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Edited Transcript of MRK.DE earnings conference call or presentation 9-Mar-17 1:00pm GMT

Thomson Reuters StreetEvents

Full Year 2016 Merck KGaA Earnings Call

Darmstadt Mar 9, 2017 (Thomson StreetEvents) -- Edited Transcript of Merck KGaA earnings conference call or presentation Thursday, March 9, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Constantin Fest

Merck KGaA - Head of IR

* Stefan Oschmann

Merck KGaA - Chairman of Executive Board & CEO

* Marcus Kuhnert

Merck KGaA - CFO

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Conference Call Participants

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* Matthew Weston

Credit Suisse - Analyst

* Peter Verdult

Citigroup - Analyst

* Sachin Jain

BofA Merrill Lynch - Analyst

* Simon Baker

Exane - Analyst

* Vincent Meunier

Morgan Stanley - Analyst

* Gunnar Romer

Deutsche Bank - Analyst

* Richard Vosser

JPMorgan - Analyst

* Florent Cespedes

Societe Generale - Analyst

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Presentation

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Operator [1]

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Dear ladies and gentlemen, welcome to the Merck investor and analyst conference call on the fourth-quarter full-year results 2016. (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.

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Constantin Fest, Merck KGaA - Head of IR [2]

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Many thanks, Vera. A warm welcome from my side here in Darmstadt to this full-year 2016 Merck conference call. My name is Constantin Fest; I am Head of Investor Relations at Merck. And I am delighted to have with me here today Stefan Oschmann, our Group CEO, as well as Marcus Kuhnert, our CFO.

In the next half hour we would like to run you through the key slides of the presentation then we would be happy to take all of your questions as always. Please also keep in mind that we have roughly about one hour for this call as some of us will have to catch a plane for the upcoming road shows. With this, and without any further delay, I would like to directly handover to Stefan to kick off this presentation.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [3]

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Thank you, Constantin, and good afternoon or good morning to all of you and welcome, everyone, to our full-year earnings call. 2016 was a very dynamic year for Merck. Overall we began to integrate our biggest-ever acquisition, Sigma-Aldrich. We did that very successfully and very fast. And at the same time we delivered diligently on our tasks be it the growth ambition in Life Science and Healthcare or be it the rapid deleveraging or the development of our pipeline.

Merck has now turned into a EUR15 billion revenue powerhouse and I can promise you we have a very full agenda to build on this and to develop Merck into an even stronger and more agile Company.

For this year, for 2017 specifically, we expect to see growing sales and ongoing progress in our pharma R&D pipeline. Therefore EBITDA pre should be about stable, but we will certainly look into this more closely later during this call.

In 2016 -- and I am now on chart number 6 -- in 2016 we reached sales of EUR15 billion, which is 17% above last year and which corresponds to 3% organic sales growth. EBITDA pre came in at around EUR4.5 million, some 24% above the prior year, and EPS pre of EUR6.21 or 46% higher.

And clearly a key driver of this strong EBITDA pre growth was the acquisition and integration of Sigma at the end of 2015 and the end of our commission payments for the co-promotion of Rebif in the US. But also the sound operational execution in all of our businesses contributed and mitigated the quite visible rise in our R&D expenses. Marcus will give you a lot more details later in the call.

I'm now moving to slide number 7. When you look at Merck from a regional perspective, you will see that our three major regions are fairly evenly balanced. North America accounts for 26% of our sales and Europe and Asia-Pacific for roughly one-third each. And this distribution is not so much different compared to 2015 with the exception of North America which has become more important to us due to the Sigma acquisition and the solid performance of Rebif in our fertility business.

You will also note that are sales in Asia-Pacific rose only slightly over 2015 and that has nothing to do with the overall economic environment but reflects the de-stocking in the display industry during the year. In fact, our Healthcare and Life Science business -- the organic growth of these businesses were in a very healthy single-digit percentage.

Moving on to slide number 8. At the AGM on April 28 we will propose a dividend of EUR1.20 per share. This is a fairly significant increase of 14% year-over-year and translates into a payout ratio of around 19% of EPS pre. The increase has to be seen, on the one hand, in the context of our notably higher earnings, but -- following the Sigma acquisition. On the other hand, in the light of our resulting strong commitment to de-leverage as quickly as possible. Also in future dividends will develop in line with our sustainable earnings.

Moving on to slide number 10. I give you highlights of each one of our businesses. Healthcare delivered very well on its two major targets. On one hand, it now posted organic sales growth for the 22nd consecutive quarter; and on the other hand, our pipeline has steadily progressed in 2016.

In fact, we have the first compounds in registration with the regulatory agencies, avelumab in Merkel Cell carcinoma and now also for metastatic urothelial cancer and cladribine tablets in Europe.

We have seen numerous [phase] transitions in 2016 and the Pfizer line is well on track. For avelumab we have nine Phase III trials by now. And what may be interesting too, we have 57 investigator initiated studies. But also when it comes to the compounds in the earlier phases, 2017 will be a highly interesting year.

Chart 11. For Life Science the key challenge in 2016 was obviously, on the one hand, to manage our customers' [buy-in] demand and maintain the ongoing renewal and innovation process for our product offering. On the other hand, we could integrate our biggest acquisition in our history. And I think that our 2016 numbers speak for themselves and indicate that this was done successfully. And in 2017 we will build on this track record.

Chart 12. For Performance Materials the year 2016 turned out to be rather challenging as a result of the environment in the display industry. In fact, while the de-stocking situation in display materials itself was very well-managed by the team, pigments and integrated circuit materials performed very strongly in 2016 and mitigated the sales and earnings decline in liquid crystals.

So therefore PM's overall very decent performance in 2016 is certainly a good proof point for its four pillar business model and the resulting increased robustness of its sales and earnings. And with this I hand over to our CFO, Marcus Kuhnert, who will guide you through the financials.

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Marcus Kuhnert, Merck KGaA - CFO [4]

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Thank you, Stefan, and good afternoon also from my side. We jump to slide number 14. In 2016, as we have already seen, net sales grew organically by more than 3% driven by Healthcare and by Life Science, which were able to more than offset the decline in Performance Materials.

The currencies developed slightly more favorable in the last quarter of the year than we had expected. The EBITDA pre came in at EUR4.49 billion for the year and this 24% increase was primarily driven by the acquisition of Sigma-Aldrich and the realization of the EUR105 million in cost synergies that we have already pointed to at the Capital Markets Day in October last year.

In Healthcare especially the end of our Rebif commission expenses and several positive effects during the year -- you may remember the disposal gain in the second quarter and the release of our determination provisions, as well as our new royalty income stream since summer 2016, were able to more than offset the notable increase in our R&D cost, especially in the fourth quarter.

On slide number 15 we see some selected key financials of the Group and, as we have just seen, sales are rising by 17%. We have an over proportionate increase in EBITDA pre by 24%, which brings us basically back almost to the 30% EBITDA pre margin. The earnings per share pre is at EUR6.21, which is a 28% rise over prior year and let me make a short [excuse] here about the number, which is a little bit short compared to the market expectation to consensus.

You may remember that in the third quarter when we did our latest guidance upgrade we notified you that we have -- in the course of the finalization of the purchase price allocation, we have had to account a mid-double-digit million euro amount of additional depreciation, which is predominantly related to property, plant and equipment. And that actually was also one of the driving factors of our revised EPS guidance for the year 2016.

And you need to bear in mind that depreciation on property, plant and equipment, even when it comes from (technical difficulty) is not adjusted in the EPS pre number. So this is actually brought down a little bit our EPS pre number now to a level that obviously is slightly below consensus. Other than that earnings per share pre benefited from an improved financial result and we were able to generate a very healthy operating cash flow of more than $2.5 billion, which we had use predominantly for the reduction of our net financial debt.

If we look a little bit on the consumption of cash in 2016, broadly the equation goes like this. So we have generated some EUR2.5 billion operating cash flow plus the more than EUR300 million from the divestiture of Kuvan, which brings us to some EUR2.9 billion.

Out of that we paid EUR600 million, roughly, dividends; some EUR800 million for CapEx; and EUR160 million for the Biocontrol acquisition per December. And the remainder of roughly EUR1.1 billion actually is the reduction in net debt that you see one line below the operating cash flow here on the slide. Working capital and employees increased slightly, but more or less in line with the growth of the business.

On slide number 16 we see the reconciliation from EBIT to EPS. So in the EBIT the disposal gain for Kuvan from the beginning of 2016 clearly left its mark and more than offset the impact from the higher acquisition and integration-related costs. Financial result improved slightly in 2016 versus prior-year. And for 2017 you can expect our interest result to be in a range between EUR250 million and EUR260 million.

Our tax rate is within the well-known range and our guidance for 2017 remains the same, namely a corridor between 23% and 25%. Obviously we will need to see what impact, if any, future changes in the US tax system will have on our tax position, but it is too early today to enter into any kind of speculations.

Now I would like to enter into a little bit more detailed view on the business sector P&L since here we focus on the most recent developments, namely the fourth quarter.

On slide number 17 we start with healthcare. Healthcare's net sales grew organically by more than 4%, which is in line with the growth rate in prior quarters, and also with our statement that we believe we will be able to fully compensate the Rebif sales erosion with growth from our other franchises.

What maybe has been a little bit out of trend in the fourth quarter is Rebif itself, which grew almost 1% organically and also endocrinology was up 20% organically. The explanations are in the case of Rebif -- so you may have noticed that we have been able again to increase prices in January 2017 by 5.5% in the US and we have actually seen stocking by pharmacies ahead of this at the end of Q4 2016. And our endocrinology sales that I have just mentioned benefited from the yearend reversal of a larger accrual for potential rebates.

EBITDA pre came slightly lower versus last year, which is largely due to the increase in R&D costs. They picked up quite noticeably in the fourth quarter versus the run rate that you have seen in the first three quarters of 2016, and this is due to a certain seasonal uptick that we sometimes see towards the year end and has strongly to do with rising activity and acceleration of measures towards the end.

In truth, when we look on the full-year R&D number, we see roughly an increase of EUR186 million in our R&D spending. This is, as we have indicated earlier in November, at the lower end of the original projection of our R&D cost development. However, we also need to keep in mind that 2015 benefited also from a reverse of termination provisions. And if we would add that back then we are in the range of some EUR250 million increase year on year.

On slide 18, Life Science -- Life Science finished the year on a slightly softer note with 3.7% organic sales growth in Q4 and, as we had expected, the growth rate is somewhat lower due to the tougher comparables on the one hand. And, on top of that, some customers have delayed their orders late in the year. So the shifted some EUR15 million of sales into 2017 and we are actually expecting that a major part of this will be recovered in the first quarter.

Sigma made a good contribution again. And if you look on Life Science full-year organic growth on a pro forma basis, then we can say that the Sigma business grew approximately at a similar rate than the legacy Millipore business, which is basically reflected in the organic growth numbers that we have reported this morning.

Synergies came in as we discussed at our Capital Markets Day at EUR105 million. And with the very solid operating performance and continuously good execution on the synergy side, we made [quite] a jump in EBITDA pre profitability from 25% to more than 29%. So a very healthy level for the start into 2017.

On page number 19, Performance Materials. You all know 2016 was a challenging year. However, on the positive side was a good proof point for our four-pillar highly innovation-driven business model and our ability actually to better mitigate sales and earnings fluctuations with a bigger diversity of our portfolio than in the past.

Of course pigments and integrated circuits has a strong contribution here. They continued their strong performance in the fourth quarter with organic sales up mid- to high-single-digits. Still the fourth quarter sales overall declined organically by minus 5.9%. And while the EBITDA pre margin held up very well as throughout the year, the level between 44% and 45%, the sales development clearly does not yet reflect the recovery in liquid crystals that we had expected when we last spoke in November.

[On top of it] a bit more sluggish return on volumes, also some customers from our point of view now used the inventory adjustment processes in the last month to recalibrate a little bit the shares between the suppliers and their supply strategies. So in Q4 specifically we saw some signs of a normalization of our very high market shares and we will keep this topic as a watch out on our radar screen for 2017.

Slide number 20 shows the balance sheet. This is not very spectacular in terms of changes versus last year. Noticeably of course the reduction in financial debt. So our equity ratio has increased now to a level of 37%. Our gearing from net debt to EBITDA is down from 3.5 end of 2015 to 2.6. And other than that there were not too many changes.

What might be a little bit surprising is a slight -- only slight decrease in intangible assets. Here I can tell you we have written down on a scheduled basis more than $1 billion in 2016. However, the uptick in currencies brought up the asset values by the end of the year.

Slide number 21, this is the cash flow statement. And here you can see the Q4 contribution to the EUR2.5 billion operating cash flow generation, which is close to EUR800 million, strongly supported by the increase in profit after tax and also a very positive contribution from changes in net working capital.

The investing cash flow is reflecting the Biocontrol acquisition on the one hand and a slightly higher CapEx spend behind Sigma and the growth of our businesses. On the other hand, the minus in financing cash flow indicates that we continue to pay down financial debt. With that I would like to hand over to Stefan again to guide you through the outlook and guidance.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [5]

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Thank you, Markus. On page 23 we are coming to the 2017 qualitative guidance and we will give [quantitative] guidance with our 1Q results in May. We expect slight to moderate organic net sales growth with currencies and portfolio unchanged. EBITDA pre should be about stable, which comprises a small single-digit percentage variation around the 2016 level. The main drivers of this are well-known, just three things to highlight for your radar screen.

Firstly, in Q2 and Q3 2016 we had several one-offs that lifted EBITDA pre by about [EUR90] million but will not recur.

Secondly, you may have read in our annual report that we recently entered into an agreement in Healthcare to swap a royalty income stream and receive a lump sum payment as compensation for future annual payments. On a net basis this list EBITDA pre this year in the mid- to high-double-digit euro million.

Thirdly, further you may have read in our annual report this morning that we are in advanced discussions with the divestment of our biosimilars activities. Until we see whether or not these succeed, the business remains part of Merck and, still as discussed at our Capital Markets Day in October, regular portfolio reviews are part of our daily business.

Moving to page 24. On a per-sector guidance for Healthcare we expect to see similar dynamics as in 2016 and hence slight to moderate net sales growth. With declining sales from Rebif despite the recent price increase in the US, we have good growth in our Asia-Pacific and LATAM markets and Erbitux is about stable-ish.

In Fertility it seems as if the second competitor in the US will not return to the market in 2017. The takeover of the commercialization rights for Glucophage from [BMS] in China should add a net about EUR100 million to EUR150 million in net sales versus last year. On the EBITDA pre sales growth and higher royalty income, based on Avonex and the royalty swap, cannot offset the unfavorable business mix effect as well as higher R&D costs and non-recurrence of 2016 benefits.

In Life Science demand remains healthy throughout our businesses and we continue to expect net sales growth slightly in excess of market growth, which soon will be around 4% per annum. This should drive EBITDA pre and the expected Sigma-related synergies of EUR185 million will add to this.

For Performance Materials we expect slight organic sales and EBITDA pre growth for 2017 driven by all four business pillars and by an approved environment in the display industry compared to 2016. However, the earthquake in Taiwan in mid-February will dampen Q1 2017 sales.

We assume that our market shares remain at their high levels. However, we cannot guarantee that the adjustments seen in Q4 2016 will not continue in 2017. So we keep this topic on our radar screen. Thank you very much. Constantin.

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Constantin Fest, Merck KGaA - Head of IR [6]

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With this we are happy to take your questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Matthew Weston, Credit Suisse.

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Matthew Weston, Credit Suisse - Analyst [2]

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A small number of questions, please. Firstly, on the bi-specific antibody in development, can you just give us an update? How many patients do you now have in the Phase II cohort expansion study? Can you tell us how many cohorts you have expanded? And I guess most importantly, when are we expecting to see significant data on the product?

Secondly, on Performance Materials, you've highlighted the market share and the impact of the Taiwan earthquake. I guess you have the advantage of having already seen 10 weeks of 2017 trading. So can you tell us what you have been seeing around market share shifts so far this year? And if you can just expand this to why you think you are losing market share I think that would be very interesting.

And then finally, a quick financial one. There seemed to be a significant spike in Healthcare underlying SG&A in 4Q. What drove that increase in spending? Thank you.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [3]

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Thank you, Matthew. Let me start with the bifunctional fusion protein which we refer to as -- in our own lingo as [trap] based on the fact that there are two molecules (inaudible) in [fusion] protein. Recruitment is ramping up rapidly. We have about 300 patients involved in the BASKET trial with about 10 indications. You should expect more data from the Phase I dose escalation trial at scientific conferences in midyear, potentially at ESCO. When it comes to PM and Q1 numbers, we will report this with Q1.

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Marcus Kuhnert, Merck KGaA - CFO [4]

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I take over the third question on the Healthcare SG&A uptick in Q4. The reason for that being predominantly increased marketing and selling expenses to prepare for the upcoming launches of avelumab MCC and cladribine.

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Matthew Weston, Credit Suisse - Analyst [5]

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Okay. Thank you very much.

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Operator [6]

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Peter Verdult, Citi.

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Peter Verdult, Citigroup - Analyst [7]

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Just a few questions, maybe kicking off with Stefan on the pipeline. Could you talk a little about portfolio prioritization? It seems that after many years Merck finally seems to be in the position of having a pipeline that has a pulse. So when you think about avelumab, the trap, the BTK inhibitors, the DNA damage/repair portfolio you've amassed, do you really have the capacity to fully invest in all these assets? Or should we be thinking more that partnership, or at least one of them, is definitely in the cards in 2017?

Secondly, just on -- you've mentioned the data for trap at ESCO -- just is there any other avelumab data that we should expect this year, or is it all for next year in ovarian?

And then a quick one on cladribine. Everyone in the market is scratching their heads working out what sort of revenue opportunity this could be. Are you willing to at least talk about what you think cladribine could do assuming approval in Europe?

And then a quick one for Markus [also] on Performance and Materials. Obviously you have expressed a degree of conservatism at the start of the year given some of the impacts that you are seeing. But just given the underlying demand trends are positive, the SA-VA launch coming and your recent comments about OLED turning profitable in this year, I just want to get a sense of your conference of maintaining profitability levels at current levels for the year. Thank you.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [8]

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Thank you, Peter. I will start with the portfolio prioritization question and obviously the biosimilars divestiture should be seen in that context. We initiated the biosimilars program at a time when our pipeline looked much less attractive. And it is now maybe also facing a situation where we had a major bio fab that was far below running far below capacity. So in a way us getting into biosimilars was a Plan B. And the fact that we are now focusing on our innovative pipeline, we ourselves interpret this as a sign of confidence.

Prioritization, you've seen that we are willing to partner. We did that with avelumab and that was a deal that was broadly noted. I think at that time it was the biggest-ever deal in the industry for a Phase I compound and we have been talking about the rationale for that.

I personally -- I've studied a couple of other companies, for instance, Boehringer Ingelheim in the 1990s when they had a very, very good pipeline. And where they clearly came to the conclusion that they could not launch -- first of all develop and commercialize all these compounds on their own. They did a lot of partnering and that was very successful.

We indicated that we would be willing to entertain discussions about partnering of [BDK]. However, we have initiated two Phase II trials and we believe that we will optimize the value of the compound after proof of concept.

So to answer your question, yes, we are willing to editing partnering discussions, but we also feel in a position of strength to (technical difficulty) commercialize some of the compounds ourselves. You have also seen that we have done the Vertex deal recently that fits very well with our internal pipeline. And so, you will see a mixture of partnering in and partnering out going forward too.

The second question was regarding avelumab data and TGF-beta trap data at ESCO. I had just indicated that you should expect data on the dose escalation for the [PL-1] TGF-beta compound. We assume that there will be exciting data on avelumab too presented at ESCO. But given the mechanics of scientific congress such as ESCO, I hope you understand that I cannot go into detail at this stage.

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Marcus Kuhnert, Merck KGaA - CFO [9]

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Peter, I will take your PM question. So when looking on the outlook for 2017 what we are currently seeing is that the macroeconomics have somewhat returned back to normal. That means specifically that the inventory levels have normalized. We see higher utilization rates at the [panel] producers basically back to pre-crisis levels. And we see also that the panel prices have come up significantly since I would say Q2/Q3 last year.

That all in all translates to our assumption that we should be able to return on the growth path with PM in 2017. And what we have seen in 2016 is that we were able to keep margin stable and the sales decline basically translated an alternate to a corresponding absolute EBITDA decline, but at relatively constant margins.

So that means that when we are able to return on the growth path again that will definitely de-burden our EBITDA pre development and will help to keep our profitability at the high level. Moreover, you have made also some points by yourself, so we think we continue to grow with OLED materials. We will introduce a new technology [mode] SA-VA from the second half of 2017 onwards, but we should not expect or should not be too bullish in terms of incremental sales related to SA-VA in 2017.

And last but not least, I mean we should also not forget that we have at the moment a very nice momentum, track record in our pigments and integrated circuits businesses. 2016 was a record year for both of these businesses in terms of growth and margin. And actually we see no reason at the moment that that would break in his track record, so this will also help us to keep profitability on a high level.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [10]

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And let me add some information; I didn't answer your [cladribine-related] question yet. You know that as a matter of policy we do not disclose our peak sales assumptions. External observers mentioned this. This is between EUR200 million and EUR400 million for the EU. We expect an [EMA] decision in Q3 and obviously peak sales depend very much on the label structure. We hope that this is going to be an attractive option for (technical difficulty) and you are familiar that the efficacy data.

We should note that the treatment regime is quite attractive. That means that patients take something like 10 tablets now; take something like 10 tablets a year later and that is a four-year treatment and you compare that to other treatment options. We at least internally assume that this is something that could be highly attractive to patients.

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Peter Verdult, Citigroup - Analyst [11]

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Thank you.

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Operator [12]

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Sachin Jain, BofA.

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Sachin Jain, BofA Merrill Lynch - Analyst [13]

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A couple of follow-up ones and then one big picture. Just a follow-up on the TGF-beta. Can you specify how many patients you have in the dose escalation portion of that study that we will see at ASCO? Could you remind us whether you still remain confident in a potential filing on Phase 1 data in certain populations? I think you have spoken before about Opdivo refractories and potential quick route to market.

Secondly on avelumab, the first-line lung cancer study you've added a higher dosage third arm to that study. Could you comment on what data has driven that so late after study start and whether you believe avelumab is underdosed in other indications too?

Thirdly on cladribine, where are you with ex-European filings? I think the prior commentary had been potentially looking at findings once you had had initial review from European regulators. You obviously had.

And then the final question is just a big picture on the Pfizer collaboration. Just given [there is] news in the media, could you outline what break clauses you have in the contract around immuno-oncology? On the flipside, have you had any discussions regarding expanding that collaboration, for example the TGF-beta or other early-stage assets? Thank you.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [14]

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Thank you, Sachin. This is quite a few questions. Please -- I am trying to work through them and please chime in if there's anything that I didn't address.

So on avelumab, the non-small cell lung cancer first-line amendment, we observed a correlation in the JAVELIN solid tumor basket trial Phase II and -- sorry, Phase I obviously -- and we have subsequently added this arm in the first-line trial where we will test this hypothesis.

We assume in terms of -- I was asked a question by MEA representatives this morning in terms of what that means for timing. You are very well aware that there has been -- after the BMS data there has been this discussion about how can we define a study design that both captures PFS and OS. And we think that with this new timing that we are not disadvantaged.

So then you have the question about TGF-beta traps. That's a theoretical question that is data-driven. If we see data as we hope that we will get, we will entertain such thoughts and such discussions with the regulatory agency. But I cannot make any valid statement right now on a TGF-beta trap filing based on Phase I data or not.

Cladribine, there was -- your question regarding a cladribine filing in the US. We have started in Europe. That was our internal focus and that was driven by academic excellence and patient groups who approached us. And it is also driven by the specifics of the EU regulatory environment. But before we said that we may eventually also look into other potential jurisdictions such as the US, which is obviously the largest MS market as of today. And there are other markets such as Australia, Russia, Canada and so on and we will go step-by-step.

Pfizer collaboration. This question about breakaway clause -- that's a question we have obviously considered when we designed the contract. We are not going to disclose any specifics of the contract, but it is very safe to assume that we were cognizant of this issue, or the potential for this issue when we designed the contract.

The TGF-beta trap compound, the PDL-1 TGF-beta trap compound is outside of the Pfizer agreement and we will discuss whether we will further develop this fully internally or whether we will partner this at the right point in time. That's too early right now. You can imagine that if this works according to our hopes -- I wouldn't say expectations, our hopes -- this could be something very big and also some other scenarios are possible too. So again, too early to discuss.

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Sachin Jain, BofA Merrill Lynch - Analyst [15]

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Thank you very much.

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Operator [16]

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Simon Baker, Exane.

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Simon Baker, Exane - Analyst [17]

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Three quick ones, if I may. Firstly on Rebif, the list price rise that you took in Jan. 17 is slightly higher than the 5% in January 2016. So I just wondered if you could comment on trends on the level of rebate there. I'm not expecting you to give us the net price rise, but if you could give us a qualitative feel for how the market is evolving from a rebate perspective.

Secondly on atacicept, I wonder if you could give us a little bit more color on the -- if you pardon the pun -- on the discoloration issues you are having with manufacturing of that drug. How long that will take to resolve and any potential delays that they could create for the development program?

And thirdly on CapEx, you're guiding to EUR850 million to EUR900 million this year. That's a little bit higher than 2016. I was wondering if that is a good guide for steady-state CapEx going forward. Thanks so much.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [18]

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So on Rebif, thank you, Simon, for pointing out that you don't have the expectations that we disclose net price effects. The price increase was, if I remember correctly, 5.5% gross and this is in line with the competitive landscape. Impossible for us to predict right now how price levels in these markets are going to be going forward. We have no idea yet what the new administration is going to do. So, I think it would be unprofessional to make any predictions at this stage.

There are external observers who think that the market is becoming somewhat more volatile through the introduction of [ocrelizumab], some patient warehousing, I don't know what. So again, very difficult to speculate on this.

On atacicept, I give you the full story. So we have 24-week data from the ADDRESS 2 Phase IIb study that confirmed the potential of atacicept as a candidate therapy for SME. And we were encouraged by the data in the high disease activity patients, noting that the primary endpoint was formerly not met. We are aiming at discussions with the FDA regarding a potential Phase III study that should be around June this year.

We currently also have a shortage of study drug supply, which is not related to any of the clinical findings and we are focusing on adjusting the manufacturing process to bridge to the approved specifications. You are aware that the manufacturing adjustments aimed to address this out-of-spec coloration issue with the current supplies of atacicept. And I would suggest that Marcus address the CapEx question.

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Marcus Kuhnert, Merck KGaA - CFO [19]

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Yes. So your question on CapEx, so the EUR900 million. Let me for elaborate very briefly on the increase versus 2015. Obviously one point is that we have now 12 months of Sigma-Aldrich included and there are some CapEx investments that will come on top from that.

Moreover, we discovered that Sigma was a little bit underinvested in the past, so that means there were some effects which -- where we had to catch up on CapEx on the Sigma side. Moreover we see also investments in the One Global Headquarters project here at the Darmstadt site, so these were the main drivers behind the 2016 numbers.

In 2017 now we will see predominantly investments behind the further growth of the business. So we will have some investments in China in Healthcare and in Life Science for new productions. We are opening up new growth opportunities. So for example, with the investments in the liquid crystal windows production side and this you can also expect when we look a little bit more forward.

So, I would think beyond 2017 the CapEx spend can go even a little bit higher, but the major driver would then be actually capacity investments. So that means it would be supported by the respective growth momentum of the businesses.

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Simon Baker, Exane - Analyst [20]

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Great. Thanks so much.

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Operator [21]

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Vincent Meunier, Morgan Stanley.

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Vincent Meunier, Morgan Stanley - Analyst [22]

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Thank you for taking my questions. The first one is on the biosimilars. Can you elaborate on the costs allocated to that business unit and the potential impact of the divestments on your targets for this year, if any?

The second question on the royalty swap. Based on your guidance, if we assume EUR50 million or EUR80 million of lump sum, that will represent what -- 1.5% maybe of the Group EBITDA pre in 2017. And so, does it mean that excluding this item the EBITDA pre would have been slightly down? And also, what will be roughly the size of the royalty stream in the future and the product?

I have also a question on Fertility. Gonal-f was down 1% organically in Q4. Is it a good proxy for the trend in 2017 and are you concerned that now competitors are fully back on track? Thank you.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [23]

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So I start with the biosimilars question. In 2016 we spent about EUR130 million on biosimilars and that was mostly on R&D, but also some manufacturing work and a little bit of money on preparation of commercialization.

I carry on with Gonal-f and then will then hand over to Markus. Q4 Gonal-f was lower in the EU due to biosimilars and competition. I was mentioning that the US situation has somewhat stabilized with one competitor coming back on the market; the other competitor not coming back and we still continue to see strong growth of fertility in China.

If we take all of this together, we should see definitely growth in 2017 being more muted than the high base in 2016.

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Marcus Kuhnert, Merck KGaA - CFO [24]

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So your question regarding the swap of the royalty stream. So, let me give you a little bit background on that. On February 6, 2017 we have entered into a contractual agreement according to which we will receive a one-time payment for royalties as compensation for future royalty and license payment.

The economic consequences are that we will receive a one-time cash inflow of EUR114 million in the exchange of three-years licensing stream. And with that you can let's say make your own calculations, basically what will be the net effect for -- or actually (inaudible) for the net effect that we have given you for 2017. And then you can also make up your mind what would be the net effect in 2018 and 2019, so the remaining two years we don't have the royalties then.

On your question for the outlook in 2017, so at this point of time we do not give a specific royalty outlook, but you can actually check in the annual report where we have basically revealed all of our royalty sources. So for example the Avonex case, which you should be well aware of. So this gives you I think a very good guidance where 2017 may land.

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Vincent Meunier, Morgan Stanley - Analyst [25]

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Thank you very much.

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Operator [26]

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Gunnar Romer, Deutsche Bank.

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Gunnar Romer, Deutsche Bank - Analyst [27]

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Just a quick follow-up on the market share normalization in Performance Materials. I was wondering whether you can comment on what you have baked into your guidance for the quarter and year.

And then second question would be on corporate cost. I think if I strip out the hedging effect you had, it's about stable year-over-year in 2017, what you are guiding for. Just wondering on the longer-term trends, we have seen a significant step up in this line over the past two years. Just help us understand how we should think about that line going forward, whether at all at some point this line may come down.

And then lastly, on Rebif and the stocking effect in the fourth quarter, I was wondering whether you can potentially quantify how much that's been roughly according to your estimates? Thank you.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [28]

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I will start with the Performance Materials assumption. We've also heard -- we heard from a couple of observers we heard questions about how come you expect to segue from a negative growth situation in 2016 into a slight organic growth pattern in 2017.

What we should note first of all, and that is something that often gets forgotten, is that our PMD, our display business, is only, so to say, about 50% of our Performance Materials business. And not all of our display materials is liquid crystal business. That's important to note.

You see positive macro trends in the display business compared to prior year. We see that the number of panels sold increases and we see that panel pricing increases too and that should filter through to us.

We also see that new modes such as SA-VA are being introduced and put into mass production as we speak and we hope that this will have a small but measurable effect toward the end of 2017 and we should also be -- we're in a situation where we have more easy comparables compared to prior year.

Our other businesses, pigments and integrated circuits, continue to grow very solid as they did -- we expect them to grow as solidly as they did in 2016.

When it comes to market shares, you know that we have high market shares. We expect these market shares to continue to be high as being by far the market leader, but we had -- among certain customers we had over the past -- actually not in 2016 but maybe early in 2016 and in 2015 -- for specific [effective] reasons we had extremely high market shares and we think we now assume that this will go back to a more natural level.

Hedging -- Markus will take over hedging.

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Marcus Kuhnert, Merck KGaA - CFO [29]

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So, Gunnar, on your second question on corporate costs, so you will have noticed that the 2017 guidance from the corporate costs segment is a little bit lower, so in a positive sense, than the number that you have seen for 2016. Indeed the current FX environment indicates even higher negative hedging effects in 2017 than what we had in 2016. So that means on a like for like basis we really see a [markable] decline in the (inaudible) cost in 2017.

If we look further down the road, it is difficult to make already concrete predictions. What we said here internally -- and that is basically also what we said in 2016 already -- that under no circumstances ever the corporate costs should crack the EUR400 million bar. We believe that looking forward, so 2018-2019, that we should have this cost segment well under control.

I would also not expect actually a further increase over the 2017-year level. However, I would like to make one comment here. You know that next year we have our 350 year anniversary and we need to see -- so we have the planning and we cannot yet say what will be the impact here, so it might be that something of that will also be visible in segment corporate. But be assured we have a close look on that cost position.

The last question, Rebif stocking effect. So you have seen in the numbers that the North America organic sales growth was 11% for Rebif in the fourth quarter. We have had two price increases in 2016 which add up to a total of around 9%, roughly. So when we grow 11% in the fourth quarter, that would mean that the volume was slightly positive in North America.

If we compare this with the run rate of the prior quarters, we always had the picture let's say by and large 10% price up, [volume-wise] is that we are more or less flat. And then you can make your own math what the stocking effect in Q4, which lifted us on a 10%, 11% basis. Okay?

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Gunnar Romer, Deutsche Bank - Analyst [30]

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Thank you. That's helpful. Maybe if I can -- just a quick follow-up on the lump sum. Shall we expect that you book that -- so I am talking about the royalty here. Should we expect that you book that on a pro rata temporis basis, or would you see that impacting just one quarter? How should we be thinking about it also then in terms of the [beta] to the cash flow statement, what you have factored in here?

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Marcus Kuhnert, Merck KGaA - CFO [31]

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The cash [in this] of course -- goes immediately into the cash flow statement. You will see the impact as other operating income in Q1 2017.

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Gunnar Romer, Deutsche Bank - Analyst [32]

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Okay. And the delta between the P&L impact and the cash flow impact, is that just conservative planning or how should we think about the delta, the EUR114 million?

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Marcus Kuhnert, Merck KGaA - CFO [33]

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The delta, Gunnar, you remember we swapped -- we got the one-time payment and we swapped three years of license payments and year one was 2017. Obviously one-third of the license payments we will not see as regular license payment, but instead as a one-time cash in.

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Gunnar Romer, Deutsche Bank - Analyst [34]

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Okay. Got it.

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Operator [35]

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Richard Vosser, JPMorgan.

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Richard Vosser, JPMorgan - Analyst [36]

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A couple of questions, please. Just on the R&D spend development in Healthcare, perhaps you could give us maybe a little bit more color on the magnitude of the increase you are thinking about in 2017.

And then on the Glucophage sales in China that you are now bringing in from Bristol-Myers, you mentioned the amount of EUR100 million to EUR150 million. Just what sort of growth have we seen in that area in terms of the sales in the past in China and what we might think going forward?

And just thinking about the profitability impact of those sales, is there anything you can do similarly to when you took over the Rebif marketing that might make that more profitable that we should think about this year? Thanks very much.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [37]

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On the R&D spend, if you look back in 2016 we had actually expected to spend more in 2016 already if you look back at the guidance that we gave. We had talked about the reasons why this spend would occur later on.

If I look into consensus, I read that market expectations for us is to be spending about EUR150 million to EUR200 million more compared to prior year. And what I would say is that that does not seem entirely totally illogical to make such an assumption. I hope that answers your question.

On Glucophage, plenty of positive events. We also -- late last year we have opened a factory in Nantong in China that makes Glucophage. So this is a local product right now with all the advantages and also Essential Medicines List.

And so, we do not disclose -- we generally do not disclose individual country sales numbers. You can get that out of -- the in-market data out of IMS. We expect until 2018 mid- to high-single-digit growth on a -- for our general medicine portfolio in this indication on a global basis. So it does have a significant impact on our overall revenue development.

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Marcus Kuhnert, Merck KGaA - CFO [38]

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So, Richard I take over and your question on Glucophage sales in China. So the past growth of that business we can derive as an approximation from the delta of the license income -- of the commission income that we have recorded. And so, the growth in 2016 was around about 20%. That however does not mean that we will continue exactly on that path going forward, but this gives you maybe a little bit the ballpark.

We actually would not see a big impact on the bottom line from that, because what we are effectively doing is that we are switching basically license income, so commission income, into a full P&L. Of course we will see that the absolute sales that will be increasing, we will see absolute EBITDA pre coming now, but no big impact on the pure bottom line.

However, please keep in mind this will have a slightly negative effect on the margin simply due to the fact that when you have just licensing income you do not have any denominator, so sales were zero, you have just licensing income.

Now we have a full P&L, that means profitability in terms of margin. The relative number is slightly diluted. However, we believe -- and that was the strategic rationale why we did it -- that under our own roof the long-term prospect of that business will be better than -- and I would like to hand over to Stefan now also for a comment.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [39]

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You referred to the Rebif Pfizer example. I would say we are facing a very different situation here. The co-promotion deal that we had with Pfizer on Rebif in the US was characterized by the fact that they had been early on -- and that was prior to us acquiring Serono -- there had been a very high upfront payment being made by Pfizer to Serono.

And then the characteristics of the deal, of the co-promotion deal were less favorable to us. So the ending of the co-promotion deal was a net positive for us. In this case here we had simply licensed out the compound to BMS and we have now repatriated it, which means that we had to build up a sales force locally, which has happened and that means that you also see higher SG&A in this area.

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Richard Vosser, JPMorgan - Analyst [40]

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Thank you.

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Operator [41]

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Florent Cespedes, Societe Generale.

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Florent Cespedes, Societe Generale - Analyst [42]

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Three quick ones. First on Healthcare, just a quick one on Erbitux. How do you see the performance going forward? And is the Q4 a good proxy for the quarters to come or years to come?

Then two questions on Life Science. First, could you elaborate a bit on the dynamic of the subdivisions? Is there any change of dynamic that you have observed recently? And the last one on Process Solutions on the delayed order, could you explain why the customer, or the delay occurred this year and not last year? So is it really something that was a kind of one-off, or should we see this pretty much every year? Thank you.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [43]

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So on Erbitux in Q4. Erbitux is obviously a mature product and midterm it will be stable-ish at best because we are seeing [ion] competition in the midterm and possibly always a further narrowing of the patient base. Dynamics in the Life Science sector overall, we must say that 2016 has been a particularly good year for the Life Science business.

If we look at our assumptions, the assumptions that we formulated when we acquired Sigma-Aldrich market growth was significantly faster, mostly driven by Process Solutions but also by Applied Solutions.

For those of you who are not so familiar with our business, again, we have three business units within Life Science. One is Process Solutions, that is bioprocess. The second one is Research Solutions, so that is research lab and academia on pharma. And the third one is Applied Solutions, which is regulated analytics, mostly quality control in pharma but also in the food industry. And the two main growth drivers were Process Solutions and Applied Solutions.

Also there were some factors -- launches that impact performance since our new next-generation lab [order] equipment which we are rolling out as we are speaking now. We aim to continue to be the profitability champion of this sector. We see in Process Solutions we assume high-single-digit growth. We have seen extreme growth in some areas in Process Solutions over last year that was an outlier. In Applied Solutions we assume mid-single-digit growth and in Research Solutions we assume low-single-digit growth.

Again, we don't really know what the policy of the Trump administration is going to be when it comes to NIH funding, which is very important for us. We have to watch that very, very closely. That was about growth dynamics within the Life Science sector.

All in all if you look at value generation of the Sigma-Aldrich acquisition, again, the higher-than-expected market growth, the continued performance of our organization above market currency, currency developments and the speed with which we have achieved synergies and as also somewhat overachieving on synergies. All of that taken together means that we have really accelerated value creation versus our base case.

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Marcus Kuhnert, Merck KGaA - CFO [44]

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Your remaining question on the order delay, it just happened in 2016. I would not make a trend out of it.

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Richard Vosser, JPMorgan - Analyst [45]

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Okay. Thank you very much.

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Constantin Fest, Merck KGaA - Head of IR [46]

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With this I would like to jump in here. I think we are well over one hour now. As I said earlier, we need to catch a plane. And with this I'd like to hand over to Stefan for the closing words.

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Stefan Oschmann, Merck KGaA - Chairman of Executive Board & CEO [47]

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Again, thank you very much for dialing in. 2016 was a really good year for Merck. You have heard about our basic assumptions for 2017. Yes, we do invest into pharma, into healthcare R&D. We believe that this is a sign of strength. And I'm looking forward to meeting many of you during the upcoming road shows. Thank you very much.

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Operator [48]

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Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.