e20vf
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As filed with the Securities and Exchange Commission on April 8, 2004



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549


FORM 20-F

         
(Mark One)        
o   REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF
THE SECURITIES EXCHANGE ACT OF 1934
OR
   
x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003.

OR
   
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-16829
   
BAYER AKTIENGESELLSCHAFT
(Exact name of Registrant as specified in its charter)
BAYER CORPORATION*
(Translation of Registrant’s name into English)
Federal Republic of Germany
(Jurisdiction of incorporation or organization)

Bayerwerk, Gebäude W11

Kaiser-Wilhelm-Allee
51368 Leverkusen, GERMANY
(Address of principal executive offices)


          Securities registered or to be registered pursuant to Section 12(b) of the Act.

     
Title of each class: Name of each exchange on which registered:


American Depositary Shares representing Bayer AG
ordinary shares of no par value
  New York Stock Exchange
Bayer AG ordinary shares of no par value
  New York Stock Exchange**


          Securities registered or to be registered pursuant to Section 12(g) of the Act.

None

(Title of class)

          Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

None

(Title of class)

          Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

          As of December 31, 2003, 730,341,920 ordinary shares, of no par value, of Bayer AG were outstanding.

          Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x          No o          Not applicable.

          Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17 o          Item 18 x

*   Bayer Corporation is also the name of a wholly-owned subsidiary of the registrant in the United States.
 
**  Not for trading, but only in connection with the registration of American Depositary Shares.




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 Exhbit 1.1
 Exhibit 4.1
 Exhibit 4.2
 Exhibit 4.3
 Exhibit 4.4
 Exhibit 12.1
 Exhibit 12.2
 Exhibit 13.01

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Defined Terms and Conventions

      Bayer AG is a corporation organized under the laws of the Federal Republic of Germany. As used in this annual report, unless otherwise specified or required by the context, the term “Company”, “Bayer” or “Bayer AG” refers to Bayer AG and the terms “we”, “us” and “our” refer to Bayer AG and, as applicable, Bayer AG and its consolidated subsidiaries.

      Due to rounding, numbers presented throughout this document may not add up precisely to the totals we provide and percentages may not precisely reflect the absolute figures.

Forward-Looking Information

      This annual report contains forward-looking statements that reflect our plans and expectations. As these statements are based on current plans, estimates and projections, you should not place undue reliance on them. We generally identify forward-looking statements with words such as “expects”, “intends”, “anticipates”, “plans”, “believes”, “estimates” and similar expressions.

      Forward-looking statements involve known and unknown risks, uncertainties and other factors. We caution you that a number of important factors may cause our actual results, performance, achievements or financial position to be materially different from any results, performance, achievements or financial position expressed or implied by forward-looking statements. These factors include, but are not limited to:

  •  Cyclicality in our industries;
 
  •  Reduced demand for older products in response to advances in biotechnology;
 
  •  Increasingly stringent regulatory controls;
 
  •  Increased raw materials prices;
 
  •  The expiration of patent protections;
 
  •  Environmental liabilities and compliance costs;
 
  •  Failure to compete successfully, integrate acquired companies or develop new products and technologies;
 
  •  Risks from hazardous materials;
 
  •  Litigation and product liability claims; and
 
  •  Fluctuations in currency exchange rates.

      A discussion of these and other factors that may affect our actual results, performance, achievements or financial position is contained in Item 3, Key Information — Risk Factors, the various “Strategy” sections in Item 4, Information on the Company, Item 5, Operating and Financial Review and Prospects and elsewhere in this annual report.

      Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events.

Enforceability of Civil Liabilities under U.S. Federal Securities Laws

      We are a German corporation. All of our directors and executive officers are residents of Germany. A substantial portion of our assets and those of such individuals is located outside the United States.

      As a result, although a multilateral treaty to which both Germany and the United States are party guarantees service of writs and other legal documents in civil cases if the current address of the defendant is known, it may be difficult or impossible for you to effect service of process upon these persons from within the United States.

      Also, because these persons and assets are outside the United States, it may be difficult for you to enforce judgments against them in the United States, even if these judgments are of U.S. courts and are based on the civil liability provisions of the U.S. securities laws.

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      If you wish to execute the judgment of a foreign court in Germany, you must first obtain from a German court an order for execution (Vollstreckungsurteil). A German court may grant an order to execute a U.S. court judgment with respect to civil liability under the U.S. federal securities laws if that judgment is final as a matter of U.S. law. In granting the order, the German court will not enquire whether the U.S. judgment was, as a matter of U.S. law, correct. However, the German court must refuse to grant the order if:

  •  the U.S. court lacked jurisdiction, as determined under German law;
 
  •  the person against whom the judgment was obtained did not receive service of process adequate to permit a proper defense, did not otherwise acquiesce in the original action and raises the lack of service of process as a defense against the grant of the execution order;
 
  •  the judgment would conflict with the final judgment of a German court or with the final judgment of another foreign court that is recognizable under German law;
 
  •  recognition of the judgment would violate an important principle of German law, especially basic constitutional rights; or
 
  •  there is a lack of reciprocity between Germany and the jurisdiction whose court rendered the original judgment.

      You should be aware that German courts hold certain elements of some U.S. court judgments, for example, punitive damages, to violate important principles of German law. Judgments for ordinary compensatory damages are generally enforceable, unless in an individual case one of the reasons described above would forbid enforcement.

      If you bring an original action before a German court based on the provisions of the U.S. securities laws and the court agrees to take jurisdiction over the case, the court will decide the matter in accordance with the applicable U.S. laws, to the extent that these do not violate important principles of German law. However, the court may refuse to accept jurisdiction if another action is pending before a U.S. or other foreign court in the same matter. Furthermore, the court might decide that, for a lawsuit brought by a U.S. resident under U.S. law against a defendant that, like Bayer, has a significant presence in the United States, a U.S. court would be the more proper forum.

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PART I

 
Item 1.  Identity of Directors, Senior Management and Advisors

Directors and Senior Management

      Not applicable.

 
Item 2.  Offer Statistics and Expected Timetable

      Not applicable.

 
Item 3.  Key Information

Selected Financial Data

      We derived the following selected financial data for each of the years in the five-year period ended December 31, 2003 from our consolidated financial statements. We have prepared our consolidated financial statements in accordance with International Financial Reporting Standards, or IFRS, and, where indicated, in accordance with U.S. Generally Accepted Accounting Standards or U.S. GAAP. Since 2002, IFRS is the term for the entire body of accounting standards issued by the International Accounting Standards Board, replacing the earlier IAS, or International Accounting Standards. Individual accounting standards that the IASB issued prior to this change in terminology continue to use the prefix “IAS”. Note 44 to our consolidated financial statements included in Item 18 of this annual report describes the reconciliation of significant differences between IFRS and U.S. GAAP.

      Since January 1, 1999, we have prepared our financial statements in European Union euros (). In this annual report, we have translated certain euro amounts into U.S. dollar amounts at the rate of $1.2597 = 1.00, the noon buying rate of the Federal Reserve Bank of New York on December 31, 2003. We have translated these amounts solely for your convenience, and you should not assume that, on that or any other date, one could have converted these amounts of euros into dollars at that or any other exchange rate.

      The financial information presented below is only a summary. You should read it together with the consolidated financial statements included in Item 18.

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Consolidated Income Statement Data

                                                 
Year ended December 31,

1999 2000 2001 2002 2003 2003






$
(in millions, except per share data)
IFRS:
                                               
Net sales from continuing operations
      (1)       (1)     21,702       22,038       22,178       27,938  
Net sales from discontinuing operations
      (1)       (1)     8,573       7,586       6,389       8,048  
Net sales
    27,320       30,971       30,275       29,624       28,567       35,986  
Operating result from continuing operations
      (1)       (1)     1,466       850       449       566  
Operating result from discontinuing operations
      (1)       (1)     210       760       (1,652 )     (2,081 )
Operating result
    3,357       3,287       1,676       1,610       (1,203 )     (1,515 )
Non-operating result
    (521 )     (297 )     (561 )     (654 )     (791 )     (996 )
Income before income taxes
    2,836       2,990       1,115       956       (1,994 )     (2,512 )
Income taxes
    (818 )     (1,148 )     (154 )     107       645       813  
Income after taxes
    2,018       1,842       961       1,063       (1,349 )     (1,699 )
Minority stockholders’ interest
    (16 )     (26 )     4       (3 )     (12 )     (15 )
Net income
    2,002       1,816       965       1,060       (1,361 )     (1,714 )
Average number of shares in issue
    730       730       730       730       730       730  
Operating result from continuing operations per share
      (1)       (1)     2.01       1.16       0.61       0.77  
Basic net income/loss per share
    2.74       2.49       1.32       1.45       (1.86 )     (2.34 )
Diluted net income/loss per share
    2.74       2.49       1.32       1.45       (1.86 )     (2.34 )
Dividends per share
    1.30       1.40       0.90       0.90       N/A   (2)     N/A   (2)
U.S. GAAP:
                                               
Net income
    1,967       1,783       800       1,277       (1,445 )     (1,820 )
Basic and diluted net income per share
    2.69       2.44       1.10       1.75       (1.98 )     (2.49 )


(1)  We do not present discontinuing operations data for 1999 and 2000 because we were unable without unreasonable effort and expense to restate these years’ financial data to reflect the operations we classified as discontinuing operations in all more recent periods.
(2)  The dividend payment for 2003 has not yet been decided on. Our Supervisory Board has accepted our Board of Management’s proposal to recommend at our annual general shareholders’ meeting a dividend for 2003 of 0.50 per share, for a total dividend of 365 million.

Consolidated Balance Sheet Data

                                                 
December 31,

1999 2000 2001 2002 2003 2003






$
(in millions, except per share data)
IFRS:
                                               
Total Assets
    31,279       36,451       37,039       41,692       37,445       47,169  
Of which discontinuing operations
    (1)     (1)     8,813       6,904       5,655       7,124  
Stockholders’ equity
    15,006       16,140       16,992       15,335       12,213       15,385  
Liabilities
    16,097       20,074       20,019       26,237       25,109       31,630  
Of which long-term financial obligations
    2,359       2,803       3,071       7,318       7,113       8,960  
Of which discontinuing operations
    (1)     (1)     3,489       3,143       3,153       3,972  
U.S. GAAP:
                                               
Stockholders’ equity
    17,177       19,110       18,300       16,734       13,327       16,788  
Total assets
    32,769       38,740       37,831       42,668       38,012       47,884  


(1)  We do not present discontinuing operations data for 1999 and 2000 because we were unable without unreasonable effort and expense to restate these years’ financial data to reflect the operations we classified as discontinuing operations in all more recent periods.

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Dividends

      The following table indicates the dividends per share paid from 2001 to 2003. Shareholders who are U.S. residents should be aware that they will be subject to German withholding tax on dividends received. See Item 10, Additional Information — Taxation.

                         
2001 2002 2003



Total dividend (euros in millions)
    657       657       N/A (1)
Dividend per share (euro)
    0.90       0.90       N/A (1)


(1)  The dividend payment for 2003 has not yet been decided on. Our Supervisory Board has accepted our Board of Management’s proposal to recommend at our annual general shareholders’ meeting a dividend for 2003 of 0.50 per share, for a total dividend of 365 million.

     See also Item 8, Financial Information — Dividend Policy and Liquidation Proceeds.

Exchange Rate Data

      The following table shows, for the periods and dates indicated, the exchange rate of the U.S. dollar to the euro based on the noon buying rate of the Federal Reserve Bank of New York. Fluctuations in the exchange rate between the euro and the dollar will affect the market price of the shares and the ADSs, the dollar amount received by holders of shares and the ADSs on conversion by the Depositary of any cash dividends paid in euro and the dollar translation of our results of operations and financial condition.

                                 
Year Period End Average High Low





(dollar per euro)
1999
    1.0070       1.0655       1.1812       1.0016  
2000
    0.9388       0.9233       1.0335       0.8270  
2001
    0.8901       0.8909       0.9535       0.8370  
2002
    1.0485       0.9454       1.0485       0.8594  
2003
    1.2597       1.1321       1.2597       1.0361  
                 
Previous six months High Low



(dollar per euro)
October 2003
    1.1833       1.1596  
November 2003
    1.1995       1.1417  
December 2003
    1.2597       1.1956  
January 2004
    1.2853       1.2389  
February 2004
    1.2848       1.2426  
March 2004
    1.2431       1.2088  

Risk Factors

      An investment in our shares or ADSs involves a significant degree of risk. You should carefully consider these risk factors and the other information in this annual report before deciding to invest in our shares or ADSs. The risks described below are the ones we consider material. However, they are not the only ones that may exist. Additional risks not known to us or that we consider immaterial may also have an impact on our business operations. The occurrence of any of these events could seriously harm our business, operating results and financial condition. In that case, the trading price of our shares or ADSs could decline and you could lose all or part of your investment.

Our intended transactions relating to Lanxess may be unsuccessful and we may not realize the benefits we expect from these transactions

      As announced in November 2003, we plan to combine Bayer Chemicals (except for Wolff Walsrode and H.C. Starck), with certain parts of the Bayer Polymers business in a new company to be named “Lanxess”. In a

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first step, we intend to contribute the activities we have identified for this business, including the foreign activities and the related functions in our service and corporate center, into Lanxess, which at that time will be a wholly-owned subsidiary. In a second step, we intend to dispose of the shares in this subsidiary. Our aim for this company is to be listed on the Frankfurt Stock Exchange by early 2005.

      We may not be successful in combining businesses with Lanxess on strategically advantageous terms, and our strategy for choosing which business we place in Lanxess and which we retain may be flawed. Lanxess and our continuing businesses could each or all fail to succeed for reasons relating to our actions or for external reasons. Any of this can lead to a loss of revenues or income. Moreover, any definitive plan for any spin-off of this business may be subject to regulatory action and other execution risks. Our financial condition, results of operations and stock price could be adversely affected if we do not conclude the Lanxess transaction on advantageous terms or in a timely manner (or if we fail to conclude it at all).

      Furthermore, we may not realize all the benefits for our Group that we intend to realize from this transaction and our related reorganization.

Cyclicality may reduce our operating margins or cause operating losses

      Several of the industries in which Bayer operates are cyclical. These industries include chemicals and polymers in particular. Typically, increased demand during peaks in the business cycle in these industries leads producers to increase their production capacity. Although peaks in the business cycle have been characterized by increased selling prices and higher operating margins, in the past these capacity increases have led to overcapacities because they have exceeded demand growth. Low periods in the business cycles are then characterized by decreasing prices and excess capacity. These factors can depress operating margins and may result in operating losses.

      We believe that several areas within the chemical and polymer industries currently show overcapacity, especially those areas, such as basic chemicals, that are subject to commoditization, and we expect that there may be further capacity additions in the next few years. Future growth in demand may not be sufficient to absorb current overcapacity or future capacity additions without significant downward pressure on prices and adverse effects on our operating results.

      The agriculture sector is particularly subject to seasonal and weather factors and fluctuations in crop prices, which may have a negative influence on our business results. As climate conditions and market prices for agricultural products change, the demand for our agricultural products generally also changes. For example, a drought will often reduce demand for our fungicides products.

Failure to develop new products and production technologies may harm our competitive position

      Bayer’s operating results significantly depend on the development of commercially viable new products and production technologies. We devote substantial resources to research and development. Because of the lengthy development process, technological challenges and intense competition, we cannot assure you that any of the products we are currently developing, or may begin to develop in the future, will become market-ready or achieve commercial success. If we are unsuccessful in developing new products and production processes in the future, our competitive position and operating results will be harmed.

      Competitive pressure from new agrochemical compounds that achieve similar or improved results with better ecotoxicological profiles and smaller doses may reduce the sales of our existing products. The growing importance of plant biotechnology in the crop protection field could reduce market demand for some of our agrochemical products and, to the extent that our competitors supply those biotechnological products, could lead to declines in our revenues.

Regulatory controls and changes in public policy may reduce the profitability of new or current products

      We must comply with a broad range of regulatory controls on the testing, manufacture and marketing of many of our products. In some countries, including the United States, regulatory controls have become increasingly demanding. We expect that this trend will continue and will expand to other countries, particularly

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those of the European Union. A proposed new EU chemicals policy could mandate a significant increase in the testing and assessment of all chemicals, leading to increased costs and reduced operating margins for these products. Although we have adopted measures to address these stricter regulations, such as increasing the efficiency of our internal research and development process in order to reduce the impact of extended testing on time-to-market, stricter regulatory regimes could delay our product development or restrict our marketing and sales.

      Our Pharmaceuticals, Biological Products segment and our Consumer Care, Diagnostics segment are subject to particularly strict regulatory regimes. Failure to achieve regulatory approval of new products can mean that we do not recoup our research and development investment through sales of that product. Withdrawal by regulators of an approval previously granted can mean that the affected product ceases to generate revenue. This can occur even if regulators take action falling short of actual withdrawal or direct their action at “over-the-counter” (OTC) products that do not require regulatory approval. For example, in November 2000, the U.S. Food and Drug Administration issued a recommendation to all manufacturers of products containing phenylpropanolamine (PPA). As a result, we voluntarily discontinued marketing our Consumer Care products that contained this substance. In addition, in some cases we may voluntarily cease marketing a product even in the absence of regulatory action.

      Our Biological Product Division is generally facing complicated production processes that are more subject to disruption than is the case with other processes and therefore pose increased risk of manufacturing problems, unplanned shutdowns and loss of products.

      Pharmaceutical product prices are subject to controls or pressures in many markets. Some governments intervene directly in setting prices. In addition, in some markets major purchasers of pharmaceutical products (whether governmental agencies or private health care providers) have the economic power to exert substantial pressure on prices. Price controls limit the financial benefits of growth in the life sciences markets and the introduction of new products. We cannot predict whether existing controls will increase or new controls will be introduced, further limiting our financial benefits from these products.

      Changes in governmental agricultural policies could significantly change the structure of the overall market for agricultural products in affected countries in which we operate. A substantial change in the level of subsidies for agricultural commodities could negatively affect the level of agricultural production and the extent of the area under cultivation. As a consequence, existing markets could change with a corresponding negative impact on our CropScience subgroup’s sales and operating results.

      As it is impossible at present to determine precisely what changes, if any, may occur, whether and when such changes will be implemented and the extent of their impact, close monitoring and analyses of the related political developments are necessary. We expect the operating result of our CropScience business to reflect the uncertainties of this industry. Similarly, but to a lesser extent, changes in agricultural policy could also have a negative effect on the sales and operating results of our Animal Health business.

Our operating margins may decrease if we cannot pass increased raw material prices on to customers or if prices for our products decrease faster than raw material prices

      Significant variations in the cost and availability of raw materials and energy may reduce our operating results. Bayer uses significant amounts of petrochemical-based raw materials in manufacturing a wide variety of our products. We also purchase significant amounts of natural gas, coal, electricity and fuel oil to supply the energy required in our production processes. The prices and availability of these raw materials and energy vary with market conditions and may be highly volatile. There have been in the past, and may be in the future, periods during which we cannot pass raw material price increases on to customers. Even in periods during which raw material prices decrease, we may suffer decreasing operating profit margins if the prices of raw materials decrease more slowly than do the selling prices of our products. In the past, we have entered into hedging arrangements with respect to raw materials prices only to a limited extent. If the market for these hedging arrangements attains sufficient liquidity and we can obtain their protection at a reasonable cost, we would consider making more extensive use of these hedge instruments.

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Litigation and administrative claims could harm our operating results and cash flows

      We are involved in a number of legal proceedings and may become involved in additional legal proceedings. See Item 8, Financial Information — Legal Proceedings. Each of these proceedings or potential proceedings could involve substantial claims for damages or other payments. These proceedings include claims alleging product liability and claims alleging antitrust violations. If our opponents in these lawsuits obtain judgments against us or if we determine to settle any of these lawsuits, we could be required to pay substantial damages and related costs.

      We are also plaintiff in lawsuits to enforce our patent rights in our products. If we are not successful in these actions, we would expect our revenue from these products to decline as generic competitors enter the market.

      In cases where we believe it appropriate, we have established provisions to cover potential litigation-related costs. Increased risks currently result from litigation commenced in the United States after we voluntarily withdrew Lipobay/Baycol (cerivastatin) from the market and voluntarily stopped marketing products containing phenylpropanolamine (PPA).

      Due to the considerable uncertainty associated with these proceedings related to Lipobay/Baycol (cerivastatin), it is currently not possible to more accurately estimate the potential liability and thus no provisions exceeding the expected insurance coverage and our accounting measures already taken have yet been made. Depending on the progress of the litigation, Bayer may face payments that exceed our expected insurance coverage and our accounting measures and will continue to reconsider the need to establish additional provisions, which may have a negative effect on our financial results.

      Due to the considerable uncertainty associated with the proceedings related to PPA, it is currently not possible to more accurately estimate potential liability and thus no provisions for such potential liabilities have yet been made. Depending on the progress of the litigation, Bayer may face payments that exceed our insurance coverage and will continue to reconsider the need to establish provisions, which may have a negative effect on our financial results.

The loss of patent protection or ineffective patent protection for marketed products may result in loss of sales to competing products

      During the life of its patent related to the compound per se, a patented product is normally only subject to competition from alternative products. After a patent expires, the producer of the formerly patented product is likely to face increased competition from generic products entering the market. This competition is likely to reduce market share and sales revenue. See Item 4, Information on the Company — Intellectual Property Protection, for a discussion of the scheduled expiration dates of our significant patents. In addition, generic drug manufacturers, particularly in the United States, may seek marketing approval for pharmaceutical or agricultural products currently under patent protection by attacking the validity or enforceability of a patent. If a generic manufacturer succeeds in voiding a patent protecting one of our products, that product could be exposed to generic competition before the natural expiration of the patent. See Item 8, Financial Information — Legal Proceedings, for a discussion of several important patent-related proceedings in which we are involved.

      The extent of patent protection varies from country to country. In some of the countries in which we operate, patent protection may be significantly weaker than in the United States or the European Union. Piracy of patent-protected intellectual property has often occurred in recent years, particularly in some Asian countries. In particular, these countries could facilitate competition within their markets from generic manufacturers who would otherwise be unable to introduce competing products for a number of years. We do not currently expect any proposed patent law modifications to affect us materially. Nevertheless, if a country in which we sell a substantial volume of an important product were to effectively invalidate our patent rights in that product, our revenue could suffer.

Failure to compete successfully or integrate newly acquired businesses may reduce our operating profits

      Bayer operates in highly competitive industries. Actions of our competitors could reduce our profitability and market share. In some commodity areas (especially within our Plastics, Rubber segment, our Polyurethanes,

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Coatings, Fibers segment and our Chemicals segment), we compete primarily on the basis of price and reliability of product and supply. All of our segments, however, also compete in specialty markets on the basis of product differentiation, innovation, quality and price. Significant product innovations, technical advances or the intensification of price competition by competitors could harm our operating results.

      In the Healthcare business our competitors are consolidating, and the strength of combined companies could affect our competitive position.

      From time to time, we acquire all or a portion of an established business and combine it with our existing business units. Integration of existing and newly acquired businesses requires difficult decisions with respect to staffing levels, facility consolidation and resource allocation. We must also plan carefully to ensure that established product lines and brands retain or increase their market position. If we fail to effectively integrate a new business or if integration results in significant unexpected costs, our results of operations could suffer.

Risks from the handling of hazardous materials could harm our operating results

      Bayer’s operations are subject to the operating risks associated with pharmaceutical and chemical manufacturing, including the related storage and transportation of raw materials, products and wastes. These hazards include, among other things:

  •  pipeline and storage tank leaks and ruptures;
 
  •  explosions; and
 
  •  discharges, disposal or releases of toxic or hazardous substances.

      These operating risks can cause personal injury, property damage and environmental contamination, and may result in the shutdown of affected facilities and the imposition of civil or criminal penalties or negatively impact the reputation of the whole company. The occurrence of any of these events may significantly reduce the productivity and profitability of a particular manufacturing facility and harm our operating results.

      Although we maintain property, business interruption and casualty insurance that we believe is in accordance with customary industry practices, this insurance may not be adequate to cover fully all potential hazards incident to our business.

      For more detailed information on environmental issues, see Item 4, Information on the Company — Business — Governmental Regulation.

Environmental liabilities and compliance costs may have a significant negative effect on our operating results

      The environmental laws of various jurisdictions impose actual and potential obligations on Bayer to remediate contaminated sites. These obligations may relate to sites:

  •  that we currently own or operate;
 
  •  that we formerly owned or operated;
 
  •  where waste from our operations was disposed; or
 
  •  where we contaminate air, water or soil by emissions or spills onto the property of third parties.

      These environmental remediation obligations could significantly reduce our operating results. In particular, our accruals for these obligations may be insufficient if the assumptions underlying these accruals prove incorrect or if we are held responsible for additional, currently undiscovered contamination. See Item 4, Information on the Company — Business — Governmental Regulation.

      Furthermore, Bayer is or may become involved in claims, lawsuits and administrative proceedings relating to environmental matters. An adverse outcome in any of these might have a significant negative impact on our operating results and public reputation.

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      Stricter environmental, safety and health laws and enforcement policies could result in substantial costs and liabilities to Bayer and could subject our handling, manufacture, use, reuse or disposal of substances or pollutants to more rigorous scrutiny than is currently the case. Consequently, compliance with these laws could result in significant capital expenditures as well as other costs and liabilities, thereby harming our business and operating results.

Existing insurance coverage may turn out to be inadequate

      We are aiming at adequately covering foreseeable risks by insurance. Such insurance coverage, however, may turn out not to fully cover the risks to which the company is exposed. For certain risks, adequate insurance coverage may not be available on the market or may not be available at reasonable conditions.

Fluctuations in exchange rates may affect our financial results

      Bayer conducts a significant portion of its operations outside the euro zone. Fluctuations in currencies of countries outside the euro zone, especially the U.S. dollar, can materially affect our revenue as well as our operating results. For example, changes in currency exchange rates may affect:

  •  the relative prices at which we and our competitors sell products in the same market; and
 
  •  the cost of items we require for our operations.

      Although these fluctuations can benefit us, they can also harm our results. From time to time, we may use financial instruments to hedge our exposure to foreign currency fluctuations. As of December 31, 2003, we had entered into forward foreign exchange contracts and currency swaps with a total notional value of 4.0 billion (excluding cross currency interest rate swaps included in our 6.3 billion notional amount of interest rate hedging contracts). For further information on these products, see Item 11, Quantitative and Qualitative Disclosures about Market Risk.

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Item 4.  Information on the Company

HISTORY AND DEVELOPMENT OF THE COMPANY

      Bayer Aktiengesellschaft, or Bayer AG, is a stock corporation (Aktiengesellschaft) organized under the laws of the Federal Republic of Germany.

      Bayer AG was incorporated in 1951 under the name “Farbenfabriken Bayer AG” for an indefinite term and adopted its present name in 1972. Bayer AG’s registered office (Sitz) and principal place of business are at the Bayerwerk, 51368 Leverkusen, Germany. Its telephone number is +49 (214) 30-1 and its home page on the World Wide Web is at www.bayer.com. Reference to our website does not incorporate the information contained on the website into this annual report. The headquarters of Bayer AG’s U.S. subsidiary, Bayer Corporation, are located at 100 Bayer Road, Pittsburgh, PA 15205-9741.

      Although Bayer AG was incorporated in 1951, it traces its roots to Friedr. Bayer & Co., an aniline dye works founded in Wuppertal, Germany in 1863 by Friedrich Bayer and Johann Friedrich Weskott. This company achieved a leading position in its industry, opening facilities and agencies in the United States and in other European countries. Friedr. Bayer & Co. made numerous discoveries, most notably of aspirin (acetylsalicylic acid), perhaps the best-known and most widely used medication in world history.

      In 1925, the original Bayer company merged with five other leading German chemical and pharmaceutical companies, including the ancestors of today’s Aventis and BASF, to form I.G. Farbenindustrie AG, or I.G. Farben. After the second World War, the Allied High Commission, formed by the United States, the United Kingdom, France and the former Soviet Union to administer occupied Germany, seized the assets of I.G. Farben. Pursuant to Law No. 35 of the Allied High Commission, some of these assets were later distributed among 12 newly formed companies, including the present Bayer AG.

      After World War I, the U.S. government expropriated the U.S. rights to the Bayer name and trademarks as “enemy property”. In 1986, Bayer reacquired the U.S. rights to the Bayer trademark with respect to products for the manufacturing industry and, in 1994, reacquired full U.S. rights to its name and trademarks, including the “Bayer cross”.

      Friedr. Bayer & Co. established operations in the United States as early as 1870. In 1992, Bayer AG’s U.S. subsidiaries Mobay Corporation, Miles Inc. and Agfa Corporation merged with the management holding company Bayer USA Inc. to form a new operating company, Miles Inc. In April 1995, Miles Inc. changed its name to the current form, Bayer Corporation.

      Since 2001, we have incurred capital expenditures as follows:

                           
2001 2002 2003



(euros in millions)
Pharmaceuticals, Biological Products
    375       178       185  
Consumer Care, Diagnostics
    238       272       201  
Animal Health
    45       26       21  
CropScience
    199       297       413  
Plastics, Rubber
    536       504       290  
Polyurethanes, Coatings, Fibers
    468       506       283  
Chemicals
    501       285       203  
Reconciliation(1)
    255       315       143  
     
     
     
 
 
Total
    2,617       2,383       1,739  
     
     
     
 


(1)  Capital expenditures not allocated to an individual segment (such as investments in the Corporate Center).

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     Our expenditures on acquisitions in the past three years were as follows:

  •  In 2001, we spent 0.5 billion on acquisitions, including rights to manufacture and market products that detect hepatitis C and HIV antibodies, as well as the corn herbicide Mikado®. We also made a 93 million equity investment in CuraGen.
 
  •  In 2002, we spent a total of 7.9 billion on acquisitions, mainly for the acquisition of Aventis CropScience effective June 1, 2002 from Aventis and Schering. Approval of this acquisition by the relevant antitrust authorities, particularly in Europe and the United States, was conditional upon our divesting or outlicensing a number of products. We also acquired Visible Genetics Inc. in Canada and Tectrade A/S in Denmark.
 
  •  In 2003, we spent a total of 72 million on acquisitions mainly for increasing our interest in the Bayer Polymers Sheet Europe Group (formerly known as Makroform) up to 100 percent.
 
  •  In March 2004, we purchased Crompton Corporation’s 50 percent stake in the Gustafson seed treatment business in the United States, Canada and Mexico for a purchase price of $124 million. This purchase gave Bayer CropScience, which already held a 50 percent stake in the U.S. and Canadian Gustafson joint ventures, full ownership of Gustafson’s NAFTA business.

      We divested the following operations in the past three years:

  •  Our acrylic fiber product line in the first half of 2001. We classified the remainder of our Fibers business group under “Discontinuing Operations”. In May 2002, we reclassified Fibers as part of our ongoing business. See Item 5, Operating and Financial Review and Prospects — Overview.
 
  •  Our interest in the EC Erdölchemie joint venture in May 2001, which we had previously classified under “Discontinuing Operations”.
 
  •  Haarmann & Reimer effective September 30, 2002, as part of the streamlining of our portfolio.
 
  •  The remaining 30 percent of our Agfa business segment in June 2002, of which we had already divested 70 percent in 1999.
 
  •  Our 94.9 percent interest in Bayer Wohnungen, effective March 1, 2002.
 
  •  A large part of the global household insecticides business of our Consumer Care division was divested in 2002 amounting to 0.4 billion; we also sold the remaining parts of this business in 2003 amounting to 0.3 billion.
 
  •  Our French and Spanish generic pharmaceutical operations, as a further part of our drive to streamline our portfolio.
 
  •  Our 50 percent interest in PolymerLatex. This transaction was closed on May 9, 2003.

      Following the acquisition of Aventis CropScience in 2002, our global business activities have been integrated and the divestments imposed by the European Commission and the United States Federal Trade Commission have largely been completed. We terminated our research agreement with Millennium Pharmaceuticals, Inc. on October 31, 2003 as planned and sold our interest in this biotechnology company in the fourth quarter 2003, realizing 0.3 billion.

      In connection with the planned realignment of the Bayer Group, we classified our chemicals activities — excluding H.C. Starck and Wolff Walsrode — and certain parts of our polymers activities under “Discontinuing Operations” (see Item 4 — Business). As part of our ongoing portfolio management, we plan to divest the plasma business of the Biological Products division. These activities are also shown under “Discontinuing Operations”.

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BUSINESS

      We are a global company offering a wide range of products, including ethical pharmaceuticals, diagnostics and other health care products; agricultural products; polymers; and chemicals.

      Bayer AG is headquartered in Leverkusen, Germany and is the management holding company of the Bayer Group, which includes over 330 consolidated subsidiaries. During 2003, we continued to implement the decision to adopt a holding company structure that was approved by our shareholders in April 2002. Under our plan for this new structure, we transferred most of Bayer AG’s assets to the new subsidiaries.

      This new structure, which evolves out of our historical “four pillar” strategy, resulted in the division of our business operations among four new, legally independent operating companies heading up four subgroups, which in turn, consist of a total of seven business segments:

  •  Bayer HealthCare AG (heading up the Bayer HealthCare subgroup, which consists of our three health care segments: Pharmaceuticals, Biological Products; Consumer Care, Diagnostics; and Animal Health), which became legally independent on September 30, 2003, with retroactive economic effect from January 1, 2003;
 
  •  Bayer CropScience AG (heading up the Bayer CropScience subgroup, which consists of our CropScience segment), which became legally independent on October 1, 2002, with retroactive economic effect from January 1, 2002;
 
  •  Bayer MaterialScience AG (heading up the Bayer Polymers subgroup, which consists of our Plastics, Rubber segment and our Polyurethanes, Coatings, Fibers segment), which became legally independent on December 30, 2003, with retroactive economic effect from October 1, 2003; and
 
  •  Bayer Chemicals AG (heading up the Bayer Chemicals subgroup, which consists of our Chemicals segment), which became legally independent on September 30, 2003, with retroactive economic effect from July 1, 2003.

      The activities of the seven business segments, which house the business operations, are performed by the operating companies Bayer HealthCare AG, Bayer CropScience AG, Bayer MaterialScience AG and Bayer Chemicals AG. Each operating company, together with the domestic and international subsidiaries assigned to it, forms a Bayer subgroup. Each of the four subgroups Bayer HealthCare, Bayer CropScience, Bayer Polymers and Bayer Chemicals is, within the framework of strategies, targets and guidelines determined by the Bayer AG Board of Management, an independent operating unit with worldwide business accountability and its own management. Each of the operating companies has entered into a control and profit and loss transfer agreement with Bayer AG.

      Three legally independent service companies provide support functions to the four subgroups, Bayer AG and third parties. They include:

  •  Bayer Technology Services GmbH (providing engineering functions), which became legally independent on September 30, 2003, with retroactive economic effect from January 1, 2003;
 
  •  Bayer Business Services GmbH (providing information management, accounting and reporting, consulting and administrative services), which became legally independent on December 30, 2003, with retroactive economic effect from October 1, 2003; and
 
  •  Bayer Industry Services GmbH & Co. OHG (operating the Bayer Chemical Park network in Germany and providing site specific services), which became legally independent on December 30, 2003, with retroactive economic effect from October 1, 2003.

      Under the new structure, our Board of Management continues to determine the overall strategy of the Bayer Group and control resource allocation. It also nominates the management of the subsidiary Group companies and sets each company’s performance criteria. Although these entities are currently wholly-owned subsidiaries, we may consider strategic partnerships and collaborations involving them.

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      For the year ended December 31, 2003, Bayer reported total sales of 28,567 million, an operating loss of 1,203 million, and a net loss of 1,361 million. Sales from continuing operations amounted to 22,178 million. As of December 31, 2003, we employed 115,400 people worldwide.

      The following table shows a breakdown of our sales in 2003 based on the location of the Bayer entity on the books of which our sales are recorded (point of origin):

                 
Sales
Region

(euros in millions) (percentage of total)
Europe
    13,518       47.3  
North America
    8,763       30.7  
Asia/Pacific
    3,913       13.7  
Latin America/ Africa/Middle East
    2,373       8.3  

      In the future, we plan to focus more closely on our strengths in the fields of health care, nutrition and innovative materials. The Board of Management and the Supervisory Board of Bayer AG have therefore decided to adjust the Group’s structure and business alignment accordingly. We plan to place the Chemicals business (except H.C. Starck and Wolff Walsrode) and parts of the Polymers subgroup that we no longer regard as core businesses into an independent company, to be named Lanxess, which we plan to list on the Frankfurt Stock Exchange by early 2005. We intend to combine the other activities of the Polymers and Chemicals subgroups in the new Bayer MaterialScience subgroup. Our goal is to strengthen the competitiveness of our fast-growing, innovation-driven businesses in the HealthCare, CropScience and MaterialScience subgroups by concentrating on the special needs of these businesses.

      We are therefore specializing in businesses that we believe have greater potential for growth, value creation and innovation. These businesses require more sophisticated structures and a substantial level of investment. We believe that businesses that do not fit this profile are better served by being placed in an environment in which they can fully deploy their own management resources and create the structures they need.

      In connection with the new alignment of the Bayer Group, we have decided to position Pharmaceuticals as a medium-sized enterprise with the appropriate structures. Here we intend to concentrate on infectious diseases, cardiovascular risk management, urology and oncology. We also intend to strengthen regional collaborations, partnerships and in-licensing activities. An additional element of our strategy is continuous life cycle management, with which we aim to further enhance the success of our products that are already on the market. See Item 4, Pharmaceuticals — Research and Development.

      In the Biological Products Division, we plan to expand our profitable Kogenate® business, emphasizing that product’s good profile and further improvements to its delivery. We announced on October 2, 2003 our intent to divest the plasma business. The Kogenate® business is not affected by this decision.

      In Bayer HealthCare, we plan to focus more closely on our competencies and experience in the consumer-oriented health care business. In Consumer Care, we aim to continue our growth by strengthening our own products and brands, including in particular non-prescription pain-relievers. We also regularly review options for expanding our product portfolio and regional presence through in-licensing and acquisitions.

      In Diagnostics, we aim to maintain our position as one of the market leaders. We intend, through the introduction of new products, to spur our growth in the consumer-oriented Self-Testing unit. In Professional Testing, we plan to pursue strong development with further product launches that will allow us to serve our customers even more specifically. Other focuses include the forging of new strategic partnerships and the expansion of existing collaborations.

      In Animal Health, we aim to further expand our position as one of the world’s leading suppliers of veterinary pharmaceuticals. Here we intend to concentrate on strengthening the consumer-oriented Companion Animals business unit and systematically expanding our Livestock business. To solidify our position, we aim to maintain our focus on attractive key markets and on the steady expansion of our core products. We are also analyzing options for improving our market position and rounding out our product portfolio through acquisitions or strategic alliances.

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      In the Bayer CropScience subgroup, the integration of Aventis CropScience and the divestitures required to fulfill antitrust conditions are nearly complete. We intend to further strengthen our market positions in Crop Protection and Environmental Science and expand our seed business and plant biotechnology activities. We regard new product launches, realization of synergies, strict cost management and portfolio streamlining as key factors in achieving our target operating result for Bayer CropScience.

      In the Crop Protection Business Group, we aim to expand our business by exploiting our strong market positions, our regional presence and our broad range of herbicide, fungicide, insecticide and seed treatment products. Over and above these activities, we are planning to focus primarily on new products from our research and development pipeline. Environmental Science intends to further strengthen its position as a leading supplier of non-agricultural pest control products, in particular through strategic partnerships in the U.S. lawn and garden business and through consistent portfolio optimization. In BioScience, the focus lies on cotton, canola, rice and vegetable crops. We also plan to access new markets using plant biotechnology.

      In the new Bayer MaterialScience subgroup, we aim to further expand our strong market positions primarily through exploiting our technological expertise in the field of innovative materials, with a focus on polycarbonates and isocyanates. By further optimizing our processes and expanding our activities in Asia in particular, we intend to create competitive advantages that will strengthen the long-term earning power of our businesses in these growth markets.

      The strategic alignment on core competencies should enable Bayer to increase investment in growth businesses and innovative technologies. We expect that this will allow us to play a leading role in these attractive markets and expand our current strong positions. We intend to optimize the allocation of resources as well as continue with our cost-saving and efficiency-improvement programs in order to increase Bayer’s corporate value over the long term.

      We aim to avoid accidents, to prevent our activities from harming human and animal health and to tailor our product range to the tenets of sustainability. Bayer’s long-term strategy and activities are guided by the principles of sustainable development. Our objective is to meet the economic, ecological and social needs of today’s society without compromising the ability of future generations to meet their own needs. We contribute to sustainable development by participating in the worldwide Responsible Care® initiative developed by companies in the global chemical industry.

BAYER HEALTHCARE

PHARMACEUTICALS, BIOLOGICAL PRODUCTS

Overview

      Our Pharmaceuticals, Biological Products segment is comprised of the Pharmaceuticals and Biological Products divisions. This segment formerly consisted of a single division responsible for both pharmaceutical and biological products. Beginning in 2002, we have organized the segment internally into two separate divisions. The following table shows the segment’s performance for the last three years.

                           
2001 2002 2003



(euros in millions)
External net sales
    5,729       4,767       4,745  
 
Percentage of total sales
    18.9       16.1       16.6  
 
thereof Discontinuing Operations
    695       679       613  
Intersegment sales
    38       33       51  
Operating result
    52       (186 )     (425 )
 
Percentage of total operating result
    3.1              
 
thereof Discontinuing Operations
    (139 )     (111 )     (353 )
 
thereof special items(1)
    (321 )     (333 )     (832 )


(1)  The special items are detailed in Item 5, Operating and Financial Review and Prospect — Operating Results 2001, 2002 and 2003 — Segment Data.

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     The following table shows our sales during the past three years from the products that we regard as material to the sales of the segment as a whole.

                                                 
Product 2001 2002 2003




Sales Percentage Sales Percentage Sales Percentage
(euros in of segment (euros in of segment (euros in of segment
millions) sales millions) sales millions) sales






Cipro®
    1,964       34.3       1,411       29.6       1,411       29.7  
Adalat®
    975       17.0       800       16.8       676       14.2  
Kogenate®
    250       4.4       400       8.4       497       10.5  
Gamimune®/Gamunex®
    343       6.0       333       7.0       304       6.4  
Avelox®
    181       3.2       280       5.9       299       6.3  
Glucobay®
    312       5.4       287       6.0       273       5.8  
Prolastin®
    131       2.3       151       3.2       166       3.5  
Trasylol®
    136       2.4       154       3.2       157       3.3  
Levitra®
    0       0       6       0.1       144       3.0  

Segment Strategy

Pharmaceutical Products

      In connection with the new alignment of the Bayer Group, we have decided to position Pharmaceuticals as a medium-sized enterprise with the appropriate structures.

      To achieve this target our strategic priorities include:

  •  Focusing on the following areas:

  •  Infectious diseases,
 
  •  Cardiovascular Risk Management,
 
  •  Urology, and
 
  •  Oncology; and

  •  Working on regional co-operations, alliances and licensing, all as appropriate in light of the local circumstances.

      In addition to our immediate priorities, life cycle management remains a continuing element of our strategy. Successful life cycle management enables us to extend the commercial success of established products. See — Research and Development — Life Cycle Management.

Biological Products

      Our strategic priorities for the Biological Products division include:

  •  In the midterm future, we intend to focus on growth of the Kogenate® brand while maintaining profitability. To achieve this, the Kogenate® strategy is to create greater differentiation between Kogenate® and other recombinant Factor VIII (FVIII) products by adding value with product improvements, expanding new technology to patients and care givers and investing in the development of strategic partnerships for the future.
 
  •  Bayer AG announced on October 2, 2003 its intent to divest the plasma business. The Kogenate® business is not affected by this decision. Until the plasma business has been divested, we intend to pursue a strategy of maintaining this business market share and generating an improved operating result and cash flow for the business. To accomplish these targets, we intend to expand the portfolio with selected product line extensions, new developments and added indications and to improve the efficiency of the plasma production site operations.

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Pharmaceuticals

Overview

      Our Pharmaceuticals division focuses on the development and marketing of ethical pharmaceuticals. Ethical pharmaceuticals are medications requiring a physician’s prescription and sold under a specific brand name.

Major Products

      The following table shows the sales of our Pharmaceuticals division during the past three years from the products that we regard as material to the sales of the division in 2003.

                                                   
Product 2001 2002 2003




Sales Percentage Sales Percentage Sales Percentage
(euros in of segment (euros in of segment (euros in of segment
millions) sales millions) sales millions) sales






Cipro®
    1,964       34.3       1,411       29.6       1,411       29.7  
Adalat®
    975       17.0       800       16.8       676       14.2  
Avelox®
    181       3.2       280       5.9       299       6.3  
Glucobay®
    312       5.4       287       6.0       273       5.8  
Trasylol®
    136       2.4       154       3.2       157       3.3  
Levitra®
    0       0.0       6       0.1       144       3.0  
Others
    1,216       21.1       750       15.7       675       14.2  
     
     
     
     
     
     
 
 
Total
    4,784       83.5       3,688       77.4       3,635       76.6  
     
     
     
     
     
     
 

      Ciprofloxacin, marketed under the trademark Cipro® in the United States and Ciproxin®, Ciproxine®, Ciprobay®, Ciproxina®, Bacip® and Ciflox® in other countries, is a broad-spectrum antimicrobial agent of the fluoroquinolone class. We launched Cipro® in 1986 and have since marketed it in more than 100 countries. Cipro®’s main uses are in the treatment of urinary tract infections and in severe hospital infections, where it competes with other fluoroquinolones as well as with antibiotics of other classes. It is also approved for the treatment of anthrax. In January 2003, we launched in the United States Cipro® XR (Extended Release) in a 500 mg extended release tablet for once daily administration in the treatment of uncomplicated urinary tract infections, and in September 2003, we launched Cipro® XR in a 1,000 mg extended release tablet for once daily therapy of complicated urinary tract infections. In addition, in June 2003, Barr Laboratories, Inc. started to supply the U.S. market with generic versions of Cipro® standard oral presentations based upon an agreement concluded with us in 1996. Barr Laboratories is sourcing the products from Bayer Pharmaceuticals Corporation. In December 2003, patent protection for the active pharmaceutical ingredient expired in the U.S. However, market exclusivity has been granted for another six months by the FDA based upon fulfillment of written requests of the FDA on the pediatric use of Cipro®. Cipro® is our leading pharmaceutical product.

      Adalat® is the brand name for nifedipine, the first representative of the dihydropyridine class of calcium antagonists. Calcium plays an important role in the body’s regulation of blood pressure and the supply of blood to the heart tissues. Calcium antagonists can reduce blood pressure and improve blood supply to heart tissue.

      Moxifloxacin, marketed under the trade name Avelox® in the United States and Avalox®, Izilox® and Actira® in other countries, is an antibiotic used to treat common bacterial respiratory tract infections. We currently market Avelox® in more than 90 countries. It is indicated for the treatment of community-acquired pneumonia, acute exacerbations of chronic bronchitis and acute sinusitis. In late 2001, we launched Avelox® i.v., a new intravenous form of this product, in the United States, our most important market for this product in terms of sales, and subsequently in other markets.

      Glucobay®, Precose® (in the United States) and Prandase® (in Canada) are our trade names for acarbose, an oral antidiabetic product that delays carbohydrate digestion. Glucobay® improves metabolic control in diabetics alone or in combination with other antidiabetic drugs.

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      Trasylol® is a natural proteinase inhibitor obtained from bovine lung tissue. Used prophylactically, it reduces blood loss during coronary bypass surgery, reducing the patient’s need for blood transfusions.

      Vardenafil, our erectile dysfunction medication marketed under the trade name Levitra®, has been launched in the United States and all major markets with the exception of Canada and Japan. The application that we filed with the Japanese authorities in December 2001 is currently under review. We market the product in co-operation with GlaxoSmithKline in all markets except Japan and also jointly perform life cycle management. For more information on life cycle management, see — Research and Development — Life Cycle Management. See Item 8, Financial Information — Legal Proceedings for a discussion of the intellectual property status in the United States of Levitra® and other erectile dysfunction medications.

      CardioAspirin refers to Bayer’s collective group of products (in both our Pharmaceuticals and Consumer Care divisions) that are professionally indicated for the prevention of an MI (myocardial infarction, or heart attack) in either those individuals who have already had an initial MI (secondary prevention) or in individuals deemed at risk for a first MI by their physician (primary prevention). These products vary in status (whether or not a prescription is required) based on local regulations. We face competition from both over-the-counter and prescription drugs in the cardiovascular marketplace which claim secondary and/or primary prevention benefits.

Markets and Distribution

      The Pharmaceuticals division’s principal markets are North America, Western Europe and Asia (especially Japan). The division’s sales by region and total sales for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    1,450       1,155       1,067  
North America
    2,049       1,420       1,532  
Asia/Pacific
    895       769       705  
Latin America/ Africa/Middle East
    390       344       331  
     
     
     
 
 
Total
    4,784       3,688       3,635  
     
     
     
 

      Among the factors that have affected, or may affect, our Pharmaceuticals business are:

  •  in Europe and North America, increasingly competitive price pressures, as managed care groups, health care institutions, government agencies and other purchaser groups seek price discounts and rebates for pharmaceutical products;
 
  •  the impact of competing generic products entering the European and North American markets;
 
  •  currency effects resulting from transactions in countries outside the euro zone;
 
  •  competition from large pharmaceutical companies in the market with substantial resources for research, product development and promotion; and
 
  •  in Japan, regulation of pharmaceutical prices and mandatory price reductions stipulated by the Japanese Ministry of Health, Labor and Welfare.

      We generally distribute our products through wholesalers, pharmacies and hospitals as well as, to a certain extent, directly to patients. Where appropriate, we actively seek to supplement the efforts of our sales force through co-promotion and co-marketing arrangements. In November 2001, we entered into a co-promotion agreement with GlaxoSmithKline for Levitra® (vardenafil), our erectile dysfunction medication. See — Major Products.

      We currently produce the active ingredients for our ethical pharmaceutical products almost entirely at the Bayer facilities in Wuppertal and Leverkusen, Germany. Bayer facilities throughout the world compound our raw materials and package the finished product for shipment. Our main pharmaceutical production facilities are in Leverkusen, Germany; Garbagnate, Italy; and Shiga, Japan.

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      We obtain the raw materials for our active ingredients in ethical pharmaceuticals partly from Bayer’s Chemicals business segment and partly from third parties in Europe and Asia. We maintain strategic reserves of our products to avoid breaks in the supply chain. We obtain additional ingredients and packaging materials from diverse suppliers on a worldwide basis. As a rule, we approve several suppliers for each required material. At the same time, we are increasingly entering into global contracts in order to secure advantageous pricing. Where a required material is available from only one supplier, our policy is to amass a strategic reserve, typically equal to a 90-day supply, while mounting an intensive search for potential alternative suppliers.

      We encounter competition in all of our geographical markets from large national and international competitors. Our main competitors are GlaxoSmithKline, Pfizer and Abbott Laboratories in the antibacterial products market; Pfizer, Merck & Co., Novartis, and AstraZeneca in the area of hypertension and coronary heart disease therapy; Takeda, GlaxoSmithKline, Aventis and Bristol-Myers Squibb in the oral antidiabetics market; and Pfizer and Eli Lilly in the erectile dysfunction market.

Research and Development

      Bayer allocates the largest part of its research and development budget to the Pharmaceuticals division. Within this division, we focus our research and development activities on therapeutic areas in which we believe there is a high degree of inadequately met medical need and where we expect our research and development investment to yield high productivity. Our established areas of core competency are infectious diseases as well as cardiovascular diseases, urology (erectile dysfunction and urinary incontinence) and oncology. Research was discontinued in the areas of respiratory diseases and neurological/ neurodegenerative disorders in 2003. However, focused development activities in these areas will be completed.

      The division’s largest research and development facilities are located in Wuppertal, Germany for cardiovascular and anti-infectives; West Haven, Connecticut for cancer and metabolic diseases; and Kyoto, Japan for urology. In December 2003, a decision was made to close the research center in Kyoto, Japan and discontinue Biotech research in Berkeley, California. Urology research will be transferred from the research center in Kyoto to the other sites, as will ongoing research projects and appropriate parts of the technology platform for the biotech research now in Berkeley.

Life Cycle Management

      We apply life cycle management measures to our marketed products to expand the scope of possible treatment opportunities by identifying new indications and improved formulations. Adalat® is a prime example of successful life cycle management: eighteen years after the patent protection for the active ingredient nifedipine, its key component, expired, the drug generated 676 million in sales in 2003. Similarly, we are implementing life cycle management measures, such as improved formulations and dosage forms, for other major products.

Phase II/III Trials

      In October 2003, Bay 43-9006, a Raf Kinase inhibitor, an investigational compound directed against a specific molecular target involved in excess growth signaling in cancer and developed jointly with U.S.-based Onyx Pharmaceuticals Inc., began enrollment in a large Phase III clinical trial in Renal Cell Carcinoma. Our Factor Xa inhibitor for the prevention and treatment of thrombosis has also done well in trials so far and is currently in phase II clinical testing. Drug candidates in Phase II/III of clinical development are listed in the following table with their respective indications:

         
Project Indication Status



Repinotan
  Acute ischemic stroke   In Phase II
Faxtor Xa inhibitor
  Thrombosis   In Phase II
Novel Taxane
  Cancer   In Phase II
PDE4 Inhibitor
  Respiratory diseases   In Phase II
Raf Kinase inhibitor
  Cancer   In Phase III

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      The listed compounds represent a snapshot of the Bayer pipeline. The nature of drug development and discovery is such that not all products can be expected to fulfill or meet with favorable regulatory response, so it is possible that some of the above listed projects under clinical development will not result in marketed products.

Microbial resistance to antibiotics

      The development by microbes of resistance to antibiotics is a cause for concern for the medical community. Resistance development is a natural process. It is almost certainly impossible to eliminate it altogether. Although emergent ciprofloxacin or moxifloxacin resistance could become a problem on an isolated, individual-patient basis, we do not believe that microbial resistance will impair the general clinical usefulness of these two products in large patient populations in the foreseeable future.

      We actively encourage health care professionals to adopt standards of appropriate antibiotic use to avoid facilitating the development of resistance. Inappropriate use of antibiotics is one factor that facilitates the development of microbial resistance. This includes using antibiotics when not indicated, for example, for treating viral infections, but it also includes not using the most efficacious antibiotics when there is a need for antibacterial treatment. To provide physicians and patients with information on how they can use antibiotics appropriately, we have initiated the LIBRAINITIATIVE.COM project to collect data on bacterial resistance on a global basis.

Collaborations

      To supplement our internal research and development efforts, we have established an integrated program for collaborations with research-oriented companies that are leaders in their technologies. Our research collaboration program brings together major research companies to create a pool of expertise covering the entire research cycle, from discovery of pharmaceutical mechanisms through characterization of new active compounds to identification of a novel development candidate.

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Research Collaborations

      The following table illustrates the phases of the typical pharmaceutical research cycle, the various disciplines and techniques involved and the major companies that provide us with active assistance in our research efforts.

         
Research Cycle Discipline/ Technique Research Company



Understanding the disease mechanism and identifying new targets   Functional genomics (functional analysis of genetic data)   Millennium; Incyte Affymetrix; CuraGen
    Proteomics (mapping protein expression and function in an organism or tissue)/Target Validation   Galapagos; Artemis; Pharmagene Jackson Labs; Dharmacon; Cenix; Cellzome; King’s College
    Bioinformatics (applying the tools of Information Technology to biological data analysis)   Lion Bioscience
Screening the candidate substances   High-throughput screening (rapid, automated testing of compounds for potential effectiveness against a given target)   Axxam; Discovery Partners
    Toxico- and Pharmacogenomics (increasing the quality and probability of success of drug candidates)   CuraGen
    Animal Models   Phenomix
Increasing the pool of potential drug candidates by small-chemical molecules and macromolecules (proteins, peptides)   Combinatorial Chemistry/ Substance synthesis (techniques for increasing the number and diversity of test compounds)   ArQule; ComGenex
    X-ray crystallography   Structural Genomix
    Pool of Bayer biomolecules (for example, monoclonal antibodies and conjugates)   Morphosys; Seattle Genetics

      In addition to the collaborations focusing on disease mechanisms and screening, we have established collaborations in the field of medicinal chemistry. These collaborations together with our internal research efforts have given us access to more than one million substances; the HTS (high-throughput screening) technologies that we developed in collaboration with our partners enable us to screen more than 200,000 substances for a given target in a single day. Although our relationship with each of the individual research partners is important to us, it is the cooperative structure as a whole that is a key element of our strategy.

      Three of our research collaborations — those with Millennium Inc., LION Bioscience and CuraGen — are or have been of particular importance.

Millennium

      Together with Millennium, we have created a substantial collaborative effort to use the tools of genomics to identify new drug targets. The collaboration ended on October 31, 2003 as planned and we sold our interest in Millennium in the fourth quarter of 2003. During the collaboration, Bayer progressed more than 180 targets into various stages of assay configuration and drug discovery. The companies amended the agreement to provide Bayer, at no additional cost, extended access for up to seven years to a pool of 280 additional proprietary targets which have for technical reasons not yet been configured into assays. At the end of the seven-year period, the targets remaining in the pool will be returned to Millennium.

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      An additional goal which has been realized in this collaboration was to obtain technology and expertise to enable us to continue the genomics program independently after the completion of the collaboration.

      The final financial volume of this collaboration was $465 million including a $96.6 million equity investment.

LION Bioscience

      We have established two collaboration projects with LION Bioscience, a bioinformatics technology provider.

      Under the first project, which began in 1999, LION established a subsidiary in Cambridge, Massachusetts, LION Bioscience Research Inc. (LBRI). LBRI provides our life sciences effort with a strong IT platform and software development program and allows us to review drug-relevant target gene data for further use in our laboratories. LBRI delivered more than 400 disease-related targets, which we have developed into a large number of new patent applications.

      In October 2000, we began our second project with LION, in the field of pharmacophore informatics. The goal of this collaboration is to develop software tools to cross-link biological and chemical data.

      We expect to invest $46.5 million plus 34.1 million in our collaborations with LION, including a 27.7 million equity investment that we have already made. We have an option to acquire LBRI when both collaboration projects are complete.

CuraGen

      In 2001, we initiated two collaborative projects with CuraGen. In the first project, CuraGen agreed to provide drug targets during an initial five-year period. The goal is to identify drug candidates for obesity and diabetes treatment for clinical development over a 15-year period. Our agreement provides that during this period, we will share the expenses of pre-clinical and clinical development (up to $1.3 billion). We will also share with CuraGen co-promotion rights and any profits derived from these drugs.

      The goal of the second project is to compile a database of gene-based markers and information to predict potential drug toxicities, understand how specific drugs function and identify new disease conditions. Through this project, we expect to reduce drug development costs and create safer and more effective drugs. We plan to invest a total of $124 million in this five-year project, including an $85 million equity investment that we have already made and which was written down in 2003.

Product Development Collaborations

      The major collaborations in the area of Product Development are described below:

      Onyx. Bayer and Onyx are co-developing Raf Kinase Inhibitor, an investigational compound directed against a specific molecular target involved in excess growth signaling in cancer. This collaboration results in Onyx funding 50 percent of the development costs for Raf-Kinase Inhibitor. In return, Onyx has a 50 percent profit share in the United States, where the companies may co-promote the product. Everywhere else in the world except Japan, Onyx’s share is somewhat less than 50 percent since Bayer has exclusive marketing rights. In Japan, Bayer funds product development and Onyx receives a royalty.

      GlaxoSmithKline. Vardenafil, the active ingredient of Levitra®, researched by Bayer, is being marketed in co-operation with GlaxoSmithKline in all markets except Japan. The co-operation also includes life cycle management.

      Paratek. Bayer and Paratek Pharmaceuticals signed a Collaborative Development and License Agreement in August 2003 for a novel aminomethylcycline antibiotic. The agreement provides Bayer with a global, exclusive patent and know-how license for the development, manufacturing and marketing of injectable preparations. Paratek will contribute to global development costs, retain co-promotion rights and share profits in the United States and receive royalties on net sales outside the United States.

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      Indena. Bayer signed a licensing agreement with Indena S.p.A in March 2000, which gives Bayer worldwide exclusive rights to IDN 5109, a new anti-cancer compound, and its derivatives. The terms of the agreement state that Indena is responsible for extracting and producing the compound and Bayer will see the compound through clinical development and commercialization.

In-licensing activities

      We supplement our portfolio of products of our own Research and Development with in-licensed products both on global or national level. Recent examples are Fosrenol®, a remedy to treat hyperphosphatemia associated with End Stage Renal Disease, which we in-licensed from Shire International Licensing BV for Japan, and Sativex®, a cannabis-based medicinal extract product for the treatment of the debilitating symptoms of multiple sclerosis and severe neuropathic pain, which we in-licensed from GW Pharmaceuticals plc for the United Kingdom and Canada. Fosrenol® is in early stage of clinical development; Sativex® is in the process of registration.

Biological Products

Overview

      Our Biological Products division focuses on biological products (for example, blood plasma products) and recombinant protein therapies. Biological Products operated as a separate business unit within Pharma until December 31, 2001. As of January 1, 2002, it has been a division within Bayer HealthCare.

Major Products

      The following table shows the sales of our Biological Products division during the past three years, broken down by category of activity.

                                                   
2001 2002 2003



Sales Percentage of Sales Percentage of Sales Percentage of
Category (euros in millions) segment sales (euros in millions) segment sales (euros in millions) segment sales







Kogenate®
    250       4.4       400       8.4       497       10.5  
Plasma
    695       12.1       679       14.2       613       12.9  
     
     
     
     
     
     
 
 
Total
    945       16.5       1,079       22.6       1,110       23.4  
     
     
     
     
     
     
 

Kogenate®

      Kogenate® FS (Kogenate® Bayer in the EU) is a genetically engineered recombinant version of the protein FVIII. Patients with Hemophilia A cannot produce sufficient FVIII, and their blood therefore cannot clot properly. Physicians use both plasma-derived and recombinant FVIII to treat Hemophilia A. Because recombinant products like Kogenate® do not derive from human donors, the risk that their users will inadvertently contract infection with HIV, hepatitis or other viruses occasionally present in plasma-derived products is greatly reduced.

      We supply recombinant FVIII to Aventis Behring, which markets it under the brand name Helixate® FS.

Plasma Products

      Gamunex® is a plasma-derived concentrate of human antibodies (chromatography purified Immune Globulin Intravenous or IGIV-C) registered in the United States and Canada. In addition, the Paul Ehrlich Institut in Germany has approved a license application for the German market. Gamunex® represents the first completely new IGIV therapy development by Bayer in more than a decade. Biological Products received approval for its new IGIV-C Gamunex® for the Canadian and the U.S. markets in August 2003 and the first sales to customers took place in October 2003.

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      Gamimune®/Polyglobin® is a plasma-derived concentrate of human antibodies (IGIV) registered worldwide, including the United States, Canada, Germany and Japan. Physicians use it to treat immune system deficiencies as well as for the treatment of some autoimmune disorders, in which the immune system mistakenly attacks the body’s own tissues.

      Prolastin® (alpha1-proteinase inhibitor human) is a plasma-derived product approved for use in the United States, Canada and several European countries. It is used for chronic therapy in individuals with emphysema related to congenital alpha1-antitrypsin (AAT) deficiency. AAT deficiency is an inherited disorder that causes insufficient AAT in the body. This deficiency can cause serious lung disease and, ultimately, emphysema.

Markets and Distribution

      The Biological Products division’s principal markets are North America, Europe and Japan. The division’s sales by region and total for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    179       256       352  
North America
    588       664       622  
Asia/Pacific
    136       115       104  
Latin America/ Africa/Middle East
    42       44       32  
     
     
     
 
 
Total
    945       1,079       1,110  
     
     
     
 

      We generally distribute our products through governmental agencies, wholesalers, pharmacies and hospitals as well as, to a certain extent, directly to patients.

      We produce plasma-derived products and, under a license from Genentech, recombinant FVIII at our facilities in Clayton, North Carolina and Berkeley, California in the United States. We obtain raw plasma as well as some intermediates and supplies for plasma-derived products from third-party U.S. suppliers. As Biological Products does not own plasma collection centers, we have to buy raw plasma from third-party collection centers or other manufacturers. The price and availability of raw plasma depends on the available donor base, ongoing consolidation between larger collectors and regulatory procedures.

      Our main competitors are Baxter and Aventis in the blood coagulation market and CSL, Baxter and Aventis in the markets for proteinase inhibitors and Immune Globulins.

      In January 2003, Bayer and Aventis terminated negotiations regarding the establishment of a joint venture for biological products.

Research and Development

      Key research and product development projects include Kogenate® — Next Generation, Kogenate® FS EZ-FuseTM, Plasmin, Prolastin® (Alpha C), and IGIV-C (Gamunex®) Expanded Indications.

R&D Facilities

      The division’s research and development facilities are located in the United States, specifically in Raleigh, North Carolina for Bioanalytic Research; Clayton, North Carolina for Bioanalytic Development and Plasma Technology; Research Triangle Park, North Carolina for Research and Pathogen Safety; Berkeley, California for Process Technology (Kogenate®); and Raleigh, North Carolina for Nucleic Acid Testing (NAT).

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Phase II/III Trials

         
Product Indication Status



IGIV-C
  Multiple Sclerosis — New Indication   Phase II
IGIV-C
  ITP (idiopathic thrombocytopenic purpura) Rapid Infusion   Phase III
IGIV-C
  CIDP — New Indication (Chronic inflammatory demyelinating polyneuropathy)   Phase III
IGIV-C
  PID (primary immune deficiency) Rapid Infusion   Phase III

Kogenate® — Next Generation

      We have identified five constructs for potential Next Generation Kogenate® development; evaluation of proteins and technology is ongoing and the decision to proceed with the initiation of clinical trials is targeted for 2004.

      On June 3, 2003, Bayer signed an exclusivity agreement with Opperbas Holding B.V. for use of Kogenate® FS in proprietary formulation development. The decision to continue further development is scheduled for the second quarter of 2004.

      Additionally, Bayer has an agreement with Avigen (signed in November 2000) to develop Factor IX (FIX) gene therapy for Hemophilia B patients to reduce spontaneous bleeding episodes and the need for FIX protein injections. Avigen’s proprietary adeno associated virus (AAV) vector, Coagulin-B®, is designed to deliver the FIX gene into the patient’s cells where it will produce FIX. Avigen is currently conducting a Phase I trial. Bayer will collaborate with Avigen in conducting Phase II/ III clinical trials for Coagulin-B®.

Kogenate®-FS EZ-FuseTM Delivery System

      The EZ-FuseTM infusion device was developed to provide patients with a more convenient and safer delivery system that complemented Kogenate® FS. It enables patients to safely reconstitute Factor VIII without having to handle any exposed transfer needles. It is a self-contained design to reduce risk of contamination, it is latex free to reduce the risk of allergic reactions and it requires fewer steps for faster infusions. The application for approval was submitted to the FDA in the fourth quarter of 2003.

Plasmin — New Protein

      A new thrombolytic agent, plasmin (derived from human plasma) has entered Phase I clinical trial stage. It is a direct thrombolytic agent and is infused at the site of the clot to prevent it from activating plasmin downstream, making it potentially safer. The Phase I trial for Hemodialysis Graft Occlusion has begun screening patients. It is planned that Phase II will commence in the third quarter of 2004 and, based on successful outcomes, trials for a second indication, deep vein thrombosis, will commence late 2004. Launch is anticipated in 2008.

Prolastin® — Aerosolized AAT and Alpha-C

      The Alpha-C project is the development of an improved Alpha-1 Proteinase Inhibitor (A1-Pi; Prolastin®) product with greater purity and increased yield as an intravenous formulation for congenitally deficient (CD) patients and as an aerosol formulation.

      On October 8, 2003, Bayer acquired exclusive rights for a new advanced inhalation technology for the dosing of alpha-1 antitrypsin (AAT) protein from Inamed GmbH. Under this deal, Bayer will have worldwide exclusive rights to the new AKITA compressor and any other products developed by Inamed based on the same technology for clinical development and marketing of its inhaled AAT products. Currently, all AAT must be administered intravenously. It is planned to commence with Intravenous Phase I and II non-inferiority pharmakokinetic to IV Prolastin® and proof of principal in patients in 2004. Anticipated launch for CD is 2007 and for the aerosolized product in 2009.

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IGIV-C — Expanded Indications

      A number of studies are being conducted to enhance marketability of Gamunex®. For the purpose of obtaining labeling for new indications, a Phase II 120-patient multinational multiple sclerosis trial was initiated in 2002 and is planned to be completed in 2005; and a Phase III 110-patient CIDP (neuropathy) trial was initiated in 2003 and is planned to be completed in 2006. To support existing indications, rapid infusion in PID Phase III (primary immune deficiency) and ITP Phase III (ideopathic thrombocytopenic purpura) patients initiated in 2003 is planned to be completed in 2004. Additionally, the division is supporting investigator-led projects in the areas of renal transplant and pregnancy loss.

CONSUMER CARE, DIAGNOSTICS

Overview

      Our Consumer Care, Diagnostics segment is comprised of the Consumer Care and Diagnostics divisions.

      The following table shows the segment’s performance of the last three years.

                           
2001 2002 2003



(euros in millions)
External net sales
    4,104       3,755       3,336  
 
Percentage of total sales
    13.6       12.7       11.7  
Intersegment sales
    2       2       4  
Operating result
    342       602       589  
 
Percentage of total operating result
    20.4       37.4        
 
thereof special items(1)
    (40 )     214       268  


(1)  The special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2001, 2002 and 2003 — Segment Data.

     The following table shows our sales during the past three years from the products that we regard as material to the sales of the segment as a whole.

                                                 
2001 2002 2003



Sales Percentage Sales Percentage Sales Percentage
(euros in of segment (euros in of segment (euros in of segment
Product millions) sales millions) sales millions) sales







Aspirin®(1)
    723       17.6       589       15.7       574       17.2  
Ascensia®
    492       12.0       689       18.3       593       17.8  
Advia Centaur®
    259       6.3       340       9.1       387       11.6  
Canesten®
    162       3.9       142       3.8       135       4.0  


(1)  The figures include CardioAspirin, which is partially distributed by our Pharmaceutical division.

Segment Strategy

Consumer Care

      The objective of our Consumer Care division is to outpace market growth in the over-the-counter (OTC) market and to improve our global position.

      The key strategic focus to exploit our organic growth potential is on our analgesics business, mainly through Aspirin®. In parallel, we plan to consider licensing and acquisitions in order to strengthen both our product portfolio and our regional presence.

Diagnostics

      Our Diagnostics business consists of two Strategic Business Entities (SBEs): the Professional Testing SBE, which includes the Laboratory Testing, the Near Patient Testing and the Nucleic Acid Diagnostics business units,

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and the Self Testing SBE. We furthermore established Viterion TeleHealthcare LLC as a joint venture with Matsushita Electric Industrial Co., Ltd.

      The overall objective for Diagnostics is to outpace industry sales growth in the markets and to achieve a long-term sustainable position with above industry average profitability.

      We strive to reach these objectives by introducing innovative solutions to improve the overall efficiency and economics of targeted Professional Testing customers by focusing our efforts in building a product portfolio with breadth and depth. In Self Testing, we are expanding our product offering by regularly introducing innovative systems with improved convenience and sampling with minimal pain for diabetic patients. To support our objectives, we continue to develop our strategic partnerships in desired areas of expertise to complement our in-house strengths.

Consumer Care

Overview

      Our Consumer Care division develops and markets over-the-counter (OTC) medications (analgesics, cough and cold, dermatological and gastrointestinal remedies), as well as vitamin and nutritional supplements.

Major Products

      The following table sets forth the sales of our Consumer Care division for the last three years, broken down by category of activity.

                                                   
2001 2002 2003



Sales Percentage Sales Percentage Sales Percentage
(euros in of segment (euros in of segment (euros in of segment
Category millions) sales millions) sales millions) sales







Analgesics
    775       18.9       621       16.5       588       17.6  
Cough/Cold
    177       4.3       120       3.2       120       3.6  
Dermatologicals
    246       6.0       218       5.8       209       6.3  
Gastrointestinals
    266       6.5       209       5.6       185       5.6  
Nutritionals
    197       4.8       174       4.6       205       6.1  
Others
    434       10.6       374       10.0       96       2.9  
     
     
     
     
     
     
 
 
Total
    2,095       51.0       1,716       45.7       1,403       42.1  
     
     
     
     
     
     
 
 
Analgesics

      The analgesics market comprises pain relief products both in oral form (for example, pills and tablets) and for topical use (for example, ointments and salves). We concentrate primarily on the oral products segment. Our OTC products also face competition from prescription drugs, for example cyclooxygenase (COX-II) inhibitor pain relievers.

      Aspirin® (Bayer® brand aspirin in the United States) is a nonsteroidal anti-inflammatory drug (NSAID). It is used for pain relief and, in countries where so indicated, for the prevention of heart attacks. Bayer first synthesized aspirin in 1893 and began marketing it in powder form in Germany in 1900. We introduced the familiar aspirin tablets in 1910.

      Aleve® is a nonprescription strength of the analgesic naproxen sodium. Aleve® is a long-lasting pain reliever and can be used for fever reduction.

      Our Midol® product family, which competes in the menstrual pain relief category, comprises several specific product positions, for example, Maximum Strength Menstrual Formula, Teen Formula, PMS and Cramp Pain. We sell Midol® products only in the United States and Canada.

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CardioAspirin (see — Pharmaceuticals — Major Products)

      CardioAspirin refers to Bayer’s collective group of products (in both our Consumer Care and Pharmaceuticals divisions) that are professionally indicated for the prevention of an MI (myocardial infarction, or heart attack) in either those individuals who have already had an initial MI (secondary prevention) or in individuals deemed at risk for a first MI by their physician (primary prevention). These products vary in status (whether or not a prescription is required) based on local regulations. We face competition from both over-the-counter and prescription drugs in the cardiovascular marketplace who claim secondary and/or primary prevention benefits.

 
Cough/Cold

      Within the total cough and cold market, we concentrate on the cold/flu remedy segment. This OTC category faces threats from “non-medicinal” remedies (for example, nutritional or herbal products such as zinc supplements and echinacea), as well as from preventive medicines available by prescription or under development.

      Alka-Seltzer Plus® is an effervescent product to relieve symptoms accompanying the common cold. We market Alka-Seltzer Plus® in the United States and Canada. Tabcin is a line of products similar to Alka-Seltzer Plus®; we market it primarily in Latin America.

      Aleve® Cold & Sinus was launched in the United States in 2000 as the first long-lasting combination of analgesic naproxen sodium and nasal decongestant.

 
Dermatologicals

      The dermatological category includes a broad range of skin treatments. Within this market, we focus on the antifungal category, which in turn consists of three sub-segments: gynecological, dermatological and general topical/ other antifungals. All topical dermatologicals face significant threats from the prescription drug area, as well as from locally marketed generic products and low-price brands.

      Canesten® is treatment for vaginal yeast infections, athlete’s foot and other dermatological problems. Originally introduced in 1973 as a prescription drug, Canesten® has been switching to OTC status on a country-by-country basis since 1990.

      Rid® is a topical head lice treatment marketed only in the U.S. We acquired this brand from Pfizer (Warner-Lambert) in 2000.

Gastrointestinals

      The gastrointestinal (GI) category includes antacids, anti-gas products, digestives, laxatives and anti-diarrheals. Our primary focus within this category includes all non-prescription segments except laxatives and anti-diarrheals. Longer term, all OTC GI products will face threats from related business areas including products switching from prescription to OTC status, OTC brand expansion from related categories (for example, anti-diarrheal brands extending or re-positioning to cover the antacid segment) and possible future preventative or curative therapies (for example, products that eradicate or manage the ulcer-causing bacterium H. pylori).

      Alka-Seltzer® was developed in the late 1920s by Miles Laboratories and U.S. national distribution began in 1931, Alka-Seltzer® is used for speedy relief of acid indigestion, sour stomach or heartburn with headache, or body aches and pains. Today we market Alka-Seltzer® in close to 100 countries.

      Phillips’ Milk of Magnesia® is a saline laxative used as an overnight remedy for constipation and acid indigestion, heartburn or sour stomach that may accompany it. The original Phillips’ formulation entered the U.S. market in 1873.

      Talcid® was originally a prescription medication developed and sold by our Pharmaceuticals segment. Since 1988, it has obtained OTC status in several countries in Europe, Asia and South America. Talcid® is used for the relief of symptoms from heartburn and acid indigestion.

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Nutritionals

      The nutritionals category is very broad, encompassing vitamins, minerals, multi-vitamins/ minerals, herbals, sports nutrition and specialty supplements in many different forms. Applicable regulations vary greatly, both from country to country and across nutritional segments (for example, herbals vs. vitamins). As a general rule, however, regulation of nutritionals tends to be less stringent than that of other OTC products. Bayer’s primary interests in the nutritionals field are in the vitamin and mineral (especially multi-vitamins/ minerals) segments.

      One-A-Day® multivitamins entered the marketplace in 1940. Since 1994, we have offered a variety of special formulations, such as Men’s, Women’s, 55 Plus, Maximum and Essential formulas. In 2003, One-A-Day® introduced WeightSmartTM, a complete multivitamin specially designed to provide nutritional support to people who are working to control their weight through diet and exercise.

      Flintstones® are multivitamin dietary supplements containing (depending on type) 10-19 essential nutrients for children ages 2-12. They were introduced nationally in the United States in 1969. Bugs Bunny® children’s sugar-free multivitamins were introduced in 1971 in the United States. To strengthen our position in the children’s vitamin market, we launched Scooby-Doo® children’s vitamins in the United States in 2001.

      We recently launched nine products the development of which was coordinated internally. These products are:

         
Product/ Brand name Principal application Status



Aspirin Complex®
  Congestion, pain relief   Launched in 2003
Canesten® Oral
  Vaginal Mycosis   Launched in 2003
Alka-Seltzer Plus® Ready Relief Tabs
  Cough & Cold   Launched in 2003
Bayer Muscle & Joint
  Topical pain   Launched in 2003
Phillips® Chews
  GI   Launched in 2003
Rid Pure AlternativeTM
  Lice treatment   Launched in 2003
One-A-Day® WeightSmartTM
  Nutritional Supplement   Launched in 2003
Lasonil® Gel
  Topical pain   Launched in 2003
Aspirin® Effect
  Pain relief   Launched in 2003

      Aspirin Complex® is a combination product (Aspirin® & pseudoephedrin), launched in Germany in 2003 for the relief of cold symptoms.

      Canesten® Oral is a one-dose antifungal oral product for the treatment of vaginal yeast infections launched in the United Kingdom.

      Alka-Seltzer Plus® Ready Relief is a fast-dissolve antihistamine/ nasal decongestant introduced in the United States.

      Bayer Muscle & Joint is a topical analgesic for pain relief launched in the United States.

      Phillips® Chews are a laxative dietary supplement providing overnight relief of occasional constipation introduced in the United States.

      Rid Pure AlternativeTM is a pesticide-free lice removal system consisting of a patented comb and dimethicone gel launched in the United States.

      One-A-Day® WeightSmartTM is a complete multivitamin specially designed to provide nutritional support to people who are working to control their weight through diet and exercise introduced in the United States.

      Lasonil® Gel is a topical painkiller containing Ketoprofene, launched in Italy, for treatment of sports-related injuries and muscle pain.

      Aspirin® Effect is a dry granule analgesic product that dissolves on the tongue and was launched in Germany.

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Markets and Distribution

      Our Consumer Care division focuses on the OTC market for medicinal products that consumers may generally purchase without a prescription. In some European markets, this category also includes products sold to consumers on a prescription basis and later reimbursed under an insurance plan.

      The division’s sales by region and totals for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    467       452       387  
North America
    894       680       668  
Asia/Pacific
    222       188       56  
Latin America/ Africa/Middle East
    512       396       292  
     
     
     
 
 
Total
    2,095       1,716       1,403  
     
     
     
 

      The division experiences moderate seasonality, primarily due to the cough/cold market.

      The typical sales and marketing channels of the division outside Europe are supermarket chains and other mass marketers. In Europe, however, pharmacies are the usual distribution channel.

      Consumer Care procures many high-volume raw materials internally from other Bayer divisions and companies. Our major externally procured high-volume raw materials are sodium citrate, sodium bicarbonate, citric acid and ascorbic acid. These are readily available and are usually not subject to significant price fluctuations. Changes in oil and energy prices can affect a few key items, such as acetylsalicylic acid, phenol and aluminum foil. We diversify our raw materials sources internationally to help balance currency exchange rate risk.

      We regard Johnson & Johnson, GlaxoSmithKline, Wyeth and Pfizer as our major competitors in the Consumer Care business.

Research and Development

      Consumer Care focuses its research and development activities on identifying, developing and launching products and initiatives which can contribute to achieving business growth through:

  •  efficient development of new products and indications to support current brands; and
 
  •  product development, clinical and regulatory strategies, which provide opportunity to capitalize on new technologies, expanded label indications and reclassifications of products from prescription required to over-the-counter.

      The division’s primary research and development facilities are located in Morristown, New Jersey.

      Bayer is involved in a joint venture with Hoffmann-LaRoche to market and sell Aleve®, Vanquish® and Midol® in the United States. Both partners are actively involved in research and development planning for these products.

Diagnostics

Overview

      Diagnostics, based in Tarrytown, New York, is one of the largest diagnostics businesses in the world. We support customers in over 100 countries with an extensive portfolio of products for the Laboratory Testing, Near Patient Testing, Nucleic Acid Diagnostics (NAD) and Self Testing environments. These products serve in the assessment and management of health in such areas as infectious diseases, cardiovascular disease, oncology, virology, women’s health and diabetes.

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Major Products

      The following table sets forth the sales of our Diagnostics division for the last three years, broken down by category of activity.

                                                   
2001 2002 2003



Sales Percentage Sales Percentage Sales Percentage
(euros in of segment (euros in of segment (euros in of segment
Category millions) sales millions) sales millions) sales







Laboratory testing
    791       19.3       813       21.7       796       23.9  
Near patient testing
    407       9.9       398       10.6       381       11.4  
NAD testing
    86       2.1       99       2.6       126       3.8  
Self-testing
    722       17.6       729       19.4       625       18.7  
Tele Healthcare
    0       0.0       0       0.0       1       0.0  
Others
    3       0.1       0       0.0       4       0.1  
     
     
     
     
     
     
 
 
Total
    2,009       49.0       2,039       54.3       1,933       57.9  
     
     
     
     
     
     
 
 
Laboratory Testing

      The ADVIA® family of products is the centerpiece of our Laboratory Testing portfolio, which provides a wide range of solutions for the laboratory. ADVIA® products include medium- and high-throughput systems for immunoassay diagnostics (the measurement of such substances as proteins, steroids, drugs and antibodies in patients’ blood), clinical chemistry and hematology analysis and other diagnostic disciplines. The main systems include ADVIA Centaur®, ADVIA®1650, ADVIA®120 and ADVIA IMS® 800i, for medium- to large-size hospitals and laboratories. In addition, we offer large laboratory integration and automation solutions with LabCell® and WorkCellTM. In addition to our ADVIA® products, we offer the ACS:180® and Bayer Immuno 1® immunodiagnostic analyzers, as well as the Clinitek Atlas® urine chemistry system for high volume urinalysis testing. The market position of the ADVIA® product line was strengthened in 2003 by the introduction of a new BNP test to assist in the diagnosis of heart failure.

 
Near Patient Testing

      We provide a variety of solutions for the Near Patient Testing environment, both in the hospital and in physicians’ office laboratories. For the critical care environment, we offer the RapidTM family of instruments and reagents for the measurement of blood gases and electrolytes.

      In the field of urinalysis, we offer the Multistix® family of urine reagent strips for visual reading of up to 10 parameters and the Clinitek® line of instruments for automated sample analysis. We also offer the DCA 2000®+ system that provides diagnostic tests for diabetes and kidney disease management.

 
Nucleic Acid Diagnostics

      With the completion of the Visible Genetics Inc. (VGI) integration, Diagnostics now offers a complete virology infectious disease portfolio including quantitative and qualitative analysis as well as genotyping and resistance testing. For highly specific testing of infectious diseases, we offer a family of DNA probes under the VERSANT® brand for the testing of HIV and Hepatitis B and C. NAD techniques detect nucleic acids such as DNA and RNA to allow for effective treatment of infectious and other diseases. In 2003, we obtained FDA approval for our VERSANT® HCV RNA 3.0 (bDNA) assay, which complements our already FDA approved products VERSANT® HIV-1 RNA 3.0 (bDNA) assay, VERSANT® HCV RNA qualitative assay and TRUGENE® HIV-1 Genotyping assay.

Self Testing

      In the Self Testing segment, we launched the Ascensia® brand for our blood glucose monitoring products. Our key products include the Ascensia® DEX®/ESPRIT® and the Ascensia® BREEZE®/CONFIRM® blood

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glucose meters. These products incorporate a 10-test disc to provide greater convenience to patients who test their blood sugar levels several times per day. Another part of our key products is the Ascensia® CONTOUR® meter which uses a single test strip. Our best selling diagnostics product, the Ascensia ELITE®, is a versatile blood glucose meter that serves a wide spectrum of patient needs.
 
TeleHealthcare

      We signed a joint venture agreement with Matsushita Electric Industrial Co. to establish ViterionTM TeleHealthcare LLC, an independent company that is marketing products and services for the telemedicine sector. The company was established in January 2003. Main products are the ViterionTM 100 TeleHealth Monitor, a compact home health care monitor and the ViterionTM 500 TeleHealth Monitor, a state of the art home health care monitor.

      We recently launched the following products:

         
Product/ Brand name Principal application Status(1)



ADVIA IMS® 800i Integrated Modular System
  Modular platform, combining immunodiagnostic and clinical chemistry on a single instrument with a broad assay menu   Launched in August 2003
ADVIA Centaur® menu expansion
  Infectious disease, Her-2/neu, BNP and homocysteine   Throughout 2003
ADVIA® 1650 & ADVIA® 2400 menu expansion
  High-volume clinical chemistry   Throughout 2003
Rapidpoint® 405
  Blood gas electrolyte instrument with co-oximetry   Launched in March 2003
Clinitek Status®
  Automated urinalysis instrument   Launched in November 2003
VERSANT® HCV RNA 3.0 (bDNA)
  Quantitative detection of Hepatitis C   Launched in May 2003
Ascensia® BREEZE®/CONFIRM®
  Next generation 10-cartridge whole blood glucose monitoring system   Launched in June 2003
Ascensia® ENTRUSTTM
  Low-cost alternative whole blood glucose monitoring system   Launched in May 2003
Ascensia® CONTOUR®
  Next generation whole blood glucose monitoring single strip system   Launched in April 2003
ViterionTM 100 TeleHealth Monitor
  Compact home healthcare monitor   FDA approved and launched in November 2003


(1)  The term “throughout” refers to the fact that there are multiple products that were launched at different times throughout the year; “launched in” refers to a single product.

Markets and Distribution

      Our Diagnostics division markets its products in over 100 countries worldwide, both directly and through a network of distributors. Our principal markets include North America, Western Europe and Japan.

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      The divisions’ sales by region and totals for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    697       742       735  
North America
    880       901       836  
Asia/Pacific
    289       268       246  
Latin America/ Africa/Middle East
    143       128       116  
     
     
     
 
 
Total
    2,009       2,039       1,933  
     
     
     
 

      Diagnostics sales are typically lower in the first quarter, but show a slightly stronger performance in the fourth quarter.

      We market our Laboratory Testing and NAD products, as well as most of our Near Patient Testing products, directly to customers, who are primarily reference or private laboratories and hospitals. In the Near Patient Testing segment, we market urine chemistry primarily through distributors. We channel our Self Testing products to the consumer market through distributors and large pharmacy and retail chains. We market our TeleHealthcare products directly to home health care agencies, disease management companies and the government.

      We manufacture or assemble a significant portion of our own products. In order to do so, we rely on a supplier management process to supply raw materials, sub-assemblies and finished goods on an OEM (original equipment manufacturer) basis. Most of our direct materials are readily available commodities. Typically, these materials are not subject to significant changes in price or availability.

      We do require some direct or OEM materials that carry a substantial risk to the business if they were to become unavailable. In these instances, we maintain strategic reserves of selected direct materials or finished products to avoid interruptions in our customers’ continuous and reliable supply. We maintain a global supplier base with contracts in place where appropriate. Our supplier management process includes procedures for continuous supplier monitoring and evaluation, as well as new supplier analysis and qualification.

      Our primary competitors in the diagnostics market are:

  •  Laboratory Testing: Abbott, Roche, Beckman Coulter, Dade Behring and Johnson & Johnson;
 
  •  Nucleic Acid Diagnostics: Roche, Abbott and Gen-Probe;
 
  •  Near Patient Testing: Roche, Radiometer, i-Stat and Instrumentation Laboratory;
 
  •  Self Testing: Roche, Johnson & Johnson (Lifescan), Abbott (Medisense) and Therasense; and
 
  •  TeleHealthcare: HomMed, American Telecare, Health Hero, Philips Medical, Alere Medical.

Research and Development

      Our Diagnostics division focuses its research and development activities primarily on strengthening its core product lines and on expanding into high growth/high margin segments of the market:

  •  in Laboratory Testing, through development of the ADVIA® family of systems and in the expansion of assays in growth areas;
 
  •  in NAD Testing, through menu expansion of assays for infectious disease and oncology testing;
 
  •  in Near Patient Testing, through enhancements of our Rapid systems and Clinitek products, and entry into the Point of Care Immunoassay market; and
 
  •  in Self Testing, through internal development and in-sourcing of mass market, user-friendly whole blood glucose monitoring systems and by focusing research on a minimally invasive system, using a small blood sample and having a short testing time, coupled with the convenience of no test strip handling and non-invasive technology, which is glucose monitoring without the painful sampling of body fluid.

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      The division’s primary research and development facilities are located in the United States: Tarrytown, New York and Walpole and Cambridge, Massachusetts for our Laboratory Testing Segment; Medfield, Massachusetts for our Near Patient Testing Segment; Elkhart, Indiana for our Self Testing Segment; and Berkeley, California and Walpole, Massachusetts for our Nucleic Acid Diagnostics Segment.

      We currently have a number of products in late stages of development. Depending on completion of clinical trials and subsequent grant of any necessary FDA approvals, we expect to launch these products during the periods indicated below. These products are:

         
Product/ Brand name Principal Application Status(1)



ADVIA Centaur® menu expansion
  Completion of full ID panel   Launches planned throughout 2004
ADVIA® 1200
  Clinical chemistry system   Launch planned for 2004
ADVIA® 1650 and ADVIA® 2400 menu expansions
  Extension of clinical chemistry menu   Launches planned throughout 2004
ADVIA® 2120 with Autoslide
  Second generation hematology system with slide maker/ stainer   Launch planned for 2004
Rapidlab® 1200
  Blood gas/electrolyte analyzer   Launch planned for 2004
VERSANT® HBV 3.0 (bDNA)
  Quantitative detection of Hepatitis B   Launch planned for 2004


(1)  The term “launch(es) planned throughout” refers to the fact that there are multiple products that we expect to launch at different times throughout the year; “launch planned for” refers to a single product.

     In December 2003, we signed an exclusive worldwide development and supply agreement with Amersham Biosciences Corp. for the joint development of assays and instrumentation in the field of human immunodeficiency virus (HIV) sequencing, as well as sequencing of other important infectious disease-causing pathogens.

      In 2003, we entered into a licensing agreement with Sontra Medical Corporation for their continuous non-invasive glucose monitoring technology, including exclusive worldwide rights to the intellectual property in Sontra’s SonoPrepTM ultrasonic skin permeation technology for the continuous non-invasive glucose monitoring field.

ANIMAL HEALTH

Overview

      Our Animal Health segment researches, develops and markets new products for the health care of animals. These products are divided between the two business units Livestock and Companion Animal. The main activities of the Animal Health segment are the development of therapies for infectious diseases caused by bacteria, virus and parasites, and the development of pharmacologicals. This range of products is supplemented by a line of cosmetic care products as well as farm hygiene products.

      The following table shows the segment’s performance of the last three years.

                           
2001 2002 2003



(euros in millions)
External net sales
    858       850       790  
 
Percentage of total sales
    2.8       2.9       2.8  
Intersegment sales
    4       1       8  
Operating result
    162       170       170  
 
Percentage of total operating result
    9.7       10.6        
 
thereof special items(1)
    0       (11 )     22  


(1)  The special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2001, 2002 and 2003 — Segment Data.

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     The following table shows our sales during the past three years from the products that we regard as material to the sales of the segment as a whole.

                                                 
Product 2001 2002 2003




Sales Percentage Sales Percentage Sales Percentage
(euros in of segment (euros in of segment (euros in of segment
millions) sales millions) sales millions) sales






Advantage® (incl. Combi)/ K9Advantix®
    211       24.6       205       24.1       196       24.8  
Baytril®
    187       21.8       183       21.5       170       21.5  

Segment Strategy

      Animal Health aims to be a worldwide leading company in the Livestock and Companion market and strives to be the preferred partner for and provider of veterinary solutions.

      It is part of our business strategy for Animal Health to sustain its current profit position by focusing on attractive key countries and target markets. Furthermore, Animal Health pursues a policy of organic growth by exploiting existing core brands supported by new business development activities. To complete our existing product portfolio, Animal Health periodically evaluates the possibility of acquisitions or strategic alliances. The Animal Health segment collaborates closely with our Pharmaceuticals division and CropScience segment as well as other life science companies in research and development in order to bring to the market new active ingredients and products that combat diseases in animals.

Major Products

      The following table sets forth the segment’s sales for the last three years, broken down by category of activity.

                                                   
Category 2001 2002 2003




Sales Percentage Sales Percentage Sales Percentage
(euros in of segment (euros in of segment (euros in of segment
millions) sales millions) sales millions) sales






Parasiticides
    455       53.0       448       52.7       406       51.4  
Antimicrobials
    208       24.2       205       24.1       187       23.7  
Biologicals
    45       5.2       39       4.6       36       4.6  
Nutritionals
    69       8.0       63       7.4       52       6.6  
Others (incl. Farm Hygiene)
    81       9.4       95       11.2       109       13.8  
     
     
     
     
     
     
 
 
Total
    858       100       850       100       790       100  
     
     
     
     
     
     
 

Parasiticides

      K9 Advantix® is a flea and tick control product in an easy-to-use spot-on application form with additional repelling effect against ticks and mosquitoes.

      Advantage® is a flea control product in an easy-to-use, spot-on application form.

      The Droncit® and Drontal® product family offers solutions for the control of tapeworm and roundworm.

      Bayticol® is a topical product against major tick species that attack livestock animals.

      Baycox® is a product for controlling coccidiosis, primarily in poultry and, more recently, in piglets.

Antimicrobials

      The Baytril® family is our line of fluoroquinolone antimicrobials for the treatment of severe bacterial infections in animals.

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Biologicals

      Before December 2003, the Bayovac® vaccine family comprised three main product types. Foot and mouth disease, or FMD, vaccines have been part of this product line for 50 years. Our Bayovac® IBR Marker vaccines, used in controlling bovine respiratory disease, make it possible to distinguish vaccinated from infected animals. Baypamune® is an immunomodulator which is an aid in the prevention and treatment of infectious and stress-induced diseases.

      In December 2003, the non-FMD products of our biological business were sold to Pfizer. The acquisition agreement, effective from December 9, 2003, also provides for cooperation in the contract manufacture of these products by Bayer. These products include IBR-Marker-Vaccine and the immunostimulant Baypamune®. FMD-Vaccines will continue to be produced and marketed by Bayer.

Nutritionals

      These highly generic and homogenous commodities are essential for higher-value proprietary products like Baytril® and Baycox® to participate in the Asian market.

Farm Hygiene

      Integrated into our livestock business is our biosecurity management process that includes Farm Hygiene products. These products include insecticides for fly control, rodenticides against rats and mice (which now belong to our CropScience segment but are also marketed by Animal Health in some countries) and disinfectants against bacteria.

Markets and Distribution

      The Animal Health business covers worldwide markets, including emerging markets such as China, Vietnam and others in South-East Asia. We divide our marketing activities into two main business areas: marketing for food-producing (livestock) animals, and marketing for companion animals including horses.

      The combined sales by region and totals for the past three years for these two business areas are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    237       243       242  
North America
    340       337       305  
Asia/Pacific
    134       136       122  
Latin America/ Africa/Middle East
    147       134       121  
     
     
     
 
 
Total
    858       850       790  
     
     
     
 

      On a worldwide basis, the activities of the Animal Health segment are not subject to any significant seasonal effects.

      Depending on national legislation, Animal Health products may be available to end users on a prescription or non-prescription basis. End users may purchase prescription products directly from veterinarians or pharmacies with a written prescription issued from a licensed practicing veterinarian. Also, based on national legislation, non-prescription products may be available through over-the-counter retailers, cooperatives, pet shops, integrators in the livestock segment and other specialized channels in the companion animal market.

      We currently obtain the active pharmaceutical ingredients for our veterinary pharmaceutical products either within the Bayer Group or from third parties world-wide. We obtain additional ingredients and packaging materials from diverse suppliers on a world-wide basis. As a rule, we approve our suppliers for each required material.

      Our main pharmaceutical production facilities devoted to formulation and packaging of our products for shipment are Kiel, Germany and Shawnee, Kansas.

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      We take measures in order to assure continuous product supply. This includes entering into long-term contracts or building strategic reserves of the material in question.

      Merial, Pfizer and Intervet are our main competitors, with Merial and Pfizer being active in both segments companion and livestock animals and Intervet concentrating on the livestock business. The global animal health market is characterized by market consolidations and increasing competitive pressure from generic substitutes.

Research and Development

      The Animal Health segment focuses its research and development activities on antimicrobials, parasiticides and pharmacologicals. A particular goal of our research and development efforts is to provide the segment with innovative and patent-protected products (new active ingredients, formulations and application technologies).

      The segment’s primary research and development facilities are located in Monheim, Germany and Kansas City, Missouri.

      We currently have several products or product families in late stages of development. Subject to regulatory approval, we expect to launch these products between 2004 and 2007. These products are:

         
Projects/Products Indication Status



Endoparasiticide and ectoparasiticide combinations
  Control of fleas, ticks, heartworm and gastrointestinal worms in cats and dogs   launch/in registration/in clinical development
Red mite control remedy
  Poultry   in clinical development
Baycox® calves
  Coccidiosis control in calves   in clinical development
Baytril® swine (North America)
  Antimicrobial infections in pigs   in registration
Pradofloxacin
  Antimicrobial for dogs and cats   in clinical development

BAYER CROPSCIENCE

Overview

      Bayer CropScience develops and markets chemical crop protection products, seeds and integrated plant biotechnology solutions for agricultural and non-agricultural uses. Bayer CropScience operates through three business groups: Crop Protection, Environmental Science and BioScience. Crop Protection markets chemical crop protection products for the control of insects, weeds and fungi (plant diseases) and develops active ingredients with new modes of action for enhanced effectiveness against these target pests. Environmental Science markets pest-control products for non-agricultural uses, including products for professional pest control; the green industry (including the treatment of golf courses, lawn care and industrial vegetation management); lawn, garden and household care; termite and vector control; and rural hygiene. BioScience focuses on the research, development and marketing of conventional seeds and plant biotechnology products. The following table shows Bayer CropScience’s performance for the last three years.

                         
2001 2002 2003



(euros in millions)
External net sales
    2,838       4,697       5,764  
Percentage of total sales
    9.4       15.9       20.2  
Intersegment sales
    102       90       69  
Operating result
    490       (108 )     324  
Percentage of total operating result
    29.2              
thereof special items(1)
    0       67       (81 )


(1)  The special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2001, 2002 and 2003 — Segment Data.

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     The following table shows the sales during the past three years from the products that we regard as material to the sales of Bayer CropScience as a whole.

                                                 
Product 2001 2002 2003




Sales Percentage Sales Percentage Sales Percentage
(euros in of segment (euros in of segment (euros in of segment
millions) sales millions) sales millions) sales






Confidor®, Gaucho®, Admire®, Merit®(1)
    608       21.4       561       11.9       590       10.2  
Folicur®/Raxil®
    272       9.6       260       5.5       315       5.5  
Puma®/Accord®(2)
                92       2.0       226       3.9  
FLINT®
    97       3.4       159       3.4       200       3.5  
Basta®/Liberty®(2)
                70       1.5       159       2.8  
Decis®/K-Othrine®(2)
                87       1.9       159       2.8  
Betanal®(2)
                41       0.9       143       2.5  
Fenikan®/Javelin®(2)
                71       1.5       115       2.0  
Aliette®/Mikal®/Chipco® Signature(2)
                64       1.4       107       1.9  
Balance®/Merlin®(2)
                36       0.8       106       1.8  


(1)  The active ingredient imidacloprid contained in these products is also used in the Animal Health segment’s Advantage® product.
(2)  Sales after Aventis CropScience acquisition (June 2002).

Segment Strategy

      Following the acquisition of Aventis CropScience in 2002, the global business activities have largely been integrated and the divestments imposed by European, United States and Canadian antitrust authorities have been completed, with the exception of the product propoxycarbazone.

      Bayer CropScience aims to strengthen its market position in the Crop Protection and Environmental Science businesses and to expand its activities in seeds and plant biotechnology. We intend to improve Bayer CropScience’s operating result by introducing new products, realizing our synergy targets, controlling costs and streamlining the portfolio. Bayer CropScience is continuously exploring opportunities to improve its portfolio through strategic joint ventures and acquisitions.

      In Crop Protection, the strategic focus is to grow our business by utilizing our strong market position, regional representation and broad product portfolio comprising insecticides, fungicides, herbicides and seed treatment products. A key growth driver is the introduction of new products from our research and development pipeline.

      Environmental Science is among the leading suppliers for non-agricultural pest control solutions worldwide. Our objective is to strengthen this market position through selective partnerships for the lawn and garden business in the United States and the continuous optimization of our portfolio.

      BioScience is an emerging player in the research, development and marketing of products derived from plant biotechnology and seeds. Our strategic approach comprises three specific business fields.

  •  Agricultural Crops focuses on delivering high quality seeds and technologies to field crop growers particularly in our core crops cotton, oilseed rape (canola) and rice.
 
  •  In New Business Ventures, we are exploring the opportunities to establish platforms that enable us to develop novel plant-based specialty products for the non-agricultural markets in the areas of Nutrition, Health and BioMaterials.
 
  •  In the Vegetables field, where the Nunza unit of BioScience is a leading developer and supplier of high quality vegetable seed varieties, we intend to pursue growth opportunities.

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Major Products

Crop Protection

Insecticides

      Imidacloprid (Confidor®, Admire®, Provado®) is an active ingredient in the chemical class of neonicotinoids. It controls a broad range of pests, including aphids, thrips, whiteflies, leafhoppers, locusts, leafminers, wireworms and many species of beetles, and is suitable for a wide variety of application methods, including foliar spray, soil drench, seed treatment and drip irrigation. Imidacloprid is now marketed in more than 120 countries for use on numerous important crops.

      Deltamethrin (Decis®) is a broad-spectrum pyrethroid insecticide. Although used primarily against chewing and biting insects, it is also effective against various sucking pests. Decis® is marketed in more than 100 countries for use on a wide range of crops (including cotton, soybeans, vegetables and cereals).

      Aldicarb (Temik®) is a broad-spectrum carbamate insecticide and nematicide in granular form. Temik® is applied to soil to protect crop roots from insects and nematodes and to protect against pests such as aphids or mites. Temik® is used on a large number of crops, such as cotton, citrus and potatoes.

Fungicides

      Tebuconazole (Folicur®) prevents the targeted fungus from synthesizing vital components of its cell membrane. It can be used as a spray and in special applications, such as sealing wounds in woody plants and in material protection. In addition, tebuconazole has certain plant growth-regulatory properties that are useful in certain crops.

      Trifloxystrobin (Flint®) is a strobilurin-type broad-spectrum fungicide used primarily to protect cereals and a variety of other crops. It is used in foliar sprays as a straight product under our lead brand Flint® and in numerous combinations such as Stratego® and Sphere®.

      Fosetyl Aluminum (Aliette®) is a fungicide with specific activity against downy mildew fungi in vines, fruits and vegetables. A key property of fosetyl aluminum is its upward and downward mobility in plants. Sprayed on leaves, it is either absorbed and transported inside the plants downward to the roots to protect them against attack from fungi in the soil, or it is re-directed inside the plants upward to protect newly emerging leaves as well. It is used in foliar sprays and soil drenches as a straight product under our lead brand Aliette® and in various combinations under brands, such as Mikal® or Valiant®.

Herbicides

      Fenoxaprop-P-ethyl (Puma®), Bayer CropScience’s best selling herbicide, is used in more than 73 countries and is one of the leading products used worldwide against grass weeds in cereals, rice, soybeans and canola.

      Glufosinate-Ammonium (Basta®) is a post-emergence herbicide with a broad spectrum of efficacy against annual and perennial weeds and grasses. It is primarily used on perennial tree crops, vegetables, non-crop areas and as a harvest aid. Liberty®, introduced in 1998 in the United States and Canada, refers to the registered trade name of glufosinate-ammonium applied on herbicide tolerant crops.

      The active ingredients phenmedipham, desmedipham and ethofumesate make up the Betanal® product family, the basis of weed control systems in various beet varieties. Ongoing improvements in the efficiency and range of uses of these products have extended the life cycle of the product family, resulting in its strong position in the sugar beet market.

      Foramsulfuron (Option®, Maister®), is a post-emergence herbicide for broad spectrum weed control in corn, launched in 2002. Primarily controlling annual and perennial grassy weeds, it controls an important range of broadleaved weeds as well. A line extension has taken foramsulfuron (Revolver®) into the turf market in our Environmental Science business for annual grass control.

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      Mesosulfuron-methyl (Mesomaxx® as globally protected trademark for the active ingredient, core product brands Atlantis® and Cossack®) stands for the latest generation of safened cereal herbicide sulfonylureas, and has been in the launch phase globally since 2002. The products offer a broad and consistent grass control performance in global cereal production.

Seed Treatment

      The insecticidal active ingredient imidacloprid (Gaucho®) is Bayer CropScience’s best selling seed treatment product. It is registered in over 100 countries for the treatment of early season pests and soil and leaf pests in key crops such as sugarbeet, corn, cereals and cotton.

      Tebuconazole (Raxil®) is registered in our most important markets worldwide as a seed treatment to control seed and soil borne diseases in cereals.

Environmental Science

      Environmental Science markets its products to different end customers, including pest management professionals, homeowners and do-it-yourself gardeners.

      Imidacloprid-based Premise® is a termite control product launched in the United States in 1996. Merit®, another imidacloprid-based product, is used in the green industry segment, in particular in turf and ornamentals. It controls a large spectrum of insects such as grubs and cutworms.

      Deltamethrin (K-Othrine®, Deltagard®), another important insecticide marketed by Environmental Science, controls a large spectrum of flying and crawling insects. Deltamethrin is recommended by the World Health Organization and has been used for many years to control insect-borne diseases such as malaria.

      Maxforce® is an insecticide used in passive treatment applications such as gels and baits. It contains hydramethylnone or fipronil. Maxforce®’s range of products includes a large number of insecticides controlling crawling insects.

      The products targeting the non-professional users are marketed under the umbrella brands Bayer Advanced® in the United States and Bayer Garden® in Europe.

BioScience

      Nunza is a leading developer and supplier of high quality vegetable seed varieties that are marketed to professional outdoor and greenhouse growers, plant raisers and the food processing and service industries. The main crop seeds are carrots, onions, melons, leeks and tomatoes. The brand names used for these products are Nunhems® and Sunseeds®.

      LibertyLink® corn, provided by licensee seed companies in North America, provides farmers with the ability to utilize Liberty® brand herbicide (glufosinate-ammonium) in a post-emergent weed control program for corn.

      FiberMax® cottonseed brand was launched in the U.S. market in 1998. It was also introduced in Greece, Spain, Turkey and some Latin American countries. FiberMax® cotton fiber displays qualities which are well suited for the textile industry.

      InVigor® hybrid canola (oilseed rape) varieties are available to farmers in Canada and the USA. InVigor® hybrid canola varieties are high yielding and provide agricultural management options that require less cultivation. These hybrid varieties also have tolerance to glufosinate-ammonium.

Markets and Distribution

      Europe has traditionally been Bayer CropScience’s strongest crop protection market, accounting for 40 percent of our sales in 2003.

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      Bayer CropScience’s sales by region and totals for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    1,063       1,851       2,296  
North America
    636       1,024       1,339  
Asia/Pacific
    558       797       963  
Latin America/ Africa/ Middle East
    581       1,025       1,166  
     
     
     
 
 
Total
    2,838       4,697       5,764  
     
     
     
 

      The following table sets forth Bayer CropScience’s sales for the last three years, broken down by category of activity.

                           
2001 2002 2003



(euros in millions)
Insecticides
    1,059       1,250       1,376  
Fungicides
    821       1,030       1,168  
Herbicides
    538       1,452       1,848  
Seed Treatment
          270       409  
     
     
     
 
Total Crop Protection
    2,418       4,002       4,801  
Environmental Science
    420       605       692  
BioScience
          90       271  
     
     
     
 
 
Total
    2,838       4,697       5,764  
     
     
     
 

      Due to the fact that more than 80 percent of Bayer CropScience’s business is realized in the northern hemisphere, the business is affected by the seasonality of the various crop and distribution cycles.

      Bayer CropScience obtains a significant part of its raw materials from within the Bayer Group but also enters into contractual agreements with non-Bayer companies. Some raw materials can be subject to price volatility caused by fluctuation in the price of oil, energy or transport costs.

      We market our Crop Protection products through a two- or three-step distribution system, depending on local market conditions. Under this system, products are sold either to wholesalers or directly to retailers.

      Environmental Science products are directed towards professional and consumer markets. For each of these markets, the products run through different distribution channels. For professional markets, products are sold to the pest control industry, the green industry, as well as the public health and rural hygiene sectors. In the consumer business, Lawn and Garden products are sold to end user consumers through specialized distribution channels. Also, specialty active ingredients are sold to marketers of household products.

      BioScience markets its seeds to end users, distributors and processing industries. Plant biotechnology traits are mainly distributed through out-licensing to seed companies, which produce commercial seeds on the licensor’s behalf. In some cases, traits are provided to other companies that utilize the technology in their own research and products.

      Our main competitors in the Crop Protection business are Syngenta, Monsanto, BASF, Dow AgroSciences and DuPont. Dow AgroSciences and Syngenta are our main competitors in the overall Environmental Science business. In the business of plant biotechnology-based products and seeds, DuPont, Monsanto and Syngenta are the market leaders.

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Research and Development

Crop Protection

      Bayer CropScience Research and Development is globally represented with main facilities in Monheim (headquarters) and Frankfurt, Germany; Lyon and Sophia Antipolis, France; Stilwell, Kansas and Raleigh, North Carolina; and Yuki City, Japan.

      The responsibility of the Crop Protection Research and Development function is to discover and develop customer-focused, innovative and profitable solutions in crop protection.

      Research covers all activities to identify new active ingredients that can be developed as insecticides, fungicides or herbicides. Genomics, high-throughput screening and combinatorial chemistry are part of the technological platform to identify new lead structures.

      Collaborations with research companies supplement our internal research activities (e.g., target identification carried out by Paradigm Genetics or GenOptera LLC, a joint venture between Bayer and Exelixis, Inc.).

      Once a compound is identified for development, its biological, environmental and toxicological profile, as well as its economic potential, is assessed. Suitable candidates are launched in the market.

      Bayer CropScience actively supports its products through continuous life cycle management. This includes the development of new formulations for existing active ingredients and expanding their applicability to additional crops and countries.

Environmental Science

      The molecules invented by Crop Protection Research are also tested and evaluated in Environmental Science for potential development. Development projects include passive treatments (gels, baits) and innovative formulations to control insects, as well as new herbicide products and new mixtures of fungicides for the turf and ornamental market segments.

BioScience

      The BioScience research and development facilities are located in Lyon and Evry, France; Haelen, The Netherlands; Gent, Belgium; and Potsdam, Germany.

      Plant biotechnology research and development is predominantly directed towards agronomic and quality improvement. The technologies include all relevant tools — from identifying the gene of interest to development — to improve key crops (cotton, oilseed rape (canola), rice) for growers and industrial partners. Research activities range from the exploration of novel agronomic traits to the discovery of new plant-based specialty products for the Nutrition, Health and BioMaterials markets.

      The following new active ingredients were launched in 2003 or are expected to be launched subject to regulatory approval in 2004:

             
New active ingredients Product Family Status



Spirodiclofen
    Insecticides     Launched in 2003
Clothianidin(1)
    Insecticides     Launched in 2003
Prothioconazole
    Fungicides     Launch expected in 2004


(1)  Co-developed with Sumitomo Chemical Takeda Agro Co. Ltd.

     The broad spectrum acaricide spirodiclofen (Envidor®) belongs to the new chemical class of tetronic acid derivatives discovered by Bayer CropScience. The product shows excellent activity against mite pests in perennial crops. Spirodiclofen has a new mode of action (interference with lipid biosynthesis) and shows no cross-resistance to any resistant mite field population and is therefore also a valuable tool for resistance management. Spirodiclofen is being developed for worldwide use in pome fruit, stone fruit, citrus, grapes, almonds and nuts.

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      Clothianidin (Poncho®) is a new active ingredient in the chemical class of chloronicotinyls. It has been jointly developed by Sumitomo Chemical Takeda Agro Co. Ltd. and Bayer CropScience AG. Bayer CropScience has exclusive rights for seed treatment developments. The active ingredient, which is applied as a seed treatment, has been developed primarily for the control of the major soil and early season pests in corn, sugarbeet, oilseed rape (canola) and cereals.

      Prothioconazole (Proline®) is the newest development in triazole chemistry for broad spectrum disease control. As part of crop resistance management, this product will be used for foliar and seed treatment application in cereals, oilseed rape (canola), peanuts and other crops.

BAYER POLYMERS

PLASTICS, RUBBER

Overview

      Our Plastics, Rubber segment comprises seven strategic business entities which are summarized under Thermoplastic Polymers and Rubber Polymers below. The following table shows the segment’s performance for the last three years.

                           
2001 2002 2003



(euros in millions)
External net sales
    5,396       5,210       4,813  
Percentage of total sales
    17.8       17.6       16.8  
 
thereof discontinuing operations
    3,689       3,337       3,096  
Intersegment sales
    116       115       76  
Operating result
    214       76       (666 )
Percentage of total operating result
    12.8       4.7        
 
thereof discontinuing operations
    6       (48 )     (716 )
 
thereof special items(1)
    (70 )     (91 )     (593 )


(1)  The special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2001, 2002 and 2003 — Segment Data.

     No individual product is material to the revenue of the segment as a whole.

Segment Strategy

      Our goal is to continue expanding our leading market position (based on product volume) in high-value added plastic and rubber products. We intend to continue developing new applications for our products. We aim to improve profit margins by continually streamlining our existing product portfolio, implementing efficient cost structures, eliminating capacity constraints and further exploiting our regional growth potential.

      In November 2003, Bayer announced that the Bayer Group intends to maintain its focus on its core businesses and therefore combine Bayer Chemicals with certain parts of the Bayer Polymers business in a new company to be named Lanxess (see — Business). Only Polycarbonates, Polycarbonate Sheets and Polycarbonate Blends will remain within Bayer Group. This remaining business within the Plastics, Rubber segment together with the Polyurethanes, Coatings segment (without Fibers), as well as Wolff Walsrode and H.C. Starck from Bayer Chemicals, will comprise the Bayer MaterialScience subgroup and will be conducted from a wholly-owned subsidiary of Bayer Group called Bayer MaterialScience AG.

      We are continuing our stringent cost and efficiency programs in the Polyurethanes, Coatings, Fibers and the Plastics, Rubber segments. As part of these programs, we had announced in 2002 that we planned to reduce the headcount in the Polyurethanes, Coatings, Fibers and the Plastics, Rubber segments. We reduced headcount by 2,200 (or 8.5 percent) in 2003 and continue to reduce the number of employees in these segments. We plan to continue cost reduction and efficiency programs as well as the reduction of headcount for Bayer MaterialScience.

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Thermoplastic Polymers

Overview

      With its broad product portfolio, our Thermoplastic Polymers business entities (Polycarbonates, Styrenics, Semi-Crystalline Products and Polycarbonate Sheets) are some of the leading global suppliers and manufacturers of engineering thermoplastics. Our acquisition of the remaining shares of Makroform GmbH on July 15, 2003 strengthens our position as a leading supplier of polycarbonate sheets based on product volumes. Many Bayer materials have chemical and physical properties that enable them to resist very low or very high operating temperatures as well as corrosive chemicals and solvents.

Major Products

Polycarbonates (will remain with Bayer)

      Polycarbonates are plastics that are transparent and highly stable across a wide temperature range. Polycarbonates almost completely dominate the field of optical data storage media, such as pre-recorded and recordable CDs and DVDs, and are widely used throughout the electrical/ electronics segments in general for injection molding purposes. The construction industry is also a major user of polycarbonates, for example, for Polycarbonate sheet applications. Makrolon® is our leading polycarbonate product. Its key characteristics include high transparency, heat resistance and toughness. It can be both sterilized — important for the food and medical industries — and recycled. Our other polycarbonates include the APEC® range for high temperature usages such as components for automobile headlights and Makroblend®.

Styrenics (will be partially transferred to Lanxess)

      Styrenics lend themselves well to blending with other forms of plastic. Blend technology can transform a palette of a few basic polymers into a wide range of new, advanced polymers with tailored properties, creating user-specific solutions and, in many cases, cost advantages as well. Styrenics are widely used in the automotive, electric/ electronic and IT industries. Special applications exist in household, packaging, toys and medical area. Novodur® and Lustran®, both acrylonitrile/ butadiene/styrene — ABS copolymers, are our leading stryrenics. Other styrenics include Lustran SAN®, Bayblend® (Polycarbonate/ABS blend) (which will stay with Bayer), Triax® and Centrex®.

Polycarbonate Sheets (Fabricated Products) (will remain with Bayer)

      We also produce plastic films as well as solid and multiwall sheets with a broad range of characteristics for a wide variety of applications. These materials consist of polycarbonate, polycarbonate blends or thermoplastic polyethers. We market our films under the trade names Makrofol® and Bayfol®, and our sheets as Makrolon®, Vivak® and Axpet®.

Semi-Crystalline Products (will be transferred to Lanxess)

      Polyamides. Polyamides are tough, strong, high-performance plastics. They are resistant to chemicals and can often replace metal and other materials. The most important consumers of polyamides are the automotive, food packaging and electrical/ electronic industries. In addition, we use these materials in producing halogen-free flame retardant products. In the automotive field alone, applications of polyamides range from such long-established uses as coolant casings, hubcaps, door handles, external mirrors, sun-roofs and central electrical systems to more recent developments, such as tail pipes, vehicle electronics and AntiBlockingSystems. Durethan® is a product within our range of engineering thermoplastics based on Polyamid 6, Polyamid 66 and their copolyamides.

      Polyesters. Semi-Crystalline thermoplastic polyesters like polybutylene terephthalate (PBT) and engineering plastics polyethylene terephthalate (PET) show high resistance to chemicals, heat distortion and stress cracking and show low water absorption. They are used unreinforced, glass fiber reinforced, flame retardant, filled and in blends. Pocan® is our trademark for engineering thermoplastics based on PBT and PET.

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Markets and Distribution

      We sell the products of our Thermoplastic Polymers business entities to thousands of customers worldwide. These customers include injection-molding operators and a large number of plastic-component manufacturers, whose products are overwhelmingly used in the automotive, electrical, electrical engineering, construction, data technology, medical and leisure fields.

      The business entities’ external sales, by region and totals, for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    1,490       1,402       1,387  
North America
    781       722       601  
Asia/Pacific
    699       700       669  
Latin America/ Africa/Middle East
    211       171       185  
     
     
     
 
 
Total
    3,181       2,995       2,842  
     
     
     
 

      The following table sets forth the business entities’ external sales for the last three years, broken down by category of activity.

                           
2001 2002 2003



(euros in millions)
Polycarbonates
    1,231       1,067       1,091  
Styrenics
    1,162       1,102       981  
Semi-Cristalline Products
    493       528       515  
Polycarbonate Sheets
    279       268       236  
Others
    16       30       19  
     
     
     
 
 
Total
    3,181       2,995       2,842  
     
     
     
 

      The market for engineering thermoplastics is characterized by constant pressure on margins and growing price competition due to globalization, excess capacities, reduced demand due to the economic slow-down and increasing customer purchasing power. The primary driver of competition is price. Our major customers also expect global presence, high quality products, technical support and service and reliable delivery. In order to meet these demands and to achieve leadership in both cost and technology, we are extending our production and marketing presence in our key regions and markets.

      Despite continually growing demand, global overcapacity remains a problem in some product lines. Although several producers have cancelled or postponed expansion plans, capacity continues to increase. We expect that the industry will continue to consolidate and new low-cost technologies will replace small, increasingly obsolete facilities.

      Bayer does not produce basic petrochemicals. The principal raw materials of our Thermoplastic Polymers business entities are styrene, butadiene, acrylonitrile, acetone, phenol, cyclohexane, butandiol and dimethylterephthalate. Because many of these materials derive from petrochemicals, we obtain them almost exclusively from third parties. We do, however, produce Bisphenol-A, which is a major precursor of polycarbonate, from phenol and acetone internally. Nevertheless, our costs are affected by fluctuations in raw material prices, driven in turn by fluctuations in oil prices. We typically procure third-party raw materials under long-term, “as-if-producer” contracts that establish cost-based pricing formulas, limiting raw material price fluctuation to the effects of fluctuation in the price of crude oil and energy.

      We market substantially all our plastics products through regional distribution channels, supported by regional competence centers and by our head office. In addition, we also use trading houses and local distributors to work with small volume customers. We are increasingly using e-commerce tools to market our products.

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      Our most significant global competitor in all regions is General Electric Plastics. We also compete with several other companies, most notably BASF, Dow and DuPont. Particularly in the Far East, local competitors with more limited product portfolios, such as Teijin, Chimei, Idemitsu, Mitsubishi and LG, are also important market players.

Research and Development

      The Thermoplastic Polymers business entities focus their research and development activities on process development in polycarbonates, styrenics and semi-crystalline thermoplastics. We have been introducing a new polycarbonate melt manufacturing process which will be the basis for our new investment in China. We are also furthering the development of the PA 6 polymerization process. In product development, we focus on consolidating our product portfolio, developing new blends, refining optical data carriers and modifying the surface of plastics with coatings.

      The business entities’ primary research and development facilities are located in Krefeld and Dormagen, Germany; Pittsburgh, Pennsylvania; Addyston, Ohio; and Moxi, India.

      The Thermoplastic Polymers business entities are currently focusing their research and development activities on the following products.

     
Product/ Brand name Application


Surface-modified Makrolon
  Automotive, construction
Improved Makrolon ODS grade
  recordable ODS formats
Extension of Bayblend FR series
  Business machines/ information technology
Electroconductive Triax for online painting
  Automotive exterior parts
Pocan, Durethan for thinwall application (EasyFlow)
  Electric/Electronic
Halogenfree flame retardant Pocan
  Electric/Electronic

Rubber Polymers (will be transferred to Lanxess)

Overview

      As a leading supplier of raw materials, our Rubber Polymers business entities (BR/Butyl, Technical Rubber Products, Rubber Chemicals) are an important partner to the rubber and tire industry. Our portfolio comprises synthetic rubber, rubber chemicals and modifiers for the plastics industry, along with special preparations and processing chemicals. On May 9, 2003, we sold our interest in PolymerLatex, a joint venture with Degussa AG.

Major Products

BR/Butyl

      Butadiene Rubber (BR). We produce polybutadiene rubbers (BR) using three different catalyst systems, each type imparting specific characteristics to the resulting polymers. BR is used principally in tire treads, invariably compounded with other rubbers to give the desired balance of properties such as long life, skid resistance and improved fuel economy. Polystyrene modification is the second major application for BR, which is also used in golf balls and some industrial products. The BR product family includes solution-polymerised styrene-butadiene rubbers.

      Butyl. We produce a full range of standard and halogenated butyl rubber, the principal characteristic of which is impermeability to air and gases, making them well suited for use in the pneumatic tire. Inner tubes are manufactured from standard grades, whereas the halogenated types are used in impermeable linings in the tire itself. Other applications include pharmaceutical stoppers and chewing gum.

Technical Rubber Products

      We produce a wide range of synthetic rubber. Our portfolio comprises polychloroprene, ethylene-proylene co- and ter-polymers, nitrile rubber and styrene-butadiene copolymers as well as hydrogenated nitrile rubber and

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ethylene-vinyl acetate copolymers specialities. Our customers may process our rubber materials into end products, often blending them with other synthetic rubbers or natural rubber to form a wide range of compounds. Our products offer customers an array of varying characteristics, including processability, hardness, flexibility and wear, heat and chemical resistance, to suit their specific needs. Our rubber products are the basis for a wide variety of other articles such as hoses, belts, cable and wire sheathing, footwear and golf balls.

      Rubber Chemicals. We produce a broad range of chemical products for use in the rubber compounding and production process. These products help rubber producers to control the speed of vulcanization, to protect rubber products against degradation caused by oxidation or effects of ozone and heat and to alter the physical properties of rubber products. The products range consists mainly of relatively mature products with limited substitution risk. These products are in general use by all rubber fabricators. The tire and automotive industry is the largest end user market.

      PolymerLatex and Rhein Chemie. Our subsidiary Rhein Chemie produces a wide variety of substances used in rubber manufacture and processing. On May 9, 2003, we sold our interest in the PolymerLatex joint venture.

Markets and Distribution

      The main markets for the Rubber Polymers business entities are Europe and North America. The tire and automotive industries generate a large percentage of the business entities’ revenue, both from new car production and replacement tires.

      The business entities’ external sales by region and total for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    1,063       1,023       950  
North America
    725       679       585  
Asia/Pacific
    307       370       306  
Latin America/ Africa/Middle East
    120       143       130  
     
     
     
 
 
Total
    2,215       2,215       1,971  
     
     
     
 

      The following table sets forth the business entities’ sales for the last three years, broken down by category of activity.

                           
2001 2002 2003



(euros in millions)
BR/Butyl
    960       951       900  
Technical Rubber
    477       508       458  
Rubber Chemicals
    287       292       270  
Rhein Chemie
    293       280       257  
PolymerLatex
    190       179       66  
Other
    8       5       20  
     
     
     
 
 
Total
    2,215       2,215       1,971  
     
     
     
 

      Our Rubber Polymers business entities are not subject to significant seasonality.

      We regard the following companies as the major competitors of our Rubber Polymers business entities:

  •  Technical Rubber: Exxon, Polimeri Europa, DuPont Dow Elastomers, DSM and Nippon Zeon;
 
  •  Rubber Chemicals: Flexsys and Crompton;
 
  •  Butyl: Exxon; and

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  •  Butadiene Rubber (BR): Michelin, Bridgestone, and Goodyear, as the largest tire companies, all have in-house production.

Research and Development

      The Rubber Polymers business entities focus their research and development activities on creating new products, improving processing technology and improving testing methods. The business entities’ primary research and development facilities are located in Leverkusen and Dormagen, Germany, and Sarnia, Canada.

      Because a substantial portion of our business comes from the automotive sector, anticipating and meeting that sector’s needs is a key priority of our research and development effort. In the non-tire automotive industry, the primary goal is developing rubber parts that have longer durability in more demanding environments. Another aspect of our work is promoting the use of our materials in non-traditional applications, such as the packaging industry.

      We have four products in late stages of development. These products are:

     
Product/Brand name Application


Therban XT
  Improved hot abrasion and adhesion
Levapren 900
  PVC substitute in NitrileButadieneRubbers blends
Vulcuren
  Vulcanization of rubber goods with less reversion
Buna VSL KA8955
  New modified Solution-StyreneButadieneRubber (S-SBR) for improved tire tread performance

POLYURETHANES, COATINGS, FIBERS

Overview

      Our Polyurethanes, Coatings, Fibers segment comprises seven strategic business entities which are summarized under Polyurethane Materials and Coatings Materials below. The following table shows the segment’s performance for the last three years.

                           
2001 2002 2003



(euros in millions)
External net sales
    5,275       5,213       5,084  
Percentage of total sales
    17.4       17.6       17.8  
 
thereof Discontinuing Operations
    228       199       167  
Intersegment sales
    138       78       207  
Operating result
    153       (134 )     (514 )
Percentage of total operating result
    9.1              
 
thereof Discontinuing Operations
    (17 )     (99 )     (67 )
 
thereof special items(1)
    (85 )     (374 )     (785 )


(1)  The special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2001, 2002 and 2003 — Segment Data.

     No individual product is material to the revenue of the segment as a whole.

Segment Strategy

      Our goal is to continue expanding our global position in Polyurethane, Coatings. We plan to focus on capacity expansion in Asia, where we see opportunities for above-average growth.

      In November 2003, Bayer announced that the Bayer Group intends to maintain its focus on its core businesses and therefore combine Bayer Chemicals with certain parts of the Bayer Polymers business in a new company to be named Lanxess (see — Business). Our Fibers business that is included in the Polyurethanes, Coatings, Fibers segment will be transferred to this new company. The remaining Polyurethanes, Coatings

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business, together with the Polycarbonates, Polycarbonate Sheets and Polycarbonate-Blends business from the Plastics, Rubber segment, as well as Wolff Walsrode and H.C. Starck from Bayer Chemicals, will comprise the Bayer MaterialScience subgroup and will be conducted through a wholly-owned subsidiary of Bayer Group called Bayer MaterialScience AG.

      As announced in 2002, we intend to boost our returns through stringent cost and efficiency programs in the Polyurethanes, Coatings, Fibers and the Plastics, Rubber segments. We reduced headcount by 2,200 in 2003 and continue to reduce the number of employees in the segments. We plan to continue cost reduction and efficiency programs as well as the reduction of headcount for Bayer MaterialScience.

Polyurethane Materials

Overview

      Our Polyurethane Materials business entities (MDI, TDI, Polyether) focus on the development, production and marketing of isocyanates and polyol materials for polyurethane formulations and systems used in producing a wide variety of polyurethane polymers for a broad range of industrial and consumer applications.

Products

      Polyurethanes are polymers formed through the reaction of two liquid chemicals: an isocyanate — typically diphenylmethane diisocyanate (MDI) or toluene diisocyanate (TDI) — and a polymeric alcohol such as polyether polyols. We produce a range of different isocyanates and polyether polyols under such brand names as Desmodur®, Desmophen®, Baydur® and Bayflex®. The characteristics of a given polyurethane depend on both the material components used as well as the precise proportion of each used in the mix.

      Our customers use our isocyanates or polyether polyols, or both, to create their own specific polyurethane formulations. In addition, upon request we design and evaluate custom blends to meet specific customer requirements. When we have perfected a formulation for a specific end product, we deliver the components to the customer, who then combines them at its manufacturing site. The customer receives a ready-to-use two-component system. The precise formulation of each custom blend is proprietary.

      Typical applications for which our customers use our polyurethane materials include furniture, mattresses, automotive components, appliances, sport and leisure equipment and construction.

Markets and Distribution

      Europe and the NAFTA nations remain the primary markets for our Polyurethane Materials business entities, although Asia is growing in importance.

      The Polyurethane Materials business entities’ external sales by region and totals for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    1,304       1,221       1,289  
North America
    1,110       1,138       1,049  
Asia/Pacific
    445       451       464  
Latin America/ Africa/Middle East
    414       387       382  
     
     
     
 
 
Total
    3,273       3,197       3,184  
     
     
     
 

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      The following table sets forth the business entities’ sales for the last three years, broken down by product type.

                           
2001 2002 2003



(euros in millions)
TDI
    575       593       581  
MDI
    1,177       1,099       1,193  
Polyethers
    1,392       1,504       1,392  
Others
    129       1       18  
     
     
     
 
 
Total
    3,273       3,197       3,184  
     
     
     
 

      For our customers’ applications, there are no significant man-made or natural substitute materials for flexible polyurethane foams. Polystyrenes can compete with rigid polyurethane foams if the required materials are in sheet or block form. Conversely, polyurethane elastomers compete with other thermoplastic materials on cost, performance and fit with the production mix at the customer’s site.

      In the automotive area, there is constant competition between polyurethanes and other polymers in many applications, except for seating and steering wheels, due to required physical properties, costs, design or functional requirements.

      On a worldwide level, the Polyurethane Materials business entities’ sales are not subject to significant seasonality. On the regional level, business can display indirect seasonality where, for example, revenue depends on such seasonal industries as construction and other outdoor applications.

      The basic raw materials for our isocyanates and polyols are commodity petrochemical products. We typically purchase these on the open market partially under long term contracts, as Bayer generally does not produce petrochemicals. However, through our acquisition of Lyondell’s polyol business, we have acquired a low-cost source for propylene oxide, one of our key raw materials. Although these raw materials are readily available, they are subject to price fluctuation driven by, for example, changes in world oil prices.

      The Polyurethane Materials business entities sell their products directly to customers and, to a much smaller degree, through so-called “system houses” and traders. System houses typically serve smaller-volume customers and may be either independent companies or the subsidiaries of larger companies. It is our strategy to systematically establish our own regional system houses.

      To further increase efficiency along the supply chain, we are establishing regional supply chain centers, replacing country-specific organizations, to fill orders. Ultimately, we plan to have the regional supply chain centers balance worldwide supply with regional demand.

      We are currently in a consolidation phase regarding our production sites. As part of this consolidation in the TDI area, we terminated the Industriale Cydsa Bayer joint venture (ICB) and closed the TDI plant at Coatzocoalcos, Mexico, as well as the TDI plants in Leverkusen, Germany, and SBU, Japan. Other parts of this consolidation included the termination of the Bayer-Shell Isocyanates N.V. (BSI) joint venture, as well as the closure of the polyether site at Institute, West Virginia during 2003.

      Our main competitors are BASF, Dow Chemical, Huntsman, Lyondell, Mitsui Takeda and Shell.

Research and Development

      The Polyurethane Materials business entities focus their research and development activities on:

  •  reducing the thermoconductivity of rigid polyurethane foams;
 
  •  halogen-free flame retardants;
 
  •  halogen-free blowing agents;
 
  •  reduction of volatile components in polyurethane raw materials;

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  •  new applications for polyurethanes and polyurethane materials; and
 
  •  reducing costs and improving quality in production processes.

      The business entities’ primary research and technical development facilities are located in Dormagen and Leverkusen, Germany; Pittsburgh, Pennsylvania; South Charleston, West Virginia; New Martinsville, West Virginia; Amagasaki, Japan; and Shanghai, China.

      The main areas of innovation in the polyurethane field are currently the development of new or improved polyether polyol types and blends as well as the improvement of manufacturing processes. The business entities concentrate their research and development efforts with respect to aromatic isocyanates on improving existing products and technologies for their manufacture. High-throughput experiments are used for the development of new formulations and will help to reduce time-to-market for new products.

Coatings Materials

Overview

      Our Coatings Materials business entities (Base- and modified isocyanates, Polyester TPU and Films, Inorganic Basic Chemicals and Fibers) develop and market a wide variety of products that serve as raw materials for lacquers, coatings, sealants and adhesives. To enable these entities to concentrate on their core business areas, we transferred the Colorants business to Bayer Chemicals in 2003.

Major Products

 
Resins and Hardeners

      Polyurethane lacquers are formed through the combination of an isocyanates component with a polyol-like polyester, polyacrylate-, polyether- or polycarbonatepolyols. We offer a variety of polyol components branded as Desmophen®, Rucote® and Bayhydrol® (Polyester, TPU and Films) and polyisocyanates such as Desmodur®, Desmodur BL®, Bayhydur®, and Crelan® (base- and modified isocyanates). This variety enables us to provide custom-tailored solutions for a number of different applications.

      Special raw materials. Our special material unit produces such specialty products as Pergut® (Polyester, TPU and Films) for coatings and adhesives, Impranil®, our polyurethane coating systems for textiles, and Baybond® for glass fiber sizing.

 
Adhesive raw materials

      Dispercoll® and Desmocoll® (Polyester, TPU and Films) are our raw materials for adhesives. Their primary users are shoe manufacturers, though we also have customers from the automotive, furniture and building industries.

      Thermoplastic polyurethanes. Thermoplastic polyurethanes, or TPUs (Polyester, TPU and Films), belong to the high-performance thermoplastic elastomers family. A key property of TPUs is their resistance to high abrasion and wear. TPUs’ abrasion- and wear-resistant properties are substantially superior to those of abrasion-resistant rubber compounds. Their wet abrasion resistance surpasses even that of most metals. We market our thermoplastic polyurethanes under the trademarks Desmopan® in Germany and other EU countries and Texin® in the United States.

      Inorganic basic chemicals. Inorganic basic chemicals are of major importance for Bayer. A large part of Bayer Polymers sales are dependent on chlorine. Chlorine is used for the production of intermediates that are subsequently processed into a variety of products, such as polyisocyanates and polycarbonates. Over 90 percent of the sodium chloride electrolysis capacity is based on the environmentally-friendly, energy-efficient membrane process. In addition to chlorine, sodium chloride electrolysis generates caustic soda, which can be sold to external markets, to the extent that it is not used internally.

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      Fibers (will be transferred to Lanxess). Our Fibers business focuses on the development, production and marketing of fibers for the textile industry under the trade name Dorlastan®, and in general applications under the trade names Atlas® and Bayco®.

Markets and Distribution

      Our Coatings Materials business entities are a major producer of raw materials for coatings and adhesives. The primary ultimate end users of our products are the automotive, furniture and plastics industries; other users include the textile, shoe and building industries.

      The business entities’ external sales by region and total for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    1,024       1,031       1,020  
North America
    526       552       477  
Asia/Pacific
    299       293       266  
Latin America/ Africa/Middle East
    153       140       137  
     
     
     
 
 
Total
    2,002       2,016       1,900  
     
     
     
 

      The following table sets forth the business entities’ sales for the last three years, broken down by category of activity.

                           
2001 2002 2003



(euros in millions)
Base- and modified isocyanates (BMI)
    773       842       791  
Polyester, TPU and Films (PTF)
    708       777       702  
Inorganic Basic Chemicals
    220       181       218  
Fibers
    232       200       170  
Others
    69       16       19  
     
     
     
 
 
Total
    2,002       2,016       1,900  
     
     
     
 

      Our revenue is not subject to significant seasonality over the course of the typical year. Some of the individual markets and regions that we serve experience seasonal fluctuation, such as the building industry during the winter months or southern Europe during the summer. All markets and regions taken as a whole, however, produce relatively constant revenue throughout the year.

      Temporary fluctuations in prices, such as the price of crude oil or energy, can have a significant effect on the cost of our raw materials. Nevertheless, because of our broadly diversified supplier base and raw material mix, we secure our most important chemical raw materials through long-term contracts.

      We coordinate and carry out our sales and marketing from our head office in Leverkusen, Germany, as well as through our various national subsidiaries. Our key account managers handle our globally active major customers directly.

      We regard the following companies as the chief competitors of our Coatings Materials business entities.

  •  Resin components (PTF): UCB/Solutia, Cray Valley, DIC;
 
  •  Aliphatic isocyanates (BMI): Rhodia, Degussa, BASF, Asahi, NPU (Nippon Polyurethane Industry);
 
  •  Aromatic isocyanates (BMI): DOW, MITSUI TAKEDA, SAPICI; and
 
  •  Inorganic basic chemicals (IBC): DOW, Solvay, Akzo Nobel.

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Research and Development

      The Coatings Materials business entities focus their research and development activities on developing products that we can formulate into high performance coatings, such as aliphatic and aromatic polyisocyanates and resin components. We are also exploring ways of reducing the amount of solvent needed by technologies such as high solids and waterborne and powder coatings systems.

      The business entities’ primary research and development facilities are located in Leverkusen and Dormagen, Germany and Pittsburgh, Pennsylvania.

BAYER CHEMICALS

Overview

      Bayer Chemicals consists of our Chemicals segment. The Chemicals segment is comprised of the Chemicals and H.C. Starck business groups.

      Our products are available to customers worldwide and are used in many different industries (e.g., electronic, optics, metal processing, food, coatings, textile, leather, paper, plastics, rubber, building materials, pharmaceuticals, and engineering ceramics industries). Our products are available as either individual building blocks or as system-wide solutions designed to assist an entire production process. Our core competencies lie in research and development and the production and marketing of highly differentiated, industrial, fine process and performance chemicals.

      The following table shows the Chemical segment’s performance for the last three years.

                           
2001 2002 2003



(euros in millions)
External net sales
    5,201       4,322       3,400  
Percentage of total sales
    17.2       14.6       11.9  
 
thereof Discontinuing Operations
    3,961       3,371       2,513  
Intersegment sales
    456       409       370  
Operating result
    527       1,057       (499 )
Percentage of total operating result
    31.4       65.7        
 
thereof Discontinuing Operations
    360       1,018       (516 )
 
thereof special items(1)
    222       857       (541 )


(1)  The special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2001, 2002 and 2003 — Segment Data.

     No individual product is material to the revenue of the Chemicals segment as a whole.

Segment Strategy

      The focus of our activities in the Chemicals segment is improving our margins. Our Industrial Chemicals business entities aim to enhance their operating result by improving the manufacturing processes. Our other business entities aim to improve their margins by streamlining the portfolio and focusing on selected activities in the chemical industry. These business entities pursue a strategy of achieving niche positions with focus on the customers.

      In November 2003, Bayer announced that the Bayer Group intends to maintain its focus on its core businesses and therefore combine Bayer Chemicals (except for Wolff Walsrode and H.C. Starck) with certain parts of the Bayer Polymers business in a new company to be named Lanxess (see — Business). After this separation, Wolff Walsrode and H.C. Starck will be grouped together with the remaining parts of the Bayer Polymers business in a wholly-owned subsidiary of Bayer Group called Bayer MaterialScience.

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      Lanxess will be focused on four core business activities: Chemical Intermediates, Performance Chemicals, Performance Plastics and Performance Rubber. All structures and processes will be adapted to the specific requirements of these businesses.

Chemicals

Overview

      The Chemicals business group covers eleven strategic business entities which are summarized under Industrial Chemicals, Custom Manufacturing, Functional Chemicals, Process Chemicals and Wolff Walsrode. All these businesses except for Wolff Walsrode will be transferred to Lanxess.

Major Products

 
Industrial Chemicals

      Our Industrial Chemicals business entities focus on the development, manufacture and marketing of a wide range of basic chemicals, mainly aromatic compounds and iron-oxide pigments. Industrial chemicals are produced in bulk quantities using few synthesis steps.

      The Industrial Chemicals business entities produce inorganic and aromatic compounds. In the few last years, the focus was on improving processes and thereby enhancing productivity.

      Bayferrox® is our iron-oxide based anorganic colorant, which is available in a variety of colors for a wide range of uses. For example, it provides the characteristic reddish tone of roofing tiles.

      The product line Lewatit® offers a broad range of ion-exchangers, adsorbers and catalysts. These products provide solutions, among others, for drinking or industrial water, for the food or chemical processing industries as well as for the mining and petrochemical industries.

 
Custom Manufacturing

      Our Custom Manufacturing business entity produces a growing range of high specification, customized fine chemicals for use in advanced industrial sectors such as life sciences. The multi-step synthesis products are high value-added chemicals made to exact specifications by means of sophisticated and complex chemical synthesis processes. These chemicals comprise two broad categories:

  •  multi-customer products, or “catalogue” products sold to more than one customer; and
 
  •  single customer products, synthesized to the specifications of individual customers. Production of our single-customer fine chemicals often involves various levels of customer cooperation as well as custom-tailored research and manufacturing; typical examples are life science intermediates for the pharmaceutical and agrochemical industries.
 
Process Chemicals

      In contrast to other chemicals business entities, the Process Chemicals business entities display a high degree of “custom tailoring” for the specific needs of its customers. There is a variety of broad product families, each of which contains several product lines. Each product line represents numerous individual compounds that are related to a general chemical composition and area of function. Overall, the product range comprises thousands of compounds and a technically trained sales force is available to consult with clients. The Process Chemicals business produces chemicals for the leather, paper and textile industries.

 
Functional Chemicals

      The Functional Chemicals business entities comprise, among others, industrial biocides, organic colorants and plastic additives.

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      Our plastic additives, including flame retardants, plasticizers, blowing agents and modifiers, improve properties and confer new ones on polymers such as PVC, thermosets, polyurethanes and elastomers. In respect of material protection, we offer a broad product range of industrial biocides and preservatives with applications ranging from wood protection to anti-fouling, disinfection, personal care, in-can preservation and corrosion inhibitors. Our range of colorants includes universal products as well as specialty products for special requirements. These products vary in their characteristics such as thermostability, color intensity, weather stability and brilliance.

 
Wolff Walsrode (will remain with Bayer)

      Wolff Walsrode (which will remain with Bayer and not be transferred to Lanxess) develops, produces and markets cellulose derivatives, primarily for use in building materials, industrial coatings and inks, pharmaceuticals, food and health care products, and other additives for coatings, emulsion paints and printing inks.

      Walocel M® is an additive that regulates water balance. It improves the workability and adhesion of building materials such as tile adhesives, plasters, mortars and dispersion paints.

      Walsroder NC® serves in resin form in wood coatings and other industrial coatings as well as in printing inks for flexible packaging. It is also used as a component of nail polish and other specialty items.

      Walocel C® is used primarily as a thickener and binder in water-based systems. It is used in pharmaceuticals, dairy products and toothpaste, as well as in ceramics compounding, textile and paper manufacture and oil drilling.

      Effective November 1, 2003, we sold Walothen GmbH to the Wihuri Group of Finland. Walothen® is a class of films based on Polypropylen for food and cigarette packaging and paper lamination.

Markets and Distribution

      The principal markets of the Industrial Chemicals business entities are industries using organic or inorganic intermediates. The products of the water treatment business are used in the consumer, semiconductor and pharmaceuticals industries, among others. The primary end users of inorganic colorants are the automotive, furniture and plastics industries.

      The principal markets for our Custom Manufacturing business entity are customized fine chemicals for the photographic, electronics and life science industries.

      Given the individualized nature of their products, the marketing activities of the Process Chemicals business entities focus on individual customer requirements. The end users are the textile, leather and paper industries.

      The plastics, construction, food and pharmaceutical industries are, among others, the main customers for the Functional Chemicals business entities.

      Wolff Walsrode competes in the building materials, industrial coatings, flexible packaging ink and life sciences markets, as well as in specialized industrial fields.

      The business group’s sales, by region and total, for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    2,277       1,883       1,567  
North America
    929       733       496  
Asia/Pacific
    622       600       441  
Latin America/ Africa/Middle East
    562       499       332  
     
     
     
 
 
Total
    4,390       3,715       2,836  
     
     
     
 

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      The following table sets forth the business group’s sales for the last three years, broken down by category of activity.

                           
2001 2002 2003



(euros in millions)
Industrial Chemicals
    1,055       1,000       975  
Custom Manufacturing
    276       215       188  
Process Chemicals
    1,038       890       740  
Functional Chemicals
    397       512       514  
Wolff Walsrode and others
    1,624       1,098       419  
     
     
     
 
 
Total
    4,390       3,715       2,836  
     
     
     
 

      Our Chemicals business group is not subject to significant seasonality over the course of the year. Some of the individual markets and regions that we serve experience seasonal fluctuation, such as the agriculture industry (which mainly affects our Custom Manufacturing business entity) and the building industry (which mainly affects our Industrial Chemicals and Wolff Walsrode business entities). All markets and regions taken as a whole, however, produce relatively constant revenue throughout the year.

      The Chemicals business group acquires a part of the raw materials they use internally from other business groups of the Bayer Group. There are typically multiple sources for the rest of its raw materials; we purchase these from suppliers worldwide, usually under long-term contracts. Chemicals has historically not been affected by shortages; however, rising oil prices have had a moderate impact on production cost.

      We produce part of our chemicals in dedicated, continuous-process manufacturing plants using advanced technologies. The other products are manufactured in batch-processing plants. The plants are predominantly located in Leverkusen and other German sites while others are located at locations around the world in order to serve the local markets more economically.

      We market the products of the business group primarily through Bayer’s worldwide network of trading companies and agencies, with their specialized and experienced salespeople.

      We regard the following companies as our chief competitors:

  •  Industrial Chemicals: BASF, Dow, Elementis, Rohm & Haas;
 
  •  Custom Manufacturing: Lonza, DSM, Degussa;
 
  •  Process Chemicals: Clariant, BASF, Ciba Specialty Chemicals;
 
  •  Functional Chemicals: Solutia, Akzo Nobel, Rhodia, Avecia; and
 
  •  Wolff Walsrode: Hercules, Dow, Clariant, Bergerac NC/SNPE, Nitroquimica Brasileira and Noviant.

Research and Development

      The business group focuses its research and development activities on:

  •  technological and chemical development and improvement of manufacturing processes of industrial and life science intermediates;
 
  •  improved optical brighteners, retention and sizing agents for the paper industry;
 
  •  improved ion exchange resins for waste water treatment and metal recovery;
 
  •  environmentally friendly formulations of products for the leather, paper and textile industry;
 
  •  polyurethane dispersions for the finishing of leather car seats;
 
  •  high-performance data storage media for information technology;
 
  •  new products for the textile industry;

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  •  new flame retardants and high performance plasticizers;
 
  •  new colorants for plastics and specialities;
 
  •  new fungicides and efficient formulations for material protection; and
 
  •  irone oxide media for drinking water and waste water treatment.

      The primary research and development facilities are located in Leverkusen, Germany; Ede, the Netherlands; Woodbridge, Connecticut; and Bomlitz, near Walsrode, Germany.

      We currently have over 120 products and new or improved processes in late stages of development. We expect to launch these during 2004 and 2005. In 2003, we launched more than 150 products and processes.

H.C. Starck (will remain with Bayer)

Overview

      Our subsidiary H.C. Starck (which will remain with Bayer and not be transferred to Lanxess) develops, produces and markets metallic and ceramic powders and mill products for various markets and applications. H.C. Starck constantly pursues its policy of forward integration (further development of the product portfolios towards the customer). After the integration of CSM Industries, we acquired a majority interest in InDec B.V. in the first quarter of 2003. InDec produces ceramic cells for use in fuel cell systems. We expect these ceramic cells to enable H.C. Starck to advance into the Solid Oxide Fuel Cell (SOFC) market and to develop higher-value added products in the field of functional ceramics. There are many future large-scale applications of SOFC systems, such as residential and commercial co-generation, auxiliary power units for trucks, buses and passenger cars and numerous other applications where reliable, high quality power is needed.

Major Products

Metallic products and compounds

      We produce a broad portfolio of products ranging from ceramic materials to such metals as tungsten, molybdenum, tantalum and niobium and their various alloys and compounds for industrial customers. We manufacture these materials not only in the form of ceramic or metallic powders but also as solid intermediates or finished parts. This gives us the ability to provide engineering and design services for a wide variety of markets and end uses. We bring this ability to customers in the aerospace, medical, chemical, electronic, lighting, sophisticated tooling and optical components industries.

      KuliteTM is our trademark for fabricated parts made from tungsten alloy powders. These products are used, for instance, as balance weights in the aerospace industry.

      Molyform® powders are our molybdenum disulfide solid lubricants. We market a range of powdered lubricants under the brand name Lubriform®. Our customers use these compounds in producing lubricants. The automotive industry also uses Molyform® in manufacturing brake linings.

 
Battery intermediates

      Ampergy® is our trade name for our nickel hydroxide and cobalt suboxide battery intermediates. Our customers in the electrochemical industry use Ampergy® in making rechargeable batteries for modern communications devices and in large-scale industrial batteries.

 
Chemical catalysts

      Amperkat® is the trade name for our line of chemical catalysts. The chemical industry uses these products in a variety of applications, such as chemical synthesis, plastics production, hydration processes and desulphurization for generating low sulphur diesel-fuels.

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Thermal spray powders

      Amperit® is the trade name of our line of thermal spray powders. Our customers use these powders to give their products a variety of protective coatings. Our Amperit® customers come primarily from the machine tool and aeronautics industries.

 
Ceramic powders and parts

      Because of their resistance to corrosive substances, high mechanical durability and low weight, high-performance ceramic materials are increasingly replacing metals in various industrial uses. We produce a broad range of intermediates for use in advanced ceramics. H.C. Starck Ceramics produces functional ceramic parts from silicon carbide and silicon nitride for various industries such as pump seal rings, foundry parts and ball bearings.

Markets and Distribution

      Although growth in the demand for ceramic products has been steady, strong competitive pressure has depressed prices. We expect, however, that the market for H.C. Starck Ceramics products will continue to grow steadily for the foreseeable future.

      For our fabricated products business, we believe that we gain strength from the wide variety of markets and customers that we serve. We believe that China will be a promising market with large demand for all of our fabricated products in the lighting, telecommunications and transportation industries.

      In 2003, the main factor influencing the H.C. Starck Group was the failure of the electronics industry to recover as we had expected.

      The business group’s external sales by region, as well as its overall sales, for the past three years are as follows:

                           
2001 2002 2003



(euros in millions)
Europe
    325       248       245  
North America
    234       148       126  
Asia/Pacific
    208       196       183  
Latin America/ Africa/Middle East
    44       15       10  
     
     
     
 
 
Total
    811       607       564  
     
     
     
 

      China is the primary source for the raw materials for tungsten products. In the past, China had limited production, thereby causing shortages. We have our own tungsten production and recycling facilities, however, and are therefore only partly dependent on Chinese imports and do not bear the full brunt of raw material price increases. Tantalum raw material prices have remained relatively stable during the last two years. Raw material supply is secured through long term contracts in general lasting 5 years.

      H.C. Starck has its own international sales organization in Europe, the United States and Japan, its most important markets. In addition, we have liaison offices for Scandinavia, the Benelux countries, France, Italy and the United Kingdom that maintain direct contact with our customers. We also have a liaison office in Singapore for the South-East Asia region. In other countries, we either rely on the Bayer-wide sales organization or use third-party sales agents.

      We regard the following companies as our chief competitors:

  •  Metallic products and compounds: Bergla, Cabot Group (including its associated joint ventures), Mitsui, MolymetOMG, Osram Sylvania, Umicore, Plansee AG, Philips Elmet, Phelps Dodge;
 
  •  Battery intermediates: Tanaka, Umicore;
 
  •  Chemical catalysts: Activated Metals, Degussa, Grace-Davison, Engelhard;

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  •  Thermal spray powders: Praxair, Sulzer Metco, Woka; and
 
  •  Ceramic powders and parts: Denki Kagaku, SB Boron; GE Ceramics, Tokuyama Soda.

Research and Development

      H.C. Starck focuses its research and development activities on innovative products and system solutions. For example, we are developing high-capacity tantalum and niobium powders as intermediates for capacitors, and precursors for thin metallic films in microelectronic devices. We are also developing high-purity tantalum and niobium compounds for electroceramics and surface acoustic wave filters in computers and mobile telephones. H.C. Starck is also strongly committed to developing materials for more technically advanced batteries, fuel cells, hybrid vehicles and other energy storage and power generation applications.

      The business group’s primary research and development facilities are located in Goslar, Germany; Newton, Massachusetts (all refractory metals); and Mito, Japan (tantalum products and battery intermediates).

      To follow the technical trends and the high innovation rates in electronics, all precursor materials for electronic components must be improved continuously and adapted to completely new and more challenging applications. In particular, tantalum and niobium powder for capacitors and filters must become finer, and the impurity level must be reduced to lower limits to make capacitors with steadily increasing capacities and higher reliabilities. We currently have seven products in late stages of development, and expect to start and continue their launch during 2004. See also Item 3, Key Information — Risk Factors — Failure to develop new products and production technologies may harm our competitive position.

     
Product/ Brand name Application


Niobium Oxide 80 and 120 K powder
  Capacitors
Tantalum 70/80 and 100/120 K powder
  Capacitors
P/M tantalum plates PVD
  Semiconductor Industry
Nb products for metal processes
  Capacitors
MMC for thermal management sophisticated electronic heat sinks
  Electronics
High temperature furnace materials
  Furnace construction
Alternative (ferrous, nickel, cobalt) binders
  Tool industry

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INTELLECTUAL PROPERTY PROTECTION

      To succeed, Bayer must continually seek new products that provide our customers with better solutions for existing problems and new solutions for emerging problems. This requires us to expend significant effort on research, development, manufacturing and marketing. To preserve the value of our investment, we rely on the patent and trademarks laws of the jurisdictions where we do business. In addition, our production technologies typically incorporate specialized proprietary know-how.

      We have both developed intellectual property internally and acquired it as assignee through acquisitions. In addition, Bayer may from time to time grant licenses to third parties to use our patents and know-how, and may obtain licenses from others to manufacture and sell products using their technology and know-how.

Patents

      We seek to protect our products with patents in major markets. Depending on the jurisdiction, patent protection may be available for:

  •  individual active ingredients;
 
  •  specific compounds, formulations and combinations containing active ingredients;
 
  •  manufacturing processes;
 
  •  intermediates useful in the manufacture of products;
 
  •  genomic research; and
 
  •  new uses for existing products.

      The protection that a patent provides varies from country to country, depending on the type of claim granted, the scope of the claim’s coverage and the legal remedies available for enforcement. For example, although patent protection in the United States is generally strong, under some circumstances, U.S. law permits generic pharmaceuticals manufacturers to seek regulatory approval of generic products before the patents expire. See Item 8, Financial Information — Legal Proceedings. In addition, some developing countries have announced plans to reduce patent protection for some drugs.

      The advance of genomic research has accelerated our patent filings for biological products. We typically seek protection upon determining a gene’s function.

      We currently hold thousands of patents, and have applications pending for a significant number of new patents. Although patents are important to our business, we believe that, with the exception of the patents covering Adalat®, Avelox®, Cipro®, Levitra® and imidacloprid, no single patent (or group of related patents) is material to our business as a whole.

Term and Expiration of Patents

      Patents are valid for varying periods, depending on the laws of the jurisdiction granting the patent. In some jurisdictions, patent protection begins from the date a patent application was filed; in others, it begins on the date the patent is granted.

      The European Union, the United States, Japan and certain other countries extend or restore patent terms or provide supplementary protection to compensate for patent term loss due to regulatory review and substantial investments in product research and development and regulatory approval. Our policy is to obtain these extensions where possible.

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      Patent protection in our major markets for some of our key products is scheduled to expire in the near term. Although the expiration of a patent for an active ingredient normally results in the loss of market exclusivity, we may continue to derive commercial benefits from:

  •  subsequently-granted patents on processes and intermediates used in manufacturing the active ingredient;
 
  •  patents relating to specific uses for the active ingredient;
 
  •  patents relating to novel compositions and formulations; and
 
  •  in certain markets (including the United States), market exclusivity under laws other than patent laws.

      The following table sets forth the expiration dates in our major markets of the patents covering Adalat®, Avelox®, ciprofloxacin, imidacloprid and vardenafil:

                                                                   
Market

Product Germany France U.K. Italy Spain Japan U.S.A. Canada









Adalat®
                                                               
 
Crystal patent (Retard)
                      2003                   2010        
 
Adalat® CC (Coat Core)
    2008       2008       2008       2008       2008       2008       2008       2009  
 
Gits/Oros excl. license (Alza)
    2004       2004       2003       2004       2004       2004             2004  
Avelox®
                                                               
 
Compound
    2009       2009       2009       2014       2009       2009       2014       2016  
 
Hydrochloride-Monohydrate
    2016       2016       2016       2016       2016       2016       2016       2016  
 
Tablet formulation
    2019       2019       2019       2019       2019       2019       2019       2019  
Ciprofloxacin
                                                               
 
Active ingredient
          2004       2002       2009                   2003       2004 (1)
 
Process
    2002       2002       2002       2002       2003       2002             2004  
 
IV formulation
    2006       2006       2006       2006       2006       2006       2007       2008  
 
Tablet formulation
    2007       2007       2007       2007       2007       2007       2011       2009  
Imidacloprid
    2006       2006       2006       2006       2007       2005       2006       2007  
Vardenafil compound
    2018       2018       2018       2018       2018       2018       2018       2018  


(1)  Composition.

     See Item 8, Financial Information — Legal Proceedings for a description of patent-related litigation in which we are involved.

Trademarks

      Our best-known trademarks include Alka-Seltzer®, Aspirin®, Canesten®, Flint®, One-A-Day®, Rid® and Admire®, as well as the Bayer name itself and our distinctive “Bayer cross”. Trademark protection varies widely throughout the world. In some countries, trademark protection continues as long as the mark is used. Other countries require registration of trademarks. Registrations are generally for fixed but renewable terms. Although our portfolio of trademarks is important to our business, we do not believe that any single trademark is material to Bayer’s business as a whole.

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GOVERNMENTAL REGULATION

      Our business is subject to significant government regulation. Many of our products must be examined and approved by regulatory agencies for safety, environmental impact and effectiveness before we may market them. In addition, all our operations must comply with applicable environmental regulations. Relevant regulation is typically national, although within the European Union (the “EU”), a considerable degree of harmonization exists. The EU institutions have created a common regulatory framework that applies in all of the EU Member States (and that sometimes allows EU Member States to adopt more detailed and more stringent regulations), and has indirect harmonizing effects in certain other European countries.

Product Regulation

      The primary emphasis of product regulation is to assure the safety and effectiveness of our products. Regulation in the United States is of particular importance because of the United States’ large share of the worldwide market. In the United States, the Food and Drug Administration (FDA) regulates many of our products, primarily in our HealthCare business. In addition, our pharmaceutical facilities typically require regulatory approval and are subject to periodic re-inspection. Comparable regulatory frameworks are in place in other regions as well, such as the EU, Japan, China and in most other industrialized countries.

      The Toxic Substance Control Act (TSCA) administered under the U.S. Environmental Protection Agency (EPA) regulates product registrations (PMNs) for new industrial chemicals and polymers and can also regulate existing chemicals under test rules. In addition, the U.S. FDA food-contact regulations permit use of many of our chemicals and materials in food-contact applications. Furthermore, the EPA registers biocidal products for use in antimicrobial applications in addition to those for agricultural uses. For industrial chemicals and polymers in the United States, in order to insure proper use and handling, product safety is regulated by the Occupational Safety and Health Administration Hazard Communication. This regulation requires notification to our workers and customers through Material Safety Data Sheets and precautionary labels for potential hazards from exposure to chemicals.

      Similarly, in the EU as well as in further regions there are restrictive rules applying to areas including the production, marketing, processing, use and disposal of “dangerous substances and preparations”, food and feeding stuffs and the use of biocides.

Pharmaceutical Products

      Pharmaceutical products must be examined and approved by regulatory agencies for safety and efficacy before we may market them. Our pharmaceutical facilities require regulatory approval and are subject to periodic re-inspection. All our operations must comply with applicable quality and environmental regulations.

      The various regulatory authorities administer and execute requirements covering the testing, safety, efficacy, labeling, approval, manufacturing and marketing of prescription pharmaceuticals. Pharmaceutical products must receive regulatory approval before they can be marketed. The regulatory requirements follow stringent standards that vary by country. Before a drug can qualify for marketing approval, a registration dossier must be submitted to a regulatory authority for review and evaluation. The registration dossier principally contains detailed information about the safety, efficacy and quality of a new medication. It also provides details about the manufacturing process, the production facilities and information to be provided to patients. The registration process can last from a few months to a few years and depends on the nature of the medication under review, the quality of the submitted data and the efficiency of the relevant agency. If a drug meets the approval requirements, the regulatory authority will grant a product license for marketing. In some countries, negotiation on pricing and reimbursement follow the grant of the product license. The process of developing a pharmaceutical product from discovery through testing, registration and initial product launch could take approximately ten years. The manufacturer is required to monitor adverse reactions and report them to the appropriate authorities.

      In recent years, the EU, the United States and Japan have sought to shorten development and registration times for medicinal products by harmonizing the individual requirements of the three regions. This process is

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called the International Conference on Harmonization. For the foreseeable future, however, we will need to obtain approval in each market.

      Increasing requirements from the FDA have resulted in a higher investment of time and money necessary to develop new products and bring them to market. The Food and Drug Administration Modernization Act of 1997 was principally designed to streamline regulatory procedures and improve the regulation of drugs, medical devices and food with a view to expediting the pre-market review process for new products.

      In the European Union, there are two different approval procedures available: a centralized procedure and one based on the Mutual Recognition Procedure. The London-based European Agency for the Evaluation of Medicinal Products governs the centralized drug registration and approval process and consists of two committees, one for proprietary medicinal products (CPMP) and one for veterinary medicinal products (CVMP). The other method is the Mutual Recognition Procedure, in which one country makes the principal evaluation. The holder of the authorization may then submit to the other member states an application for recognition of the marketing authorization, which must normally be granted within 90 days.

      Historically, two issues have affected the approval process in Japan for drugs developed outside of that country. First, the Japanese approval agency does not recognize documents used in registration procedures in other countries. Second, the Japanese approval agency requires that tests to determine appropriate dosages for Japanese patients be conducted on Japanese patient volunteers. However, with the process of ICH (International Conference on Harmonization), the Japanese approval agency is increasingly accepting study results and documentation used in registration procedures in the United States and Europe.

Biological Products

      Our pharmaceuticals segment markets substances known as “biologicals”. Biologicals derive from biological sources (e.g., from human plasma or from cell lines genetically engineered to produce a specific protein). In the United States and other markets, biologicals are regulated more stringently than other drug products. For example, in order to minimize the risk of infectious disease transmission, human plasma-derived products require donor screening and plasma testing, as well as multiple manufacturing steps designed to remove viruses and other infectious agents. Biological products are chemically complex, often depending on a precise structure (e.g., the specific folding of a molecule) for their effectiveness. Regulations require us to subject these products to rigorous testing to ensure stability throughout their shelf-life. Because biological products typically cannot withstand conventional sterilization techniques, we must use special processes to ensure sterility. Under applicable regulatory requirements, we must submit detailed documentation to demonstrate appropriate controls over our manufacturing facilities, including associated equipment and supporting utilities like water supply and climate control.

Consumer Care Products

      Most Consumer Care products are subject to regulations similar to those in the Pharmaceuticals segment. In the United States, for example, the FDA and, in part, the Federal Trade Commission, oversee the marketing, manufacturing and labeling of Consumer Care products.

Diagnostics Products

      The products of the Diagnostics business group are in vitro diagnostic (IVD) products, subject to regulatory controls similar to those governing the development and marketing of pharmaceutical products. In the United States, the FDA regulates IVD products as medical devices, through its Center for Devices and Radiological Health. All manufacturers of medical devices must register their facilities with the FDA. Registered establishments are subject to periodic inspections by FDA investigators to ensure compliance with quality standards.

      Most IVD products require FDA clearance or approval before they may be marketed. For devices requiring clearance, we seek where possible to obtain it on the grounds that the new product is “substantially equivalent” to a product the FDA has already cleared. FDA clearance usually takes between two and eighteen months,

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depending on the degree of novelty involved. For truly new IVD products, we must submit extensive data to the FDA based on actual clinical trials. FDA approval almost invariably involves an inspection of our facilities and a review of our design and manufacturing processes. After obtaining FDA approval, we must report all adverse incidents in which a product was allegedly involved.

      In the EU, two Directives regulate these products. The Medical Device Directive governs diagnostic products that come in direct contact with the human body. The IVD Directive, as the name implies, applies to products used in vitro, that is those that do not come in direct contact with the human body. In Japan, a special section of the Pharmaceutical Affairs Law regulates diagnostic products. In Australia and Canada, the applicable laws and regulations are similar to the European model. Many countries in South America and Asia have regulatory requirements similar to those promulgated either by the FDA or the European Commission. All of these requirements involve product registration and approval and the reporting of adverse incidents and corrective actions.

Animal Health Products

      Veterinary products must be examined and approved by regulatory agencies for quality, safety and efficacy before marketing in all countries. In the United States, the FDA’s Center for Veterinary Medicine is responsible for ensuring that animal drugs are safe and effective for their intended uses and that food from treated animals is safe for human consumption. Animal health products are also regulated in the United States by the U.S. Department of Agriculture (USDA) and the Environmental Protection Agency (EPA).

      In the EU, animal health products are subject to regulations similar to those governing the Pharmaceutical sector, including the two registration procedures described above. The centralized registration process is also governed by the European Agency for the Evaluation of Medicinal Products in London, but the committee responsible for animal health products is the Committee for Veterinary Medicinal Products (CVMP).

Crop Protection Products

      In most countries, crop protection products must obtain government regulatory approval prior to marketing. This regulatory framework seeks to protect the consumer, the applicator and the environment. The strictest standards are applied in the United States, Japan and in the EU. Because humans may be exposed to these products (for example, through residues on food) the safety assessment considers human risk as well. If the product is used on a food crop, a legal limit for chemical residue is established.

      It generally takes seven to nine years from discovery of a new crop protection product until the dossier is submitted to the appropriate regulatory authority for product approval. Afterwards the authorities usually need another two to four years to evaluate the data submitted in order to decide whether a registration can be granted.

      The introduction of new regulations, data requirements or test guidelines is a normal part of enhancing safety assessments for crop protection products. However, unpredictable new requirements and inappropriate deadlines have led to numerous delays of registrations of crop protection products in the past, especially in the authorization processes in the EU and in the NAFTA countries. Therefore, Bayer CropScience must anticipate new regulatory trends and must closely follow the process of developing and requiring new data. Bayer CropScience also actively participates in these processes by commenting on draft guidelines and regulations proposed by the authorities.

Environmental Science Products

      In both the professional and the consumer business, as in crop protection, our products must obtain government regulatory approval prior to marketing. In most countries, Environmental Science products are regulated by authorities other than those which regulate the crop protection products. The regulatory requirements are often different from crop protection products, due to different routes of exposure. Generally, there is an increase of regulatory requirements, in particular in the United States, Europe and Japan. To some extent, the regulatory files developed for crop protection products with the same active ingredients can also be used for the regulatory purposes in the Environmental Science area.

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      In the EU, certain products sold in the professional pest control area, as well as pest control products available to consumers, fall under the Biocidal Products Directive (BPD), which requires that complete regulatory dossiers be developed before placing on the EU market biocidal products or active substances for use in such products. Certain green industry products and consumer lawn and garden products are governed by the Plant Protection Directive, which requires authorization before products can be placed on the market.

      In the United States, registration of Environmental Science products is granted by the EPA. There has been an increase of registration requirements due to the implementation of the Food Quality Protection Act (FQPA), which considers both dietary and non-dietary exposure aspects. Certain food-related regulatory requirements exist in other areas, notably in the EU.

      The review period for registration depends on the country and could vary from two to five years for a product containing a new active ingredient.

BioScience Products

      Plant biotechnology products, in particular those based on genetic modification, are subject to specific regulatory oversight covering environmental impact as well as use and trade of products and derivatives in food and feed. The number of countries that have regulatory frameworks concerning plant technology is increasing each year and, in countries that already have such regulations, the requirements are also increasing or changing. The most important countries, based on their importance to us as an agricultural center and/or trading partner, include the United States, Canada, the EU, Japan, Brazil, Argentina, Australia and China. In the United States, the main regulatory authorities are the USDA, the FDA and the EPA. The EU has implemented a set of new regulations including the creation of a new EU Food Safety Authority. Similar regulations in Japan are under review and being updated. Many Asian countries have developed regulatory frameworks over the last few years, most recently China, Taiwan, Korea and the Philippines. With the Cartagena Protocol on BioSafety, which came into force in September 2003, it is expected that more countries will establish regulatory frameworks over the next few years.

      The timeframe for approvals varies substantially around the world. The development of the regulatory file will take two to three years. In the USA, Canada and Japan, typically the review of a regulatory file will take another one to two years. However in the EU, no approvals have been granted over the last five years, during which time the regulations have been updated.

Proposed new EU Regulations

      We must comply with an increasing range of regulatory measures concerning testing, manufacturing and marketing of our products. In some countries, including the United States, regulatory controls have become increasingly demanding. We expect this trend to continue and expand to other countries.

      Within the European Union a new chemicals policy has been proposed and may become effective in 2005/2006. It will mandate a significant increase in the testing and assessment of all chemicals used, leading to increased costs and reduced operating margins for these products. Although we have adopted measures to address the stricter regulations, such as increasing the efficiency of our internal research and development process in order to reduce the impact of extended testing on time-to-market, stricter regulatory regimes could delay product development or restrict marketing and sales.

      In addition, the EU directive on emissions trading may affect Bayer’s business opportunities, especially in Europe. The directive requires EU member states to meet the carbon dioxide emissions targets set for each member state under EU legislation and based on the Kyoto Protocol. Emissions levels have to be reduced by 21 percent in Germany and 7.5 percent in Belgium, in each case based on 1990 carbon dioxide emission levels. Compliance may require material capital expenditures.

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Health, Safety and Environmental Regulation

      The production and distribution of Bayer products involves the use, storage, transportation, handling and disposal of toxic and hazardous materials. We are subject to increasingly stringent environmental regulations, which address:

  •  emissions into the air;
 
  •  discharges of waste water;
 
  •  other releases into the environment;
 
  •  generation, handling, storage, transportation, treatment and disposal of hazardous and non-hazardous material; and
 
  •  construction and operation of facilities.

      It is our policy to comply with all environmental, health and safety requirements and to provide workplaces for employees that are safe and environmentally sound. We track, check and evaluate all environmental legal initiatives and laws regarding their potential impact on our actual and past activities in order to develop appropriate measurements in a timely and effective manner. When necessary, we incur capital expenditures to ensure this. We expect that Bayer will continue to be subject to stringent environmental regulation. Although we cannot predict future expenditures, we believe that current spending trends will continue.

      We are subject to regulations that may require us to remove or mitigate the effects of the disposal or release of chemical substances. Under some of these regulations, a current or previous owner or operator of property may be held liable for the costs of remediation on, under, or in its property, without regard as to whether it knew of or caused the presence of the contaminants, and regardless of whether the practices that resulted in the contamination were legal at the time they occurred. As many of our industrial sites have long histories, we cannot predict the effect these regulations will have on us. We cannot assure you that soil or groundwater contamination will not occur or be discovered.

      In the United States, we are subject to potential liability under the U.S. Federal Comprehensive Environmental Response, Compensation, and Liability Act (commonly known as “Superfund”), the U.S. Resource Conservation and Recovery Act and related state laws for investigation and clean-up costs at a number of sites. At many of these sites, companies including Bayer have been notified that the EPA, the state governing body or private individuals consider such companies to be potentially responsible parties under Superfund or related laws. The proceedings relating to these sites are in various stages. The clean-up process at many sites is ongoing. We regularly review the liabilities for these sites and have accrued our best estimate of our ultimate liability for investigation or clean-up costs.

      It is difficult to estimate the future costs of environmental protection and remediation because of uncertainties about the status of regulations, their future developments, and information related to individual sites, products and facilities. Taking into consideration our experience and currently known facts, we believe that capital expenditures and remedial actions to comply with environmental regulations will not have a material adverse effect on our financial position, results of operations or cash flows. As of December 31, 2003, we had reserved 200 million for environmental matters.

      We believe that we are in substantial compliance with applicable environmental, health and safety laws and regulations. We devote considerable attention to the health and safety of our employees and the protection of public health and the environment. Although this compliance has not adversely effected our competitive position or business, we cannot predict the effect of possible future regulations. As a member of the American Chemical Council, Bayer is committed to the principles of Responsible Care®, the chemical industry’s health, safety and environmental performance improvement initiative.

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ORGANIZATIONAL STRUCTURE

      Since the reorganization of our Group, which was completed at the end of 2003, Bayer AG has been functioning as the Group’s strategic holding company. The Bayer Group is managed by the four-member Board of Management of Bayer AG. Among other things, the Board of Management sets long-term targets and strategies for the Bayer Group and its subgroups and prescribes guidelines and principles for the corporate policy derived from them. The Board of Management furthermore decides on the Group’s holdings, oversees the management, distributes the (financial) resources and is responsible for the financial management of the Group. The Corporate Center created within Bayer AG supports the Board of Management in performing its tasks, by providing certain governance, support and service functions.

      Bayer AG consists of the following corporate center functions: the Corporate Office; Communications; Investor Relations; Corporate Auditing; International Human Resources & Organization; Human Resources Germany; Corporate Development; Law & Patents, Insurance; Finance; Group Accounting and Controlling; Governmental & Product Affairs; and Regional Coordination.

      The activities of the seven business segments, which house the business operations, are performed by the operating companies Bayer HealthCare AG, Bayer CropScience AG, Bayer MaterialScience AG and Bayer Chemicals AG. Each operating company, together with the domestic and international subsidiaries assigned to it, forms a Bayer subgroup. Each of the four subgroups Bayer HealthCare, Bayer CropScience, Bayer Polymers and Bayer Chemicals is, within the framework of strategies, targets and guidelines determined by the Bayer AG Board of Management, an independent operating unit with worldwide business accountability and its own management. Each of the operating companies has entered into a control and profit and loss transfer agreement with Bayer AG.

      Three legally independent service companies, Bayer Technology Services GmbH, Bayer Business Services GmbH and Bayer Industry Services GmbH & Co. OHG, provide support functions to the four subgroups as well as Bayer AG.

      Apart from its interests in the operating and service companies, Bayer AG also has interests in other domestic and international companies.

      For more information on our current organizational structure, see — Business.

Subsidiaries

      The following table lists Bayer AG’s principal consolidated subsidiaries as of December 31, 2003 and its beneficial ownership interest in each.

         
Bayer’s
Company Name and Place of Business Interest (%)


Germany
       
Bayer Chemicals AG, Leverkusen
    100  
Bayer CropScience AG, Monheim
    100  
Bayer CropScience Deutschland GmbH, Langenfeld
    100  
Bayer CropScience GmbH, Frankfurt am Main
    100  
Bayer HealthCare AG, Leverkusen
    100  
Bayer MaterialScience AG, Leverkusen
    100  
Bayer Vital GmbH, Leverkusen
    100  
H.C. Starck GmbH, Goslar
    100  
Wolff Cellulosics GmbH & Co. KG, Bomlitz
    100  

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Bayer’s
Company Name and Place of Business Interest (%)


Other European Countries
       
Bayer Antwerpen N.V., Belgium
    100  
Bayer Biologicals S.r.l., Italy
    100  
Bayer CropScience France S.A., France
    100  
Bayer CropScience Holding S.A., France
    100  
Bayer CropScience Limited, U.K. 
    100  
Bayer CropScience S.r.l., Italy
    100  
Bayer CropScience S.A., France
    100  
Bayer Diagnostics Europe Ltd., Ireland
    100  
Bayer International S.A., Switzerland
    100  
Bayer Pharma S.A., France
    99.8  
Bayer Polimeros S. L., Spain
    100  
Bayer Public Limited Company, U.K. 
    100  
Bayer Rubber N.V., Netherlands
    100  
Bayer S.p.A., Italy
    100  
Quimica Farmaceutica Bayer, S.A., Spain
    100  
North America
       
Bayer CropScience LP, USA
    100  
Bayer HealthCare LLC, USA
    100  
Bayer Inc., Canada
    100  
Bayer Pharmaceuticals Corporation, USA
    100  
Bayer Polymers LLC, USA
    100  
Asia/Pacific
       
Bayer Australia Ltd., Australia
    100  
Bayer CropScience K.K., Japan
    100  
Bayer (India) Ltd., India
    71.2  
Bayer Medical Ltd., Japan
    100  
Bayer Polymers Co. Ltd., Hong Kong
    100  
Bayer South East Asia Pte Ltd., Singapore
    100  
Bayer Thai Company Ltd., Thailand
    100  
Bayer Yakuhin Ltd., Japan
    100  
Sumika Bayer Urethane Co., Ltd., Japan
    60  
Latin America/ Africa/Middle East
       
Bayer CropScience Ltda., Brazil
    100  
Bayer de México, S.A.de C.V., Mexico
    100  
Bayer (Proprietary) Ltd., South Africa
    100  
Bayer S.A., Argentina
    100  
Bayer S.A., Brazil
    100  

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      Also included in the consolidated financial statements are the following material associated companies:

         
Bayer’s
Company Name and Place of Business Interest (%)


DyStar Textilfarben GmbH, Frankfurt am Main, Germany
    35  
DyStar Textilfarben GmbH & Co. Deutschland KG, Frankfurt am Main, Germany
    35  
Lyondell Bayer Manufacturing Maasvlakte VOF, Netherlands
    50  
PO JV, LP Corporation, USA
    42.7  

PROPERTY, PLANTS AND EQUIPMENT

      We operate through a large number of offices, research facilities and production sites throughout the world. The principal executive offices of Bayer AG as well as a number of Bayer’s key production facilities are located in Leverkusen, Germany. We also have facilities in Europe, North and South America, Asia, Oceania and Africa, of which the most important are in Germany and the United States. We also have other properties, including office buildings, laboratory and research laboratories and distribution centers.

      Our policy is to acquire full ownership rights in our manufacturing facilities whenever possible. We own most of our manufacturing facilities and other properties. Where locally applicable law does not permit this or acquisition of full property rights is otherwise unfeasible, we acquire possessory interests conferring substantially the same rights of use as ownership (for example, German-law hereditary building rights or Erbbaurechte and granted land-use rights in Asian countries).

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Item 5.  Operating and Financial Review and Prospects

      Prospective investors should read the following operating and financial review and prospects together with the consolidated financial statements and the notes to those financial statements included elsewhere in this annual report. We have prepared these financial statements in accordance with IFRS, which differs in some respects from U.S. GAAP. For a reconciliation of net income and stockholder’s equity to U.S. GAAP, see Note 44 to our consolidated financial statements.

      The forward-looking statements in this Item 5 are not guarantees of future performance. They involve both risk and uncertainty. Several important factors could cause our actual results to differ materially from those anticipated by these statements. Many of those factors are macroeconomic in nature and are, therefore, beyond the control of our management. See — Forward-Looking Information.

      We have based the presentation of our results in this section on certain significant accounting assumptions. For a more detailed description of these assumptions, see — Critical Accounting Policies, below.

OVERVIEW

      We are a global company offering a wide range of products, including high-value pharmaceuticals, diagnostics and other health care products; agricultural products; polymers; and chemicals.

      Bayer comprises the parent company, Bayer AG of Leverkusen, Germany, and over 330 consolidated subsidiaries. We are organized into seven business segments — Pharmaceutical, Biological Products; Consumer Care, Diagnostics; Animal Health; CropScience; Plastics, Rubber; Polyurethanes, Coatings, Fibers; and Chemicals. In 2003, we completed the implementation of plans to transform Bayer AG into a strategic holding company that holds our operating businesses through four newly-formed direct operating subsidiaries. See Item 4, Information on the Company — Business.

      Although Bayer AG was first incorporated in 1951, we trace our historical roots to Friedr. Bayer & Co., founded in 1863. Since our formation in 1951, we have pursued a program of growing both organically and through selective acquisitions. In 2001, we spent a total of 514 million on acquisitions. The largest acquisition in that year was the purchase by Bayer Corporation, our U.S. subsidiary, of the development, manufacturing and distribution rights for products that detect antibodies to the hepatitis C (HCV) and human immunodeficiency (HIV) viruses. Nearly equal in magnitude was our acquisition of the Mikado® corn herbicide, which included patents, other product rights and know-how.

      In October 2001, we entered into an agreement to acquire Aventis CropScience from Aventis and Schering. We closed this transaction on June 3, 2002. In 2002, we also acquired Visible Genetics Inc. in Canada and Tectrade A/S in Denmark.

      We selectively divest businesses and assets that no longer fit in our strategic plan. We took the following steps in the years indicated to streamline our portfolio and concentrate our business on our core businesses:

      In 2001:

  •  In May 2001, we sold our interest in the EC Erdölchemie joint venture, which we had previously classified under “Discontinuing Operations”.
 
  •  During the first half of 2001, we sold our former acrylic fiber product lines and classified the remainder of the Fibers business group as “Discontinuing Operations”.

      In 2002:

  •  In May 2002, we decided to retain our Fibers business as part of Polymers. We included the Fibers business in our ongoing business for all periods beginning with the second quarter of 2002.
 
  •  We sold Haarmann & Reimer effective September 30, 2002.
 
  •  We sold the remaining 30 percent of our Agfa business segment, of which we had already divested 70 percent in 1999.

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  •  Effective March 1, 2002, we sold our 94.9 percent interest in Bayer Wohnungen.
 
  •  We sold a large part of the global household insecticides business of our Consumer Care business group.
 
  •  We divested our French and Spanish generic pharmaceutical operations.
 
  •  We contracted to sell our 50 percent interest in PolymerLatex. (This transaction closed on May 9, 2003.)

      In 2003:

  •  We sold the products (and the related rights) comprising the insecticidal active ingredients fipronil (for regions worldwide outside China) and ethiprole, as well as a number of fungicidal active ingredients (primarily for regions in Europe and, based on a non-exclusive license, for seed treatment outside Europe) to BASF. The sale included production facilities in Elbeuf, France.
 
  •  We sold the remainder of the global household insecticides business to SC Johnson & Son Inc.
 
  •  We sold our interest in Millennium Pharmaceuticals Inc. to Credit Suisse First Boston.

      In the future, we plan to focus more closely on our strengths in the fields of health care, nutrition and innovative materials. The Board of Management and the Supervisory Board of Bayer AG have therefore decided to adjust the Group’s structure and business alignment accordingly. We plan to place the Chemicals business (except H.C. Starck and Wolff Walsrode) and parts of the Polymers subgroup that we no longer regard as core businesses into an independent company, to be named Lanxess, which we plan to list on the Frankfurt Stock Exchange by early 2005. We intend to combine the other activities of the Polymers and Chemicals subgroups in the new Bayer MaterialScience subgroup. Our goal is to strengthen the competitiveness of our fast-growing, innovation-driven businesses in the HealthCare, CropScience and MaterialScience subgroups by concentrating on the special needs of these businesses.

      Lanxess plans to focus on four core business activities: Chemical Intermediates, Performance Chemicals, Performance Plastics and Performance Rubber. All structures and processes will be adapted to the specific requirements of these businesses.

      Because we have determined that we will be disposing of the Lanxess businesses, we began in 2003 to account for it as a Discontinuing Operation pursuant to IAS 35. In accordance with IAS 35, we show net sales from Discontinuing Operations and operating result from Discontinuing Operations on the face of our statement of income, and Note 6 to our Consolidated Financial Statements breaks down our Discontinuing Operations, including the Lanxess businesses, in our statement of income individually. We also show Discontinuing Operations separately in the discussion of our segments appearing below. We have restated the comparable information for past periods to segregate the Lanxess businesses from our continuing operations.

      The following table sets forth net sales, operating result and net income (loss) from Discontinuing Operations attributable to each of the individual Discontinuing Operations shown in our financial statements for the three years under review and the segments to which they relate.

                                                                                                 
Lanxess Plasma Haarmann & Reimer Erdölchemie




2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003












(euros in millions) (euros in millions) (euros in millions) (euros in millions)
Net sales
    6,773       6,241       5,776       695       679       613       872       666             233              
Operating result
    (57 )     (109 )     (1,299 )     (139 )     (111 )     (353 )     73       980             333              
Net income (loss)
    (77 )     (93 )     (975 )     (139 )     (126 )     (230 )     34       954             326              
                 
Affected segments
  Plastics,   Pharmaceuticals,   Chemicals   Chemicals
    Rubber/Polyurethanes,   Biological        
    Coatings, Fibers/Chemicals   Products        

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CRITICAL ACCOUNTING POLICIES

      Critical accounting policies are those that are both most important to the portrayal of the Group’s financial position and results, and that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. We are not aware of any reasonably possible events or circumstances that would result in different amounts being reported that would have a material effect on our results of operations or financial position.

      Our significant accounting policies are outlined in the notes to the financial statements. While not all of these significant accounting policies require the Group to make difficult, subjective or complex judgments, we believe that the following accounting policies could be considered critical.

Intangible Assets and Property, Plant and Equipment

      Intangible assets, including goodwill, and property, plant and equipment, are amortized over their estimated useful lives. Useful lives are based on our estimates of the period that the assets will generate revenue.

      Intangible assets and property, plant and equipment are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment testing under IAS 36 requires management to compare the carrying value of the assets to the expected discounted future cash flows from the related assets. Determining the expected discounted future cash flows involves significant estimations, including future sales prices and sales volumes, costs, and risk-adjusted discount rates. In connection with the impairment review we conducted at year-end 2003, the necessity of which was indicated by sustained changes in the macroeconomic environment and the reorganization of our group, we estimated the future cash flows with our reoriented long-term planning. This in turn took into account revised views on the competitive environment in which our businesses operate, changes in our expectations of long-term price developments and our expectations about economic growth prospects in our target markets. The discounting process also requires assumptions and estimations, which have also changed as macroeconomic conditions have changed, concerning the cost of capital.

      Although we believe that our estimates of useful lives, our assumptions concerning the macroeconomic environment and developments in our industries and our estimations of discounted future cash flows are appropriate, changes in assumptions or circumstances could require changes to our analysis. This could lead to additional impairment charges in the future, or writebacks of value should the trends we have identified reverse (or our assumptions and estimates prove incorrect). This would impact our future reported results.

      In 2003, we continued to amortize goodwill according to IFRS, even though for U.S. GAAP purposes we ceased to amortize goodwill in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142 Goodwill and Other Intangible Assets (“SFAS 142”). SFAS 142 requires us to perform an annual review of our U.S. GAAP goodwill for impairment. We recognize impairment losses if necessary based on this annual review. As a result of the impairment test we conducted at the end of 2003, we wrote off, under U.S. GAAP (but not IFRS), 182 million of pre-1995 goodwill relating to a 1990 acquisition which we had capitalized under U.S. GAAP. In general, the process of evaluating goodwill involves making adjustments and estimates relating to the projection and discounting of future cash flows. In addition to their sensitivities to our assumptions regarding the future performance of the assets concerned, these evaluations are sensitive to changes in the discount rate we apply. An increase in discount rates increases the likelihood of impairment charges under U.S. GAAP.

Pensions and other obligations

      We sponsor pension and other retirement plans in various forms covering employees who meet the plans’ eligibility requirements. These plans cover the majority of our employees. We use several statistical and other models, which attempt to anticipate future events in calculating the expenses and liabilities related to the plans. These factors include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases. In addition, our actuarial consultants also use statistical information such as withdrawal and mortality rates to estimates these factors. The actuarial assumptions used may differ materially from actual

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results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. Such differences may result in a significant impact on the amount of pension income or expense recorded in future years.

Environmental Provisions

      Our compliance with environmental laws and regulations may require us to remove or mitigate the effects of the disposal or release of chemical substances in jurisdictions where we do business or maintain properties. The cost of such compliance is provided for when it is probable and can be reasonably estimated. Provision amounts are estimated based on currently available facts, remediation strategies, regulations, our relative share of the total remediation costs, and discount rate. Changes in these assumptions could impact our future reported results.

Litigation Provisions

      As more fully described in Note 29 to the financial statements, we are involved in a number of legal proceedings. As a global company active in a wide range of life sciences and chemical activities, we have and may, in the normal course of our business become involved in proceedings relating to such matters as:

  •  product liability;
 
  •  patent validity and infringement disputes;
 
  •  tax assessments;
 
  •  competition and antitrust; and
 
  •  past waste disposal practices and release of chemicals into the environment.

      We cannot predict with certainty the outcome of any proceedings in which we are or may become involved. An adverse decision in a lawsuit seeking damages from us could result in a monetary award to the plaintiff and, to the extent not covered by our insurance policies, could significantly harm our business or the results of our operations. If we lose a case in which we seek to enforce our patent rights, we could sustain a loss of future revenue as other manufacturers begin to market products we developed.

      Litigation cases and claims raise difficult and complex legal issues and are subject to many uncertainties and complexities, including, but not limited to, the facts and circumstances of each particular case and claim, the jurisdiction in which each suit is brought, and differences in applicable law. Upon resolution of any pending legal matters, we may incur charges in excess of presently established provisions and related insurance coverage. It is possible that our results of operations and cash flows could be materially affected by an ultimate unfavorable outcome of certain pending litigation.

Income Taxes

      We are required to make estimates in determining our provision for income taxes and our deferred tax assets and liabilities.

      Additional estimates are made to determine whether valuation allowances are required against deferred tax assets. Such valuation allowances are recognized when it is not sufficiently certain that the assets will be realized. Uncertainties exist in respect of interpretation of complex tax regulations and the amount and timing of future taxable income. Differences between actual results and our assumptions, or changes in our assumptions in future periods, could result in adjustments to tax expense in future periods.

Use of Estimates

      The preparation of all financial statements includes the use of estimates and assumptions that affect a number of amounts included in our financial statements, including employee benefit costs and related disclosures, inventory valuations, sales allowances, income taxes and contingencies. We base our estimates on historical experience and other assumptions that we believe are reasonable. If actual amounts are ultimately different from estimates, revisions are included in our results of operations for the period in which the actual amounts become

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known. Historically, the aggregate differences, if any, between our estimates and actual amounts in any year have not had a significant impact on our consolidated financial statements.

OPERATING RESULTS 2001, 2002 and 2003

Introduction

      The most significant drivers of our sales, results of operations and cash flows in 2003 were:

  •  our decisions to separate the businesses being combined in “Lanxess” from our Group’s remaining businesses and the determination, arising in part from our strategic reorientation, the Lanxess decision and the changing business conditions in our industries and generally, that it was appropriate to recognize impairment charges, unscheduled amortization expenses and other write-downs on a number of our businesses and investments;
 
  •  the net gains and losses on dispositions of businesses and other assets described and set forth in — Acquisitions and Dispositions below;
 
  •  our incurrence of other charges that we view as special, consisting primarily of provisions established and other expenses incurred in connection with legal matters and some headcount reduction initiatives; and
 
  •  the effects on our results of operations of the substantial strengthening of the euro against other currencies, especially the dollar.

      In the consolidated operating results information we present below, we report, in addition to our operating result, a measure of operating result that excludes these items (other than exchange rate effects), all of which we refer to as “special items”. We present this measure because we believe that doing so assists readers in understanding the performance of our business without the large impacts on the net result figures resulting from our decisions to reorient our business and because of certain expenses (such as some of our impairments and provisions in respect of legal contingencies). The following table shows our operating profit, the special items and our operating profit excluding the special items.

                           
2001 2002 2003



(euros in millions)
Operating result
    1,676       1,610       (1,203 )
Impairment charges and write-downs
    (116 )     (289 )     (1,927 )
Restructuring charges and unscheduled amortization
    (216 )     (470 )     (508 )
Portfolio changes
    229       1,905       469  
Other charges
    (210 )     (364 )     (619 )
     
     
     
 
 
Total special items
    (313 )     782       (2,585 )
Operating result excluding special items
    1,989       828       1,382  
     
     
     
 

      The following paragraphs describe these major drivers and the related special items we take into account in arriving at operating result excluding special items.

Impairments, unscheduled amortization and restructuring charges

      In November 2003, we announced that we intend to strengthen our focus on our core businesses and therefore combine Bayer Chemicals (except for Wolff Walsrode and H.C. Starck) with certain parts of the Bayer Polymers business in a new company to be named “Lanxess”. The aim for this company is to be listed on the Frankfurt Stock Exchange by early 2005. After this separation, Wolff Walsrode and H.C. Starck will be grouped together with the remaining parts of the Bayer Polymers business in a wholly-owned subsidiary of Bayer Group called Bayer MaterialScience, and we intend to focus on our core businesses retained in this subsidiary as well as in Bayer HealthCare and Bayer CropScience.

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      In light of the strategic realignment of our Group, and the changing business conditions for portions of it (which are described below under — Segment Data), we determined that it was necessary to carry out impairment tests on those assets and investments in accordance with IAS 36 and to recognize unscheduled amortization on some of our businesses. Accordingly, we recognized charges related to impairments and other asset write-downs of 1,927 million in 2003 relating to portions of our polymers and chemicals activities and our plasma business.

      We also incurred charges of 508 million in respect of restructuring measures and unscheduled amortizations, including closures of facilities and the related severance payments. Of this 508 million, we charged 408 million in respect of the closure of facilities and the cessation of business activities and the remaining 100 million relating primarily to write-downs of enterprise management systems. This was necessary when we changed and reoriented these systems when we reorganized our Group into a holding company structure. Of the 408 million in restructuring charges and unscheduled amortization in 2003, 182 million related to severance payments, 145 million related to unscheduled amortization of fixed assets and intangibles and 81 million related to other expenses. We expect that the majority of the severance payments and other expenses charged in 2003 will be paid in 2004.

      In 2002, we recognized impairment charges totaling 289 million and restructuring charges and unscheduled amortization totaling 470 million. The impairment charges related to our polyols and fibers businesses. Of the 470 million, 372 million related to the closure of facilities and the cessation of business activities, including severance payments, and 98 million related to write-downs on our enterprise management systems as described above.

      In 2001, we incurred impairment charges totaling 116 million and charges in respect of restructuring measures and unscheduled amortization totaling 216 million. The impairment charges were on inventory and resulted from the voluntary withdrawal from the market of Lipobay/Baycol.

      The following table sets forth the components of these charges during each of the last three years.

                           
2001 2002 2003



(euros in millions)
Impairment charges and write-downs
    (116 )     (289 )     (1,927 )
Restructuring charges and unscheduled amortization
    (216 )     (470 )     (508 )
     
     
     
 
 
Total
    (332 )     (759 )     (2,435 )
     
     
     
 

      The following table allocates the restructuring charges and unscheduled amortization of fixed assets and intangibles we recognized in 2003 according to the businesses and activities to which they relate:

                                   
Severance Unscheduled Other
Activity/ Business in 2003 payments amortization charges Total





(euros in millions)
Closure of research facilities in Kyoto, Japan and Berkeley, California
    10       101       28       139  
Continued integration of businesses acquired in 2002 from Aventis CropScience
    100       2       0       102  
Personnel adjustments in Polymers area
    52       0       0       52  
Plant closure in West Haven, Connecticut
    8       21       3       32  
Closure of the polyether production site at Institute, West Virginia
    3       12       4       19  
Further ongoing restructuring programs to improve profitability
    9       9       46       64  
Totals
    182       145       81       408  
     
     
     
     
 
Write-downs on enterprise management systems
    0       100       0       100  
     
     
     
     
 
 
Grand totals
    182       245       81       508  
     
     
     
     
 

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      The following table allocates the restructuring charges and unscheduled amortization of fixed assets and intangibles we recognized in 2002 according to the businesses and activities to which they relate. Due to the reorganization of our businesses in 2003 we are unable to separate severance payments and other charges for 2002 and 2001 without unreasonable effort.

                           
Severance
payments
Unscheduled and other
Activity/ Business in 2002 amortization charges Total




(euros in millions)
Integration of businesses acquired from Aventis CropScience
    0       89       89  
Restructuring of the rubber production site in Sarnia, Ontario, Canada
    41       26       67  
Shutdown of polymers production in Rieme, Belgium
    31       7       38  
Shutdown of production of iron oxide in New Martinsville, West Virginia
    10       20       30  
Closure of powder coatings production in Hicksville, New York
    18       8       26  
Restructuring measures in connection with sale of organic pigments facility in Bushy Park, South Carolina
    0       23       23  
Restructuring of the Consumer Care production in Elkhart, Indiana
    8       12       20  
Closure of production plant in Barcelona, Spain
    2       17       19  
Expenses in connection with cooperation arrangement with Aventis Behring
    0       17       17  
Reduction of headcount in Polymers area
    0       10       10  
Restructuring in New Martinsville, West Virginia
    7       3       10  
Further ongoing restructuring programs to improve profitability
    14       9       23  
 
Totals
    131       241       372  
     
     
     
 
Write-downs on enterprise management systems
    98       0       98  
     
     
     
 
 
Grand totals
    229       241       470  
     
     
     
 

      The following table allocates the restructuring charges and unscheduled amortization of fixed assets and intangibles we recognized in 2001 according to the businesses and activities to which they relate.

                           
Severance
payments
Unscheduled and other
Activity/ Business in 2001 amortization charges Total




(euros in millions)
Restructuring of styrenics production in Brazil, U.S.A. and Germany
    35       30       65  
Restructuring of several facilities regarding the Lyondell integration, U.S.A., France and Germany
    7       32       39  
Restructuring plans in Baytown, Texas and New Martinsville, West Virginia
    0       35       35  
Restructuring measures in connection with sale of organic pigments facility in Bushy Park, South Carolina
    0       20       20  
Restructuring measures at Bayer AG
    0       17       17  
Restructuring of the Consumer Care production in Elkhart, Indiana
    9       6       15  
Restructuring measures relating to iron oxide production in New Martinsville, West Virginia
    10       3       13  
Further ongoing restructuring programs to improve profitability
    12       0       12  
     
     
     
 
 
Totals
    73       143       216  
     
     
     
 

Acquisitions and Dispositions

      Acquisition and disposition activities also affect our results of operations, and are responsible for substantial swings in our results from year to year. As a diversified global company, we often enter into numerous merger

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and acquisition transactions that, taken as a whole, can have a significant effect. In connection with our strategic reorientation and focus on our core businesses, we have been disposing of numerous businesses, investments and participations. Our most recent transactions are summarized above in — Overview. Our net gains from our dispositions were 469 million in 2003, 1,905 million in 2002 and 229 million in 2001.

      Acquisitions and divestitures during 2003 and 2002 had a negative effect on net sales in 2003 of 95 million, and acquisitions and divestitures during 2002 and 2001 had a positive effect on net sales of 1.9 billion. This activity affected the comparison between the three years’ sales figures as shown in the following two tables:

           
Change in 2003
from 2002

(euros in millions)
Acquisitions
       
Aventis Crop Science Holding S.A.
       
 
(Acquired in 2002)
    1,450  
Visible Genetics Inc.
       
 
(Acquired in 2002)
    9  
Tectrade A/S
       
 
(Acquired in 2002)
    6  
Other
    1  
     
 
      1,466  
     
 
Divestitures
       
Haarmann & Reimer Group (divested in 2002)
    (666 )
Dispositions in compliance with antitrust conditions by Bayer CropScience
    (435 )
Household insecticides business
    (272 )
PolymerLatex group
    (117 )
Organic pigments
    (54 )
Walothen GmbH
    (10 )
Other
    (7 )
     
 
      1,561  
     
 
Net effects on sales
    (95 )
     
 
           
Change in 2002
from 2001

(euros in millions)
Acquisitions
       
 
Aventis CropScience Holding S.A.
    1,977  
 
Tectrade A/S
    12  
 
Other
    3  
     
 
      1,992  
     
 
Divestitures
       
 
ChemDesign Corporation (divested in 2001)
    (56 )
 
Covexx Films (divested in 2001)
    (42 )
 
Sale of the generic business
    (16 )
 
Other
    (8 )
     
 
      (122 )
     
 
Net effect on sales
    1,870  
     
 

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Changes in Exchange Rates

      Our net sales and our operating result were significantly affected during 2003 by changes in exchange rates. Because a substantial portion of our assets, liabilities, sales and earnings are denominated in currencies other than the euro zone currencies, we have exposure to fluctuations in the values of these currencies relative to the euro. These currency fluctuations, especially the fluctuation of the value of the U.S. dollar relative to the euro, but also fluctuations in the currencies of the countries in which we have significant operations and/or sales, can have a material impact on our results of operations. We face both transaction risk, where our businesses generate sales in one currency but incur costs relating to that revenue in a different currency, and translation risk, which arises when we translate the income statements of our subsidiaries into euro for inclusion in our financial statements. With respect to transaction risk, we generally enter into hedging transactions for a significant portion of our forecasted operational foreign currency exposure and therefore do not believe that even significant increases or decreases in the exchange rates of the euro relative to other world currencies materially affect our cash flows or results of operations. However, transaction risks could over time adversely affect our cash flows and results of operations to the extent we are unable to reflect changed exchange rates in the pricing of our products in local currency. We do not quantify the effects on our financial statements of transaction risks. Translation risks, which we do quantify and against which we do not hedge, do not affect our local currency cash flows or results of operations, but do affect our consolidated financial statements. In general, declines in the value of the U.S. dollar relative to the euro, such as those that occurred in 2003, will decrease the euro value of our sales and earnings made in the dollar zone and decrease the competitiveness of our products produced in Europe in the United States and in other countries with falling currencies.

      In 2003, the euro appreciated substantially against the dollar and other currencies. This adversely affected our net sales in cases in which products are sold at prices denominated in one of the currencies against which the euro strengthened. To the extent that our non-euro denominated expenses do not match our non-euro denominated sales, our operating result is also adversely affected by these translation effects. The following table sets forth the exchange rates for the euro of currencies important for our results of operations during 2003:

                                 
Units of foreign currency per euro

Average for the
year ended
At December 31, December 31,


2002 2003 2002 2003




Argentinean pesos
    3.53       3.70       2.97       3.33  
Brazilian reals
    3.71       3.66       2.78       3.47  
Canadian dollars
    1.66       1.62       1.48       1.58  
Great Britain pounds
    0.65       0.70       0.63       0.69  
Japanese yen
    124.39       135.05       118.06       130.96  
Mexican pesos
    10.99       14.18       9.15       12.22  
Swiss francs
    1.45       1.56       1.47       1.52  
U.S. dollars
    1.05       1.26       0.95       1.13  

      The translation effects of these currency changes had a negative impact on our sales in 2003, decreasing them by 2.5 billion compared to 1.5 billion in 2002 and a positive effect of 0.1 billion in 2001. For further information concerning our exchange rate exposure, see Item 11, Quantitative and Qualitative Disclosures about Market Risk.

Raw Materials, Pricing

      The single most important factor that affects our costs on a continuing basis is the price of raw materials for our products. We seek to reduce our sensitivity to fluctuations in many raw material prices by producing at least a part of our requirements internally, within the Bayer Group. Petrochemical feedstocks are important raw materials in many of our products, especially in our Polymers and Chemicals segments. We do not produce significant volumes of petrochemicals. Effective May 1, 2001, we sold our 50 percent interest in the EC Erdölchemie joint venture, which had been our one significant venture into this area, to Deutsche BP, our former

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joint venture partner. Because of this lack of internal petrochemicals sourcing, as well as the volatility of oil prices in recent years, our single greatest raw-materials sensitivity is to fluctuations in the price of petrochemicals. In the first half of 2003, these prices were about 10 percent above the average prices in 2002; in the second half, they returned to a level comparable to those at the beginning of 2002, which were slightly above the average prices for that year.

Bayer Group

      The following table shows sales and income for Bayer as a whole.

                                           
Change from Change from
Previous Year Previous Year
2001 (%) 2002 (%) 2003





(euros in millions)
Net sales from continuing operations
    21,702       1.5       22,038       0.6       22,178  
Net sales from discontinuing operations
    8,573       (11.5 )     7,586       (15.8 )     6,389  
 
Net sales
    30,275       (2.2 )     29,624       (3.6 )     28,567  
Gross profit
    13,047       (8.5 )     11,944       (1.8 )     11,733  
 
as percentage of sales (%)
    43.1             40.3             41.1  
Selling expenses
    (7,205 )     3.8       (6,933 )     6.5       (6,484 )
Research and development expenses
    (2,559 )     (0.7 )     (2,577 )     6.3       (2,414 )
General and administrative expenses
    (1,037 )     (40.8 )     (1,460 )     (15.8 )     (1,690 )
Other operating income
    885       205.8       2,706       (57.2 )     1,158  
Other operating expenses
    (1,139 )     (81.7 )     (2,070 )     (69.4 )     (3,506 )
Operating result from continuing operations
    1,466       (42.0 )     850       (47.2 )     449  
Operating result from discontinuing operations
    210       261.9       760             (1,652 )
 
Operating result
    1,676       (3.9 )     1,610             (1,203 )
 
as percentage of sales (%)
    5.5             5.4             (4.2 )
Non-operating result
    (561 )     (16.6 )     (654 )     (20.9 )     (791 )
Income before income taxes
    1,115       (14.3 )     956             (1,994 )
Net income
    965       9.8       1,060             (1,361 )

      The following table shows a geographical breakdown of our sales based on where we sold our products.

                                         
Change from Change from
Previous Year Previous Year
2001 (%) 2002 (%) 2003





(euros in millions)
Europe
    12,383       (0.9 )     12,266       (0.8 )     12,162  
North America
    9,720       (7.4 )     9,005       (4.1 )     8,636  
Asia/Pacific
    4,826       1.6       4,901       (7.6 )     4,529  
Latin America/ Africa/Middle East
    3,346       3.2       3,452       (6.1 )     3,240  

2003 compared with 2002

Net Sales

      Net sales represents the gross inflow of economic benefits from the sales of goods and services that we receive or that are receivable by us. Net sales excludes rebates and discounts that we give our customers, as well as the amounts that we collect on behalf of third parties, such as sales taxes, goods and services taxes and value added taxes. Net sales of the Bayer Group declined by 3.6 percent, or 1,057 million, from 2002 to 28,567 million in 2003. Net sales from continuing operations remained essentially flat, while the difficult economic and industry conditions contributed to a 15.8 percent decline in net sales of discontinuing operations. Total net sales increased, however, in local currency terms. Had the average exchange rates we used to translate

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our non-euro denominated revenues into euros stayed constant in 2003 as compared with 2002 rather than declining as they in fact did, our net sales would have increased, primarily due to volume increase, by 1,433 million, or 4.8 percent; this was more than offset by the 2,545 million less in net sales caused by the currency changes. Prices were on average fairly flat in 2003; in comparison with 2002, price increases led only to 150 million of increased net sales, an increase of 0.5 percent. Changes in our portfolio of businesses accounted for a 95 million reduction in our net sales.

Gross Profit

      Gross profit represents net sales after cost of goods sold and services provided. Cost of goods sold and services provided include the production costs of goods sold and the cost of goods purchased for resale.

      The cost of goods sold and services provided decreased by 4.8 percent in 2003 to 16,834 million, due mainly to currency effects, as our non-euro denominated costs were also reduced by the strong euro. Other cost-reducing factors, apart from portfolio effects, were improved manufacturing efficiencies in HealthCare and plant closures in Polymers.

Operating Result

      Operating result represents gross profit after selling expenses, research and development expenses, general administration expenses and other operating income and expenses. We distinguish between our result from continuing and discontinuing operations.

      Selling expenses diminished by 6.5 percent to 6,484 million due to currency and portfolio factors.

      The 15.8 percent increase in general administration expenses, to 1,690 million, was largely related to the Aventis CropScience acquisition.

      Other operating income amounted to 1,158 million. This figure includes the gain from the sale of the remaining part of the household insecticides business (256 million), the PolymerLatex group (28 million) and real estate in Germany, Belgium and Spain (106 million). The previous year’s figure contained the gain from the sale of the Haarmann & Reimer group (933 million), company housing units (452 million), a large part of the household insecticides business (272 million) and generics activities (75 million).

      Other operating expenses increased to 3,506 million, including impairment charges and other write-downs of 1,927 million. The impairments resulted mainly from a global review of asset values according to IAS 36 in connection with the planned strategic realignment of the Bayer Group and the sustained adverse conditions affecting our industrial business. Other operating expenses also included the 300 million we charged to income as a result of the settlement we reached with a majority of our insurers in connection with Lipobay/Baycol. (See Item 8 — Legal Proceedings.)

      Operating result declined to a loss of 1,203 million, with special items — mainly impairment charges, restructuring expenses and items related to portfolio changes — having a 2,585 million net negative effect. For a breakdown of these special items, see — Overview — Introduction — Impairment, unscheduled amortization and restructuring charges. Excluding these items, however, operating profit climbed by 66.9 percent to 1,382 million. Operating profit from continuing operations was 47.2 percent below 2002’s level.

Non-Operating Result

      The non-operating result declined to an expense of 791 million, due particularly to a drop in the net result of investments in affiliated companies to an expense of 93 million. This decrease was attributable to write-downs of our investments in DyStar and Curagen and a net loss position for companies included at equity. The principal item of non-operating income was the 190 million tax-free gain from the sale of our equity interest in Millennium Pharmaceuticals.

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Income (Loss) Before Income Taxes

      We incurred a loss before income taxes of 1,994 million in 2003, as compared with income before income taxes of 956 million in 2002.

Income Taxes

      We recognized an income tax credit of 645 million in 2003, as compared with a credit of 107 million in 2002. The tax rate for our Group was 32 percent. The tax result was composed of income taxes paid or payable of 607 million, offset by deferred tax changes that led to a net credit of 1,252 million.

Net Loss

      The Group recorded a 1,361 million net loss.

2002 compared with 2001

Net Sales

      Our net sales were down by 651 million in 2002, a decrease of 2.2 percent. Currency movements and price declines reduced sales by 4.8 percent and 2.4 percent, respectively, while portfolio changes — particularly the acquisition of Aventis CropScience — added 5.4 percent.

      Sales in our Pharmaceuticals, Biological Products segment decreased 16.8 percent in 2002 to 4,767 million. Sales in our Consumer Care, Diagnostics segment decreased 8.5 percent to 3,755 million. Sales in our Animal Health segment declined 0.9 percent to 850 million, while sales in our CropScience segment increased 65.5 percent, to 4,697 million. Sales in our Plastics, Rubber segment decreased 3.4 percent to 5,210 million. Sales in the Polyurethanes, Coatings, Fibers segment decreased 1.2 percent to 5,213 million. Sales in our Chemicals segment decreased 16.9 percent to 4,322 million. See — Segment Data, below, for a more detailed discussion of the results of each of our business segments.

Gross Profit

      Our gross profit decreased 8.5 percent in 2002.

Operating Result

      Our operating result fell 3.9 percent to 1,610 million in 2002 from 1,676 million in 2001. We incurred special charges of 1,123 million relating mainly to asset write-downs, restructuring measures and site consolidations. For a breakdown of these special items, see — Overview — Introduction — Impairment, unscheduled amortization and restructuring charges. Also included here are provisions established in connection with an agreement reached with the U.S. federal authorities relating to an investigation into pharmaceutical product prices. These charges were partially offset by special income of 1,905 million, generated mainly by the sale of the Haarmann & Reimer group, Bayer Wohnungen GmbH and the household insecticides business. The previous year’s figure contained 333 million pertaining to EC Erdölchemie.

      The operating result before special items decreased by 58.4 percent to 828 million. We attribute this development primarily to additional depreciation and amortization of goodwill determined and inventories remeasured in purchase accounting following the Aventis CropScience acquisition.

      In 2002, our selling expenses decreased 3.8 percent, while research and development expenses increased 0.7 percent. General administration expenses increased 40.8 percent mainly due to expenses incurred in connection with the reorganization of the Bayer Group.

Non-Operating Result

      Our non-operating loss for 2002 increased 16.6 percent over the previous year, mainly because of the additional interest expense associated with the financing of the Aventis CropScience acquisition and also as a

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consequence of securities write-downs. Income from investments in affiliated companies was sharply higher due to the sale of our interest in Agfa-Gevaert N.V.

Income Before Income Taxes

      Our income before taxes decreased by 14.3 percent from 2001 to 956 million.

Income Taxes

      The lower operating result, tax-free income and deferred tax assets resulted in net tax income of 107 million. The effective tax rate (i.e., adjusted for tax free income and expenses) calculated on taxable income was 37.5 percent.

Net Income

      Group net income rose by 9.8 percent to 1,060 million.

Segment Data

      We use operating result before special items as an internal reporting measure for our segments in order to promote comparability from period to period. The special items we report include primarily expenses relating to impairment charges, accelerated depreciation, restructuring measures charged to operating result, costs of facilities shutdowns and income from divestments. On a consolidated basis, operating result before special items is considered a non-GAAP financial measure under applicable rules of the Securities and Exchange Commission.

Pharmaceuticals, Biological Products

                                           
Change from Change from
Previous Year Previous Year
2001 (%) 2002 (%) 2003





(euros in millions)
Net sales (external), continuing operations
    5,034       (18.8 )     4,088       1.1       4,132  
Net sales (external), discontinuing operations
    695       (2.3 )     679       (9.7 )     613  
     
             
             
 
 
Total net sales (external)
    5,729       (16.8 )     4,767       (0.5 )     4,745  
Intersegment sales
    38       (13.2 )     33       54.5       51  
Operating result from continuing operations
    191             (75 )     4.0       (72 )
Operating result from discontinuing operations
    (139 )     20.1       (111 )     (218.0 )     (353 )
     
             
             
 
 
Total operating result
    52             (186 )     (128.5 )     (425 )
Special items
    (321 )     (3.7 )     (333 )     (149.8 )     (832 )
     
             
             
 
Operating result before special items
    373       (60.6 )     147       176.9       407  

      The primary special items were as follows:

             
Year Nature of special item Income/ charge



(euros in millions)
2001
  Write-downs of inventories and recall charges in connection with Lipobay/Baycol     (328 )
2002
  Legal provisions for settlement with U.S. authorities in the context of an investigation into pharmaceuticals product prices     (272 )
    Restructurings and write downs     (49 )
2003
  Charges taken on the basis of the final agreement reached with the majority of insurers in connection with Lipobay/Baycol     (300 )
    Impairments and write-downs of plasma business     (317 )
    Shutdown costs     (171 )

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2003 compared with 2002

      Sales of the Pharmaceuticals, Biological Products segment, at 4,745 million in 2003, almost matched the 4,767 in sales of the previous year. Sales increased, however, in local currency terms. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2003 as compared with 2002 rather than declining as they in fact did, our net sales in the Pharmaceuticals, Biological Products segment would have been 542 million higher, and would have risen by 11.4 percent in comparison with 2002.

      Sales growth in the Pharmaceuticals Division was to a large extent driven by the successful introduction of the erectile dysfunction drug Levitra®, which is now being marketed in the United States, Europe, numerous South American countries and the Asia/Pacific region. In the United States — the most significant market for Levitra® — the product had already captured a 16 percent share of new prescriptions by the end of 2003, according to the data published by International Medical Statistics (IMS) Dataview. Levitra® also made inroads in new prescriptions in other major markets. Levitra® accounted for 144 million of net sales in 2003, its first year on the market. We are engaged in a dispute with Pfizer, Inc., in which Pfizer claims that the sale of Levitra® infringes upon Pfizer’s U.S. patent relating to products for the treatment of erectile dysfunction. See Item 8, Financial Information — Legal Proceedings — Patent validity challenges and infringement proceedings; patent-related antitrust actions — Vardenafil-related actions. Sales of the respiratory antibiotic Avalox®/Avelox® continued to expand in a highly competitive environment, with sales of this product rising by 6.8 percent to 299 million. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2003 as compared with 2002, sales of this product would have shown a 20.4 percent increase. The increased net sales attributable to Levitra® and Avalox®/Avelox® were offset in part by a decline in sales of the antihypertensive drug Adalat®, which fell by 15.5 percent to 676 million due to increased competition from producers of generic substitutes, particularly in the United States. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2003 as compared with 2002, Adalat sales would have declined by 7.6 percent. Sales of our anti-infective Ciprobay®/Cipro®, our largest volume health care product in terms of net sales, remained constant at the high level of 1,411 million, with sales in local currencies terms rising by 14.2 percent. The increase was mainly attributable to continued strong demand in the United States, especially product sales to the U.S. generics manufacturer