Executives: Constantin Fest - Head of IR Stefan Oschmann - CEO Walter Galinat - CEO of Performance Materials Marcus Kuhnert - CFO Kai Beckmann -

CAO
Analysts: Peter Verdult - Citi Richard Vosser - JPMorgan Matthew Weston - Credit Suisse Florent Cespedes - Societe Generale Gunnar Romer - Deutsche Bank Vincent Meunier - Morgan Stanley David Evans - Kepler Cheuvreux Simon Baker - Exane Holger Blum - Deutsche

Bank
Operator: Dear ladies and gentlemen, welcome to the Merck investor/analysts conference call on second quarter results 2017. [Operator Instructions] May I now hand you over to Constantin Fest, Head of Investor Relations, who will lead you through this conference. Please go ahead, sir.

Constantin Fest: Many thanks Jasmine and a warm welcome from my side here in Darmstadt to this Merck Q2 2017 conference call. My name is Constantin Fest, I'm Head of Investor Relations at Merck.

Joining us today on this call is Stefan Oschmann, our Group CEO; Walter Galinat, CEO of Performance Materials; and Marcus Kuhnert, our Group CFO. Also stepping in for a few minutes during the start of this call and to introduce himself to you is Kai Beckmann, who will soon be in charge of the Performance Materials business sector. As always, we'd like to run you briefly through the key slides of this presentation. And then we'd be happy to take all of your questions. With this and without any further delay, I would like directly to hand over to Stefan.

Stefan Oschmann: Thank you very much, Constantin and welcome to - everyone to this quarter's earnings call. I want to give you briefly a couple of highlights from Q2. Healthcare had a solid performance in Q2 and we saw further positive news from our pipeline. As you know, we received the FDA approval for Bavencio for bladder cancer second-line and the EMA's CHMP issued a positive opinion on two of our pipeline candidates in the last 6 weeks for Mavenclad in multiple sclerosis and for avelumab to treat MCC. Life Science saw a pickup in growth in Q2 versus Q1, despite a persistently challenging prior year base and margins are well on track.

For Performance Materials, the quarter was difficult. We had discussed the market share adjustments in Liquid Crystals already in our Q1 earnings call, and in Q2 the decline continued. Walter will give you more insights later. So compared to the beginning of this year, Q2 overall was clearly more challenging for us, with [indiscernible] remaining in correction mode, with the one-time royalty gain from Q1 out and exchange turning negative in the last weeks. Nevertheless, we are committed to manage these headwinds and maintain our guidance range for the bottom line of an EBITDA pre of EUR4.4 billion to EUR4.6 billion.

A couple of words about this morning's news. With the changes to our Executive Board, we are underscoring on one hand continuity within the board, while setting the course for the future of Performance Materials. Over the past decade or even longer than that, Walter Galinat has led Performance Materials from one success to the next. His name is legendary within our company and we are very grateful to him for this, and we are pleased to continue building on his vast wealth of experience. And as an experienced member of our Executive Board, Kai Beckmann has extensive business, technological and international expertise, among other things, from the very important Asian markets.

For him and for Mac, the aim now is to pave the way to a successful future for Performance Materials. And as he is here with us on the call today, I would say it's probably best if he says a couple of words about himself. So Kai, welcome.

Kai Beckmann: Thank you Stefan for the opportunity to quickly step into this call and to introduce myself. I'm really excited to take over this task and there are quite a number of reasons for my excitement.

Let me just explain two of them. First, I am absolutely passionate about technology. I have an information technology background. In my earlier years as a research assistant, I even spent time with microelectronics and the design of microchips. So technology matters a lot to me.

And second, the focus towards Asia. Not only since I led the Merck business in Singapore and Malaysia, many projects and business just brought me to Asia again and again. And it is just fantastic to see how dynamic these markets are. And of course, I know the Performance Materials business and its 4 pillars and I am familiar with the market environment of the LC business. I now look forward to dive deeper into all the details.

It's really impressive to witness how Walter successfully navigated this business in a very dynamic market environment. Starting September 1, it is now my turn, together with the team, to prepare the business for future growth. I am glad to have Walter with all his experience and all his expertise by my side to ensure a smooth handover. And in the nutshell, I feel honored and privileged to take over responsibility for this fascinating business globally. And with this, I hand back to Stefan.

Thank you Stefan.

Stefan Oschmann: Thank you Walter. We are all excited to have you still in our team in this new important function. I would now move on in the slide deck, and I am on - I have difficulties reading the slide number Constantin, it's among slide 5. So the key messages are, in Q2, net sales grew organically by about 2%, driven by Life Science and Healthcare, which more than offset the lower sales in Performance Materials.

Currencies were still marginally positive for us in Q2. Especially the strength of the euro towards the end of the quarter has reduced the benefit for us. EBITDA pre declined by just over 6% year-over-year to EUR 1.093 billion in Q2. Life Science was on track with a 9% year-over-year increase in EBITDA pre. And Healthcare EBITDA pre decreased versus last year, predominantly as our marketing and selling costs continued to rise ahead of the anticipated pipeline launches.

In Performance Materials, EBITDA pre declined visibly by 12% year-over-year and we will talk through the main drivers later on. Now on the next - I am on the next chart. When you look at the regional distribution of our net sales, the picture hasn't really changed compared to the last few quarters. North America accounts for 25% of our sales and Europe and Asia-Pacific account for roughly one-third each. And for the detailed financials I now hand over to our CFO, Marcus Kuhnert.

Marcus Kuhnert: Thank you Stefan and good afternoon from my side. And we jump to slide number 9 and I will walk you briefly through the key financials of the quarter. The EBITDA pre in Q2 came in at EUR 1,093,000,000, which is EUR65 million below last year's levels and EUR 147 million below Q1 2017. The drivers for this decline are not new and we discussed them extensively in previous conference calls. First of all, you know that in Q1 2017, we benefited from a lump sum payment in exchange for future royalty and license income of some EUR100 million in our Healthcare business.

Secondly, this leads to a sequential decline in EBITDA pre in Healthcare. On top of this, we continue to ramp up our R&D and marketing and selling activities as planned. We prepare on the one hand for the upcoming launches for Bavencio and for Mavenclad and we are further investing into of our pipeline, as you know. The third point worth to mention is that we have still ongoing market share correction in our Liquid Crystals business, which adversely affects the earnings and margins in Performance Materials, both year-on-year and also in a quarterly comparison versus Q1. The earnings per share before exceptionals are pretty stable year-on-year, as the decrease in EBITDA pre versus last year is basically mitigated by considerably better financial results.

Net financial debt is slightly higher compared to the end of March, but significantly lower than year-end 2016. Please keep in mind that in the second quarter, we always face a quarter of some significant cash-out items. First and foremost to mention, the dividend payment, but also the payout of the bonus accruals to our employees. And this leaves us with a net debt-to-EBITDA ratio of around about 2.5 by the end of Q2, and of course we are fully committed to continue the way of deleveraging. I expect that we will pay back this year more than EUR 1 billion in net financial debt - or net financial debt reduce by more than EUR 1 billion in 2017.

Going to Slide number 10. I am having a look at the reconciliation from EBIT- to- earnings per share. While our EBITDA pre, as we have just seen, is some EUR65 million below prior year, you will notice that the EBIT, in fact, is above last year's level. We are talking about roughly EUR140 million swing, which is pretty much due to two special effects, so to say. On the one hand, in Q2 last year we had the impairment of Xalkori, due to the anticipated entry of a new competitor in that space.

And secondly, this year in the second quarter, we have reversed an impairment write-down of our third line in Vevey of our biggest biopharma production facility, which we had undertaken in 2011 and now after the approval of Bavencio, we are pretty confident that we will - that we are going to use this line again in the future and thus we have reversed the impairment. The financial result has improved markedly. The smaller effect actually comes from the interest result amidst the further progress in deleveraging. The bigger effect is actually attributable to changes from our long term in certain tenders provision. So, here we have seen amid not a worse share price performance and then at the same quarter in the last year, we have seen more favorable P&L effect.

Effective tax rate is the envisaged range between 23% and 25% and net income and earnings per share are up by approximately 35% and the effect that I just mentioned. Let's now dive a little bit deeper into the P&Ls of our three business sectors. I'm on slide 11 starting with Healthcare. Healthcare had a solid performance in the second quarter. The base business remains on track with organic net sales growth of 2.6% and we have now the 24th consecutive quarter of stable to slight organic sales growth with as we call that the base business so actually excluding any pipeline sales.

Rebif sales have declined organically by approximately 4% year-on-year with good performance in North America supported by a positive inventory effect and despite unfavorable tender phasing effect in Europe. Erbitux swung a little bit into negative territory in Q2 on the back of strong prior year quarter and a persistently difficult environment in Europe. You will remember we had a positive - a very positive start in Q1. Now we see some phasing effects, but we continue to believe that Erbitux all in all should be establish going forward so the longer-term perspective. Net sales in Gonal-f declined by approximately 7% year-on-year.

This is largely due to the very high base last year in the U.S. Also, this is not new. We have pointed to that at the beginning of the year that we were facing in 2016 strong benefits from a, I would say, unique competitive situation where up to two competitors were completely absent from the market for quite a while of time. As indicated in the last call, R&D costs are rising as we work through our pipeline programs. For 2017 overall, we continue to expect R&D costs to rise by some EUR150 million to EUR200 million versus 2016.

And with the two approvals and the positive CHMP opinion on cladribine tablets, we are also stepping up our launch initiatives, which is the key driver for the increase in marketing and selling costs. Slide 12, Life Science saw solid demand in Q2 and a slight uptick in momentum compared to the first quarter still against pretty tough comparables. However, when you look into the businesses, you will notice very little change at Research Solutions and at Applied Solutions, but a considerable improvement versus Q1 in Process Solutions with a 7.5% organic sales growth. Good news here, however, is that all of the three business units have contributed positively to the 4.2% organic growth that we have seen in Life Science. At the beginning of the year, we had seen some of our larger customers with slower ordering pattern, which has not fully recovered yet.

But our single-use business and the service business are developing very well. Unchanged versus our view in May, Life Science should be able to grow slightly above the market growth of what we see at the moment being 4% in 2017 and on top of that, synergies are ramping up and the business continues to grow. On that basis, we achieved a 9% growth in EBITDA pre in the second quarter and very healthy margin in excess of 30%. Last but not least, turning to Performance Materials. Stefan has mentioned it at the beginning.

We have seen a challenging quarter resulting in an organic sales decline of minus 3.2% year-on-year and a roughly 12% to 13% year-on-year decline in EBITDA pre. Similarly to the first quarter, integrated circuit materials, pigments and also advanced technologies; our three pillars alongside the display materials business; performed very well and mitigated the year-on-year and Q-on-Q sales decline in display materials. And as discussed with you on our two previous conference calls and during our meetings at roadshows and conferences, Liquid Crystals has seen continued market share normalization over the last few quarters. We had expected already at Q1 results release that this situation would remain on the agenda for 2017 and the development in Q2 confirms this assessment, but Walter will give you more details in a minute. The ongoing sales decline in Liquid Crystals also left a mark in our EBITDA pre margin in the second quarter, which dropped to some 39% clearly due to the unfavorable business mix and the recent weakness of the U.S.

dollar, which is not helpful either for Performance Materials. Now, I know what the next question might be. Can we keep the 40% margins threshold until 2018? And for 2017, let me say although being a big challenge or representing a challenge, I would say the 40% is still in reach. For 2018, given what you will hear from Walter in a minute, you will notice that the challenges will not become less, but we also have some strength into the game. However, it will be a very challenging way forward to keep the 40%.

A short glance on the balance sheet. Here actually we do not see anything spectacular that happened in the second quarter. The overall number of assets and liabilities have come down somewhat and this is predominantly due to currency effects, which is also the reason for the decline in equity although we have profit after tax on net earnings in the first half of the year of almost EUR1 billion, but on the other hand, we have a minus EUR1.5 billion effect in currencies and that has also brought our intangible asset base down further on top of the regular amortizations that we are undergoing after the consolidation, especially of Sigma-Aldrich, which has lifted this position significantly up. Last but not least, cash flow statement. Here I would be very brief.

Yes, we have seen a healthy cash flow generation in the second quarter of more than EUR500 million. This has benefited from a one-time effect that had burdened last year, one-time tax payment reducing operating cash flow in Q2 '16, but positive to note on top of that is also a positive contribution from changes in working capital of some EUR70 million. And we are committed to continue the deleveraging and I expect to actually to reduce net financial debt in 2017 by more than EUR1 billion. So, that means more to come in Q3 and Q4. With that, I would like now to hand over to Walter for the deep dive in Performance Materials.

Walter Galinat: Thank you, Marcus, and also warm welcome from my side as well. Over the last couple of weeks and months, we have already talked extensively about market shares in Liquid Crystals and we are well aware that there is considerable uncertainty in the market around this topic. So, I will try to deliver today a little bit more transparency and I would like to start with slide 17. On this slide, we try to show what we believe has happened over the last couple of years and where we are right now. Back in the time frame 2012-2013, China developed into a major display market with meaningful panel manufacturing capacity.

Obviously in such a ramp-up phase, the preference is always for well-established technology leading supplier, which in that case was us - was Merck. For us, this led to a further surge in our market shares above the share we had commanded historically. Now as our customers become more experienced, they begin to look elsewhere and identify new supply alternatives that are meanwhile able to supply acceptable qualities to meet their present requirements. This is a development that we have now seen for a few quarters and we believe it will be an ongoing gradual trend for the coming quarters and most likely also through 2018. Next Chart 18.

Now such a situation clearly reduces our revenue in Liquid Crystals in two ways. Obviously, we lose volume due to the market share losses. At the same time, the market continues to grow, but the volume growth for us from this is not sufficient to outweigh the usual price reductions in this market at this moment. Net-net, we believe that this reduces our sales by about EUR200 million to EUR300 million versus 2016 levels. In other words, we are returning to normal.

Consequently and given our high operating leverage in the business, this impacts Liquid Crystals' earnings and margins. And in turn will cause an unfavorable margin mix for Performance Materials overall. Next Slide. Now we have talked a lot about China, let's have a look into this market a bit more closely and a bit more in detail. Overall, we have to deal with three effects in China.

Firstly, the display markets will continue to grow, which is good news. Secondly, new capacities to satisfy this demand are being and will be built in China. And thirdly, the Chinese capacity will potentially evolve from a local - for local production to a more globally-oriented, export-oriented, higher-end supply. This has at least two implications for us. China typically tends to be more volatile, which reducers somehow the visibility and predictability for us.

But we will take our share in the projected growth in demand and capacities and the potential trend to higher-end displays should in principle benefit us. We have already started to leverage our market position in China. For example, we reallocated resources to step up our customer support. We also expended our R&D hubs to be ready when customers start technology-challenging capacity ramp-up and I talk here about new Gen 8.5 and Gen fabs. Next chart.

Now we have talked a lot about Liquid Crystals display industry. But let me give you a couple of points that I find also noteworthy in this context. It is important to keep in mind that Performance Materials overall is more than just liquid crystals for displays. Already today, but even more so in the future, we have heard that the 3 pillars except Liquid Crystal are developing very nicely and I expect it to continue to do so. So we have and are working on many exciting ideas and initiatives that will drive this growth in the longer term and diversify further our revenue base.

On the next slide. In fact, you can see what I mean with this. We are confident that mid-term, Performance Materials has the potential to return to its low single digit organic growth trajectory. Of course, after the re-calibration process this year and next in Liquid Crystals. Most of the projects we are working on are well known to you and I will not bore you with diving into the details.

However, Performance Materials will increasingly become an enabler and a critical supplier for the range of materials that lies before us. And taking a long-term perspective, Performance Materials will be an agile and innovative solution provider in such a highly dynamic and promising environment. So I come to my conclusion on slide - what is this - 22. We expect a return to normal in Liquid Crystal for display application. Second, China, even if volatile, will become even bigger and we want to be and are determined to be part of it.

Our margins will reflect the shifting business composition, but remain on an industry- leading level. And finally, Performance Materials will remain a highly value-generating business. With this, I hand over to Stefan.

Stefan Oschmann: Thank you, Walter. And now coming to the 2017 guidance.

We continue to expect slight-to-moderate organic net sales growth for the group, while currencies are now forecasted to be neutral for net sales, as opposed to the about 1% to 2% tailwind we have expected so far. Nevertheless, we expect that EBITDA pre will be in the range of EUR 4.4 billion to EUR 4.6 billion with EPS pre of EUR6.15 to EUR6.50. In this context, there are 4 main topics that you should consider. Firstly, with the recent weakness of the US dollar or the strength of the euro, depending on the perspective, the currency tailwind we had expected still in May, will turn into a headwind in the second half of 2017 and our guidance obviously depends on that to some degree. Marcus can give you details.

Secondly, in Performance Materials, we lower our EBITDA pre guidance range, as the trend of market share normalization we have already seen in May has [indiscernible] in Q2. Walter just gave you the details. Thirdly, Merck's 3 business segments are fairly different, which leads to a certain degree of diversification at group level. And fourthly, we are committed to and we will actively manage the headwinds. But now to your questions.

Operator: [Operator Instructions] The first question we've received comes from Peter Verdult, Citi.

Peter Verdult: Just two questions please. Firstly, for Walter or Marcus on Performance Materials. What do you believe your market share to be as of today or as of Q2? That's part one of the first question. And then over the last couple of Capital Markets Day, we've heard about SAVA OLED moving into profitability in 2017 Liquid Crystals windows.

Could you just maybe map out for us where we are on those 3 projects? I think the market is working on the assumption that the OLED business is currently around EUR100 million of revenues and moving into breakeven this year. So just some color around those projects. And then more briefly for Stefan on the pipeline. You're moving the VCK inhibitor in RA into Phase IIb. I realize the data won't be presented until ACR in November and you are not going to discuss it.

But perhaps you could let this go on how you've - competitive you think the profile looks versus other oral classes like JAK inhibitors. They are my two questions, thank you.

Walter Galinat: Okay, thank you for the questions, it's Walter. I will try to answer your question. So, number one, the market shares.

So our firm belief, as good as we can tell is that we should be at the high end of our historic range of our market share, which is between 50% and 60%. Regarding the - some of the new projects so let's start with OLED. OLED, we are on track. The business is nicely developing in double digit and we are well prepared for further developments, including new investments that have just been announced the other day. Regarding LC Windows, here we are also on track.

The factory is just under construction and will go onstream as projected around October, November of this year. Then we will have some trial runs and so on and then we will start in next year to acquiring business and we'll see the first smallish turnover. Regarding SA-VA, so here we are on track. We have several customers and in particular we have two we are in line test, which already means this is a high commitment from the customer because he reserves his production capacity for testing our materials. So, these tests are ongoing and should be concluded towards the end of the year.

But as we know from the past that it is still a long way for this material to be in broad mass production. So, it will start with some small types and models of display sets and then it will expand. So we will see a turnover in next year, but again smallish. We expect then significant turnover in the years 2019 and following.

Stefan Oschmann: So Peter, coming to your BTK question of evobrutinib.

I mean you're aware that the compound we believe has greater selectivity - kinase selectivity compared to - compared to competition and the hypothesis that we're trying to prove is that this would lead to lower AEs. We have in the IIa trial - in the rheumatoid trial IIa trial, we have done single finding. We're now going into a Phase IIb for dose finding. What you should remember is that RA gives us the fastest response and this is why we see these data first. We have three Phase II programs ongoing; now the RA Phase IIb trial with a readout in Q4 2018, we have the multiple sclerosis trial readout Q1 '19 and we have the readout for the Phase II in Italy in Q4 '19 and we are planning to publish the results of the Phase IIa in RA over the next month.

Operator: The next question comes from Mr. Richard Vosser, JPMorgan.

Richard Vosser: Just maybe on Performance Materials again. Obviously the iPhone is switching to OLEDs I think under speculation this year. So, just your thoughts on what that would impact in terms of the ultra-bright fringe field switching Liquid Crystals and how that might impact the margin? Is there any impact there? And then just I understand that obviously if SA-VA takes off, that will help both on price and potentially mitigate losses of market share, but just perhaps you could give us a thought why market share more generally is going to stop at 50% level? Why is this a normalization rather than a start of a decline I suppose? And then one final question on pharma.

Just how should we think about the R&D spend increases for 2017 in the light of both the biosimilar disposal and if there's relatively limited increase so for this year? Thanks very much.

Walter Galinat: So, I will start with your first question. So number one, OLED and I understand that you were referring to the inroad of OLED in the iPhones and what might be the consequence of this. So, I think we said several times that at the end of the day, the significance of OLED and the importance will be determined by the inroad in larger size displays. So, OLED is already commonly used in small displays for iPhone and smartphone applications, but the big jump forward will come when the OLED becomes more common in large size TV applications.

So, I do not expect that this development with the present iPhone no matter how big the share will be that will be equipped with OLED will have a huge impact on the overall display market. The second question? The second question was referring to the market share, if I got it right, and why we are still claiming that we are on the higher range of 50% to 60%. So here I need a little bit more space, more time to explain. So, we are and we intend to remain the technology leader in Liquid Crystals and have a very full and active pipeline of new materials that is Liquid Crystal singles, but also new molds. Our investment in this R&D pipeline over the years gives us a much stronger portfolio of materials, technical capabilities and know-how than any other competitor.

And we keep investing in new technologies, you also refer to SA-VA and I also may remind you about UB-Plus and others to follow in order to fulfill the needs of our customers. On top of that, we have strengthened our organization as I outlined in the context of China to give first-hand support through production lines of customers. In case of issues, no other competitor can do it in this way. So therefore, our assumption today is based on this and also our experience we have made in the past in other countries like Japan, Korea and Taiwan that we can sustain this level of market share.

Marcus Kuhnert: Richard, Marcus speaking.

I would answer your question regarding R&D spend. As I already lined out in my presentation today, we project an increase over 2016 numbers between EUR150 million and EUR200 million. With that, we are following our planned ramp-up of R&D spend in our clinical programs, which is progressing absolutely according to plan and also the progress on the sale of our biosimilars unit is actually fully progressing according to plan. That was already back then included in the projection of platform EUR 150 million to EUR 200 million. So, that means also here we are on plan.

That means if you compare our Q1, Q2 R&D expenses with prior year, which has seen only a very moderate increase, that you can expect further ramp-up of R&D costs now going forward in Q3 and Q4.

Operator: The next question you receive comes from Matthew Weston, Credit Suisse.

Matthew Weston: The first one is a follow-on to Richard's about market share in Liquid Crystals. You highlight the advancing competition from Chinese competitors. Also, I'd be very interested if you could name them.

Previously you've been very dismissive about the impact that they would have, but again the question why are you confident you can keep 50% to 60% share, if what's a 3-player market today becomes a much more than 3-player market in the future, particularly given the political pressure in China often where the government likes or asks their companies to favor local suppliers? And the second question is around SG&A in Healthcare. Really, second half of the year and into '18, given the significant investment in cladribine prelaunch costs, Marcus can you help us with what we should expect in the mid-term? And then finally, again another one for Marcus, it's around guidance. For the first time ever I think that I can remember the sum of your divisional guidances does not add up to your group guidance. And actually if I take the midpoint of all the divisions, even that is lower than what you're saying the group will achieve at the bottom end of the range for EBITDA pre. So I just wonder, you telling us something about the corporate that spending is going to be a lot lower or if not, can you just explain it? Thank you.

Walter Galinat: Okay. So I'll start with the questions related to TM. So the names of the three Chinese competitors are Slichem, HCCH, and Pi-E. These are the three Chinese competitors. The second question was what makes us confident that we maintain relatively high market share, even there are now more players - more competitors in the market.

So we - first talking about China, I think with the introduction of new fabs in China with very high technology levels like Gen 8.5, G-10 and above, the technical requirements of those customers will become higher, because they will also have to compete, other than today, in international markets. And therefore I believe that we are particularly well prepared to serve the needs. And if I may remind that we were the only supplier of material for the groundbreaking of the G-10 line in South China and now also most recently in Wisconsin, in the U.S. that was [indiscernible]. So second we see at this moment, this may change, but at this moment, little activities of these Chinese competitors outside China.

So outside China, we have established relationships between suppliers and customers, they are used to deal with the traditional suppliers and this has proven to work very well. So numbers really of course. In the long run, we cannot exclude that Chinese competitors will also try to get business outside of China, but our assumption today is that this is limited, because this would also involve some regulatory affairs if you build infrastructure [indiscernible].

Marcus Kuhnert: Matthew, I take over your following 2 questions. So first of all, on the SG&A in Healthcare.

I would say - so let me make 1 point in advance. So we do not give guidance on single P&L lines and it's also early today to have any kind of projections for 2018. However, a couple of arguments. We see relatively strong SG&A increase in Healthcare in 2017 and this is due to the fact that we are basically preparing from scratch upcoming market launches, where we have to rebuild certain infrastructure in multiple sclerosis. I mean, for Rebif you are well aware that we've also managed this business over the last couple of years with declining sales with a lean cost basis.

And here we are - we need to fill back a little bit in order to secure a successful launch of Mavenclad going forward. And secondly also we had to build up a complete new infrastructure in oncology in the U.S. And so these are, if you want, one-time costs, which will not reoccur over the next quarters and years. However, we have a broad pipeline, obviously, and we have a broad pipeline and we will be - it will be necessary also going forward to prepare launches thoroughly in order to secure the necessary market success. Furthermore, I would like to remind you that also in this cost line item, we show the cost for medical affairs for Congresses et cetera and also this needs to be pushed further in the future in order to have here a competitive setup.

And last but not least, please keep in mind that from now on and also in the future, we have additional marketing and selling costs in our P&L from the repatriation of Glucophage in China that was until end of last year completely absent in our P&L, we just received the license payments. The third question on the guidance. You are absolutely right with your conclusions. We have reduced the guidance for Performance Materials, but for good reasons we have kept the guidance for the group intact. There are several reasons.

First of all, very honestly, we want to send a signal, we are willing to fight. We are facing challenges, but we don't give up, we want to come - we are committed to manage them actively and to achieve our commitments that we have given to the capital markets in May. Secondly, for good reasons we give guidance in a range in the beginning of the year, because we are well aware there are uncertainties that we are going to face and this allows us obviously, within a certain headroom to manage difficulties. And we believe that we will be able to enter the corridor in the end of 2017, although I must say, given the headwinds that you have just heard from Walter in Performance Materials and given also a more adverse FX environment, Stefan has mentioned we will be facing headwinds in H2, this will require some efforts here and this will not be a walk in the park, so this is quite a commitment. And you're right, when adding up the midpoints of the three business sectors, but we always said the group guidance is leading and the business sector guidances should provide some, I would say, additional information.

And that simply also means that one or other business unit in our group, we will have to overperform or have to end up at the upper range in order to make it happen. And let me make one more point. Please keep in mind that the guidance we now give to you is subject to certain currency assumptions. So we are able, or we try to digest a decline in currencies from $1.6 to $1.10 which was our guidance in May for the U.S. dollar.

We are now between $1.9 and $1.13 and we believe we can still compensate this in the bottom line, together with the challenges in PM. If the currency should continue to move further in a headwind direction, and we see currently U.S. dollar rate in the range of $1.18, then of course - so this guidance is subject to the currency staying in the range which is what we communicated today, are not much deviating from that, this is also noteworthy to mention. Thank you.

Operator: Then next question we've received comes from Florent Cespedes, Societe Generale.

Your line is now open.

Florent Cespedes: Three quick ones, first, Performance Materials. What is the magnitude of the margin range of the division in the coming, let's say, two years? Is Q2 this year a good proxy? My second question is on Sigma and cladribine. When will you start to present some data that convince the authorities to approve your products? Will be during second half of this year at the [indiscernible] Congress or will it be next year, and when will you update on your intention for US? And my last question is on Life Science. Process solution looks a bit better, when research solution remains a bit tough, although it's slightly [indiscernible] Q1 in terms of performance.

Could you elaborate a bit on these two subdivisions, please? Thank you.

Marcus Kuhnert: Marcus here. So I take the first question on the margin question. I think I've addressed this already in my presentation. We said we are facing headwinds at the moment, but still we believe that 40% for 2017 might be in range.

Going forward, we will use or we will lose volumes and that will inhibit our ability to realize efficiency gains just from production and from scale. We will be facing a negative product mix from the decline in Liquid Crystals, which is when you look on the overall PM portfolio, the most profitable part of the business and we would be facing obviously the typical price reductions and all of this points into the direction that keeping the 40% margin beyond 2017 might become extremely challenging.

Stefan Oschmann: Claude, this is Stefan about you asked two questions, first about cladribine data and secondly about the sub sectors of our Life Science business. On cladribine, as you know, we have filed basically the extension of the trials that we had initially conducted and that has together with a large pharmacovigilance space, that was the update to the original file and that has led to the positive CHMP opinion. So, the process now between the CHMP opinion and the approval by the EU does not require any further data submission.

We are publishing data at the regular congresses, but you should not expect major - major new data as our clinical program for cladribine prior to approval was basically just a follow-on to the previous clinical program. We have initiated discussions in the U.S. FDA on submission of the compound for the U.S. market and we will keep you updated as we progress in these discussions. You asked questions about - specific about Process Solutions and Research Solutions or let's say all of the sectors.

We see that in Process Solutions that market growth is slightly - is somewhat lower compared to last year. We had very, very high comparables last year, it's still good and we're still growing - we believe we're growing above market. We see a little bit of a phasing issue. We ourselves and we assume the competition faces the same situation where some of the large global accounts prior to the introduction of biosimilars are reducing inventories and doing other things. So that at the end of the day, should be from our point of view a left pocket, right pocket type of thing, but there are some - there are some phasing issues as less supplies will be used by the originators and more will be - might be used by the biosimilars companies.

We see that Research Solutions for the quarter grows 1.7% year-over-year, that is still a bit slow. Applied Solutions grows slightly above 3%. And Research benefits from a strong demand in China, the U.S. is slightly improving while Europe remains - remained soft.

Operator: The next question we've received comes from Gunnar Romer, Deutsche Bank.

Gunnar Romer: The first one would be on Healthcare. I was wondering whether you can share any initial launch experience with regard to Bavencio and also the competitive situation for Gonal-f, if you can just quickly provide an update here that would be great. Then secondly, following on to Florent’s questions on Process Solutions, organic growth picked up very nicely here and it also looks favorable compared to some of your peers and I think you just mentioned that you believe you're taking share. I was wondering whether you can provide some additional color here in what part of the business that you're seeing that? And last, but not least again on Performance Materials, how much of the EUR200 million to EUR300 million sales decline that you're anticipating is baked into the 2017 guidance, please? Thank you.

Stefan Oschmann: Just taking notes, Gunnar, of your questions so that we don't forget anything.

So, let me start with the Healthcare questions. Bavencio launch, you know that we have received two approvals within more or less six weeks. The label for MCC in the U.S. is fairly broad, it includes first line that is a positive. We expect singe - we have generated single-digit revenue in this quarter.

We have received the bladder indication towards the mid of May so you should assume that we're still ramping up for launch for - although this is a much more competitive space compared to MCC obviously with MSD and others being already approved in that indication. And in Europe, we have received the CHMP opinion for MCC so there's no revenue generated. So far, the MCC - the MCC rollout goes according to plan. When we come to Gonal-f, so we have seen fertility minus 1.5% or so year-over-year in Q2. You remember that Marcus was referring to that we had a very, very high base in Q2 2016 where two competitors were out of the market, one competitor is fully back and we're also seeing that we have the impact of biosimilars in Europe.

The launch of the new players in biosimilars is to be taken much more seriously compared to what we've seen before. On the positive side, we see that Chinese market is still growing very fast and that what we call the fertility technology is also picking up. So in balance, this is - this remains an attractive field for us. Then there was the question about how much of the EUR200 million to EUR300 million decline is baked into 2017 guidance and Walter is going to answer that.

Walter Galinat: So obviously this is not easy to calculate, but we might assume that it should be slightly less than half of this range should be baked in 2017.

Marcus Kuhnert: Gunnar, then I take your question on Process Solutions. I mean Stefan has already alluded to this, maybe I can give a little bit more color, but most of the facts were already told by Stefan. What was especially good was that all of our sub SBUs in Process Solutions were contributing nicely to the 7.5% organic sales growth. Moreover, we see the long-term growth drivers in that segment still intact meaning the higher need for monoclonal antibodies on the one hand and also a shift more and more towards single-use products. And both segments also so single-use performed well in the second quarter especially high growth was exhibited by the services business, but also the other sub SBUs was very nice growth.

So, here good picture across the board. However, as mentioned it in my early part of the presentation, we have seen in the Q1 a somewhat slower start in global key accounts and this has not yet fully recovered and Stefan has given you the reasons, which are predominantly related to inventory topics behind biosimilar.

Stefan Oschmann: There's one piece of information, Gunnar, that you also might find Interesting. We define Process Solutions as bioprocess and what we call active formulations, which is our small molecule business. And there we also see very good performance lately and this is very much driven by the good work that we are doing - that the organization is doing, for instance, on topics such as ADCs, antibody-drug conjugates.

Gunnar Romer: That's very helpful indeed. Just a quick follow-up for Marcus. Can you just tell us how we should be thinking about the accounting of Bavencio in light of the Pfizer agreement? So when you talk about single-digit million revenues, is that the in-market sales and would you pick half of it or how should be thinking about that please?

Marcus Kuhnert: Yes, so the agreement that we would record sales - full sales in all countries where we are selling avelumab or Bavencio. So we are accounting for the full sales. And when it comes to the bottom line impact, we have 50%, 50% profit-sharing agreement.

That means we will show then ultimately only 50% on the bottom line, which obviously means that the margin, the Bavencio margin is not as high as we might expect if we would market this completely under our own roof.

Gunnar Romer: Okay perfect. And just quickly on FX. The current movements, does that mean that you're likely to end the year at the lower end for your corporate cost range - for corporate cost guidance, because obviously there should be some gains here?

Marcus Kuhnert: We have given you by purpose a range, but you are right, while the current FX movements are hurting us in top and bottom line in the businesses, we get some mitigating effects in segment corporate. That's correct.

Operator: The next question we receive comes from Vincent Meunier, Morgan Stanley.

Vincent Meunier: I mean, the first one is another follow-up on Performance Materials, this time with a margin angle. So with SA-VA to become a material contributor as from '19, not before, and the market just doing back into the 50% to 60% market share corridor, how can you actually protect the margins in the region of 40%, and even product margins from a bigger degeneration, below 40% if you don't have a new technology and if your market share is actually going down? Second question is on Healthcare and the price environment for Rebif in the U.S. So we see in your slides that you had a price hike in Q2 in the U.S. for Rebif.

But is there room for additional price increase in the context of the launch of Ocrevus? And the last question is on the group and the corporate costs. You have created a new business - a new unit, business services, so what is your plan behind that? Do you want to generate more savings, can you explain how the unit will work and how you want to use it?

Stefan Oschmann: Okay. I would start with the first question regarding the margin. It is clear that every introduction of a new mode in principle helps us to maintain a higher price level and this will be most likely also the case with SA-VA. But as Marcus has already pointed out, while we feel that in this year we have an opportunity to defend 40%, looking further into the future, this is a real challenge and we cannot give any concrete indications right now.

Marcus Kuhnert: So your question about Rebif pricing in the U.S. and Ocrevus - impact on Ocrevus as Roche stated themselves recently, they gained market share, mainly from orals and from high efficacy or reserve injectable such as Tysabri. So I think it's safe to assume that the impact on Rebif was negligible in Q2 and we should also remember that the prices are not comparable. When it comes to our own price, I just have to give you a standard response. It will be illegal to selectively disclose anything on prices and we continue to price our product in line with the market and the value of the product within the U.S.

market.

Stefan Oschmann: So I take the question on Merck Business Services. So first of all, behind the acronym of Merck Business Services, that is related basically to our Shared Service Center initiative. It is a cross-functional approach comprising finance, HR, procurement and IT and the ultimate target or the ultimate goal of this initiative is to harmonize and standardize processes on the one hand and to bundle activities with scale and repetitive character in certain centers of excellence, which are spread basically all over the world. So we have one big shared service center for each and every region and we have a global hub in Manila in the Philippines, from which we are - or where we are allocating material, standardized English-speaking processes actually to serve the whole world.

By that we want predominantly to free up time for our functional people that can be used in a more value - for more value-generating activities. Of course, we want to realize efficiency gains. Also going forward, we want to move in the direction of creating a business system, which for example allows us, based on a much, much higher standardization than what we have today in terms of systems and processes. We want to facilitate in the future integration of the M&A activities. And of course, last but not least, to mention this is a longer ongoing initiative.

So we are talking here about a time frame of between three and four years, it's an initiative that will proceed until 2021 and we have started this year with the implementation.

Operator: The next question we receive comes from David Evans, Kepler Cheuvreux.

David Evans: One on Liquid Crystals first. Could you just give us some more detail on, I guess, relative pricing of Liquid Crystals from the Chinese manufacturers? I mean is this a 20% cheaper price, 50% cheaper and also is there any other government-driven incentive to use those liquid crystals? And then in Pharma, just checking on time lines for readouts of when we are likely to see TGF-beta trap data still Q4 is it? And then also, avelumab combination, first data on combinations with 4-1BB and OX40 and so on? If you could just let us know when those are likely to be presented.

Stefan Oschmann: So regarding your question regarding prices of liquid crystals, of course this is competitive information, we are reluctant to disclose this.

But you may assume that we still command a premium over our competition by the way in not only Chinese, but also our Japanese competition. On the readouts on the Healthcare pipeline, yes, we stay on the same time line as we had announced relating to the readouts of the TGF beta trap data towards the end of this year. We are expecting them - otherwise we are expecting the EMA decision on MCC soon. We expect the readout for avelumab Phase III data in gastric third-line in Q1 2018, as well as the Phase III data readout in second-line. We are also in the process of analyzing the Phase II readout for Sprifermin.

You asked specifically about the combination - real MAP combination readouts, for what it is and for when it will be. It is December 2000 - we estimate it - a completion date is December 2019. That's the basket trial. So that is - given the sign of such a trial, it depends on the - it depends - there's different timelines for different products, but within that framework.

David Evans: Can I just check are we likely to see any data out of the study before that final completion? So, I understand Pfizer seems to indicate maybe we would see some earlier data.

Stefan Oschmann: Nothing to say in addition to that.

Operator: The next question we've received comes from Mr. Simon Baker, Exane.

Simon Baker: Firstly, on Performance Materials. Could you give us an idea of the split of Liquid Crystal revenues by level of IP protection? So, an idea of how much is in areas where there are no legal barriers to entry versus areas where you have a higher degree of protection.

Secondly, I wonder if you could give us a little bit more color on the headcount increase. Looks like you've added about 2,000 employees since last Q2 '16, I wonder if you could elaborate on that. And then finally back to Performance Materials and this is more as much as a question, but you made the very valid point that this division is about a lot more than Liquid Crystals and presumably one way of enhancing our understanding is that would be like we would see with Life Sciences to get some kind of divisional sub split of revenues and the organic growth rates therein. Do you have any plans to do that? Thanks so much.

Stefan Oschmann: Maybe I start with the headcount increase and Walter will then give you an answer on the PM question.

The headcount increase is mostly driven by the group of project maturation in China where we have - now have the full sales force on our headcount and it's also about conversion of temporary positions into permanent position, which is basically a regulatory or a statutory requirement also to be seen in the context of the Sigma-Aldrich integration. So, it should not be seen as - fully as additional headcount. However, we also had to staff up some groups such as medical to support the launches in Healthcare. Walter?

Walter Galinat: So regarding the IP protection, I'm not in a position to specify exact numbers. But what is clear is that with every new introduction of a new mold or a new substance to the market, we also apply for IP protection so the share is significant relatively high and we also leverage on this high share.

That means we defend our IP no matter where it is necessary and we do things like cutting brand new TVs to check what is inside, what kind of mix and order to determine whether there is an infringement or not.

Stefan Oschmann: If you look at the IP situation, you compare the dynamics and mechanics in the Performance Materials market versus Pharma, it is very, very different. It is - we should remember that the people who would be infringing our IP would be our customers and that this is - so this is a complex - it's a complex situation. And therefore we are very, very active in ensuring that our IP is fully protected. At the same time with certain customers, this requires a more - it requires a more flexible approach.

There are some of the molds where we have no more patent protection, but they are not central to our strategy. Our business model relies on continuous innovation. As Walter mentioned, we are in the process of launching SA-VA. And if you look at the roll out of these innovations also historically, that explains a certain degree of cyclicity in that market.

Marcus Kuhnert: Simon.

I would take your question on the disclosure. I mean the question is a fair one. But when you think about it and we have compared - we have drawn the comparison to Life Science. Process Solutions, Research Solutions and Applied Solutions; if you look on them individually, they are all almost as big as PM the whole division. In other words, in PM we have by far biggest single business which is Liquid Crystals, but we have three significantly smaller ones.

And it's a management decision, we have said okay, we do not want to disclose PM numbers on a lower level than the whole segment. This may change one day and of course also the new head of the division, Kai, will have a say on this; but for the time being, there are no plans to go for a more granular reporting in Performance Materials. And moreover, I also believe that we have a pretty good degree of detailed disclosures and for the time being, there are no plans to make any changes in the PM disclosure.

Operator: The last question comes from Mr. Holger Blum.

Holger Blum: Holger Blum, Deutsche Bank. I just wanted to get your view on a longer-term picture. We see now a lot of nervousness about EUR200 million lower revenues and on a EUR15 billion revenues company and a company that plans to launch EUR4 billion of new product until 2022. So, could you maybe help us by explaining the other side of the equation until 2022? How much of the existing business you expect to be rolled up until that time horizon?

Stefan Oschmann: I was going to address this in my summary. All in all, I would recommend that we will - that we discuss this in depth at the next Capital Markets Day when we have an opportunity to really look very deep into individual trends.

I mean today we prepared to focus on Q2, but if I go through the different businesses. In Healthcare, we feel now that we are in a situation where our pipeline is really meaningful and we're extremely happy about that and we see that the capital market, that the scientific community, the academic centers, the medical thought leaders take us a lot more seriously these days. This has a downside and it's - in a way it's a luxury problem. Yes, we need to finance this clinical program. I think it is fair to give us credit for our track record so far where we've - where we have compensated this through performance in the underlying business, through savings and also through quartering approaches.

You should assume that we stay prudent and over the past six years, I remember I joined the company in January 2011, we have delivered 25 quarters of organic growth and we have shown that we have a very resilient core business. I also think that over the past years we have done an acceptable job in creating a Life Science business through inorganic moves - mostly through inorganic moves, but also through very good institutional capability that we have in integrating businesses and in delivering synergies and also at creating growth in these businesses. We see that Life Science that in PM - in PS - that we maintain growth above market, even if we don't have exact market share data that we can that can publish, but we are very confident that we are growing above market. We are integrating very fast in research and applied the previous - the legacy Merck business with the legacy Sigma-Aldrich businesses and we are delivering, or even slightly over-delivering on the synergies. In PM, PM has been, one could say, carrying us for quite some while and we have been used - we got very much used to very, very good news continuously coming out of PM.

We now see a face of what we call normalization, but we strongly believe that this business with its attractive mix and with our technology and quality leadership, will continue to be a growth business that delivers attractive margins and attractive growth rates mid- and long term. So we see a short-term dip right now. You can bet on us working extremely hard on fueling growth mid- and long term in this very attractive business. Sorry for my long speech, but this is kind of the - this is our original data, so to say. So I try to answer your question and summarize at the same time.

We now need to hit the road, because most of us are going on road show right now and we are looking very much forward to meet you in London, to meet you in the U.S., and in Boston. And so herewith, I would like to thank you. Thank you for joining us in this call and see you soon. Thank you very much.

Operator: Ladies and gentlemen, thank you for your attendance.

This call has been concluded, you may now disconnect.