and liabilities is based on the official market prices and market values quoted on the balance sheet date (Level 1 assets and liabilities) as well as mathematical calculation models with inputs observable in the market on the balance sheet date (Level 2 assets and liabilities). Level 1 assets comprise stocks and bonds and are classified as “available-for-sale”, Level 1 liabilities comprise issued bonds and are classified as “other liabilities”. Level 2 assets and liabilities are primarily liabilities to banks classified as “other liabilities”, interest-bearing securities classified as “available-for-sale” as well as derivatives with and without hedging relationships. The fair value of interest-bearing securities is determined by discounting future cash flows using market interest rates. The fair value measurement of forward exchange contracts and currency options uses spot and forward rates as well as foreign exchange volatilities applying recognized mathematical principles. The fair value of interest rate swaps is determined with standard market valuation models using interest rate curves available in the market.

The fair values of the financial instruments disclosed in the balance sheet and the fair values deviating substantially from the carrying amount were determined as follows:

Related-party disclosures

As of June 30, 2014 there were liabilities by Merck Financial Services GmbH to E. Merck KG in the amount of € 637.4 million as well as to Merck Capital Asset Management, Malta, and Merck Capital Asset Management Holding, Malta, amounting to € 0.2 million and € 0.1 million, respectively. In addition, as of June 30, 2014, there were receivables by Merck KGaA to E. Merck Beteiligungen KG in the amount of € 7.7 million as well as by Merck & Cie, Switzerland, to E. Merck KG in the amount of € 4.8 million. The balances resulted mainly from the profit transfers by Merck & Cie to E. Merck KG as well as the reciprocal profit transfers between Merck KGaA and E. Merck KG. They included financial liabilities of € 637.7 million, which were subject to standard market interest rates.

From January to June 2014, Merck KGaA performed services for E. Merck KG and Emanuel-Merck-Vermögens-KG with a value of € 0.7 million and € 0.2 million, respectively. During the same period, E. Merck KG performed services for Merck KGaA with a value of € 0.5 million.

Subsequent events

Effective July 2, 2014, Merck acquired the remaining outstanding shares of AZ Electronic Materials S.A. within the scope of a squeeze-out. Subsequent to the balance sheet date, no further events of special importance occurred that could have a material impact on the net assets, financial position and results of operations of the Merck Group.

Accounting for 73% of sales (Q2 2013: 75%), the Emerging Markets region generated the vast majority of the division’s sales. This is due to the concentration of customers for liquid crystals as well as high-tech materials from the new AZ business unit in Asia. Despite a high year-earlier basis, the already existing business units achieved soft organic sales growth of 2.3%. Sales in the Emerging Markets region rose by 17.8% due to acquisitions, in other words the takeover of AZ. Taking negative foreign exchange effects of –5.3% into account, sales in this region rose to € 370 million (Q2: 2013: € 323 million).