e20vf
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As filed with the Securities and Exchange Commission on March 6, 2006
 
 
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
 
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005.
 
OR
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
o
  SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    Date of event requiring this shell company report....
For the transition period from                        to                       
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
Bayer AG ordinary shares of no par value
 
New York Stock Exchange
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, 2005, 730,341,920 ordinary shares, of no par value, of Bayer AG were outstanding.
        Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes þ        No o
        If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o        No þ
        Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
        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 þ        No o        Not applicable o.
        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
þ Large accelerated filer        o Accelerated filer        o Non-accelerated filer
        Indicate by check mark which financial statement item the registrant has elected to follow:
Item 17 o        Item 18 þ
        If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o        No þ
        (APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
        Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
Yes o        No o
  *  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.
 
 


 

TABLE OF CONTENTS
             
        Page
         
 PART I
   Identity of Directors, Senior Management and Advisors     5  
   Offer Statistics and Expected Timetable     5  
   Key Information     5  
   Information on the Company     15  
     History and Development of the Company     15  
     Business     17  
       Bayer HealthCare     19  
       Bayer CropScience     38  
       Bayer MaterialScience     47  
     Intellectual Property Protection     58  
     Governmental Regulation     60  
     Organizational Structure     65  
     Property, Plants and Equipment     67  
   Unresolved Staff Comments     69  
   Operating and Financial Review and Prospects     70  
     Overview     70  
     Critical Accounting Policies     70  
     Operating Results 2003, 2004 and 2005     75  
       Bayer Group     84  
       Segment Data     88  
     Liquidity and Capital Resources 2003, 2004 and 2005     99  
     Research and Development     106  
     Basis of Presentation     106  
   Directors, Senior Management and Employees     110  
   Major Shareholders and Related Party Transactions     124  
   Financial Information     125  
   The Listing     136  
   Additional Information     137  
   Quantitative and Qualitative Disclosures about Market Risk     146  
   Description of Securities Other Than Equity Securities     152  
 
 PART II
   Defaults, Dividend Arrearages and Delinquencies     153  
   Material Modifications to the Rights of Security Holders and Use of Proceeds     153  
   Controls and Procedures     153  
   [Reserved]     153  
   Audit Committee Financial Expert     153  
   Code of Ethics     153  
   Principal Accountant Fees and Services     154  
   Exemptions from the Listing Standards for Audit Committees     155  
   Purchases of Equity Securities by the Issuer and Affiliated Purchasers     155  
 
 PART III
   Financial Statements     156  
   Financial Statements     156  
   Exhibits     156  
 Exhibit 1.1
 Exhibit 4.4
 Exhibit 4.5
 Exhibit 4.6
 Exhibit 4.7
 Exhibit 12.1
 Exhibit 12.2
 Exhibit 13.1

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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 on Form 20-F, 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 on Form 20-F 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 technology;
 
  •  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, 2005 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 (IASB), replacing the earlier International Accounting Standards, or IAS. 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 on Form 20-F describes the reconciliation of significant differences between IFRS and U.S. GAAP.
      In this annual report we have translated certain euro amounts into U.S. dollar amounts at the rate of $1.1842 = 1.00, the noon buying rate of the Federal Reserve Bank of New York on December 31, 2005. 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.

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      The financial information presented below is only a summary. You should read it together with the consolidated financial statements included in Item 18.
Consolidated Income Statement Data
                                                   
    Year ended December 31,
     
    2001   2002   2003   2004   2005   2005
                         
              $
    (In millions, except per share data)
IFRS:
                                               
Net sales (continuing operations)
    21,981       22,283       22,417       23,278       27,383       32,427  
Operating result (continuing operations)
    1,518       815       575       1,875       2,812       3,330  
Non-operating result(1)
    (467 )     (423 )     (708 )     (653 )     (613 )     (726 )
Income before income taxes(1)
    1,051       392       (133 )     1,222       2,199       2,604  
Income taxes(1)
    (173 )     5       84       (473 )     (641 )     (759 )
Income after taxes(1)
    878       397       (49 )     749       1,558       1,845  
Income after taxes from discontinued operations(1)
    50       681       (1,242 )     (67 )     37       44  
Income after taxes total(1)
    928       1,078       (1,291 )     682       1,595       1,889  
Minority stockholders’ interest
    4       (3 )     (12 )     3       2       2  
Net income
    932       1,075       (1,303 )     685       1,597       1,891  
Average number of shares in issue
    730       730       730       730       730       730  
Operating result from continuing
                                               
 
operations per share(1)
    2.08       1.12       0.79       2.57       3.85       4.56  
Basic net income/loss per share(1)
    1.28       1.47       (1.78 )     0.94       2.19       2.59  
Diluted net income/loss per share(1)
    1.28       1.47       (1.78 )     0.94       2.19       2.59  
Dividends per share(1)
    0.90       0.90       0.50       0.55       N/A (2)     N/A (2)
U.S. GAAP:
                                               
Net income
    800       1,277       (1,445 )     653       1,327       1,571  
Basic and diluted net income per share
    1.10       1.75       (1.98 )     0.89       1.82       2.15  
 
(1)  Prior year data have been restated for these items due to adoption of new IFRS accounting standards. For more details, see Notes 2, 3 and 28 to the consolidated financial statements appearing elsewhere in this annual report.
 
(2)  The dividend payment for 2005 has not yet been decided on. Our Supervisory Board has accepted our Board of Management’s proposal to recommend at our Annual Stockholders’ Meeting a dividend for 2005 of 0.95 per share, for a total dividend of 694 million.

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Consolidated Balance Sheet Data
                                                 
    Year ended December 31,
     
    2001   2002   2003   2004   2005   2005
                         
              $
    (In millions, except per share data)
IFRS:
                                               
Total Assets(1)
    36,868       40,966       37,516       37,588       36,722       43,486  
Stockholders’ equity(1)
    16,916       14,666       11,290       10,943       11,157       13,212  
Liabilities(1)
    19,952       26,300       26,226       26,645       25,565       30,274  
of which noncurrent financial obligations
    2,981       7,228       7,288       7,025       7,185       8,508  
U.S. GAAP:
                                               
Stockholders’ equity
    18,300       16,734       13,325       13,046       12,347       14,621  
Total assets
    37,831       42,668       38,012       38,496       38,133       45,157  
 
(1)  Prior year data have been restated for these items due to adoption of new IFRS accounting standards. For more details, see Notes 2, 3 and 28 to the consolidated financial statements appearing elsewhere in this annual report.
Dividends
      The following table indicates the dividends per share paid from 2003 to 2005. Stockholders 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.
                         
    2003   2004   2005
             
Total dividend ( in millions)
    365       402       N/A (1)
Dividend per share ()
    0.50       0.55       N/A (1)
Dividend per share ($)
    0.57       0.68       N/A (1)
 
(1)  The dividend payment for 2005 has not yet been decided on. Our Supervisory Board has accepted our Board of Management’s proposal to recommend at our Annual Stockholders’ Meeting a dividend for 2005 of 0.95 per share, for a total dividend of 694 million.
      See also Item 8, Financial Information — Dividend Policy and Liquidation Proceeds.

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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 U.S. dollar will affect the market price of the shares and the ADSs, the U.S. dollar amount received by holders of shares and the ADSs on conversion by the Depositary of any cash dividends paid in euro and the U.S. dollar translation of our results of operations and financial condition.
                                 
Year   Period End   Average   High   Low
                 
    (U.S. dollar per euro)
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  
2004
    1.3538       1.2438       1.3625       1.1801  
2005
    1.1842       1.2449       1.3476       1.1667  
                 
Previous six months   High   Low
         
    (U.S. dollar
    per euro)
September 2005
    1.2538       1.2011  
October 2005
    1.2148       1.1914  
November 2005
    1.2067       1.1667  
December 2005
    1.2041       1.1699  
January 2006
    1.2287       1.1980  
February 2006
    1.2100       1.1860  
      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 on February 28, 2006 was $1.1925 = 1.00. In this annual report, we have translated certain euro amounts into U.S. dollar amounts at the rate of $1.1842 = 1.00, the noon buying rate of the Federal Reserve Bank of New York on December 31, 2005.
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 on Form 20-F 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.
Cyclicality may reduce our operating margins or cause operating losses
      Several of the industries in which Bayer operates are cyclical. This applies particularly to our Materials and Systems segments. 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 excess capacities because they have exceeded demand growth. Low periods in the business cycles are then characterized by decreasing prices and excess capacity. These factors lead to volatile operating margins and may result in operating losses for Bayer.
      Excess capacities can affect our operating results especially with respect to those commodity businesses that are characterized by slow market growth. We believe that some areas of the isocyanate business, in particular, face slow growth in demand together with substantial excess production capacity. Excess capacity in polycarbonates has declined but continues to affect the structure of the polycarbonates market.

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      Future growth in demand may not be sufficient to absorb current excess capacity 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. For these reasons, we may be unable to meet our expectations and targets with respect to products we are currently developing, particularly in our Pharmaceuticals; Crop Protection and Environmental Science, BioScience segments. Our competitive position and operating results could be harmed, if we are unsuccessful in developing new products and production processes in the future or if our ability to generate sufficient levels of sales through investments in new products and expenditures on research and development declines.
      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, manufacturing 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 those of the European Union (EU). A proposed 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 processes in order to reduce the impact of extended testing on time-to-market, stricter regulatory regimes could substantially delay our product development or restrict our marketing and sales.
      Our Pharmaceuticals segment and our Consumer Care segment are subject to particularly strict regulatory regimes. Rising regulatory requirements, such as those governing clinical trials, may increase the cost of product development and the time it takes to bring new products to market, thus reducing the overall financial benefits from these products. Failure to achieve regulatory approval of new products in a timely manner or at all can mean that we do not recoup our research and development and/or commercial investment through sales of that product. We do not know when or whether any approvals from regulatory authorities will be received. 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 products that do not require regulatory approval. In addition, in some cases we may voluntarily cease marketing a product even in the absence of regulatory action.
      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 expect that price controls and pressures on pricing will remain or increase. Any increase may further limit or eliminate our financial benefits from the affected products.

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      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.
      See Item 4, Information on the Company — Governmental Regulation for a more detailed discussion of the regulatory regimes to which we are subject.
Our operating margins may decrease if we are not be able to 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. We use significant amounts of petrochemical-based raw materials and aromatics (benzene, toluene) in manufacturing a wide variety of our products. We also purchase significant amounts of natural gas, coal and electricity 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 were to attain sufficient liquidity and we could obtain their protection at a reasonable cost, we would consider making more extensive use of these hedging instruments.
Shortages or disruptions of supplies to customers due to unplanned capacity decreases or shutdowns of production plants may reduce sales
      Production at some of our manufacturing facilities or the supply of raw materials to them could be adversely affected by technical failures, strikes, natural disasters, regulatory rulings and other factors. Our biological products, in particular, generally face 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. Production capacities at one or more of our sites or major plants could therefore decline temporarily or over the long term. If the capacity of one or more material facilities is reduced or manufacture of material products is shut down for a prolonged period and we are unable to shift sufficient production to other plants or draw on our inventories, we can suffer declines in sales revenues and in our results, be exposed to damages claims and suffer reputational harm.
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, patent infringement proceedings, claims alleging breach of contract 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, voluntarily stopped marketing products containing phenylpropa-

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nolamine (PPA), antitrust proceedings relating to our polymers business and antitrust proceedings associated with Bayer’s ciprofloxacin anti-infective product, Cipro®.
      Since the existing insurance coverage with respect to Lipobay/ Baycol and PPA is exhausted, it is possible — depending on the future progress of the litigation — that Bayer could face further payments that are not covered by the provisions already established. We will regularly review whether further accounting measures are necessary depending on the progress of the litigation. Please see also — Existing insurance coverage may turn out to be inadequate.
      Bayer expects that, in the course of the antitrust proceedings relating to our polymers business, additional charges, which are also currently not quantifiable, will become necessary. Please see Item 8, Financial Information — Legal Proceedings, for a discussion of these proceedings.
Competition from generic pharmaceuticals after patent expiration may reduce market share and sales revenue
      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. See Item 4, Information on the Company — Intellectual Property Protection, for a discussion of the scheduled expiration dates of our significant patents.
      In response to rising healthcare costs, many governments (including many U.S. states) and private health care providers, such as Health Maintenance Organizations (HMOs) in the United States, have instituted reimbursement schemes favoring less expensive generic pharmaceuticals over brand-name pharmaceuticals. We expect that the pressure for generic substitution will increase as a result of the implementation of the Medicare prescription drug benefit in 2006. Increased competition from generic products after patent expiration is likely to reduce market share and sales revenue of our formerly patented products.
The loss of patent protection or ineffective patent protection for marketed products may result in loss of sales to competing products
      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 expiration date 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 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 revenues could suffer.
Failure to compete successfully or weak performance by our marketing partners may reduce our operating results
      Bayer operates in highly competitive industries. Actions of our competitors could reduce our profitability and market share. In some commodity areas (especially within our Materials and Systems segments), 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.

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      We depend on third parties for the marketing of some of our products, most notably in our pharmaceutical business. Therefore, our operating performance is influenced by the quality of our partners’ marketing and sales performance.
Our transactions relating to LANXESS expose us to continuing liability
      As announced in November 2003, Bayer combined its former Bayer Chemicals segment (except for Wolff Walsrode and H.C. Starck) with parts of its former Bayer Polymers business to form the LANXESS subgroup with economic effect from July 1, 2004 as part of its portfolio realignment. LANXESS AG became a legally independent company on January 28, 2005, when its spin-off was registered in the Commercial Register (Handelsregister) for Bayer AG at the Local Court of Cologne (Amtsgericht Köln), Germany.
      Our liability for prior obligations of the LANXESS subgroup following its spin-off is governed by both statutory and contractual provisions. Under the German Transformation Act, all entities that are parties to a spin-off are jointly and severally liable for obligations of the transferor entity that are established prior to the spin-off date. Bayer AG and LANXESS AG are thus jointly and severally liable for all obligations of Bayer AG that existed on January 28, 2005. The company to which the respective obligations were not assigned under the Spin-Off and Acquisition Agreement, dated September 22, 2004, between Bayer AG and LANXESS AG ceases to be liable for such obligations after a five-year period.
      Under the Master Agreement between Bayer AG and LANXESS AG of the same date, each of Bayer AG and LANXESS AG agreed to release the other party from those liabilities each has assumed as principal debtor under the Spin-Off and Acquisition Agreement. The Master Agreement contains provisions for the general apportionment of liability as well as special provisions relating to the apportionment of product liability and of liability for environmental contamination and antitrust violations between Bayer AG and LANXESS AG. The Master Agreement applies to all activities of Bayer AG and LANXESS AG units throughout the world, subject to certain conditions for the United States. For a description of these agreements, please see Item 10, Additional Information — Material Contracts.
      We may bear expenses in the future relating to liabilities of the former LANXESS subgroup under the German Transformation Act or pursuant to the Spin-Off and Acquisition Agreement or the Master Agreement. These could have a material adverse effect on our financial condition and results of operations.
Risks from the handling of hazardous materials could negatively impact our operating results
      Bayer’s operations are subject to the operating risks associated with pharmaceutical and chemical manufacturing, including the related risks associated with storage and transportation of raw materials, products and wastes. These risks include, among other things, the following hazards:
  •  pipeline and storage tank leaks and ruptures;
 
  •  fires and explosions;
 
  •  malfunction and operational failure; and
 
  •  releases, discharges or disposal of toxic and/or hazardous substances resulting from these or other causes.
      These operating risks have the potential to cause personal injury, property damage and environmental contamination, and may result in the shutdown of affected facilities and in business interruption and the imposition of civil or criminal penalties, and negatively impact the reputation of the company. The occurrence of any of these events may significantly reduce the productivity and profitability of the affected manufacturing facility and harm our operating results. Furthermore, our property damage, business interruption and casualty insurance policies may not be adequate to cover fully all potential hazards incidental to our business.
      For more detailed information on environmental issues, see Item 4, Information on the Company — Business — Governmental Regulation.

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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 we disposed of waste from our operations;
 
  •  where external toll manufacturers operate or operated; or
 
  •  where property owned by third parties was contaminated by the emission or spill of contaminants for which we bear responsibility.
      The costs of 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 — 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 reputation.
      Stricter health, safety and environmental laws and regulations as well as enforcement policies could result in substantial liabilities and costs to Bayer and could subject our handling, manufacturing, use, reuse or disposal of substances or pollutants to more rigorous scrutiny than is currently the case. Consequently, compliance with these laws and regulations could result in significant capital expenditures and expenses as well as liabilities, thereby harming our business and operating results.
Existing insurance coverage may turn out to be inadequate
      We seek to cover foreseeable risks through insurance coverage. Such insurance coverage, however, may not fully cover the risks to which the company is exposed. This can be the case with respect to insurance covering legal and administrative claims, as discussed above, as well as with respect to insurance covering other risks. For certain risks, adequate insurance coverage may not be available on the market or may not be available at reasonable conditions. Consequently, any harm resulting from the materialization of these risks could result in significant capital expenditures and expenses as well as liabilities, thereby harming our business and operating results.
Significant fluctuations in exchange rates 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 and Japanese yen, 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;
 
  •  the cost of products and services we require for our operations; and
 
  •  the euro-denominated items in our financial statements.
      Although these fluctuations can benefit us, they can also harm our results. From time to time, we may use financial instruments to hedge some of our exposure to foreign currency fluctuations. For further information on these products, see Item 11, Quantitative and Qualitative Disclosures about Market Risk.

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Negative developments affecting capital markets may make additional contributions to our pension funds necessary and changes in the yield assumptions could have an impact on the valuation of liabilities
      Changes and movements in the equity, fixed income, real estate and other markets could significantly change the valuation of the assets of our plans. A change in yield assumptions could also have an impact on the discounted present value of our pension obligations. In addition, changes in pension and postretirement benefit plan assumptions, such as rates for compensation increase, retirement rates, mortality rates, health care cost trends and other factors can lead to significant increases or decreases in our pension or postretirement benefit obligations, which would affect the reported funded status of our plans and therefore could also negatively affect net periodic pension cost, future cash contributions and equity. For further details on underfunding of pensions and other post-retirement benefit obligations, refer to Note 28 to the consolidated financial statements appearing elsewhere in this annual report.
      We cannot assure you that any future expenses or cash contributions that become necessary under our pension or postretirement benefit plans will not have a material adverse effect on our financial condition and results of operations.

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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 on Form 20-F. The headquarters of Bayer AG’s U.S. subsidiary, Bayer Corporation, are located at 100 Bayer Road, Pittsburgh, Pennsylvania 15205-9741.
      The major acquisitions and divestitures of the Bayer Group during the last three years are listed below. For capital expenditures (excluding acquisitions) for these years, please refer to Item 5, Operating and Financial Review and Prospects — Liquidity and Capital Resources 2003, 2004 and 2005 — Capital Expenditures. For capital expenditures by individual business segment for the last three years, refer to the segment data in Note 1 to our consolidated financial statements appearing elsewhere in this annual report.
      Our principal expenditures on acquisitions in the past three years were as follows:
  •  In 2003, we spent a total of 68 million on acquisitions, mainly for increasing our interest in the Bayer Polymers Sheet Europe Group (formerly known as Makroform) to 100 percent.
 
  •  In 2004, Bayer spent a total of 0.4 billion on acquisitions. Of this amount, approximately 0.1 billion was used for the purchase of Crompton Corporation’s 50 percent stake in the Gustafson joint venture (seed treatment business) based in the United States, Canada and Mexico, in which Bayer already held a 50 percent share. In connection with the acquisition of Roche’s Consumer Health business in 2005, Bayer acquired, by the end of 2004, Roche’s 50 percent interest in the Bayer-Roche joint venture that had been established in the United States in 1996. The purchase price for the 50 percent equity interest was 0.2 billion. Not included in the 2004 total acquisition amount is a first payment of 0.2 billion we made for Roche’s Consumer Health business in the rest of the world, because, as of December 31, 2004, this business had not yet been transferred to Bayer.
 
  •  In 2005, we spent a total of 2.4 billion on acquisitions. Roche’s Consumer Health business in the rest of the world (except in Japan) was acquired for approximately 2.1 billion. Both this amount and the 2005 total acquisition amount include the first payment of 0.2 billion we made for Roche’s Consumer Health business in the rest of the world. Since January 2005, the business involving non-prescription drugs and vitamins has been part of Bayer HealthCare’s Consumer Care Division and has already been integrated into the Bayer organization. Aside from the 50 percent stake in the Bayer-Roche joint venture, the acquired business includes five production sites, consumer brands such as Aleve®, Bepanthen®, Redoxon®, Rennie® and Supradyn®, vitamins and nutritional supplements. The acquisition has primarily been financed through the use of our own funds, although loans were taken out in several countries for legal and tax reasons.
  The remaining 2005 acquisition amount of approximately 0.3 billion related primarily to expenses incurred in connection with a license agreement and a co-marketing and distribution agreement. After divesting its product rights concerning the active ingredient fipronil (see below), Bayer signed an agreement with BASF at the end of January 2005 to license back fipronil for agricultural uses in certain countries outside Europe, the United States and Brazil. The transaction has been approved by the relevant authorities. In July 2005, Bayer acquired marketing rights for the cardiovascular drug Zetia® under a co-marketing and distribution agreement with Schering-Plough.

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      Our principal divestitures in the past three years were as follows:
  •  In 2003, we sold the remaining parts of the household insecticides business (0.3 billion), our 50 percent interest in PolymerLatex (0.1 billion) and our stake in the biotechnology company Millennium Pharmaceuticals, Inc. (0.3 billion). As part of the conditions imposed by the European, U.S. and Canadian antitrust authorities in connection with the Aventis CropScience acquisition in 2002, a number of active ingredients, especially in the area of insecticides and fungicides, were divested (1.3 billion). In particular, Bayer divested the product rights concerning the active ingredient fipronil in the first quarter of 2003.
 
  •  In July 2004, we sold, pursuant to contractual obligations, our 15 percent interest in the KWS Saat AG, a seed company acquired as part of Aventis CropScience in 2002.
 
  •  In 2005, we divested our LANXESS subgroup, our plasma operations and several CropScience operations.
  –  LANXESS: At the end of January 2005, the LANXESS subgroup was spun off and ceased to be part of the Bayer Group. As part of its portfolio realignment, Bayer had combined its former Bayer Chemicals segment (except for Wolff Walsrode and H.C. Starck) with parts of its former Bayer Polymers business to form the LANXESS subgroup with economic effect from July 1, 2004. Those portions of our business that were combined into our LANXESS subgroup and subsequently spun off are shown as “discontinued operations” in accordance with International Financial Reporting Standard (IFRS) 5. For further information on IFRS 5 and the treatment of LANXESS for reporting purposes, please refer to Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Discontinued Operations and Note 7.2 to the consolidated financial statements contained elsewhere in this annual report.
 
  –  Plasma: At the end of March 2005, Bayer divested the U.S. plasma operations of its former Biological Products division to two U.S. financial investors (approximately 0.2 billion). All plasma activities in the United States were transferred to Talecris BioTherapeutics, Inc. (Talecris), a corporation newly formed by the two investors. To account for the final agreements signed at the end of March 2005, we adjusted the previous year’s presentation to show the continued non-U.S. marketing and distribution activities as part of the continuing operations. In our financial statements for 2005, only the U.S. plasma business is reflected in discontinued operations. Revenues from our marketing and distribution activities for plasma products outside the United States are reflected in sales from continuing operations of our Pharmaceuticals, Biological Products segment. The comparative periods 2004 and 2003 have been adjusted to reflect the inclusion of non-U.S. distribution in continuing operations. For further details on the treatment of our plasma operations for reporting purposes, please refer to  — Bayer HealthCare — Pharmaceuticals, Biological Products; Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Discontinued Operations; and Note 7.2 to the consolidated financial statements contained elsewhere in this annual report.
 
  –  The Bayer CropScience subgroup divested a number of operations in 2005 for an aggregate selling price of approximately 80 million. These included the subsidiaries Philagro Holding S.A., France, and EqSeeds Comercia de Sementes Ltda., Brazil, as well as the location in Hauxton, UK. Bayer CropScience also divested the businesses relating to the manufacturing and marketing of certain active ingredients used by the Crop Protection business units and the Environmental Science business group, including the acaricide and insecticide amitraz (Mitac®).

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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 and polymers. Bayer AG is headquartered in Leverkusen, Germany and is the management holding company of the Bayer Group, which includes approximately 280 consolidated subsidiaries.
      Following the spin-off of the LANXESS subgroup in January 2005, our business operations are organized in three subgroups:
  •  Bayer HealthCare (consisting of four segments: Pharmaceuticals, Biological Products (renamed Pharmaceuticals as of January 1, 2006); Consumer Care; Diabetes Care, Diagnostics; and Animal Health) develops, produces and markets:
  –  prescription pharmaceuticals and biological products;
 
  –  over-the-counter medications and nutritional supplements;
 
  –  diagnostic products for laboratory testing, near-patient testing and self-testing applications; and
 
  –  veterinary medicines, nutritionals and grooming products for companion animals and livestock.
  •  Bayer CropScience (consisting of the Crop Protection segment and the Environmental Science, BioScience segment):
  –  develops and markets a comprehensive portfolio of fungicides, herbicides, insecticides and seed treatment products to meet a wide range of regional requirements; and
 
  –  develops and markets a wide range of products for the green industry, garden care, non-agricultural pest and weed control and conventional seeds, and is active in plant biotechnology.
  •  Bayer MaterialScience (comprising the Materials segment and the Systems segment) primarily develops, manufactures and markets:
  –  high-quality plastic granules, methylcellulose, metallic and ceramic powders and semi-finished products; and
 
  –  polyurethanes for a wide variety of applications as well as coating and adhesive raw materials and basic inorganic chemicals.
      The following service organizations provide support functions to the three subgroups, Bayer AG and third parties:
  •  Bayer Technology Services, which provides engineering functions such as process development, process and plant engineering, construction and optimization.
 
  •  Bayer Business Services, which provides information management, accounting, consulting and administrative services.
 
  •  Bayer Industry Services, which operates the Bayer Chemical Park network of industrial facilities in Germany and provides site-specific services in the areas of technology, environmental protection, waste management, utility supply, infrastructure, safety, chemical analysis and vocational training to Bayer and non-Bayer companies. Bayer Industry Services GmbH & Co. OHG is held by Bayer AG (60 percent) and by LANXESS (40 percent).
      Our strategic alignment on core competencies should enable us to increase investment in growth businesses and innovative technologies. We expect that this will allow us to play a leading role in these markets and to 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.

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      Bayer’s long-term strategy and activities are guided by the role of a socially and ethically acting “corporate citizen” and the principles of sustainable development, whose objectives are 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.
      For the year ended December 31, 2005, Bayer reported total sales from continuing operations of 27,383 million, an operating result from continuing operations of 2,812 million and net income of 1,597 million. As of December 31, 2005, we employed 93,700 people worldwide. Based on customers’ location, Bayer’s activities in Europe accounted for 43 percent of the Group’s total sales in 2005; North America for 27 percent; the Asia/Pacific region amounted to 17 percent; and the Latin America/ Africa/Middle East region accounted for 13 percent of total sales.
      The LANXESS spin-off in early 2005 and the acquisition of Roche’s Consumer Health business led to a shift in the relative sizes of our businesses in terms of sales, operating result and assets. We therefore changed our segment structure and reporting with effect from January 1, 2005. We restated our segment reporting for 2003 and 2004 to correspond to the new structure in compliance with IAS 14 (Segment Reporting). The changes in our segments are as follows: The former Consumer Care, Diagnostics segment was divided into the Consumer Care segment (consisting of the historical Consumer Care business and the acquired Roche Consumer Health business) and the Diabetes Care, Diagnostics segment (consisting of our Diabetes Care and Diagnostics divisions). The former CropScience segment was divided into the Crop Protection segment (consisting of the strategic business units Insecticides, Fungicides, Herbicides and Seed Treatment) and the Environmental Science, BioScience segment (consisting of our business groups Environmental Science and BioScience).
      The following table shows external sales from Bayer’s continuing business activities by subgroup and reporting segment, with a reconciliation to the Bayer Group.
                                                   
        Percentage       Percentage       Percentage
    2003   of total sales   2004   of total sales   2005   of total sales
                         
    (Euros in millions)
HealthCare
    8,497       37.9       8,058       34.6       9,429       34.4  
 
Pharmaceuticals, Biological Products(a)
    4,371       19.5       3,961       17.0       4,067       14.9  
 
Consumer Care
    1,403       6.3       1,336       5.7       2,355       8.6  
 
Diabetes Care, Diagnostics
    1,933       8.6       1,975       8.5       2,151       7.9  
 
Animal Health
    790       3.5       786       3.4       856       3.0  
CropScience
    5,764       25.7       5,946       25.5       5,896       21.5  
 
Crop Protection
    4,801       21.4       4,957       21.3       4,874       17.8  
 
Environmental Science, BioScience
    963       4.3       989       4.2       1,022       3.7  
MaterialScience
    7,453       33.2       8,597       36.9       10,695       39.1  
 
Materials
    2,777       12.4       3,248       13.9       4,086       14.9  
 
Systems
    4,676       20.8       5,349       23.0       6,609       24.2  
Reconciliation
    703       3.2       677       3.0       1,363       5.0  
Total Sales from Continuing Operations(b)
    22,417       100.0       23,278       100.0       27,383       100.0  
 
(a) With effect from January 1, 2006, the former Pharmaceuticals, Biological Products segment has been renamed the Pharmaceuticals segment.
(b) In accordance with new accounting standard IFRS 5 and other related standards, the financial information presented in this annual report only includes the continuing operations of the Bayer Group and its segments, except where specific reference is made to discontinued operations. Our revenues from discontinued operations were 627 million in 2005, 6,480 million in 2004 and 6,150 million in 2003.

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BAYER HEALTHCARE
PHARMACEUTICALS, BIOLOGICAL PRODUCTS
Overview
      During the period to which this annual report relates, our Pharmaceuticals, Biological Products segment consisted of the Pharmaceuticals division and the Biological Products division. Effective January 1, 2006, the segment was renamed the Pharmaceuticals segment. It continues to contain all of the businesses that were formerly included in the Pharmaceuticals and Biological Products divisions (other than our U.S. plasma business, which has been divested as described below). The segment is now divided into the three business units Oncology, Primary Care and Hematology/ Cardiology, with all of the remaining activities from the former Biological Products division forming part of the Hematology/ Cardiology business unit. We continue to use the name “Pharmaceuticals division” when describing the current operations of the businesses that are part of our Pharmaceuticals segment for reporting purposes. Because the reorganization occurred after the end of the fiscal year to which this annual report relates, we refer to the segment and its divisions under their old names whenever we refer to past activities or financial performance.
      The segment focuses on the development and marketing of ethical pharmaceuticals, i.e., medications requiring a physician’s prescription and sold under a specific brand name, and the development of recombinant protein therapies.
      At the end of March 2005, Bayer divested the U.S. plasma operations of its Biological Products division to two U.S. financial investors, Cerberus Capital Management, L.P., New York, New York and Ampersand Ventures, Wellesley, Massachusetts. The newly-formed entity, named Talecris BioTherapeutics, Inc., began operations on April 1, 2005. The agreement covers the products, facilities and employees representing the plasma portion of the division. Key products include Polyglobin®, Gamimune® N, Gamunex® and Prolastin®. The remaining portion, consisting of our Kogenate® business, is not affected by this agreement and, effective January 1, 2006, forms part of our Pharmaceuticals division. To account for the final agreements signed at the end of March 2005, we adjusted the previous year’s presentation to show the continued non-U.S. marketing and distribution activities as part of the continuing operations. In our financial statements for 2005 only the U.S. plasma business is reflected in discontinued operations. Revenues from our marketing and distribution activities for plasma products outside the United States are reflected in sales from continuing operations of our Pharmaceuticals, Biological Products segment. The comparative periods 2004 and 2003 have been adjusted to reflect the inclusion of non-U.S. distribution in continuing operations. For further information refer to Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Discontinued Operations.
      The following table shows the segment’s performance for the last three years.
                           
    2003   2004   2005
             
    (Euros in millions)
External net sales
    4,371       3,961       4,067  
 
Percentage of total sales
    19.5       17.0       14.9  
Intersegment sales
    42       38       58  
Operating result
    (16 )     399       475  
 
thereof special items(a)
    (515 )     (53 )     (140 )
 
(a)  The significant special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Segment Data.

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      The segment’s sales by region for the past three years are as follows.
                           
    2003   2004   2005
             
    (Euros in millions)
Europe
    1,412       1,577       1,600  
North America
    1,817       1,172       1,129  
Asia/Pacific
    804       851       900  
Latin America/ Africa/Middle East
    338       361       438  
                   
 
Total
    4,371       3,961       4,067  
                   
      Our Pharmaceuticals business unit generated 3,108 million in 2005, 3,166 million in 2004 and 3,635 million in sales in 2003, whereas our Biological Products business unit (not including our former U.S. plasma operations) generated 959 million 2005, 795 million in 2004 and 736 million in 2003. The following table shows our sales during the past three years from the products that account for the largest portion of segment sales.
                                                   
    2003   2004   2005
             
        Percentage of       Percentage of       Percentage of
Product   Sales   Segment Sales   Sales   Segment Sales   Sales   Segment Sales
                         
    (Euros in       (Euros in       (Euros in    
    millions)       millions)       millions)    
Kogenate®
    497       11.4       563       14.2       663       16.3  
Adalat®
    676       15.5       670       16.9       659       16.2  
Ciprobay®/Cipro®
    1,411       32.3       837       21.2       525       12.9  
Avalox®/Avelox®
    299       6.8       318       8.0       364       9.0  
Glucobay®
    273       6.2       278       7.0       295       7.2  
Levitra®
    144       3.3       193       4.9       260       6.4  
Trasylol®
    157       3.6       171       4.3       230       5.7  
Aspirin®(a)
    111       2.5       147       3.7       177       4.3  
Other
    803       18.4       784       19.8       894       22.0  
                                     
 
Total
    4,371               3,961               4,067          
                                     
 
(a)  CardioAspirin is also distributed by our Consumer Care division. These figures do not include sales by the Consumer Care division.
Segment Strategy
      Our goal is to transform the segment into a specialty business, i.e., a business that markets to specialists rather than general practitioners, with a focus on diseases that have a great need for improvement in diagnosis and treatment, especially in the fields of hematology, cardiology and oncology with our products Kogenate®, Trasylol® and Nexavar®. These therapeutic areas are also the main focus of our research and development activities where we have several promising products in development, such as our Factor Xa inhibitor BAY 59-7939. See Item 5, Operating and Financial Review and Prospects — Research and Development.
      A major step in our transformation into a specialty business was the launch of Nexavar® for the treatment of advanced kidney cancer in the United States at the end of 2005. This treatment has also been submitted to regulatory authorities in Europe and other regions and is in late development phases for other cancers with unmet medical needs.
      Another major step in our transformation into a specialty business, which illustrates the adaptation of our marketing strategy to fit our regional and product market strengths, is the marketing alliance with Schering-Plough in the U.S. primary care market. In this alliance formed in 2004, Schering-Plough markets and sells several of our primary care products in the United States, allowing our U.S. organization to focus on specialty

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products. Outside the United States, we intend to expand our specialty business to all major geographic regions, where we continue to have a strong presence in the primary care market with the growing products Avelox® and Levitra®, as well as with established products like Adalat®, Glucobay® and Cipro®.
      Life cycle management, licensing activities and alliances continue to be major elements of our strategy. We use these business development activities in addition to R&D to strengthen our portfolio. See Item 5, Operating and Financial Review and Prospects — Research and Development. Examples of licensing activities are the collaboration with Nuvelo on the development and commercialization of alfimeprase, a novel thrombolytic drug (blood clot dissolver) currently in Phase III development, and the acquisition of marketing rights from GlaxoSmithKline for the antihypertensive product Pritor® in certain European countries. These agreements are aimed at strengthening our cardiovascular specialty and primary care franchises, respectively.
Major Products
      Adalat® is the brand name for nifedipine, a 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.
      Ciprofloxacin, marketed under the trademark Cipro®, mainly in the United States, and Ciproxin®, Ciproxine®, Ciprobay®, Ciproxina®, Baycip®, Ciflox® and Uniflox® in other countries, is a broad-spectrum antimicrobial agent of the fluoroquinolone class. Cipro®’s main uses are in the treatment of urinary tract infections and in severe hospital infections. It is also approved for the treatment of anthrax. In June 2004, market exclusivity for the active pharmaceutical ingredient in Cipro® expired in the United States.
      Moxifloxacin, marketed under the trade name Avelox®, mainly in the United States, and Avalox®, Izilox®, Actira® and Octegra® in other countries, is an antibiotic used to treat common bacterial respiratory tract infections. It is indicated for the treatment of community-acquired pneumonia, acute exacerbations of chronic bronchitis, acute sinusitis and uncomplicated skin and skin structure infections.
      Acarbose, marketed under the trademark Glucobay®, Glucor® in most countries, Precose® (in the United States) and Prandase® (mainly in Canada) is an oral antidiabetic product that delays carbohydrate digestion. Glucobay® improves metabolic control in diabetics alone or in combination with other antidiabetic drugs.
      Vardenafil, our erectile dysfunction medication marketed under the trade name Levitra®, is marketed in the United States in co-operation with GlaxoSmithKline and Schering-Plough. We also jointly perform life cycle management with these companies.
      CardioAspirin (e.g., Aspirin® Protect in Germany and Aspirin Regimen Bayer in the United States) refers to Bayer’s collective group of products (distributed by both our Consumer Care and Pharmaceuticals divisions depending on whether local regulations require a prescription for these products) 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).
      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 infections, such as HIV, hepatitis or those caused by other viruses occasionally present in plasma-derived products, is greatly reduced.
      We supply recombinant FVIII to ZLB Behring, which markets it under the brand name Helixate® FS.
      For further information regarding the discontinued plasma business, please refer to the introduction to — Business.

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      Trasylol® Aprotinin, marketed under the trademark 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.
      In January 2006, two studies published in the medical literature reported an association of Trasylol® (aprotinin) with an increased risk of serious renal dysfunction and cardiovascular/ cerebrovascular events (heart failure and stroke) in patients undergoing open-heart surgery.
      The first, a study by Mangano et al. (New England Journal of Medicine, January 2006), studied patients undergoing coronary artery bypass graft (CABG) surgery who received either aprotinin or one of two other drugs intended to decrease perioperative bleeding. The study reported an association of aprotinin with an increased risk of cardiovascular events (myocardial infarction or heart failure), cerebrovascular events such as stroke, encephalopathy or coma, and renal dysfunction or failure in these patients. The increases in renal failure, myocardial infarction, congestive heart failure and stroke or encephalopathy reported by the authors are not consistent with Bayer’s data from randomized, placebo-controlled clinical trials of Trasylol®.
      The second, a study by Karkouti et al. (Transfusion, On-Line Edition) reported an association of aprotinin with renal dysfunction and renal failure. Renal dysfunction and renal failure have previously been reported with Trasylol®. The data on renal function in patients receiving Trasylol® in Bayer’s clinical trials are reflected in the approved labeling for Trasylol®. The findings by Karkouti et al., specifically that there was a statistically significant increased rate of serum creatinine elevations in the aprotinin group, is at variance with Bayer’s own experience in randomized, placebo-controlled clinical trials of Trasylol®. Karkouti et al. did not find an increased rate of cardiovascular or cerebrovascular events in Trasylol®-treated patients and reported comparable mortality rates between the control treatment group and the Trasylol® group.
      Relevant regulatory authorities are currently reviewing these reports. Based upon the results of these reviews, the authorities will determine what actions may be warranted. Negative findings or the negative publicity associated with the studies or the regulatory review could lead to a material reduction in the volume of Trasylol® sales, and this could have a material adverse affect on revenues or results of operations, at least at the segmental level. Bayer has been working and will continue to work closely with regulatory authorities worldwide to address questions of product safety.
Markets and Distribution
      The Pharmaceuticals division’s principal markets are North America, Western Europe and Asia (especially Japan).
      We do not experience any significant seasonality in our markets for the division’s products.
      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. In January 2005, we terminated the Levitra® co-promotion agreement with GlaxoSmithKline in most of the world outside of the United States. This enables us to exercise the marketing rights ourselves. In September 2004, we entered into a strategic alliance with Schering-Plough. In this alliance, Schering-Plough markets and distributes selected primary care pharmaceutical products in the United States, including Cipro®, Avelox® and Levitra®. Furthermore, we are co-promoting selected Schering-Plough oncology products for a certain period of time in the United States and selected major European markets, e.g., in Germany, France and Italy. Both parties intend to cooperate in marketing Schering-Plough’s Zetia® in Japan after its approval by the Japanese regulatory authorities.
      In October 2005, we entered into a strategic alliance with Ortho-McNeil Pharmaceutical Inc., a Johnson & Johnson subsidiary. In this alliance, Ortho-McNeil will contribute to the development of BAY 59-7939 and will later market and distribute BAY 59-7939 in the United States. BAY 59-7939 is an oral direct Factor Xa inhibitor, being developed to meet currently unmet clinical needs in the anticoagulation market for the prevention and treatment of thrombotic events. In addition, Bayer will co-promote Johnson & Johnson’s Elmiron® in the United States.

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      We produce the active ingredients for our ethical pharmaceutical products almost entirely in Wuppertal, Germany. Recombinant FVIII products are made at our facility in Berkeley, California, under an exclusive license from Genentech. Bayer facilities in countries around the world compound our raw materials and package the finished product for shipment. Our main pharmaceutical production facilities are in Leverkusen, Germany; Berkeley, California; Garbagnate, Italy; Rosia, Italy and Shiga, Japan.
      We obtain raw materials for our active ingredients in ethical pharmaceuticals in part from our former LANXESS subgroup and the rest from third parties mainly in Europe and Asia. For our Kogenate® product, we obtain raw materials and packaging materials from diverse third-party suppliers in various countries around the world. As a rule, we approve our suppliers for each required material. For the production of Kogenate® we use human albumin sourced from Talecris for the nutrition of the cell lines.
      We maintain strategic reserves of many of our key products to avoid shortages upon any breaks in the supply chain. Where a required material is available from only one supplier, our policy is to amass a strategic reserve, while mounting an intensive search for potential alternative suppliers. We obtain additional ingredients and packaging materials from diverse suppliers in various countries around the world. For building blocks and intermediates, used to manufacture active ingredients in ethical pharmaceuticals, we either approve several suppliers or enter into global contracts. This also helps us to reduce the effects of price volatility.
      We encounter competition in all of our geographical markets from large national and international competitors, such as:
  •  antibacterial products: Pfizer, GlaxoSmithKline and Abbott Laboratories;
 
  •  hypertension and coronary heart disease therapy: Pfizer, Novartis, AstraZeneca and Merck & Co.;
 
  •  oral antidiabetics: Takeda, GlaxoSmithKline, Aventis and Bristol-Myers Squibb;
 
  •  blood coagulation: Baxter, Wyeth and ZLB Behring; and
 
  •  erectile dysfunction: Pfizer and Eli Lilly.
Research and Development
      Bayer HealthCare allocates the largest part of its research and development budget to the Pharmaceuticals division. Within this division, the Pharmaceuticals Research & Development department was divided into the Global Drug Discovery and the Global Development & Compliance units effective January 1, 2006. The restructuring measure is intended to direct research and development more intensively toward obtaining early evidence of efficacy in humans (also called “proof of concept”). The Research Center in West Haven, Connecticut focuses on oncology and activities in the Wuppertal Pharmaceuticals Center are concentrated on cardiovascular research. The division’s main research and development facilities for Kogenate® are located in Berkeley, California.
      Bayer HealthCare is carving out the anti-infectives research unit of its Pharmaceuticals division into a new company in which Santo Holding (Deutschland) AG of Stuttgart, Germany, will own a majority share. Bayer HealthCare will retain a minority share of 12 percent. The carve-out is expected to close in March 2006.
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: nineteen years after the patent protection for the active ingredient nifedipine, its key component, expired, the drug generated 659 million in sales in 2005. Similarly, we are implementing life cycle management measures, such as improved formulations and dosage forms or identifying new indications, for other major products.

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Phase II/III Trials
      BAY 59-7939 is an oral direct Factor Xa inhibitor, being developed to meet currently unmet clinical needs in the anticoagulation market for prevention and treatment of thrombotic events. Phase III trials were initiated in December 2005 for the prevention of venous thromboembolism (VTE) after major orthopedic surgery. In chronic indications (VTE treatment, stroke prevention in patients with arterial fibrillation) Phase II trials are ongoing. In October 2005, Bayer HealthCare (BHC) and the Johnson & Johnson subsidiary Ortho-McNeil entered into an alliance under which Ortho-McNeil contributes to the development of BAY 59-7939.
      At the end of 2005, the FDA granted U.S. approval for the anti-cancer drug Nexavar® (sorafenib), co-developed by Bayer HealthCare and Onyx Pharmaceuticals, Inc., for the treatment of patients with advanced renal cell carcinoma. Nexavar® is a novel multi-kinase inhibitor that targets serine/ threonine and receptor tyrosine kinases in both the tumor cell and the tumor vasculature. It has been shown to double progression free survival in patients with advanced renal cell carcinoma. BHC has also filed for regulatory approval with the European Medicines Evaluation Agency (EMEA) for the treatment of advanced renal cell carcinoma. In the first half of 2005, Phase III trials for the treatment of hepatocellular carcinoma and malignant melanoma were initiated. The launch of an additional Phase III program for the treatment of non-small cell lung cancer (NSCLC) was announced in December 2005. Other tumor types are under investigation in earlier stages of clinical development.
      Drug candidates in Phase II/III of clinical development are listed in the following table with their respective indications:
         
Project   Indication   Status
         
Factor Xa inhibitor
  VTE prevention,   In Phase III
    VTE treatment,   In Phase II
    Stroke prevention in patients with atrial fibrillation    
Nexavar®
  Advanced renal cell carcinoma,   FDA approval
    Hepatocellular carcinoma,   In Phase III
    Malignant melanoma, NSCLC,    
    First line renal cell carcinoma   In Phase II
Trasylol® (aprotinin injection)
  Hematology   In Phase III
    (Hip-surgery, Spinal-surgery)    
Alfimeprase
  Acute peripheral arterial   In Phase III
    occlusion (PAO)/catheter occlusion (CO)    
      The listed compounds represent a snapshot of the Bayer pipeline. The nature of drug discovery and development is such that not all compounds can be expected to meet the pre-defined project target profile, so it is possible that the above listed projects under clinical development may have to be discontinued due to scientific and/or commercial reasons and will not result in marketed products. It is also possible that the requisite FDA, EMEA or other regulatory approval will not be granted for our compounds described above.
Kogenate®
      Key research and product development projects involving our Kogenate® product are Kogenate® — Next Generation and Kogenate® Bio-Set®, as well as gene therapy for hemophilia B.
Kogenate® — Next Generation
      We have also identified five constructs for potential development of products under the umbrella Kogenate® — Next Generation. Evaluation of proteins as well as technology is ongoing. Optimization of candidates is expected to be completed by the end of 2006.

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      In June 2003, Bayer signed an exclusivity agreement with Opperbas Holding B.V. for use of their proprietary Liposome formulation for Kogenate® FS. Following signing of a license agreement with Zilip-Pharma, a subsidiary of Opperbas Holding B.V., in the fourth quarter of 2004, Bayer has begun Phase I clinical studies in the United States for BAY 79-4980 (Kogenate®-FS reconstituted with pegylated liposome diluent) under an Investigational New Drug application process (IND) filed by Bayer in April 2005 and accepted by the FDA.
Kogenate® FS Bio-Set® Delivery System
      Kogenate® with Bio-Set® is a recombinant Factor VIII with a self-contained system that includes a needleless reconstitution device that avoids the risk of accidental needlestick injuries during reconstitution. In May 2005, a Phase I global trial was initiated in several European countries. Canada introduced Bio-Set® in September 2005 and trials in other European markets were launched in the fourth quarter of 2005. The United States launched Bio-Set® in January 2006. Japan is planning the introduction of Bio-Set® for the first quarter of 2006.
Gene Therapy
      Finally, on May 18, 2005, Bayer entered into an early stage research and collaboration agreement to develop gene therapy for the treatment of Hemophilia with Askleplos Biopharmaceutical Inc.
Bayer HealthCare posts information on clinical trials on the internet
      Bayer HealthCare posts information on the clinical trials being conducted by its Consumer Care and Pharmaceuticals divisions on the internet. The database is intended to increase the transparency of the clinical trials for physicians, scientists and other interested parties. This measure is consistent with the recommendations in the position paper issued by pharmaceutical associations in Europe, Japan and the United States, and the International Federation of Pharmaceutical Manufacturers and Associations.
Collaborations
Research Collaborations
      To supplement our internal research and development efforts, we collaborate with several companies in different stages of the typical pharmaceutical research cycle. Our more significant collaborations are described in the table below.
         
Research Cycle   Discipline/ Technique   Research Company
         
Understanding the disease mechanism and identifying new targets   Functional genomics
(functional analysis of genetic data)
  Affymetrix, CuraGen
Screening the candidate substances
  High-throughput screening
(rapid, automated testing of compounds for potential effectiveness against a given target)
  Axxam
Increasing the pool of potential drug candidates by small-chemical molecules and macromolecules (proteins, peptides)   Pharmacophore informatics Pool of Bayer biomolecules
(for example, monoclonal antibodies and conjugates)
  MetaKey Software Morphosys; Seattle Genetics
      Our collaboration with LION Bioscience was terminated in 2004.
CuraGen
      In 2001, 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

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provided that, during this period, we will share the expenses of pre-clinical and clinical development. Effective October 31, 2005, Bayer and CuraGen revised the agreement in that with respect to BAY 76-7171, CuraGen will no longer contribute to the ongoing development costs and revert to a tiered royalty structure on any BAY 76-7171 product sales.
Product Development Collaborations
      The major collaborations in the area of product development are described below:
Onyx
      Bayer and Onyx are co-developing Nexavar®, a novel Raf Kinase and VEGFR inhibitor that is intended to prevent tumor growth by combining two anti-cancer activities: inhibition of tumor cell proliferation and tumor angiogenesis. This collaboration results in Onyx funding 50 percent of the development costs for this compound except for Japan. In return, Onyx has a 50 percent profit share in the United States, where the companies may co-promote the product. In all markets outside Japan, Bayer has the right to market the product exclusively and will share profits equally with Onyx. In Japan, Bayer will develop and market the product exclusively and Onyx will receive a royalty.
Schering-Plough
      In September 2004, Bayer entered into a strategic alliance with Schering-Plough. The alliance also includes cooperation in life cycle management mainly for Avelox® and Levitra®. See — Markets and Distribution.
GlaxoSmithKline
      Vardenafil, the active ingredient of Levitra®, researched by Bayer, is being marketed in cooperation with GlaxoSmithKline and Schering-Plough in the United States. The cooperation also includes life cycle management. In January 2005, we terminated our Levitra® co-promotion agreement with GlaxoSmithKline in most of the world outside of the United States in order to exercise the marketing rights ourselves.
Johnson & Johnson
      Bayer HealthCare and Ortho-McNeil, a subsidiary of Johnson & Johnson, have concluded an agreement in October 2005 to develop and market BAY 59-7939 (Factor Xa inhibitor) for the prevention and treatment of thrombosis.
In-licensing activities
      We supplement our portfolio of products emerging from our own research and development with in-licensed products, both on a global and a national level. Recent examples are the purchase of the European business for Boehringer Ingelheim’s blood pressure treatment telmisartan (Pritor® and PritorPlus®) from GlaxoSmithKline in January 2006. Also in January 2006, we entered into an agreement with Nuvelo, Inc. for the global development and commercialization of alfimeprase, a novel clot dissolver, which is currently in Phase III development and received “Fast track” status by the FDA in January 2006. Bayer will have the right to market the drug, once approved by the competent authorities, in all countries except the United States.
CONSUMER CARE
Overview
      As further explained in the introduction to — Business, we have changed our segment reporting with effect from January 1, 2005. The former Consumer Care, Diagnostics segment was divided into the Consumer Care segment (identical to the Consumer Care division, consisting of the hitherto existing Consumer Care business and the acquired Roche Consumer Health business) and the Diabetes Care, Diagnostics segment (consisting of our Diabetes Care and Diagnostics divisions). Our Consumer Care segment develops and markets “over-the-counter”

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(OTC) medications (analgesics, cough and cold, dermatological and gastrointestinal remedies), as well as vitamin and nutritional supplements.
      The following table shows the segment’s performance in the last three years. Segment data for 2003 and 2004 have been restated to reflect the presentation of Diagnostics and Diabetes Care as part of a new segment.
                           
    2003   2004   2005
             
    (Euros in millions)
External net sales
    1,403       1,336       2,355  
 
Percentage of total sales
    6.3       5.7       8.6  
Intersegment sales
    7       16       14  
Operating result
    486       183       174  
 
thereof special items(a)
    288       (30 )     (118 )
 
(a)  The significant special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Segment Data.
      The segment’s sales by region for the past three years are as follows. Segment data for 2003 and 2004 have been restated to reflect the presentation of Diagnostics and Diabetes Care as part of a new segment.
                           
    2003   2004   2005
             
    (Euros in millions)
Europe
    387       401       1,019  
North America
    668       616       665  
Asia/Pacific
    56       40       132  
Latin America/ Africa/Middle East
    292       279       539  
                   
 
Total
    1,403       1,336       2,355  
                   
      The following table shows our sales during the past three years from the products that account for the largest portion of segment sales.
                                                   
    2003   2004   2005
             
        Percentage       Percentage       Percentage
        of Segment       of Segment       of Segment
Product   Sales   Sales   Sales   Sales   Sales   Sales
                         
    (Euros in       (Euros in       (Euros in    
    millions)       millions)       millions)    
Aspirin®(a)
    463       33.0       454       34.0       453       19.2  
Aleve®/Naproxen(b)
    88       6.3       90       6.7       178       7.6  
Canesten®
    135       9.6       140       10.5       145       6.2  
Supradyn®(c)
                            125       5.3  
One-A-Day®
    130       9.3       127       9.5       118       5.0  
Other
    587       41.8       525       39.3       1,336       56.7  
                                     
 
Total
    1,403               1,336               2,355          
                                     
 
(a) CardioAspirin is also distributed by our Pharmaceuticals division. These figures do not include sales by the Pharmaceuticals division.
(b) As the product Aleve® was part of the former U.S. joint venture with Roche, sales figures for 2003 and 2004 only represent the Bayer portion of the joint venture’s sales. 2005 sales figures represent total sales of the product after the acquisition of the remaining 50 percent of the U.S. joint venture. Naproxen is the active ingredient included in products marketed in the United States under the brand Aleve® and in other countries using different local brands, the latter having been acquired as part of Roche’s Consumer Health business in 2005.
(c) Acquired as part of Roche’s Consumer Health business in 2005.

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Segment Strategy
      The objective of our Consumer Care division is to further consolidate our strong global position in the Consumer Health market.
      Building on our successful acquisition and integration of the Roche Consumer Health business, the key element of our strategy is to exploit organic growth potential within our significant Consumer Health categories by leveraging the strength of our well-known brands (including Aspirin®, Supradyn®, One-A-Day®, Canesten® and Bepanthen®), as well as through cross-fertilization of the Bayer/ Roche portfolios, portfolio prioritization and a focus on marketing.
      We also intend to drive growth in high growth regions of the world (such as Eastern Europe and Asia-Pacific) and develop business in new and emerging growth areas. We will also pursue external growth opportunities through acquisitions and licensing with appropriate strategic fit.
Major Products
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 Consumer Health products face competition from prescription drugs, for example cyclooxygenase (COX-II) inhibitor pain relievers and prescription non-steroidal anti-inflammatory drugs (NSAIDs).
      Aspirin® (Bayer® brand aspirin in the United States) is a non-steroidal anti-inflammatory drug (NSAID). It is used for pain relief and, in countries where so indicated, for the prevention of heart attacks. Aleve® (also known as Flanax® and Apronax® in some Latin American countries) is a nonprescription strength version of the analgesic naproxen sodium. Aleve® is a long-lasting pain reliever and can be used for fever reduction. Our Midol® product family competes in the menstrual pain relief category.
CardioAspirin (see — Pharmaceuticals, Biological Products — Major Products)
      CardioAspirin (e.g., Aspirin® Protect in Germany and Aspirin Regimen Bayer in the United States) refers to Bayer’s collective group of products (distributed by both our Consumer Care and Pharmaceuticals divisions depending on whether local regulations require a prescription for these products) 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).
Cough/Cold
      Within the total cough and cold market, we concentrate on the cold/flu remedy segment. This Consumer Health category faces competition from “non-medicinal” remedies (for example, nutritional or herbal products), as well as from preventive medicines available by prescription or under development.
      Alka-Seltzer Plus®, marketed in the United States, is a product to relieve symptoms accompanying the common cold. Tabcin®, primarily marketed in Latin America, is a product line similar to Alka-Seltzer Plus®. Aleve® Cold & Sinus is a 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, wound healing and skin protection categories. Competition in topical dermatologicals ranges from prescription antifungal products to cosmetic emollients and locally marketed generic products and low priced brands.

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      Canesten® is a treatment for vaginal yeast infections, athlete’s foot and other dermatological fungal problems. Rid® is a topical head lice treatment marketed only in the United States. Bepanthen® is a topical wound healing brand with a sister brand — Bepanthol® — which is a skin protectant and emollient. These were both acquired in the Roche Consumer Health acquisition.
Gastrointestinals
      The gastrointestinal (GI) category includes antacids, anti-gas products, digestives, laxatives and anti-diarrheals.
      Alka-Seltzer® is used for speedy relief of acid indigestion, sour stomach or heartburn with headache, or body aches and pains. 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. Rennie® relieves symptoms of indigestion and is typically marketed directly to the consumer. Talcid® is used for the relief of symptoms from heartburn and acid indigestion.
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 Consumer Health products. Bayer’s primary interests in the nutritionals field are in the vitamin and mineral (especially multi-vitamins/ minerals) areas.
      One-A-Day® multivitamins offer a variety of special formulations, such as Men’s, Women’s, 50 Plus, Maximum, Essential and WeightSmarttm formulas. Flintstones® are multivitamin dietary supplements containing (depending on type) 10-19 essential nutrients for children ages 2-12.
      Major vitamin/ mineral brands acquired in the Roche Consumer Health acquisition include Supradyn® (a multi vitamin/ mineral brand), Redoxon® (a vitamin C brand), and Berocca® (a higher potency supplement).
      In 2005, we launched various line extensions to our existing brands.
Markets and Distribution
      Our Consumer Care division focuses on the Consumer Health market for medicinal products that consumers may generally purchase without a prescription.
      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, drugstores and other mass marketers. In Europe, however, pharmacies are the usual distribution channel.
      Consumer Care procures some high-volume raw materials internally from within Bayer HealthCare. Our major externally procured high-volume raw materials are ascorbic acid, citric acid, paracetamol sodium citrate and tartaric 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 phenol, a basic material for our major ingredient acetylsalicylic acid, and aluminum foil. We diversify our raw materials sources internationally to help balance business risk and generally seek long-term contracts with contract manufacturers. At the moment our major contract manufacturer is F. Hoffmann La Roche, Basle, with whom we have signed a global framework supply agreement as well as a global framework toll manufacturing agreement.
      We regard the following companies as our main competitors:
  •  analgesics: Johnson & Johnson, Bristol-Myers Squibb and Wyeth;
 
  •  cough and cold products: Pfizer, Schering Plough and Novartis;
 
  •  dermatological products: Johnson & Johnson, Pfizer and Novartis;

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  •  gastrointestinal products: Procter & Gamble, Johnson & Johnson and GlaxoSmithKline; and
 
  •  vitamins: Wyeth and Merck KGaA.
Research and Development
      Consumer Care focuses its development activities on identifying, developing and launching products and initiatives that 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 those for which a prescription is required to those dispensed over-the-counter.
      The division’s primary research and development facilities are located in Morristown, New Jersey and Gaillard, France.
DIAGNOSTICS, DIABETES CARE
Overview
      As further explained in the introduction to — Business, we have adjusted our segment reporting with effect from January 1, 2005. We have restated the segmented financial data for 2003 and 2004 to reflect the new structure. The former Consumer Care, Diagnostics segment was divided into the Consumer Care segment and the Diagnostics, Diabetes Care segment (the latter consisting of our Diagnostics and Diabetes Care divisions).
      The following table shows the Diagnostics, Diabetes Care segment’s performance in the last three years.
                           
    2003   2004   2005
             
    (Euros in millions)
External net sales
    1,933       1,975       2,151  
 
Percentage of total sales
    8.6       8.5       7.9  
Intersegment sales
    0       1       1  
Operating result
    115       217       274  
 
thereof special items(a)
    (20 )     0       34  
 
(a)  The significant special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Segment Data.
      The segment’s sales by region for the past three years are as follows:
                           
    2003   2004   2005
             
    (Euros in millions)
Europe
    735       785       848  
North America
    836       824       893  
Asia/Pacific
    246       249       277  
Latin America/ Africa/Middle East
    116       117       133  
                   
 
Total
    1,933       1,975       2,151  
                   

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      The following table shows our sales during the past three years by division:
                           
Division   2003   2004   2005
             
    (Euros in millions)
Diagnostics
    1,308       1,322       1,433  
Diabetes Care
    625       653       718  
                   
 
Total
    1,933       1,975       2,151  
                   
      The following table shows our sales during the past three years from the products that account for the largest portion of segment sales.
                                                   
    2003   2004   2005
             
        Percentage of       Percentage of       Percentage of
Product   Sales   Segment Sales   Sales   Segment Sales   Sales   Segment Sales
                         
    (Euros in       (Euros in       (Euros in    
    millions)       millions)       millions)    
Ascensia®
    578       29.9       627       31.7       701       32.6  
Advia Centaur®
    387       20.0       441       22.3       512       23.8  
Rapidlab®/Rapidpoint®
    154       8.0       153       7.7       163       7.6  
Clinitek® Urinalysis
    156       8.1       147       7.4       152       7.1  
Advia Hematology®
    117       6.0       130       6.6       141       6.6  
Other
    541       28.0       477       24.3       482       22.3  
                                     
 
Total
    1,933               1,975               2,151          
                                     
Segment Strategy
Diagnostics
      The objective of the Diagnostics division is to be a global leader in the markets in which we compete and to pursue above-market profitability growth by being the preferred supplier for clinical laboratories.
      Our strategy to achieve this objective is to focus our resources and investments in our high-growth business areas of Immunoassay, Clinical Chemistry, Molecular Testing as well as Lab Automation.
      We aim at
  •  focusing on growth in market segments that offer the greatest opportunity;
 
  •  expanding to reach new groups of customers with our existing products while investing in fast growing markets such as Asia Pacific; and
 
  •  building customer loyalty by delivering cost efficient systems solutions across all groups of customers we serve.
Diabetes Care
      The Diabetes Care division’s objective is to realign its core business of blood glucose monitoring (patient testing) to create a sustainable competitive advantage in the Diabetes Monitoring and Management market while allowing Diabetes Care to profitably grow market share.
      To achieve our overall goal in the Diabetes Care division, we are expanding our product offering by developing second and third generations of meters and strips that are more intuitive and easier to use, resulting in glucose testing with minimal pain for diabetic patients. We intend to target our marketing efforts in order to direct customers to improved versions of our meters and to increase our competitiveness through continuous improvement of our products, reductions in our costs and operational efficiencies. We also plan to realign our research and development activities and investments. To support our objectives, we intend to continue to develop our strategic partnerships in desired areas of expertise to complement our in-house strengths.

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Diagnostics
Overview
      The Diagnostics division is headquartered in Tarrytown, New York. We support customers with an extensive product portfolio of instruments and assays for the Central Clinical Laboratory, Near Patient Testing, Molecular Testing and Home Healthcare. All our products are used to serve patients in the health and the home health care sector.
Major Products
Central Laboratory Testing
      The Advia® family of products is the centerpiece of our Central Laboratory Testing portfolio, which provides a wide range of solutions for the laboratory. Advia® products include medium- and high-throughput systems for immuno-diagnostics (the measurement of such substances as proteins, steroids, drugs and antibodies in patients’ blood), clinical chemistry, hematology and other diagnostic disciplines. The main analytical systems include Advia Centaur®, Advia Centaur® CP and Advia® 1650. Through our LabCell®, WorkCelltm and CentraLink® products, we provide a broad range of automation and laboratory integration solutions. We are enhancing the attractiveness of our clinical laboratory testing portfolio by introducing new instrument systems and expanding the menu of assays available to the customer.
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 with its newest addition, the Rapidlab® 1200 analyzer, a high throughput, low-maintenance instrument 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. We also offer the DCA 2000®+ system that provides diagnostic tests for diabetes and kidney disease management.
Molecular Testing
      Molecular testing offers a significant virology infectious disease portfolio including quantitative analysis, 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, Hepatitis B and Hepatitis C. Molecular techniques detect nucleic acids such as DNA and RNA to allow for effective treatment of infectious and other diseases.
Home Healthcare
      Together with Matsushita Electric Industrial Co. Ltd. we established the subsidiary Viterion TeleHealthcare LLC, which markets products and services for the telemedicine sector. Main products are the Viteriontm 100 TeleHealth Monitor, a compact home health care monitor and the Viteriontm 500 TeleHealth Monitor, a comprehensive home health care monitor.

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      Products launched in 2005 include the following:
         
Product/ Brand Name   Principal application   Status(a)
         
Advia Centaur® menu expansion
  Eight new infectious disease assays launched (HCV, HAV IgM & Total, HBc IgM, anti-HBs & HBc Total, HBsAg and HBsAg Confirmatory). Two additional claims for BNP.   Launched throughout 2005
Advia® 1650 and Advia® 2400 menu expansion
  Nine new drugs-of-abuse assays (cannabinoid (thC), opiate (300 & 2000), benzodiazepine, methadone, phencyclidine, propoxyphene, cocaine, amphetamine and barbiturate).   Launched throughout 2005
Rapidlab® 1200
  High throughput, bench-top analyzer   Launched in July 2005
Advia Centaur® CP
  Medium throughput, bench-top immunoassay analyzer   Launched in November 2005
 
(a)  The term “throughout” refers to the fact that there are various versions of the 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 both directly and through a network of distributors. Our principal markets are North America, Western Europe and Japan.
      Diagnostics division sales are typically lower in the first quarter, but show a slightly stronger performance in the fourth quarter.
      We market our Central Laboratory and Molecular Testing 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 market our Home Healthcare products directly to home health care agencies, disease management companies and the various governmental agencies.
      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, for example antigens and blood chemistry systems, for the Advia® systems. If these were to become unavailable, the division’s results of operations would be impacted. In these instances, we maintain strategic reserves of selected direct materials or finished products to avoid interruptions in our customers’ continuous and reliable supply.
      Our primary competitors are:
  •  Central Laboratory Testing: Roche, Abbott, Beckman Coulter, Dade Behring and Ortho Clinical Diagnostics;
 
  •  Molecular Testing: Roche, Abbott and Gen-Probe;
 
  •  Near Patient Testing: Roche, Radiometer, Abbott, Ortho Clinical Diagnostics and Biosite;
 
  •  Home Healthcare: Alere Medical, AMD Telemedicine, American TeleCare, Cardiocom, Cybernet Medical, Health Hero Honeywell HomMed, iMetrikus, Philips Medical Systems.

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Research and Development
      Our Diagnostics division focuses its research and development activities primarily on strengthening its core product lines and on developing products in the fast growing molecular markets:
  •  in Central Laboratory Testing, through development of the Advia® family of systems and in the expansion of assays in growth areas;
 
  •  in Molecular Testing, through menu expansion of assays for infectious disease and automation;
 
  •  in Near Patient Testing, through enhancements of our DCA 2000®+ analyzer and through expansion of the immunoassay menu on the Clinitek Status® analyzer.
      The division’s primary research and development facilities are located in the United States: Tarrytown, New York; Edgewater, Cambridge and Walpole, Massachusetts and Berkeley, California.
      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, the products we expect to launch during the periods indicated below include:
         
Product/ Brand Name   Principal Application   Status(a)
         
Advia Centaur® and Advia Centaur® CP menu expansion
  Menu expansion for infectious disease, autoimmune, transplant drug monitoring, allergy and cardiovascular disease.   Launches planned throughout 2006
Advia® 1800
  Fully automated chemistry analyzer with 1800 test throughput per hour   Launch planned in 2006
Versant® 440
  Complete viral-load molecular system   Launch planned in 2006
Advia Centaur® XP
  Next generation high throughput immunoassay system   Launch planned in 2006
 
(a)  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 in” refers to a single product.
      In September 2005, we signed a semi-exclusive license agreement with CIS Biotech, Inc., which will allow us to collaborate and commercialize automated serum assays for stroke testing.
      In November 2005, we signed four agreements with Inverness Medical Innovations to broaden our assay menu offerings worldwide in the diagnostics arena. Two assays aid in improving early diagnosis of congestive heart failure, one assay assists in the early evaluation of acute coronary syndrome and the fourth agreement grants Bayer rights to hybridoma cell line capable of producing monoclonal antibodies against the envelope protein of the Hepatitis B virus.
      Both the agreement with peS Gesellschaft fuer medizinische Diagnosesysteme mbH & Siemens Medical Solutions and the agreement with Amersham Biosciences Corp. were discontinued.
Diabetes Care
Overview
      The Diabetes Care division is headquartered in Elkhart, Indiana and is a midsize Diabetes Care competitor. In November 2005, the division announced to move the headquarters to Tarrytown, New York during the year 2006. We support customers by delivering innovative products and services that empower people with diabetes to improve their quality of life.

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Major Products
      In the Diabetes Care division, we continue to expand the Ascensia® brand by introducing several new blood glucose monitoring products. Our key products include two platforms, the multi test platform and the single test strip platform. Our family of multi test products include Ascensia® Breeze®, Ascensia® Confirm, Ascensia® Dex® and Ascensia® Esprit. These products incorporate a 10-test disc to provide greater convenience to patients who test their blood sugar levels several times per day. Our family of single strip products includes the Ascensia Elite®, Ascensia Brio®, Ascensia® Entrust and Ascensia® Contour® with its no coding feature for greater convenience and accuracy. This platform serves a wide spectrum of patient needs.
Markets and Distribution
      We channel our Diabetes Care products to the consumer market through distributors and large pharmacy and retail chains. Our principal markets are North America, Western Europe and Japan.
      Diabetes Care sales are typically lower in the first half of the year, but show a slightly stronger performance in the second half.
      Our single manufacturing facility of Diabetes Care is located in Mishawaka, Indiana. We manufacture and/or assemble approximately one third (by units) of our own products with the balance coming from OEM suppliers. We rely on a supplier management process to supply raw materials, sub-assemblies and finished goods, of which most are contractually controlled and are not subject to significant changes in price or availability.
      We do require some direct or Original Equipment Manufacturer (OEM) materials that would impact our results of operations if they were to become unavailable. These materials include, for in-house manufacturing, customized integrated circuits and sensors for the Ascensia® strips. 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 the majority of materials and products being sourced from South-East Asia.
      Our primary competitors in the diabetes care market are: Roche Diagnostics, Lifescan (a Johnson & Johnson company) and Abbott Diagnostics.
Research and Development
      Our Diabetes Care 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. We achieve this through internal development and OEM of mass market, user-friendly whole blood glucose monitoring systems and by focusing research on a minimally invasive system, requiring only a small blood sample and having a short testing time, coupled with the convenience of no test strip handling. We are also investing in technologies that will allow glucose monitoring without painful invasive sampling of body fluids.
      The division’s research and development facility is located in the United States in Elkhart, Indiana. In November 2005, the division announced its intention to move the facility to Tarrytown, New York during the year 2006.
      In 2004 and 2005, we continued to launch several new Ascensia® systems. During 2006, our research and development will continue the support of these newer systems and also will be developing next generation systems that we intend to introduce in 2007 and thereafter.
      We continue to maintain a licensing agreement with Sontra Medical Corporation for their continuous non-invasive glucose monitoring technology, which includes worldwide rights to intellectual property relating to obtaining glucose readings using ultrasonic techniques.

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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 Food Animal Products and Companion Animal Products. This range of products is supplemented by a line of farm hygiene products as well as cosmetic care products.
      The following table shows the segment’s performance for the last three years.
                           
    2003   2004   2005
             
    (Euros in millions)
External net sales
    790       786       856  
 
Percentage of total sales
    3.5       3.4       3.0  
Intersegment sales
    6       4       8  
Operating result
    172       157       179  
 
thereof special items(a)
    22       0       7  
 
(a)  The significant special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Segment Data.
      The Animal Health segment sales by region for the past three years are as follows:
                           
    2003   2004   2005
             
    (Euros in millions)
Europe
    242       245       252  
North America
    305       295       314  
Asia/Pacific
    122       120       141  
Latin America/ Africa/Middle East
    121       126       149  
                   
 
Total
    790       786       856  
                   
      The following table shows our sales during the past three years for the two business units.
                           
    2003   2004   2005
             
    (Euros in millions)
Food Animal
    383       375       394  
Companion Animal
    407       411       462  
                   
 
Total
    790       786       856  
                   
      2005 sales of the segments’ material products were 249 million for the Advantage® (including Combi)/K9 Advantix® product family (representing 29.1 percent of total segment sales; compared to 206 million, or 26.2 percent, in 2004 and 196 million, or 24.8 percent, in 2003) and 163 million for Baytril® (representing 19.0 percent of total segment sales; compared to 160 million, or 20.4 percent, in 2004 and 170 million, or 21.5 percent, in 2003). Apart from these two products, no product of this segment accounted for more than 12 percent of total segment sales in 2005, 2004 or 2003.
Segment Strategy
      Animal Health aims to be a worldwide leading competitor in the Food Animal 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 countries and markets. Furthermore, Animal Health pursues a policy of organic growth by exploiting existing core brands through life cycle management activities supported by new business development activities. To complete our existing product portfolio, Animal Health periodically evaluates the possibility of acquisitions or

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strategic alliances. The Animal Health segment collaborates closely with our Pharmaceuticals division and the Bayer CropScience subgroup 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
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 for dogs.
      Advantage® is a flea control product in an easy-to-use, spot-on application form for dogs and cats.
      The Droncit® and Drontal® product family offers solutions for the control of tapeworm and roundworm for dogs and cats.
      Bayticol® is a topical product against major tick species that attack livestock animals.
      Baycox® is a product for controlling coccidiosis in poultry and in piglets.
Antimicrobials
      The Baytril® family is our line of fluoroquinolone antimicrobials for the treatment of severe bacterial infections in animals.
Biologicals
      These products consist of vaccines covering Foot-and-Mouth Disease (FMD-vaccines) for livestock animals.
Nutritionals
      These are premixes or feed additives, e.g., vitamins, minerals and others, to support our business model with proprietary products like Baytril® and Baycox®.
Farm Hygiene
      Integrated into our Food Animal Products 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 the Bayer CropScience subgroup 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 animals, and marketing for companion animals including horses.
      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 worldwide. We obtain additional ingredients and packaging materials from diverse suppliers on a worldwide basis. As a rule, we approve our suppliers for each required material. We take measures in order to assure continuous product supply and to reduce the effects of price

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volatility. This includes entering into long-term contracts or building strategic reserves of the material in question.
      Our main pharmaceutical production facilities devoted to formulation and packaging of our products for shipment are Kiel, Germany and Shawnee, Kansas.
      Merial, Pfizer and Intervet are our main competitors, with Merial and Pfizer being active in both companion and livestock animal products and Intervet concentrating mainly on food animal products. The global animal health market is characterized by market consolidations and increasing competitive pressure from generic products.
Research and Development
      The Animal Health segment focuses its research and development activities on antimicrobials, parasiticides and active ingredients useful for the treatment of non-infectious diseases such as renal failure, pain management, oncology and congestive heart failure. 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 or they are subject to regulatory approval. We expect to launch these products between 2006 and 2010. Major 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   Submitted
Baycox® calves
  Coccidiosis control in calves   In registration
Baytril® swine (North America)
  Antimicrobial infections in pigs   In registration
Pradofloxacin
  Antimicrobial for dogs and cats   In clinical development, two formulations in EU already submitted
Renal failure and congestive heart failure
  Non-infectious diseases in dog and cats   Clinical development started
BAYER CROPSCIENCE
      As described under the introduction to — Business, we have changed our segment reporting with effect from January 1, 2005 in compliance with IAS 14 (Segment Reporting). The former CropScience segment is now split into the Crop Protection and the Environmental Science, BioScience segments. The segmented financial data for 2003 and 2004 have been restated to reflect the new structure.
CROP PROTECTION
Overview
      Our Crop Protection segment markets chemical crop protection products for the control of insects, weeds and plant diseases and develops products for enhanced effectiveness against these target pests.

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      The following table shows Crop Protection’s performance for the last three years.
                           
    2003   2004   2005
             
    (Euros in millions)
External net sales
    4,801       4,957       4,874  
 
Percentage of total sales
    21.4       21.3       17.8  
Intersegment sales
    62       71       70  
Operating result
    242       386       532  
 
thereof special items(a)
    (70 )     (42 )     7  
 
(a) The significant special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Segment Data.
      Crop Protection’s sales by region and totals for the past three years are as follows.
                           
    2003   2004   2005
             
    (Euros in millions)
Europe
    1,945       1,898       1,901  
North America
    919       979       1,076  
Asia/Pacific
    863       820       811  
Latin America/ Africa/Middle East
    1,074       1,260       1,086  
                   
 
Total
    4,801       4,957       4,874  
                   
      The following table sets forth Crop Protection’s sales for the last three years, broken down by category of activity.
                           
    2003   2004   2005
             
    (Euros in millions)
Insecticides
    1,376       1,378       1,311  
Fungicides
    1,168       1,277       1,248  
Herbicides
    1,848       1,855       1,840  
Seed Treatment
    409       447       475  
                   
 
Total
    4,801       4,957       4,874  
                   

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      The following table shows the segment’s sales by major products(1) during the past three years.
                                                   
    2003   2004   2005
             
        Percentage of       Percentage of       Percentage of
Product   Sales   Segment Sales   Sales   Segment Sales   Sales   Segment Sales
                         
    (Euros in       (Euros in       (Euros in    
    millions)       millions)       millions)    
Confidor®/ Gaucho®/Admire®(a)(b)
(Insecticides/ Seed Treatment)
    467       9.7       455       9.2       444       9.1  
Folicur®/ Raxil®(a)
(Fungicides/ Seed Treatment)
    310       6.5       401       8.1       327       6.7  
Basta®/ Liberty®(a) (Herbicides)
    153       3.2       189       3.8       212       4.3  
Puma®(a) (Herbicides)
    226       4.7       226       4.6       202       4.1  
Flint®/Stratego®/Sphere® (a)
(Fungicides)
    190       4.0       235       4.7       188       3.9  
Atlantis®/Mesomaxx® (Herbicides)
    58       1.2       97       2.0       142       2.9  
Betanal®(a) (Herbicides)
    142       3.0       143       2.9       127       2.6  
Poncho® (Seed Treatment)
    19       0.4       57       1.1       110       2.3  
Temik® (Insecticides)
    90       1.9       109       2.2       104       2.1  
Fenikan®(a) (Herbicides)
    105       2.2       104       2.1       101       2.1  
Other
    3,041       63.2       2,941       59.3       2,917       59.9  
                                     
 
Total
    4,801               4,957               4,874          
                                     
 
(a) The main active ingredients contained in these products are also used in products sold by the Environmental Science business group.
 
(b) The active ingredient imidacloprid contained in these products is also used in the Animal Health segment’s Advantage® product. These figures do not include sales by the Animal Health segment.
Segment Strategy
      Crop Protection aspires, together with Bayer CropScience’s Environmental Science, BioScience segment, to be a leading partner for the production of quality food, feed and fiber. Our mission is to become the world’s leading provider of products and combined solutions for agriculture. We strive to build long-term, consistent, predictable and mutually beneficial partnerships with our customers and stakeholders. We aim to fulfill our commitment to sustainable development and to achieve long-term profitable growth.
      Key factors in achieving our profitability targets are new product launches, further portfolio streamlining and focus on cost management. Our “Challenge 2007” cost savings and process improvement initiative should further enhance efficiency in all areas of Bayer CropScience by improving internal business processes.
      With its Crop Protection business, Bayer CropScience strives to maintain its leading position in the crop protection industry (based on sales)(2) by utilizing its broad regional representation and a well-balanced portfolio comprising innovative, high-performance insecticides, fungicides, herbicides and seed treatment products.
      We attempt to achieve these strategic objectives through the continuous introduction of new products from our research and development pipeline, our life cycle management and the complementary activities of our Environmental Science and BioScience businesses.
 
(1)  The amounts shown represent sales by main active ingredient group; for the sake of clarity, however, only the principal brands are listed.
(2)  This statement is based on 2004 and first half 2005 data published in AgriFutura, The newsletter of Phillips McDougall-Agriservice, No. 65 (March 2005) and No. 70 (August 2005); data for the full year 2005 have not yet been published.

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Major Products
Insecticides
      Imidacloprid (major brands: Confidor®, Admire®) 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 100 countries for use on numerous important crops.
      Aldicarb (major brand: 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.
      Deltamethrin (major brand: Decis®) is a broad-spectrum pyrethroid insecticide. It is used primarily against chewing and biting insects, and 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).
Fungicides
      Tebuconazole (major brand: Folicur®) is a broad-spectrum fungicide sold in about 100 countries and effective in more than 90 crops. Folicur® is especially effective against Fusarium and rusts (in particular, soybean rust) as well as many other fungal diseases in cereals and is available in many liquid or solid formulations adapted to our customers’ needs.
      Trifloxystrobin (major brand: Flint®), the active ingredient of the Flint® product family, is sold in more than 80 countries. The product range consists of solo products and several co-formulations (e.g. Sphere®, Stratego®, Nativo®), all tailor-made to meet the specific requirements of highly diverse crop production systems under various climatic conditions. These products feature crop safety, broad-spectrum disease control and beneficial physiological effects on yield, quality and shelf life of fruit and grain.
      Prothioconazole (major brand: Proline®) is a broad-spectrum fungicide for use in cereals, canola (oilseed rape), peanuts, soybeans and field vegetables, which provides long-term protection by means of a uniform and stable distribution in the leaves. Products containing prothioconazole are effective against stem-based diseases, leaf diseases, especially Septoria tritici, as well as ear diseases (Fusarium spp) in cereals.
Herbicides
      Glufosinate-Ammonium (major brand: Basta®), Bayer CropScience’s best selling herbicide, 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. The product is also applied on herbicide-tolerant crops in Canada and the United States (Liberty®).
      Fenoxaprop-P-ethyl (major brand: Puma®) is used in more than 75 countries and is one of the leading products used worldwide against grass weeds in cereals. It is also used in rice, soybeans and canola and controls grass weed problems under a wide range of conditions.
      Mesosulfuron-methyl (major brands: Mesomaxx®, Atlantis®) belongs to the latest generation of safened cereal herbicide sulfonylureas. These products offer a broad and consistent grass control performance in global wheat production. Our ongoing development of new mesosulfuron-methyl combinations (major brands: Alister®, Olympus® Flex) is expected to continue to position Bayer CropScience as one of the leaders in cereal herbicides.
Seed Treatment
      The insecticidal active ingredient imidacloprid (major brand: Gaucho®) is Bayer CropScience’s best selling seed treatment product. It is marketed in over 70 countries for the treatment of early season pests and soil and leaf pests in key crops such as sugarbeet, corn, cereals and cotton.

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      Clothianidin (major brand: Poncho®) is an active ingredient in the chemical class of neonicotinoids, jointly developed by Sumitomo Chemical Takeda Agro Co. Ltd. and Bayer CropScience AG. The active ingredient was developed primarily for the control of the major soil and early season pests in corn, sugarbeet, canola (oilseed rape), sunflower and cereals.
      Tebuconazole (major brand: Raxil®) is registered in our most important markets worldwide as a seed treatment to control seed and soil-borne diseases in cereals.
Markets and Distribution
      Europe has traditionally been our strongest market in Crop Protection, accounting for nearly 40 percent of our sales in this segment in 2005. Due to the fact that the major part of Bayer CropScience’s Crop Protection business is realized in the northern hemisphere, the business is affected by the seasonality of the various crop and distribution cycles.
      Crop Protection obtains a significant part of its raw materials from LANXESS, as well as from other non-Bayer companies, but also obtains part of its raw materials from within the Bayer Group. Some raw materials can be subject to price volatility caused by fluctuations in the price of oil or energy or transport costs.
      Generally, 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.
      Our main competitors in the Crop Protection business are Syngenta, BASF, Dow AgroSciences, Monsanto and DuPont.
Research and Development
      Crop Protection Research and Development operates major facilities on three continents: Monheim (headquarters) and Frankfurt, Germany; Lyon and Sophia Antipolis, France; Stilwell, Kansas and Raleigh, North Carolina; and Yuki City, Japan.
      While research is concentrated in specialized sites, development activities range from central facilities to field testing stations across the globe, enabling product testing in the relevant geographical areas.
      Crop Protection Research and Development is responsible for the identification and development of innovative, safe and economically sustainable solutions in crop protection. Research covers activities to identify new active ingredients that can be developed as insecticides, fungicides or herbicides. In addition to classical chemistry, biology and biochemistry, modern technologies such as combinatorial chemistry, ultra-high-throughput-screening, genomics and bioinformatics play an important role in the identification of new lead structures. Collaborations with third parties supplement our internal research activities.
      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 after having obtained the required regulatory approvals.
      We actively support our products through continuous life cycle management. This includes the development of new formulations for existing active ingredients and products, e.g., expanding their applicability to additional crops or improving handling and facilitating application of the product.

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      The following new active ingredients were launched in 2004/2005 or are expected to be launched by Crop Protection in 2006, subject to regulatory approval.
         
New active ingredients   Product Family   Status
         
Fluoxastrobin
  Fungicides   Launched in 2004/2005(a)
Spiromesifen
  Insecticides   Launched in 2004/2005(a)
Ethiprole
  Insecticides   Launched in 2005
Fluopicolide
  Fungicides   Launch expected in 2006
 
 
  (a)  This active ingredient was first registered in a key market at the end of 2004, whereas its first significant sales were generated in 2005.  
      Fluoxastrobin is a leaf-systemic, broad-spectrum strobilurin with curative and protective properties. Products containing fluoxastrobin will be used for foliar (major brand: Fandango®) and seed treatment applications (Bariton®, Scenic®) in cereals, potatoes, vegetables, peanuts and other crops.
      Spiromesifen (major brand: Oberon®) belongs to a new chemical class named tetronic acids. Oberon® is a new insecticide/ miticide for foliar application in annual crops, offering protection primarily against all important whitefly, mite and psyllid species. Oberon® has been developed for worldwide use on vegetables, fruits, cotton, corn, beans, tea and some ornamentals.
      Ethiprole (major brands: Curbix® and Kirappu®) belongs to the family known as phenyl pyrazoles. It is effective against a wide range of biting-and-chewing and piercing-and-sucking insects, for example, thrips, stink bugs, plant hoppers and aphids. The main crops are rice, tea and fruits.
      Fluopicolide (major brand: Infinito®) belongs to a new chemical class named acylpicolides. Products containing this novel chemical compound have been developed for use to control oomycete diseases in potatoes, vegetables and ornamentals. The new mode of action should enable farmers to control oomycete diseases that are resistant to standard fungicides.
ENVIRONMENTAL SCIENCE, BIOSCIENCE
Overview
      The two business groups Environmental Science and BioScience together form the Environmental Science, BioScience segment.
      The following table shows the segment’s performance for the last three years.
                           
    2003   2004   2005
             
    (Euros in millions)
External net sales
    963       989       1,022  
 
Percentage of total sales
    4.3       4.2       3.7  
Intersegment sales
    14       7       13  
Operating result
    100       106       158  
 
thereof special items(a)
    (11 )     12       (2 )
 
 
  (a)  The significant special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Segment Data.  

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      The segment’s sales by region and totals for the past three years are as follows:
                           
    2003   2004   2005
             
    (Euros in millions)
Europe
    351       340       340  
North America
    420       433       452  
Asia/Pacific
    100       107       122  
Latin America/Africa/Middle East
    92       109       108  
                   
 
Total
    963       989       1,022  
                   
      The following table sets forth the segment’s sales for the last three years, broken down by category of activity.
                           
    2003   2004   2005
             
    (Euros in millions)
Environmental Science
    692       678       694  
BioScience
    271       311       328  
                   
 
Total
    963       989       1,022  
                   
      2005 sales of the segments’ material products(3) were 143 million for Merit®/Premise® (representing 14.0 percent of total segment sales; compared to 148 million, or 15.0 percent, in 2004 and 123 million, or 12.8 percent, in 2003) and 68 million for K-Othrine® (representing 6.7 percent of total segment sales; compared to 66 million, or 6.7 percent, in 2004 and 56 million, or 5.8 percent, in 2003). Apart from these two products, no product of this segment accounted for more than 5 percent of total segment sales in 2005, 2004 or 2003.
Segment Strategy
      The segment Environmental Science, BioScience complements Bayer CropScience’s Crop Protection segment by addressing specific market needs. Environmental Science capitalizes on Crop Protection’s development and production facilities and its pipeline of new active ingredients. BioScience leverages on the Crop Protection’s customer base and biological competency in bringing seeds and plant biotechnology products to the market.
      Environmental Science is among the leading suppliers for non-agricultural pest control solutions worldwide (in terms of sales)(4). Our strategy is to strengthen our market position by developing and marketing quality products and providing solutions with health or hygiene benefits or that will allow growth of healthier plants and lawns. Our objective also includes the development of strong partnerships with our customers and the focus on “proximity innovations,” the ability to offer customized brand-connected solutions.
      BioScience is internationally active in the research, development and marketing of seeds and solutions derived from plant biotechnology and breeding. We bring to the market seeds and agronomic traits in vegetables, canola, cotton and rice and plant-based solutions for agriculture and industrial use. Our strategic approach comprises three business fields: In Agricultural Crops, we focus on delivering seeds and crops with improved performance and productivity, particularly in respect of our three core crops. In New Business Ventures, we are developing plant-derived materials for applications in fields such as health, biomaterials and nutrition. In the Vegetables field, where we believe that the Nunhems unit of BioScience is among the leading developers and suppliers of high quality vegetable seed varieties, we intend to pursue growth opportunities.
 
(3)  The amounts shown represent sales by main active ingredient group; for the sake of clarity, however, only the principal brands are listed.
(4)  This statement is based on 2004 data published in the Cropnosis report Industry performance Agchems&Agbiotech 2004-05 (September 2005).

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Environmental Science
Overview
      Environmental Science serves non-agricultural professional and consumer markets worldwide, by developing and marketing 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.
Major Products
      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 (major brands: K-Othrine®, Deltagard®), 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, fipronil or imidacloprid. Maxforce®’s range of products includes a large number of insecticides controlling crawling insects.
      Our consumer-branded products intended for sale to non-professional users and leisure gardeners are marketed under the umbrella brands Bayer Advanced® in the United States and Bayer Garden® in Europe.
Markets and Distribution
      Environmental Science’s business is subject to seasonality. This seasonality is particularly pronounced for the consumer branded lawn and garden business, which represents approximately 25 percent of segment sales, with its peak season usually running from January through May.
      Environmental Science obtains a significant part of its raw materials from within the Bayer Group, but also enters into agreements with non-Bayer companies. Some raw materials may be subject to price volatility caused by fluctuations in the price of oil or energy or transport costs.
      Our products are sold in the professional and consumer markets. For professional markets, products are sold to the pest control industry, the green industry and the public health and rural hygiene sectors. In the consumer business, lawn and garden products are sold to consumers through specialized distribution channels. Active ingredients are sold to marketers of household products.
      Dow AgroSciences, Syngenta, BASF and Scotts are our main competitors in the overall Environmental Science business.
Research and Development
      The molecules discovered by Crop Protection Research are also tested and evaluated in Environmental Science for potential development. Molecules from other companies may be tested and purchased if suitable. Development projects include passive treatments (gels, baits) and formulations to control insects, as well as new herbicide products and new mixtures of fungicides for the turf and ornamental market segments.
      In 2005, we launched the insecticide Allectus® (imidacloprid-based) and the fungicide Armada® (trifloxystrobin+triadimefon-based) for the green industry and the insecticide tablet K-O Tab® 1-2-3 (deltamethrin-based) for impregnating mosquito bed nets. In 2006, we expect to launch the insecticide Forbid® (spiromesifen-based) in the green industry and the sprayable Quickbayt® (imidacloprid-based) for fly control in professional pest control applications.

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BioScience
Overview
      BioScience focuses on the research, development and marketing of conventional and genetically enhanced seeds and other plant biotechnology products.
Major Products
      With Nunhems (Nunhems®), Bayer CropScience is one of the leading developers and suppliers 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.
      FiberMax® cotton seed brand was launched in the U.S. market in 1998. It was also introduced in Greece, Spain, Turkey, Brazil and some other Latin American countries. FiberMax® varieties offer cotton growers high performance in lint yield and quality as well as advanced technologies for insect and herbicide control.
      InVigor® hybrid canola (oilseed rape) varieties are available to farmers in Canada and the United States. InVigor® hybrid canola varieties provide high yield and require less cultivation. These hybrid varieties also have tolerance to glufosinate-ammonium.
      Arizetm is the trademark for our hybrid rice seed offering a high-yield, high quality solution requiring less seeds per hectare than conventional rice. It has been introduced in India, the Philippines, Indonesia and Brazil.
Markets and Distribution
      BioScience markets its seeds to end users, distributors and processing industries. We distribute plant biotechnology traits either through out-licensing to seed companies, to incorporate in their own commercial seeds, or through our own seed companies — mainly under either the InVigor® or FiberMax® brands. In some cases, traits are provided to other companies that utilize the technology in their own research and products.
      Due to the fact that the major part of our business is realized in the northern hemisphere, the business is affected by the seasonality of the crop and distribution cycles.
      In the bio science business, DuPont, Monsanto and Syngenta are the market leaders.
Research and Development
      The primary BioScience research and development facilities are located in Lyon, France; Haelen, The Netherlands; Gent, Belgium; and Potsdam, Germany.
      Plant biotechnology research and development is predominantly directed towards agronomic and quality improvement. The technologies used include all relevant tools — from identifying the gene of interest to developing it — necessary to improve key crops (cotton, canola (oilseed rape), 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. This includes plants with improved stress tolerance (e.g., drought resistance), health-promoting canola oils and the manufacture of materials based on renewable sources.
      Our growth is supported by continuous new product introduction. We launched four new varieties of cotton and one new canola variety in 2005 and expect to launch several new varieties of cotton in 2006.

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BAYER MATERIALSCIENCE
      As described under the introduction to — Business, we have changed our segment reporting with effect from January 1, 2005. The financial data for our Materials and Systems segment have not been affected by this change.
MATERIALS
Overview
      Our Materials segment comprises the business units Polycarbonates and Thermoplastic Polyurethanes, as well as our subsidiaries Wolff Walsrode and H.C. Starck. The following table shows the segment’s performance for the last three years.
                           
    2003   2004   2005
             
    (Euros in millions)
External net sales
    2,777       3,248       4,086  
 
Percentage of total sales
    12.4       13.9       14.9  
Intersegment sales
    10       13       14  
Operating result
    58       293       633  
 
thereof special items(a)
    (29 )     0       27  
 
(a)  The significant special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Segment Data.
      The segment’s external sales, by region and in total, for the past three years are as follows:
                           
    2003   2004   2005
             
    (Euros in millions)
Europe
    1,246       1,382       1,697  
North America
    608       703       901  
Asia/Pacific
    747       947       1,164  
Latin America/ Africa/Middle East
    176       216       324  
                   
 
Total
    2,777       3,248       4,086  
                   
      The following table sets forth the segment’s external sales, broken down by category of activity, for the past three years:
                           
    2003   2004   2005
             
    (Euros in millions)
Polycarbonates
    1,713       2,035       2,645  
Thermoplastic Polyurethanes
    177       182       192  
Wolff Walsrode
    323       328       329  
H.C. Starck
    564       703       920  
                   
 
Total
    2,777       3,248       4,086  
                   
      2005 sales of the segments’ material products were 1,513 million for the Makrolon® product family (representing 37.0 percent of total segment sales; compared to 1,088 million, or 33.5 percent, in 2004 and 903 million, or 32.5 percent, in 2003) and 485 million for Bayblend® (representing 11.9 percent of total segment sales; compared to 360 million, or 11.1 percent, in 2004 and 312 million, or 11.2 percent, in 2003). Apart from these two products, no product of this segment accounted for more than 5 percent of total segment sales in 2005, 2004 or 2003.

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Segment Strategy
      Our goal is to continue expanding our global market positions by exploiting the growth potential of our optimized portfolio and focusing on our Asian investment projects. To achieve further performance improvements, we are continuing our cost and efficiency programs in the Materials segment. As announced in 2002, these programs include headcount reduction. From 2003 through 2005, total headcount reduction amounted to 410, which represents approximately 4.1 percent of the segment’s headcount in January 2003.
      For our Polycarbonates business, we strive to achieve cost-competitive world-scale facilities with new technology and to increase our capacities to fulfill the demand for polycarbonates. We intend to monitor product life cycles of current applications and allocate sufficient resources for product and application development. In addition to our growth market People’s Republic of China we plan to evaluate potential business opportunities in other regions to continuously expand our market coverage. With respect to our semi-finished products Sheet and Films, we continue to improve profitability while focusing on market segments exhibiting higher growth rates.
      Our Thermoplastic Polyurethanes (TPU) business unit plans to shift its focus towards high-margin growth segments with the goal of reaching and maintaining higher profitability levels. One strategic goal of TPU is to increase our Asian market share by means of entering into strategic partnerships or using own capacity to increase sales.
      Wolff Walsrode, with its core business Wolff Cellulosics, continues to aim for above-market growth. We plan to achieve this by focusing on the building additives, food and pharmacy industries as well as on rapidly-growing markets.
      H.C. Starck’s portfolio consists of a combination of metal- and ceramics-related high performance materials and technologies. Our focus lies on rapidly-growing markets and we have designed our internal business processes to meet the requirements of our customers. The continuous development of our business is based on efficient R&D and is being supported by strategic partnerships as well as “forward integration” (further developing the product portfolio in order to fulfill more directly customers’ needs).
Polycarbonates
Overview
      With its broad product portfolio, our business unit Polycarbonates (Polycarbonates, Polycarbonate Blends, Polycarbonate Films and Sheets) includes some of the leading global suppliers and manufacturers of engineering polycarbonates (based on capacity). Our Bayer Sheet Europe GmbH (formerly Makroform GmbH) has a strong position as a supplier of polycarbonate sheets. Our products have chemical and physical properties that enable them to resist low or high operating temperatures as well as corrosive chemicals and solvents.
Major Products
Polycarbonates (Makrolon®/APEC®)
      Polycarbonates are plastics that are transparent and highly stable across a wide temperature range. Because of their light weight, impact stability and design flexibility, polycarbonates are used in the electrical/ electronic industry in general and in the field of optical data storage media (such as pre-recorded and recordable CDs and DVDs) in particular, for injection molding purposes, and as a carrier material for solar panels. The construction industry is also a major user of polycarbonates, for example, for polycarbonate sheet applications. Makrolon® is our leading polycarbonate product range. 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® product range for high temperature uses, for example as components for automobile headlights.
Polycarbonate Blends (Bayblend®/Makroblend®)
      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. Polycarbonate Blends are widely used in the

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automotive, electric/ electronic and business machine industries. Makroblend® is our brand name for engineering thermoplastics blends based on Polybutylene Terephthalate (PBT) or Polyethylene Terephthalate (PET). The Bayblend® product lines of amorphous, thermoplastic polymer blends based on polycarbonate and ABS (acrylonitrile/ butadiene/styrene) are our leading blends for applications in the health, automotive and IT area.
Polycarbonate Films
      Polycarbonate films, Makrofol®, are made of our polycarbonate Makrolon® and are characterized by product attributes such as high heat resistance, good printability and graphic quality. The polycarbonate films of our Makrofol® range are used for applications such as instrument dials, automotive heater control panels, nameplates and a variety of film insert molding parts (a combination of a back printed and formed foil with Makrolon® and Bayblend®) as well as for security identification cards.
      Bayfol® is the trade name of our films made of polycarbonate blends and other polymers. Bayfol® CR films are noted for their superior chemical resistance and enhanced flexibility compared with pure polycarbonate film. They are both thermo formable and cold formable, with good electrical insulating and dielectric properties, and are easily printable with standard inks. Their main application areas are keypads or housings in the IT industry. Further applications are in the area of IMD (In Mold Decoration) technology, automotive interior applications, electrical and electronic engineering, domestic appliances (decorative and functional panels), blister packaging and decorative top layers for athletic equipment.
Polycarbonate Sheets (Fabricated Products)
      We also produce solid and multiwall sheets with a broad range of characteristics for a wide variety of applications. These materials consist of polycarbonates, polycarbonate blends or thermoplastic polyesters. We market our sheets as Makrolon®, Bayloy®, Vivak® and Axpet®. Makrolon® is a material with high impact resistance and can be exposed to a wide range of temperatures. Vivak® is a co-polyester sheet material which combines thermoforming and mechanical properties. Axpet® sheets are also thermoplastic polyester sheets, best suited in product and advertising presentations, particularly for folding displays, poster protection, price tags, cases and trays and for packaging food and pharmaceutical products. Bayloy® sheets are colored plastic sheets used when high shock-and break resistance is necessary.
Markets and Distribution
      We sell the products of our Polycarbonates business entities to numerous 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 industries.
      Depending on the region and the general economic situation, sales of polycarbonates may show moderate seasonality. Generally, sales are lower in the first quarter in all regions.
      Bayer does not produce basic petrochemicals. The principal petrochemical raw materials consumed by our Polycarbonates business unit are acetone and phenol, supplied exclusively by third parties. We do produce Bisphenol-A, which is a major precursor of polycarbonate based on phenol and acetone. Our costs are affected by fluctuations in raw material prices, mainly driven by the price volatility of crude oil and benzene. We typically procure third-party raw materials under long-term contracts that contain cost-based and market price formulas, which partially reduce raw material price fluctuation.
      We market substantially all of our plastic 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 use e-commerce tools, such as our BayerONE® portal, to market our products.
      Our most significant global competitor is GE Plastics. We also compete with several other companies, most notably Dow Chemical, and, particularly in the Far East, with local competitors such as Teijin, Chi Mei, Idemitsu, Mitsubishi Engineering Plastics and Formosa Plastics.

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Research and Development
      Our Polycarbonates business unit allocates resources for research and development both to process and product development with the aim of constantly improving our manufacturing processes and of developing new formulations and applications of our products. The primary research and development facilities are located in Krefeld-Uerdingen, Leverkusen and Dormagen, Germany and Pittsburgh, Pennsylvania. The Polycarbonates business unit is also building a new polymers research and development center at Pudong, China (near Shanghai) together with the other Bayer MaterialScience (BMS) business units.
      We are currently working on the optimization of our new polycarbonate melt manufacturing process for our investment in a new production facility in Caojing, China, part of the largest investment program Bayer has ever made outside Germany. Other current projects relate to the analysis of our existing manufacturing processes based on interfacial polycondensation to improve both product quality and cost performance.
      In product development, we focus our activities on developing new blends, refining material for optical data storage, developing modified base materials for polycarbonate sheets and modifying the surface of polycarbonates using various coating technologies as summarized in the following table:
     
Product/ Brand Name   Application
     
Surface-modified Makrolon®
  Automotive
Improved Makrolon® ODS grade
  New ODS formats, such as Blue Laser based disks
Extension of Bayblend® FR series
  Business machines/ information technology
Diffusor sheets for LCD Screens
  Electric/ Electronic
      In the area of polycarbonate glazing, Exatec, our joint venture with GE Plastics, is progressing with implementing the glazing technology, especially in the automotive industry. In March 2005, a first license agreement was signed between Exatec and a customer and we received regulatory approval for use of Exatec® 900 for all non-windshield automotive glazing applications.
Thermoplastic Polyurethanes
Overview
      Our Thermoplastic Polyurethanes business unit develops and markets a wide variety of granules that serve as raw materials for extrusion, blow molding, calandering, or injection molding processed products. Additionally, our subsidiaries Epurex Films (Germany) and Deerfield Urethane (Massachusetts) manufacture different grades of thermoplastic polyurethane films (TPU films).
Major Products
      Thermoplastic polyurethanes, or TPUs (TPU resins and films), belong to the family of high-performance thermoplastic elastomers. A key property of TPUs is their high resistance to abrasion and wear. TPUs’ abrasion- and wear-resistant properties are substantially superior to those of abrasion-resistant rubber compounds. We market our thermoplastic polyurethanes granulates under the trademarks Desmopan®, Texin® and Desmomelt®. Since April 2005, our product range has also included the trademark Desmoflex®, a thermoplastic elastomer compound. BMS and PTS (Plastic Technologie Service Marketing & Vertriebs GmbH) have signed a cooperation agreement to develop and market Desmoflex®. Our TPU films are marketed under the trademarks Walotex®, Walopur®, and Platilon® (Epurex Films) and Dureflex® (Deerfield Urethane) and are used in a number of different applications, e.g., as belts, hoses or automotive parts.
Markets and Distribution
      Our Thermoplastic Polyurethanes business entities (TPU Resins and TPU Films) primarily serve customers of the sports and leisure, automotive and engineering industries. Other users include the textile, cable and agricultural industries.

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      Our revenue is subject to moderate seasonality. All markets and regions taken as a whole, however, generate relatively constant revenue throughout the year.
      Temporary fluctuations in price for raw materials and energy can have an impact on the cost of our products. We secure our most important chemical raw materials through long-term contracts.
      Our head office in Leverkusen, Germany, has global responsibility for the business. We coordinate and carry out our sales and marketing from Leverkusen, Germany, for the regions Europe, Middle East, Africa and Latin America, from our regional hubs in North America (Pittsburgh) and the Asia/Pacific region (Hong Kong), and through our various national subsidiaries.
      We regard the following companies as the main competitors of our TPU business entities:
      • TPU Resins: BASF/Elastogran, Lubrizol/ Noveon, Huntsman, Taiwan Uretec, Dow Chemical;
      • TPU Films: Stevens Urethane, Fait Plast, Ding Zing.
Research and Development
      The bulk of research and development activities conducted by the Thermoplastic Polyurethanes business entities consists of developing products that we can formulate into high performance thermoplastic polyurethanes resins and films, such as transparent grades.
      TPU Resins’ primary development facilities are located in Dormagen, Germany and Pittsburgh, Pennsylvania. The development facilities of TPU Films are located in Bomlitz, Germany (Epurex Films) and in Whately, Massachusetts (Deerfield Urethane).
Wolff Walsrode
Overview
      We operate the Wolff Walsrode business group primarily through Wolff Walsrode AG, our wholly-owned subsidiary, assisted by other companies of the Bayer Group. The business group develops, produces and markets cellulose derivatives as well as various sausage casings.
Major Products
Cellulose Derivatives
  •  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.
Other
  •  Under the brand name Walsroder®, we offer a wide range of sausage skins for industrial or handcraft usage.
Markets and Distribution
      Wolff Walsrode competes in the building materials, industrial coatings, flexible packaging ink and life sciences markets, as well as in specialized industrial fields.
      Wolff Walsrode generally conducts direct sales operations in Germany and the United States for its cellulose products. Outside these geographic areas, we ordinarily sell through Bayer’s worldwide sales organization.

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      The main raw material for our cellulose derivatives is chemical-grade cellulose derived from wood pulp and cotton. Because we have developed technologies to use either wood pulp or pulp based on cotton linters and because we have qualified a number of suppliers for both types of pulp, we have not had any significant problems with availability. Prices for chemical-grade cellulose show only moderate fluctuations, as a result of our diversified supplier base (located in both the euro and dollar zones), the raw material mix and an increasing number of contracts with our suppliers having terms of one year.
      Our main competitors in the cellulose derivatives business are Hercules (Aqualon), Dow, SE Tylose GmbH & Co.KG, Shin-Etsu Chemical Co., Bergerac NC/SNPE, Nobel Enterprises, Nitroquimica Brasileira, Noviant and Akzo Nobel.
Research and Development
      Wolff Walsrode’s research on cellulose and other polysaccharides takes advantage of the unique structural and chemical properties of these important renewable materials. The activities are focused on products such as additives for building materials, binders for printing inks and coatings, as well as formulation aids for food, cosmetics and pharmaceuticals.
      Wolff Walsrode’s primary research and development facilities, including a state-of-the-art pilot plant, are at industrial site “Industriepark Walsrode” in Bomlitz, near Walsrode, Germany.
H.C. Starck
Overview
      Our subsidiary H.C. Starck develops, produces and markets metallic and ceramic powders and fabricated products for various markets and applications.
Major Products
      H.C. Starck produces a broad portfolio of products ranging from ceramic materials to metals such as tungsten, molybdenum, tantalum and niobium and their alloys and compounds for industrial customers in the aircraft, medical, chemical, electronic, lighting, tooling and optical components industries. We manufacture these products both in the form of ceramic or metallic powders and as solid intermediates or finished parts. Products are marketed under brand names such as Kulite®, Molyform®, Ampergy®, Amperkat®, Amperit® and Ampersint®. Our conductive polymers for the electronic industry are marketed under the brand name Baytron® and our functional materials (such as colloidal silica) are named Levasil®.
Markets and Distribution
      Some of our markets are affected by pressure on prices and fluctuations in demand. Sales are also influenced by currency exchange rates. China is the primary source of raw materials for tungsten products. In the past, China limited production, thus causing shortages. Since we have our own tungsten production and recycling facilities, we are only partially dependent on Chinese imports. The price for tungsten has increased significantly (+ 130 percent) during 2005 due to an increase in Chinese raw material prices. The price of molybdenum, historically less volatile, has increased substantially throughout the second half of 2004 and remained stable at the record high level throughout 2005. Tantalum raw material prices have remained relatively stable during the past three years. For this raw material, we secure our supply through long-term contracts generally lasting three to five years.
      We maintain our own sales organizations and liaison offices in an number of countries. Additionally, we use Bayer or third-party sales organizations who maintain direct contact with our customers. Amperit® products are marketed jointly with Flame Spray Technologies B.V., Netherlands.

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      We regard the following companies as our main competitors:
  •  Metallic products and compounds (Kulite®, Molyform®, Ampersint® and other non-branded metallic and ceramic powders and part): Wolfram Bergbau- und Hütten GmbH, Cabot Group, Mitsui, MolymetOMG, Osram Sylvania, Japan New Metals, Plansee AG, Phelps Dodge;
 
  •  Battery intermediates (Ampergy®): Tanaka Chemical, Kelong, Kansai Catalysts Co. Ltd, Jiangmen Chancsun Umicore Industry Co., Ltd.;
 
  •  Chemical catalysts (Amerkat®): Johnson Matthey, Degussa, Grace-Davison, Engelhard;
 
  •  Thermal spray powders (Amperit®): Praxair, Sulzer Metco, Fujimi;
 
  •  Ceramic powders and parts: Denki Kagaku, SB Boron; GE Advanced Ceramics, Tokuyama.
Research and Development
      H.C. Starck’s research and development activities are directed at innovative products and system solutions. We are developing high-capacity tantalum and niobium powders as intermediates for capacitors and conducting polymers for polymer capacitors and antistatic applications. H.C. Starck is continuously developing new generations of improved sputtering targets for diffusion barrier coatings in microelectronic devices and flat panel displays. H.C. Starck is also committed to developing materials for fuel cells, hybrid vehicles and other energy storage and power generation applications. Additionally, we are working on high corrosive, high temperature resistant materials for powder metallurgy applications.
      The primary research and development facilities of this subsidiary are located in Goslar, Laufenburg and Leverkusen, Germany; Newton, Massachusetts and Mito, Japan.
      We currently have eleven product groups in late stages of development, and expect to start and continue their launch during 2006. The most important projects being:
     
Product/ Brand Name   Application
     
Powder and components for SOFC
  SOFC (Solid Oxide Fuel Cells)
Tantalum 70/80, 100/120 and 150 K powder
  Capacitors
Molybdenum plates for physical vapor disposition (PVD)
  Flat panel displays
Tantalum plates for PVD
  Microelectronic devices
HEM (High Energy Milled) and prealloyed binder powders
  Powder metallurgy
SYSTEMS
Overview
      Our segment Systems comprises the business units Polyurethanes; Coatings, Adhesives, Sealants; and Inorganic Basic Chemicals.
      The following table shows the segment’s performance for the last three years:
                           
    2003   2004   2005
             
    (Euros in millions)
External net sales
    4,676       5,349       6,609  
 
Percentage of total sales
    20.8       23.0       24.2  
Intersegment sales
    103       116       142  
Operating result
    (455 )     348       736  
 
thereof special items(a)
    (715 )     (27 )     (62 )
 
(a)  The significant special items are detailed in Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Segment Data.

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      The segment’s external sales, by region and in total, for the past three years are as follows:
                           
    2003   2004   2005
             
    (Euros in millions)
Europe
    2,107       2,494       3,035  
North America
    1,406       1,483       1,891  
Asia/Pacific
    678       822       979  
Latin America/ Africa/Middle East
    485       550       704  
                   
 
Total
    4,676       5,349       6,609  
                   
      The following table sets forth the business entities’ external sales for the last three years, broken down by category of activity:
                           
    2003   2004   2005
             
    (Euros in millions)
Polyurethanes
    3,228       3,872       4,792  
Coatings Adhesives Sealants
    1,191       1,237       1,330  
Inorganic Basic Chemicals
    218       218       380  
Others
    39       22       107  
                   
 
Total
    4,676       5,349       6,609  
                   
      2005 sales of the segments’ material products were 1,983 million for Desmodur® products (representing 30.0 percent of total segment sales; compared to 1,708 million, or 31.9 percent, in 2004 and 1,567 million, or 33.5 percent, in 2003). Apart from Desmodur® and two other products, each of which accounted for less than 12 percent of segment sales in 2005, no other product of the segment accounted for more than 5 percent of segment sales in 2005, 2004 and 2003.
Segment Strategy
      Our goal is to continue expanding our global market positions by exploiting the growth potential of the optimized portfolio and focusing on our Asian investment projects. To further achieve performance improvements, we will continue our cost and efficiency programs, which were announced in 2002, in all business units of the Systems segment. As part of these programs, we reduced headcount by a total of 1,127 from 2003 through 2005, which represents approximately 12.4 percent of the segment’s headcount in January 2003.
      For our Polyurethanes business we strive to achieve cost-competitive world-scale production facilities with new technology. We are pursuing an organic growth strategy supported by both product and process innovation. As part of our growth strategy, we are currently increasing our production capacity of diphenylmethane diisocyanates (MDI). In selected segments we strive to improve profitability by shifting our focus towards high value products. We believe that a well-balanced product portfolio combined with optimized R&D and cost structures will help keep the Polyurethanes business unit well positioned.
      The Coatings, Adhesives and Sealants business unit will focus its activities on maintaining its current position in the field of Base Modified Isocyanates. Resins will increase its efforts to grow in profitable modern technologies and reduce the share of low margin products with limited value contribution. At the same time we intend to expand our portfolio with new products for new markets.
      Using current technology, Inorganic Basic Chemicals provides basic raw materials such as chlorine and caustic soda to the Polyurethanes; Coatings, Adhesives, Sealants and Polycarbonates business units as well as to third parties. To ensure best possible cost position and uninterrupted supply, various strategic options related to making or buying raw materials are being pursued depending on the specific site set-up.

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Polyurethanes
Overview
      Our Polyurethanes 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.
Major 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® and Desmophen®. The characteristics of a given polyurethane depend on both the material components used as well as the precise proportion of each in the mix.
      Our customers use our isocyanates or polyether polyols, or both, to create their own specific polyurethane formulations. In addition, we design and evaluate custom blends to meet specific customer requirements. 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, shoes, automotive components, appliances, sport and leisure equipment and construction.
Markets and Distribution
      Europe and the NAFTA nations remain the primary markets for our Polyurethanes business entities, with the Asian market showing the strongest growth.
      The predominant cushioning material for upholstered furniture nowadays is flexible polyurethane foam. For our customers’ applications, there are no man-made or natural substitute materials that could replace significant amounts of flexible polyurethane foams in the future. Rigid polyurethane foam is used for thermal insulation purposes competing with other insulating materials such as mineral fibers or polystyrene foam. 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 due to required physical properties, costs, design or functional requirements.
      On a worldwide level, the Polyurethanes business entities’ sales are not subject to significant seasonality. On the regional level, business can display 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 petrochemical raw materials. We typically purchase these on the open market mostly under long-term contracts, as Bayer generally does not produce petrochemicals. However, through a global joint venture with Lyondell, we have acquired a source for propylene oxide, one of our key raw materials. These petrochemical raw materials are subject to price fluctuation driven by supply and demand factors and price volatility in the crude oil and derivates markets.
      The Polyurethanes business entities sell their products directly to customers and, to a much smaller degree, through “system houses” and traders. System houses are focused regionally and typically serve smaller-volume customers.
      To further increase efficiency along the supply chain, we have established regional service centers. They act as a central point of contact for customers on all issues concerning order processing, logistics and billing.
      Our main competitors are BASF, Dow Chemical and Huntsman.

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Production facilities
      Bayer’s polyurethane raw material production facilities, which meet ISO 9001:2000 quality standards, are strategically located around the world to support its global product line. The business unit’s main production sites are located in Antwerp, Belgium; Brunsbüttel, Dormagen and Krefeld-Uerdingen, Germany; Fos-sur-Mer, France; Tarragona, Spain; Baytown and Channelview, Texas, and South Charleston, West Virginia. Other production facilities are located in Brazil, Germany, Indonesia, Italy, Japan, Mexico, Taiwan and the United States. In addition, we have started building up capacities at our site in Caojing, China.
      We have completed a consolidation phase regarding our production facilities by closing our TDI plants in Mexico, Germany, Belgium, Japan and, during 2005, in the United States. TDI production is now concentrated in three integrated plants in Baytown, Texas and Brunsbüttel and Dormagen, Germany.
Research and Development
      The business entities’ primary research and technical development facilities are located in Dormagen and Leverkusen, Germany; Pittsburgh, Pennsylvania, South Charleston and 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 Polyurethanes business entities concentrate their research and development efforts with respect to aromatic isocyanates on improving existing products and technologies for their manufacture. Some research activities go into new structures for isocyanates. High-throughput experiments are used for the development of new formulations and will help to reduce time-to-market for new products.
Coatings, Adhesives, Sealants
Overview
      Our Coatings, Adhesives, Sealants business entities (RES, BMI) develop and market a wide variety of products that serve as raw materials for lacquers, coatings, sealants and adhesives.
Major Products
Resins and Hardeners
      Polyurethane lacquers are formed through the combination of an isocyanates component with a polyol-like polyester, polyacrylate-polyether- or polycarbonate-polyols. We offer a variety of polyol components branded as Desmophen®, Rucote® and Bayhydrol® (Resins; RES) and polyisocyanates such as Desmodur®, Desmodur® BL, Crelan® and Bayhydur® (Base- and modified isocyanates; BMI). 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® (Resins) for coatings and adhesives, Impranil®, our polyurethane coating systems for textiles, and Baybond® for glass fiber sizing.
Adhesive raw materials
      Dispercoll®, Desmocoll® and Baypren® (Resins) are our raw materials for adhesives. Their primary users are shoe manufacturers, though we also have customers from the automotive, furniture and building industries.
Markets and Distribution
      Our Coatings, Adhesives, Sealants 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, plastics, construction and adhesives industries; other users include the textile, shoe and building industries.

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      Generally, our revenue is not subject to significant seasonality. 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.
      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. 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 serve our globally active major customers directly.
      We regard the following companies as the chief competitors of our Coatings, Adhesives, Sealants business entities.
  •  Resin components (RES): Cytec / UCB, Cray Valley, DIC (Dainippon Ink and Chemicals), DSM
 
  •  Aliphatic isocyanates (BMI): Rhodia, Degussa, BASF, Asahi Kasei, NPU (Nippon Polyurethane Industry)
 
  •  Aromatic isocyanates (BMI): Dow, Mitsui Takeda Chemicals, SAPICI
Research and Development
      The Coatings, Adhesives, Sealants 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, Germany and Pittsburgh, Pennsylvania.
Inorganic Basic Chemicals
Overview
      The business unit Inorganic Basic Chemicals (IBC) produces inorganic basic chemicals such as chlorine, caustic soda, hydrogen and hydrochloric acid. The focus is on the safe and cost-efficient supply of chlorine to the customers. IBC has one of the largest production capacities of any chlorine manufacturer in Europe.
Major Products
      Inorganic basic chemicals are of major importance for Bayer MaterialScience (BMS): about 70 percent of its sales are dependent on chlorine. Chlorine is used for the production of intermediates that are subsequently processed into a variety of products, such as polyurethanes (foams, insulating materials) and polycarbonates (CDs, glazing). The four IBC production sites in Leverkusen, Dormagen and Krefeld-Uerdingen, Germany, and Baytown, Texas, have a total chlorine capacity of around 1.4 million metric tons per year. At sites where Bayer does not produce any chlorine, IBC supports external chlorine procurement.
      In addition to chlorine, sodium chloride electrolysis generates caustic soda and hydrogen. These by-products, as far as they are not used internally, are sold in external markets.
      During the processing of chlorine into intermediate products, hydrochloric acid may be produced. IBC is responsible for managing the balance of hydrochloric acid: if it is not sold or used internally, it is recycled in the hydrochloric acid electrolysis units of IBC in Leverkusen and Dormagen, Germany and Baytown, Texas.
Markets and Distribution
      In general, chlorine is supplied by pipeline to internal and external customers located at Bayer sites where chlorine is produced. IBC markets the caustic soda and hydrochloric acid that is not used internally to customers from various industries worldwide.

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      The main raw materials for chlorine production are sodium chloride and power. Sodium chloride is purchased on the open market under long term contractual agreements and therefore generally not subject to price volatility. Power is purchased via Bayer Industry Services in Germany. Recently, costs of power have increased due to regulatory requirements of the European Union and Germany.
      Our main competitors are Dow, Solvay, Akzo Nobel, BASF, Vestolit and Ineos.
Research and Development
      Processes and plants are continuously enhanced and optimized within IBC while keeping in mind environmental compatibility. The main area of innovation in chlorine production is currently the development of the “Oxygen Depolarized Cathode” (ODC) in sodium chloride alkali (sodium chloride) and hydrochloric acid membrane electrolysis to save energy.
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 trademark 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.

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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.
      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)
                                        2010        
 
Adalat® CC (Coat Core)
    2008       2008       2008       2008       2008       2008       2008       2009  
Avelox®
                                                               
 
Compound
    2014       2014       2014       2014       2014       2009       2014       2015  
 
Hydrochloride-Monohydrate
    2016       2016       2016       2016       2016       2016       2016       2016  
 
Tablet formulation
    2019       2019       2019       2019       2019       2019       2019       2019  
Ciprofloxacin
                                                               
 
Active ingredient
                      2009                          
 
IV formulation
    2006       2006       2006       2006       2006       2011       2007       2008  
 
Tablet formulation
    2007       2007       2007       2007       2007       2007       2011       2009  
Imidacloprid
    2006       2006       2006       2006       2007             2006       2007  
Vardenafil compound
    2018       2018       2018       2018       2018       2018       2018       2018  
      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 Ascensia®, Kogenate®, Adalat®, Aspirin®, Ciprobay®/Cipro®, Avalox®/Avelox®, Levitra®, Aleve®, Confidor®/Gaucho®/Admire®/Merit®, Basta®/Liberty®, Flint®/ Stratego®/ Sphere® and Makrolon®, 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 governmental 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 regulations are typically of a national scope, although within the European Union (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. 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, called premanufacture notices (PMNs), for new industrial chemicals and polymers and can also regulate existing chemicals under test rules. In addition, the 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 (OSHA). The OSHA Hazard Communication Standard requires information concerning the hazards of chemicals to be transmitted to our workers and customers through material safety data sheets and precautionary product labels for potential hazards from exposure to chemicals.
      Similarly, in the EU as well as in other 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. For more information on how regulatory requirements may impact our business, refer to Item 3, Key Information — Risk Factors — Regulatory controls and changes in public policy may reduce the profitability of new or current products.
      The various regulatory authorities administer and execute requirements covering the testing, safety, efficacy, labeling, approval, manufacturing, marketing and post-marketing surveillance 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 but this period varies considerably for different products and countries. For

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marketed products, the pharmaceutical company is required to monitor adverse reactions and submit periodic reports on these reactions, if any, to the appropriate authorities.
      In recent years, the European Medicines Evaluation Agency (EMEA) in the EU, the FDA in the United States and the Ministry of Health, Labor and Welfare (MHLW) in Japan have sought to shorten development and registration times for pharmaceutical products by harmonizing the individual requirements of the three regions. This process is called the International Conference on Harmonization. For the foreseeable future, however, we will need to obtain separate approval in each market.
      Our Hematology/Cardiology business unit markets, among others, 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 under specific sets of regulations that contain unique requirements specifically for biologicals. 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 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 such as 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 division 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 (CDRH), although the Center for Biologics Evaluation and Research (CBER) retains jurisdiction over medical devices intended for use in the diagnosis and monitoring of HIV infections. 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, where possible we seek 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, 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 (PAL) regulates diagnostic products. The Japanese Ministry of Health is currently implementing significant ‘PAL reforms’ with which all IVD manufacturers and their Japanese representatives must comply. 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.

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Diabetes Care Products
      Diabetes Care products are subject to regulations similar to those in the Diagnostics division. In the United States, for example, the FDA and, in part, the Federal Trade Commission, oversee the marketing, manufacturing and labeling of Diabetes Care products, while in the EU and in Japan, they are regulated by the Conformite Europeene (CE) and the MHLW, respectively.
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 EPA.
      In the EU, animal health products are subject to regulations similar to those governing the Pharmaceutical sector. 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).
      Three registration procedures with different regional coverage are available within the EU: In the centralized registration process (Centralized Procedure), after the dossier is submitted to the EMEA, the CVMP carries out a scientific evaluation. The CVMP opinion is then transmitted to the European Commission for its opinion, which, if also favorable, results in a binding decision for marketing authorization in all EU Member States. A company is obliged to use the Mutual Recognition Procedure if it intends to sell a medicinal product in more than one Member State, but not necessarily throughout the entire EU. A National Procedure can be used if a company wishes to license a product in just one Member State.
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 operator and the environment. Strict 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 relatively long evaluation period, which may include new requirements imposed on a company after it has submitted a dossier for approval, shortens a company’s utilizable patent protection time. In some jurisdictions, part of the patent period lost due to the long regulatory process can be regained through the granting of a “supplemental protection certificate.”
      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 regulations proposed by the authorities.
Environmental Science Products
      In both the professional and the consumer pest control business, as in crop protection, our products must obtain 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

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often different from Crop Protection products, due to different routes of exposure. Generally, there has been an increase of regulatory requirements, in particular in the United States, Europe and Japan. To some extent, the regulatory dossiers developed for Crop Protection products with the same active ingredients can also be used for the regulatory purposes in the Environmental Science area.
      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 these products or active substances for use in such products on the EU market. 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. These regulatory procedures may lead to an increase in the time period and costs involved with developing new Environmental Science products.
BioScience Products
      Plant biotechnology products, marketed by our BioScience business group, 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 relevant regulatory frameworks over the next few years.
      The timeframe for approvals varies substantially around the world. The development of the regulatory dossier generally takes two to three years. In the United States, Canada and Japan, the review of a regulatory dossier will typically take another one to two years. After over five years of moratoria and regulation changes, the EU is now operating under its new procedures with dossiers advancing slowly. To date the only significant progress has been on importation uses. Approvals of biotechnology-derived products for agricultural growing in the EU are not expected for some time yet.
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 2007/2008. It will, if adopted, mandate a significant increase in administration and in the testing and assessment of all chemicals used, leading to increased costs and reduced operating margins for these products.
      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.

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Compliance may require material capital expenditures in the future depending on developments in the market for emissions trading.
      A communication entitled “European Environment and Health Strategy” was published by the Commission of the EU in June 2003 (SCALE). The strategy is intended to reduce the burden of disease caused by environmental factors in the EU by identifying and preventing new health threats caused by environmental factors. In furtherance of this strategy, the Commission adopted the European Environment and Health Action Plan for 2004-2010 on June 9, 2004. Currently, specific consequences of SCALE on our business cannot be estimated, but we are monitoring further developments and participate in relevant stakeholder processes.
Health, Safety and Environmental Regulations
      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;
 
  •  incidental and other releases into the environment;
 
  •  generation, handling, storage, transportation, treatment and disposal of hazardous and non-hazardous materials; and
 
  •  construction and operation of facilities.
      It is our policy to comply with all health, safety and environmental requirements and to provide workplaces for employees that are safe. 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 measures 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 into the environment. 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 the 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 full impact of these regulations on us. We cannot assure 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 (CERCLA, 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 those currently quantifiable costs.
      It is difficult to estimate the future costs of environmental protection and remediation because of uncertainties about the status of regulations and their future developments. 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, 2005, we had reserved 279 million for environmental matters.
      We believe that we are in substantial compliance with applicable health, safety and environmental laws and regulations. We devote considerable attention to the health and safety of our employees and the protection of

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public health and the environment. As a member of the International Council of Chemical Associations (ICCA) and the American Chemistry Council, Bayer is committed to the principles of the Responsible Care Global Charter, the chemical industry’s health, safety and environmental performance improvement initiative.
      While our compliance has not adversely affected our competitive position or business, we cannot predict the impact of possible future regulations. 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.
ORGANIZATIONAL STRUCTURE
      As the management holding company of the Bayer Group, Bayer AG determines the long-term strategy for the Group and its subgroups and prescribes guidelines and principles for the corporate policy derived therefrom. Bayer AG holds equity interests in the subgroup management companies and the service companies (described below) and also in other domestic and foreign entities. The Bayer Group is managed by the four-member Board of Management of Bayer AG, which is supported by the Corporate Center. The Board of Management is responsible for the oversight of management and for the Group’s financial management.
      The Corporate Center, which provides services to the Board of Management and to the subgroup management companies, consists of the following corporate center functions: the Corporate Office; Communications; Investor Relations; Corporate Auditing; Corporate Human Resources & Organization; Corporate Development; Law & Patents, Insurance; Finance; Group Accounting and Controlling; Governmental & Product Affairs; and Regional Coordination.
      After the spin-off of the LANXESS subgroup, effective January 28, 2005, the Bayer Group conducts its business operations in the three subgroups Bayer HealthCare, Bayer CropScience and Bayer MaterialScience. The management companies Bayer HealthCare AG, Bayer CropScience AG and Bayer MaterialScience AG, heading up the three subgroups, manage the business activities of the domestic and foreign affiliates assigned to them. Each subgroup is, within the framework of strategies, goals and guidelines determined by the Bayer AG Board of Management, an independent operating area with worldwide business accountability and its own management. Each of the subgroup management companies has entered into a control and profit and loss transfer agreement with Bayer AG.
      Three service companies, Bayer Technology Services GmbH, Bayer Business Services GmbH and Bayer Industry Services GmbH & Co. OHG (in which Bayer AG owns a 60 percent stake and LANXESS a 40 percent stake), provide support functions to the three subgroups as well as to Bayer AG.
      For more information on our current organizational structure, see the introduction to — Business.
Subsidiaries
      The financial statements of the Bayer Group as of December 31, 2005 included 283 consolidated companies, compared to 349 companies in 2004. With the deconsolidation of the LANXESS subgroup, 60 companies have left the Group in the first quarter of 2005.

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      The following table lists Bayer AG’s principal consolidated subsidiaries as of December 31, 2005 and its beneficial ownership interest in each.
         
    Bayer’s
Company Name and Place of Business   Interest
     
    (%)
Germany
       
Bayer Business Services GmbH, Leverkusen
    100  
Bayer CropScience AG, Monheim
    100  
Bayer CropScience Deutschland GmbH, Langenfeld
    100  
Bayer HealthCare AG, Leverkusen
    100  
Bayer Industry Services GmbH & Co. OHG, Leverkusen
    60  
Bayer MaterialScience AG, Leverkusen
    100  
Bayer Technology Services GmbH, Leverkusen
    100  
Bayer Vital GmbH, Leverkusen
    100  
H.C. Starck GmbH, Goslar
    100  
Wolff Cellulosics GmbH & Co. KG, Walsrode
    100  
 
Other European Countries
       
Bayer Antwerpen Comm.V, Belgium
    100  
Bayer Consumer Care AG, Switzerland
    100  
Bayer CropScience France S.A.S., France
    100  
Bayer CropScience Limited, U.K
    100  
Bayer CropScience S.r.l., Italy
    100  
Bayer Diagnostics Europe Ltd., Ireland
    100  
Bayer International S.A., Switzerland
    99.7  
Bayer Pharma S.A.S., France
    99.9  
Bayer Polyols S.N.C., France
    100  
Bayer Public Limited Company, U.K
    100  
Bayer S.p.A., Italy
    100  
Bayer Santé Familiale S.A.S., France
    100  
Bayer SP.Z.O.O., Poland
    100  
Quimica Farmaceutica Bayer, S.A., Spain
    100  
 
North America
       
Bayer CropScience Inc., Canada
    100  
Bayer CropScience LP, USA
    100  
Bayer HealthCare LLC, USA
    100  
Bayer Inc., Canada
    100  
Bayer MaterialScience LLC, USA
    100  
Bayer Pharmaceuticals Corporation, USA
    100  
H.C. Starck Inc., USA
    100  

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    Bayer’s
Company Name and Place of Business   Interest
     
    (%)
Asia/Pacific
       
Bayer Australia Limited, Australia
    99.9  
Bayer CropScience K.K., Japan
    100  
Bayer Korea Ltd., Republic of Korea
    100  
Bayer MaterialScience Limited, Hong Kong
    100  
Bayer Medical Ltd., Japan
    100  
Bayer South East Asia Pte Ltd., Singapore
    100  
Bayer Yakuhin, Ltd., Japan
    100  
H.C. Starck Ltd., Japan
    100  
Sumika Bayer Urethane Co., Ltd., Japan
    60  
 
Latin America/ Africa/Middle East
       
Bayer (Proprietary) Limited, South Africa
    100  
Bayer CropScience Ltda., Brazil
    100  
Bayer de Mexico, S.A. de C.V., Mexico
    100  
Bayer S.A., Argentina
    99.9  
Bayer S.A., Brazil
    99.9  
Bayer Türk Kimya Sanayi Limited Sirketi, Turkey
    100  
      Also included in the consolidated financial statements are the following material associated companies:
         
    Bayer’s
Company Name and Place of Business   Interest
     
    (%)
GE Bayer Silicones GmbH & Co. KG, Germany
    49.9  
Lyondell Bayer Manufacturing Maasvlakte VOF, Netherlands
    50.0  
Palthough Industries (1998) Ltd., Israel
    20.0  
PO JV, LP, USA
    42.7  
Polygal Plastics Industries Ltd., Israel
    25.8  
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 are located in Leverkusen, Germany. Our key production facilities are located in Germany and the United States. We also have other properties, including office buildings, laboratory and research laboratories and distribution centers throughout the world. For the major production and R&D facilities by segment please refer to — Markets and Distribution and — Research and Development for each of the segments.
      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).
      We believe that our production plants and manufacturing facilities have capacities adequate for our current and projected needs. In 2005, no assets of the Bayer Group were pledged to secure financial liabilities.

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      The acquisition of the Roche’s global Consumer Health business — except for Japan — includes production sites in Germany, France, Morocco, Indonesia and Argentina. For further details on the acquisition refer to — History and Development of the Company.
      At the time of its spin-off, the LANXESS subgroup, which ceased to be part of the Bayer Group at the end of January 2005, operated production sites in about 18 countries. The sites were located on property owned or purchased by LANXESS, rented to LANXESS by Bayer or used by LANXESS based on hereditary building rights (Erbbaurechte). For further details on the spin-off, refer to  — History and Development of the Company or to Item 5, Operating and Financial Review and Prospects — Operating Results 2003, 2004 and 2005 — Discontinued Operations — LANXESS.
      The following table summarizes our major facilities by subgroup:
               
    Size of developed    
    property in    
    thousand square    
Location   meters   Major use
         
Bayer HealthCare
           
 
Leverkusen, Germany
    125     Formulation and packaging of pharmaceutical products
 
Wuppertal, Germany
    448     Production of active ingredients for ethical pharmaceutical products, research and development
 
Berkeley, California
    112     Production of recombinant FVIII
 
Myerstown, Pennsylvania
    44     Formulation and packaging of Consumer Care products
 
Mishawaka, Indiana
    32     Production of instruments for Diabetes Care division
Bayer CropScience
           
 
Monheim, Germany
    651     Research and development for Crop Protection and Environmental Science, headquarters of Bayer CropScience
 
Frankfurt, Germany
    261     Research and development as well as production and formulation for Crop Protection and Environmental Science
 
Dormagen, Germany
    140     Production and formulation for Crop Protection and Environmental Science
 
Kansas City, Missouri
    732     Production and formulation for Crop Protection and Environmental Science
 
Haelen, The Netherlands
    500     Research and development as well as production for BioScience (Seeds)
Bayer MaterialScience
           
 
Krefeld-Uerdingen, Germany
    208     Production of polycarbonates, diphenylmethane diisocyanates, chlorine, caustic soda, hydrochloric acid and hydrogen
 
Baytown, Texas
    1,628     Production of base- and modified isocyanates, polycarbonates, diphenylmethane diisocyanates, toluene diisocyanates, chlorine, caustic soda, hydrochloric acid and hydrogen
 
Dormagen, Germany
    264     Production of modified isocyanates, resins, polycarbonate films, toluene diisocyanates, polyether, thermoplastic polyurethanes, chlorine, caustic soda, hydrochloric acid and hydrogen
 
Antwerp, Belgium
    639     Production of polycarbonates, aniline, nitrobenzene and polyether
 
Brunsbüttel, Germany
    137     Production of diphenylmethane diisocyanates, toluene diisocyanates, chlorine, hydrochloric acid and hydrogen

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      Since the end of 2003, Bayer MaterialScience has been expanding capacities and establishing large-scale facilities at its integrated production site in Caojing, China (near Shanghai), as presented in the following table:
                 
    Plant Capacity   Start-Up   Status
             
    (in kt)        
Coatings, Adhesives, Sealants (Desmodur® N)
    12     April 2003   In operation
Coatings, Adhesives, Sealants (Desmodur® L)
    11     January 2005   In operation
Polycarbonates (Compounding)
    40     July 2005   In operation
Polycarbonates (PCS Phase I)
    100     expected: 2nd quarter 2006   Under construction
Polyurethanes (MDI Phase I, MMDI-Splitter)
    80     expected: 3rd quarter 2006   Under construction
Coatings, Adhesives, Sealants (HDI-4)
    30     expected: January 2007   Under construction
Polyurethanes (MDI Phase II)
    350     2008    
Polycarbonates (PCS Phase II)
    100     2008    
Polyurethanes (TDI)
    160     2009    
      For information on environmental issues relating to Bayer’s properties see Information on the Company — Governmental Regulation — Health, Safety and Environmental Regulations. Additional information regarding Bayer’s property, plant and equipment is contained in Item 5, Operating and Financial Review and Prospects — Liquidity and Capital Resources 2003, 2004 and 2005 — Capital expenditures and in Note 20 to the consolidated financial statements appearing elsewhere in this annual report.
Item 4A.     Unresolved Staff Comments
      None.

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Item 5.     Operating and Financial Review and Prospects
      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.
      In connection with the adoption of IFRS 5, as well as the application of related IFRS standards, the financial information presented in this annual report for 2003, 2004 and 2005 only reflects continuing operations of the Bayer Group and its segments, except where specific reference is made to discontinued operations. The 2003 and 2004 figures for operating result, non-operating result, operating expenses and related key figures have been restated to give effect to this new form of presentation and to new IFRS accounting standards adopted in 2005 that require retrospective application. For more details, refer to — Basis of Presentation — Effects of new accounting pronouncements and Note 3 to the consolidated financial statements appearing elsewhere in this annual report.
OVERVIEW
      We are a global company focusing on our strengths in the fields of health care, nutrition and innovative materials. Our goal is to strengthen the competitiveness of our businesses in the HealthCare, CropScience and MaterialScience subgroups by concentrating on the special needs of these businesses.
      Bayer comprises the parent company, Bayer AG of Leverkusen, Germany, and approximately 280 consolidated subsidiaries. After the spin-off of the LANXESS subgroup, we are organized into eight business segments — Pharmaceuticals, Biological Products (known as Pharmaceuticals effective January 1, 2006); Consumer Care; Diabetes Care, Diagnostics; Animal Health; Crop Protection; Environmental Science, BioScience; Materials and Systems. For further information on our organizational structure, see Item 4, Information on the Company — Business and  — Organizational Structure.
      To streamline our portfolio and to concentrate on our core businesses, we selectively divest businesses and assets that no longer fit our strategic plan. For our principal acquisitions and divestitures during the last three years, refer to Item 4, Information on the Company — History and Development of the Company and Note 7.2 to the consolidated financial statements appearing elsewhere in this annual report.
      At the end of January 2005, the LANXESS subgroup was spun off from, and ceased to be part of, the Bayer Group. LANXESS AG is now a legally independent company. The shares of LANXESS AG have been listed on the Frankfurt Stock Exchange since January 31, 2005. For more details on the spin-off, please refer to — Operating Results 2003, 2004 and 2005 — Discontinued Operations.
CRITICAL ACCOUNTING POLICIES
      The preparation of the financial statements for the Bayer Group requires the use of estimates and assumptions. These affect the classification and valuation of assets, liabilities, income, expenses and contingent liabilities. Estimates and assumptions mainly relate to the useful life of noncurrent assets, the discounted cash flows used in impairment testing and the establishment of provisions for litigation, pensions and other benefits, taxes, environmental protection, inventory valuations, sales allowances, product liability and guarantees. Estimates are based on historical experience and other assumptions that are considered reasonable under the

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circumstances. Actual values may vary from the estimates. The estimates and the assumptions are continually reviewed.
      To enhance the information content of the estimates, certain provisions that could have a material effect on the financial position, results of operations or cash flows of the Group are selected and tested for their sensitivity to changes in the underlying parameters. To reflect uncertainty about the likelihood of the assumed events actually occurring, the impact of a 5 percent change in the probability of occurrence is examined in each case. For long-term interest-bearing provisions, the impact of a 1 percent change in the interest rate used is analyzed. Analysis has not shown other provisions to be materially sensitive. The interest sensitivity of pension obligations is discussed in Note 28 to the consolidated financial statements appearing elsewhere in this annual report.
      Critical accounting and valuation policies and methods are those that are both most important to the portrayal of the Bayer Group’s financial position, results of operations and cash flows, and that require the application of difficult, subjective and complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain and may change in subsequent periods. The main accounting and valuation policies used by the Bayer Group are outlined in Note 4.3 to the consolidated financial statements appearing elsewhere in this annual report. While not all of the significant accounting policies require difficult, subjective or complex judgments, the Company considers that the following accounting policies should be considered critical accounting policies.
Intangible assets and property, plant and equipment
      At December 31, 2005 the Bayer Group had intangible assets with a net carrying amount of 7,688 million including goodwill of 2,623 million (Note 19), and property, plant and equipment with a net carrying amount of 8,321 million (Note 20). Intangible assets with finite useful lives and property, plant and equipment are amortized over their estimated useful lives. The estimated useful lives are based on estimates of the period during which the assets will generate revenue. Further, until the end of fiscal 2004, the Bayer Group amortized goodwill arising from business combinations with an agreement date prior to March 31, 2004 over its scheduled useful life. This practice was discontinued effective January 1, 2005 in compliance with IFRS 3 (Business Combinations) and the revised versions of IAS 36 (Impairment of Assets) and IAS 38 (Intangible Assets), which prohibit the amortization of goodwill and other intangible assets with indefinite useful lives.
      Intangible assets with finite useful lives and property, plant and equipment are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may no longer be recoverable. Goodwill and intangible assets with indefinite useful lives must be tested annually for impairment. In compliance with IAS 36 (Impairment of Assets), impairment losses are measured by comparing the carrying amounts to the discounted cash flows expected to be generated by the respective assets. Where it is not possible to estimate the impairment loss for an individual asset, the loss is assessed on the basis of the discounted cash flow for the cash-generating unit to which the asset belongs. Estimating the discounted future cash flows involves significant assumptions, especially regarding future sales prices, sales volumes and costs. The discounting process is also based on assumptions and estimations relating to business-specific costs of capital, which in turn are based on country risks, credit risks and additional risks resulting from the volatility of the respective line of business as well as the capital structure of the relevant subgroup. Further information on the procedure for impairment testing and the residual carrying amounts of goodwill at the balance sheet date is presented in Note 4.5 to the consolidated financial statements appearing elsewhere in this annual report.
      To illustrate the Bayer Group’s impairment loss measurement, if the actual present value of future cash flows were 10 percent lower than the anticipated present value, the net carrying amount of goodwill in the Crop Protection segment would have to be impaired by 48 million. The present value of future cash flows measures an asset’s “value in use”, i.e., its value based on our continuing use of the asset and its retirement at the end of its useful life. In the Systems segment, the net carrying amount of goodwill would have to be impaired by 5 million and that of other intangible assets by 19 million. If the weighted average cost of capital used for the impairment test were increased by 10 percent, it would not affect the net carrying amounts of the strategic business entities’ assets.

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      Estimates are also used in the course of acquisitions to determine the fair value of the assets and liabilities acquired. Land, buildings and equipment are usually appraised independently, while marketable securities are valued at market price. If any intangible assets are identified, depending on the type of asset and the complexity of determining its fair value, Bayer either consults with an independent external valuation expert or develops the fair value internally, using an appropriate valuation technique which is generally derived from a forecast of the total expected future net cash flows. Assets may be valued using methods based on cost, market price or net present value, depending on the type of asset and the availability of information. The valuation method based on net present value (income approach) is particularly important with respect to intangible assets. Trademarks and licenses, for example, are valued by the relief-from-royalty method, which includes estimating the cost savings that result from the company’s ownership of trademarks and licenses on which it does not have to pay royalties to a licensor. The intangible asset is then recognized at the present value of these savings.
      Although the Board of Management of Bayer AG believes that its estimates of the relevant expected useful lives, its assumptions concerning the macroeconomic environment and developments in the industries in which the Bayer Group operates and its estimations of the discounted future cash flows are appropriate, changes in assumptions or circumstances could require changes in the analysis. This could lead to additional impairment charges in the future or to valuation write-backs should the trends expected by the Board of Management of Bayer AG reverse.
Research and development
      In addition to the in-house research and development activities, various research and development collaborations and alliances are maintained with third parties; these collaborations and alliances involve the provision of funding and/or payments for the achievement of performance milestones. All research costs are expensed as incurred. Since development projects are subject to regulatory approval procedures and other uncertainties, the conditions for the capitalization of costs incurred before approvals are received are not satisfied, and these costs, too, are therefore expensed as incurred. With respect to costs incurred in collaborations and alliances with third parties, considerable judgment is involved in assessing whether milestone-based payments simply reflect the funding of research, in which case expensing is always required, or whether, by making a milestone payment, an asset is acquired. In the latter case, the relevant costs are capitalized.
Net sales
      The nature of the Bayer Group’s business activities means that the structure of many sales transactions is complex. Sales are recognized upon transfer of risk or rendering of services to third parties. Revenues from contracts that contain customer acceptance provisions are deferred until customer acceptance occurs. It is customary to grant price discounts in the normal course of business. Allocations to provisions for discounts and rebates to customers are recognized in the same period in which the related sales are recorded based on the contract terms, using a consistent method. The cost of such sales incentives is estimated on the basis of historical experience with similar incentive programs. For rebates, provisions are recorded based upon the experience ratio to the respective period’s sales to determine the rebate accrual and related expense. Provisions related to the Group’s trade accounts amounted to 648 million on December 31, 2005.
      Some of the Bayer Group’s revenues are generated from licensing agreements under which third parties are granted rights to certain of our products and technologies. Upfront payments and similar non-refundable payments received under these agreements are recorded as miscellaneous liabilities and recognized in income over the estimated performance period stipulated in the agreement. Non-refundable milestone payments linked to the achievement of a significant and substantive technical/ regulatory hurdle in the research and development process, pursuant to collaborative agreements, are recognized as revenue upon the achievement of the specified milestone. Revenues are also derived from research and development collaborations and co-promotion agreements. Such agreements may consist of multiple elements and provide for varying consideration terms, such as upfront, milestone and similar payments, which may be complex and require significant analysis by management in order to separate individual revenue components and recognize them on the most appropriate dates. This may have to be done partially on the basis of assumptions.

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Pensions and other post-employment benefits
      Group companies provide retirement benefits for most of their employees, either directly or by contributing to independently-administered funds. The way these benefits are provided varies according to the legal, fiscal and economic conditions of each country, the benefits generally being based on the employees’ remuneration and years of service. The obligations relate both to existing retirees’ pensions and to pension entitlements of future retirees. Group companies provide retirement benefits under defined contribution and/or defined benefit plans. In the case of defined contribution plans, the company pays contributions to publicly or privately administered pension insurance plans on a mandatory, contractual or voluntary basis. Once the contributions have been paid, the company has no further payment obligations. All other retirement benefit systems are defined benefit plans, which may be either unfunded, i.e., financed by provisions (accruals), or funded, i.e., financed through pension funds. Statistical and actuarial methods are used to anticipate future events in calculating the expenses and liabilities related to the plans. These calculations include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases.
      The interest rate used to discount post-employment benefit obligations to present value is derived from the yields of senior, high-quality corporate bonds in the respective country at the balance sheet date. These generally include AA-rated securities. The discount rate is based on the yield of a portfolio of bonds whose weighted residual maturities approximately correspond to the duration necessary to cover the entire benefit obligation. If AA-rated corporate bonds of equal duration are not available, a discount rate equivalent to the effective interest rate for government bonds at the balance sheet date is used instead but increased by about 0.5 to 1.0 percentage point since corporate bonds generally provide higher yields by virtue of their risk structure.
      Determination of the discount rate is also based on the average yield for a bond portfolio corresponding to the expected cash outflows from the pension plans.
      The assumption for the expected return-on-assets reflects a long-term outlook for global capital market returns that corresponds to the duration of the pension obligation, and a diversified investment strategy. The investment policy of Bayer Pensionskasse is geared toward regulatory compliance and toward maintaining the risk structure corresponding to the benefit obligations. To this end, Bayer Pensionskasse has developed a strategic target portfolio commensurate with the risk profile. This investment strategy focuses principally on stringent management of downside risks rather than on maximizing absolute returns. In other countries, too, the key criteria for the funds’ investment strategies are the structure of the benefit obligations and the risk profile. Other determinants are risk diversification, portfolio efficiency and a country-specific and global risk/return profile capable of ensuring payment of all future benefits. The expected return is applied to the fair market value of plan assets at each year end.
      Statistical information such as withdrawal and mortality rates is also used in estimating the expenses and liabilities under the plans. Because of changing market and economic conditions, the expenses and liabilities actually arising under the plans in the future may differ materially from the estimates made on the basis of these actuarial assumptions. The plan assets are partially comprised of equity and fixed-income instruments. Therefore, declining returns on equity markets and markets for fixed-income instruments could necessitate additional contributions to the plans in order to cover future pension obligations. Also, higher or lower withdrawal rates or longer or shorter life of participants may have an impact on the amount of pension income or expense recorded in the future. On December 31, 2005, the present value of provisions for pensions and other post-employment benefits payable under defined benefit plans was 15,561 million. Further details on pension provisions and their interest rate sensitivity are provided in Note 28 to the consolidated financial statements appearing elsewhere in this annual report.
Doubtful accounts
      Doubtful accounts are reported at the amounts likely to be recoverable based on historical experience of customer default. As soon as it is learned that a particular account is subject to a risk over and above the normal credit risk (e.g., low creditworthiness of customer, dispute as to the existence or the amount of the claim, non-enforceability of the claim for legal reasons etc.), the account is analyzed and written down if circumstances

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indicate the receivable is uncollectible. Accumulated write-downs of receivables amounted to 348 million as of December 31, 2005.
Environmental provisions
      The business of the Bayer Group is subject to a variety of laws and regulations in the jurisdictions in which it operates or maintains properties. Provisions for expenses that may be incurred in complying with such laws and regulations are set aside if environmental inquiries or remediation measures are probable, the costs can be reliably estimated and no future benefits are expected from such measures.
      It is difficult to estimate the future costs of environmental protection and remediation because of many uncertainties, particularly with regard to the status of laws, regulations and the information available about conditions in the various countries and at the individual sites. Significant factors in estimating the costs include previous experiences in similar cases, expert opinions regarding environmental programs, current costs and new developments affecting costs, management’s interpretation of current environmental laws and regulations, the number and financial position of third parties that may become obligated to participate in any remediation costs on the basis of joint liability, and the remediation methods which are likely to be deployed. Changes in these assumptions could impact future reported results. Subject to these factors, but taking into consideration experience gained to date regarding environmental matters of a similar nature, Bayer believes the provisions to be adequate based upon currently available information. However, given the inherent difficulties in estimating liabilities in this area, it cannot be guaranteed that additional costs will not be incurred beyond the amounts accrued. It is possible that final resolution of these matters may require expenditures to be made in excess of established provisions, over an extended period of time and in a range of amounts that cannot be reasonably estimated. Management nevertheless believes that such additional amounts, if any, would not have a material adverse effect on the Group’s financial position, results of operations or cash flows. Group provisions for environmental protection measures amounted to 279 million on December 31, 2005. Further information on environmental provisions can be found in Note 29.2 to the consolidated financial statements appearing elsewhere in this annual report.
Litigation provisions
      As a global company with a diverse business portfolio, the Bayer Group is exposed to numerous legal risks, particularly in the areas of product liability, patent disputes, tax assessments, competition and antitrust law, and environmental matters. The outcome of the currently pending and future proceedings cannot be predicted with certainty. Thus, an adverse decision in a lawsuit could result in additional costs that are not covered, either wholly or partially, under insurance policies and that could significantly impact the business and results of operations of the Bayer Group. If the Bayer Group loses a case in which it seeks to enforce its patent rights, a decrease in future earnings could result as other manufacturers could be permitted to begin to market products that the Bayer Group or its predecessors had developed.
      Litigation and other judicial proceedings as a rule 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, issues regarding the jurisdiction in which each suit is brought and differences in applicable law. Upon resolution of any pending legal matter, the Bayer Group may be forced to incur charges in excess of the presently established provisions and related insurance coverage. It is possible that the financial position, results of operations or cash flows of the Bayer Group could be materially affected by the unfavorable outcome of litigation. Litigation and administrative proceedings are evaluated on a case-by-case basis considering the available information, including that from legal counsel, to assess potential outcomes. Where it is considered probable that a future obligation will result in an outflow of resources, a provision is recorded in the amount of the present value of the expected cash outflows if these are deemed to be reliably measurable. These provisions cover the estimated payments to plaintiffs, court fees and the cost of potential settlements.
      Provisions for litigation-related expenses totaled 663 million on December 31, 2005. Further details on legal risks are contained in Item 8, Financial Information — Legal Proceedings and in Note 35 to the consolidated financial statements appearing elsewhere in this annual report.

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Income taxes
      To compute provisions for taxes, estimates have to be made. Estimates are also necessary to determine whether valuation allowances are required against deferred tax assets. These involve assessing the probabilities that deferred tax assets resulting from deductible temporary differences and tax losses can be utilized to offset taxable income. Uncertainties exist with respect to the interpretation of complex tax regulations and the amount and timing of future taxable income. Given the wide range of international business relationships and the long-term nature and complexity of existing contractual agreements, differences arising between the actual results and the assumptions made, or future changes to such assumptions, could necessitate adjustments to tax income and expense in future periods. The Group establishes what it believes to be reasonable provisions for possible consequences of audits by the tax authorities of the respective countries. The amount of such provisions is based on various factors, such as experience with previous tax audits and differing interpretations of tax regulations by the taxable entity and the responsible tax authority. Such differences of interpretation may arise on a wide variety of issues depending on the conditions prevailing in the respective Group company’s domicile. On December 31, 2005, net liabilities for current tax payments amounted to 381 million, and net deferred tax assets amounted to 1,418 million. Further information on income taxes is provided in Note 16 to the consolidated financial statements appearing elsewhere in this annual report.
OPERATING RESULTS 2003, 2004 AND 2005
Introduction
Most significant drivers of our sales, results of operations and cash flows in 2005
      The most significant drivers of our sales, results of operations and cash flows in 2005 were:
  •  The general economic situation and improvements in the business climates in the industries of some of our customers in the course of 2005;
 
  •  Raw materials, pricing — i.e., the effects on our results of operations of the increased prices of petrochemical raw materials, other precursors and energy;
 
  •  Effects on net sales from acquisitions and divestitures — particularly our acquisition of Roche’s Consumer Health business and our spin-off of LANXESS;
 
  •  Our incurrence of other charges that we view as special, consisting primarily of provisions established and other expenses incurred in connection with legal matters (special charges did not affect our sales, results of operations and cash flows to the same extent as they did in 2003, when we incurred substantial impairment charges, unscheduled amortization expenses and other write-downs), which are discussed in  — Reconciliation from operating result to operating result before special items.
      In addition, changes in exchange rates — i.e., the effects on our results of operations of the strengthening of the euro against other currencies — have in recent years been a significant driver of our results of operations. In 2005, these changes were less significant.
General Economic Situation
      The global economy continued to grow strongly in 2005. Following a slight downswing in the second quarter, rapid expansion continued for the remainder of the year. The uncertainty caused by several sharp rises in the price of oil, particularly in the first half of the year, did not completely negate the positive underlying trend. Two of the world’s major growth engines, the United States and China, once again performed very well, stimulating other countries’ economies with their demand for imports. The overall business environment in the industrialized countries was further buoyed by favorable monetary conditions. Despite moderate increases in interest rates in the United States and Europe during the year, interest-rate policy as a whole, had a stimulating effect on the economy.

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Raw Materials, Pricing
      The single most important factor that affects our costs is the price of raw materials for our products. Petrochemical feedstocks are important raw materials in many of our products, especially in our Materials and Systems segments. We do not produce petrochemical raw materials. For this reason and due to the volatility of oil and petroleum commodity and futures markets in recent years, our single greatest raw materials sensitivity is to fluctuations in the price of petrochemicals and related derivative products. In 2005, these prices were approximately 10 percent above the average prices in 2004. During the same period, the average annual crude oil price (IPE Brent) increased by approximately 30 percent.
Effects on net sales from acquisitions and divestitures
      Acquisitions and divestitures during 2005 and 2004 had a positive effect on net sales in 2005 of 2,070 million, and acquisitions and divestitures during 2004 and 2003 had a negative effect on net sales in 2004 of 224 million. These portfolio changes affected the comparison between the three years’ sales figures as shown in the following two tables:
         
    Change in
    2005
    from 2004
     
    (Euros in
    millions)
Acquisitions
       
Roche
    1,061  
Gustafson (remaining 50 percent acquired in 2004)
    25  
BaySystems
    7  
       
      1,093  
       
Divestitures
       
Nutritions, Spain (divested in 2004)
    (4 )
       
Net sales to LANXESS after the spin-off on January 31, 2005 (in 2004, sales to LANXESS were classified as internal sales)
    981  
       
Net effects on sales
    2,070  
       

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    Change in
    2004
    from 2003
     
    (Euros in
    millions)
Acquisitions
       
Gustafson
    34  
Other
    11  
       
      45  
       
Divestitures
       
Dispositions in compliance with antitrust conditions in connection with purchase of Aventis CropScience
    (100 )
PolymerLatex group (divested in 2003)
    (62 )
Walothen GmbH (divested in 2003)
    (47 )
Household insecticides business (divested in 2003)
    (25 )
Animal Health vaccines (divested in 2003)
    (16 )
Bayer Shell (divested in 2003)
    (15 )
Other
    (4 )
       
      (269 )
       
Net effects on sales
    (224 )
       
Reconciliation from operating result to operating result before special items
      In the consolidated operating results information we present below, we report, in addition to our operating result, a measure of operating result that excludes impairment charges and write-downs, restructuring charges and unscheduled amortization, portfolio changes and other charges that we view as special (consisting primarily of provisions established and other expenses incurred in connection with legal matters), all of which we refer to as “special items”. “Operating result before special items” is defined neither under IFRS nor under U.S. GAAP and may not be comparable with measures of the same or similar title that are reported by other companies. Under the rules of the Securities and Exchange Commission (SEC) “operating result before special items” is considered a non-GAAP financial measure. It should not be considered as a substitute for, or confused with, any IFRS or U.S. GAAP financial measure. We believe the most comparable IFRS and U.S. GAAP measure is operating result. We present “operating result before special items”, both on a consolidated and on a segment basis, because we believe that doing so assists readers in understanding the performance of our business without the large impacts on the operating result figures resulting from our decisions to reorient our business and from certain expenses (such as some of our impairments and provisions and expenses in respect of legal matters). Readers should consider “operating result before special items” in conjunction with operating result recorded on our income statement. Due to the application of new International Financial Reporting Standard IFRS 5, all figures presented below are reported for our continuing business only. The special items described in this section therefore only relate to our continuing business operations. For information on the significant charges relating to our discontinued operations that were classified as special items in previous years, please refer to — Discontinued Operations.

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      The following table shows our operating result, the special items and our operating result before special items.
                           
    2003   2004   2005
             
    (Euros in millions)
Operating result
    575       1,875       2,812  
Impairment charges and write-downs
    (622 )     0       0  
Restructuring charges and unscheduled amortization
    (405 )     (82 )     (127 )
Portfolio changes
    458       (40 )     (72 )
Other charges
    (495 )     (120 )     (289 )
                   
 
Total special items
    (1,064 )     (242 )     (488 )
Operating result before special items
    1,639       2,117       3,300  
                   
Impairment charges and write-downs
      In 2005, we did not incur any impairment charges or write-downs. All impairment charges and write-downs incurred by us in 2004 related to our discontinued businesses LANXESS and the U.S. activities of our former plasma business. They therefore do not appear in our operating result from continuing operations.
      In 2003, we recognized charges related to impairments and other asset write-downs of 622 million relating to portions of our polymers activities that remained with the Bayer Group after the LANXESS spin-off and now form part of our Systems segment.
      For details on those impairment charges and write downs in 2003 and 2004 that relate to LANXESS and the U.S. activities of our former plasma business, please refer to — Discontinued Operations.
Restructuring charges and unscheduled amortization
      In 2005, we incurred charges in connection with restructuring measures and unscheduled amortization totaling 127 million. The following table allocates the restructuring charges and unscheduled amortization of fixed assets and intangibles we recognized in 2005 according to the businesses and activities to which they relate:
                                 
    Severance   Unscheduled   Other    
Activity/ Business in 2005   Payments   Amortization   Charges   Total
                 
    (Euros in millions)
Reorganization of the polyurethanes business
    0       0       33       33  
Restructuring measures relating to CropScience activities in France
    23       0       0       23  
Consolidation of smaller CropScience sites in the United States
    7       2       3       12  
Relocation of headquarters of the Diabetes Care division to Tarrytown, New York
    7       12       0       19  
Reduction in useful economic life of licenses and inventory write-down
    0       15       3       18  
Restructuring of pharmaceutical activities in West Haven, Connecticut and Wuppertal, Germany
    0       17       5       22  
                         
Totals
    37       46       44       127  
                         

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      In 2004, we incurred charges in connection with restructuring measures and unscheduled amortization totaling 82 million. The following table allocates the restructuring charges and unscheduled amortization of fixed assets and intangibles we recognized in 2004 according to the businesses and activities to which they relate:
                                 
    Severance   Unscheduled   Other    
Activity/ Business in 2004   Payments   Amortization   Charges   Total
                 
    (Euros in millions)
Restructuring of the pharmaceutical research and development activities
    24       0       0       24  
Closure of major parts of a production facility in Hauxton, U.K. 
    5       7       1       13  
Personnel reductions in connection with the Schering-Plough alliance
    32       0       13       45  
                         
Totals
    61       7       14       82  
                         
      In 2003, we incurred charges in connection with restructuring measures and unscheduled amortization totaling 405 million. 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
    28       0       0       28  
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
    0       5       36       41  
Totals
    149       141       71       361  
                         
Write-downs on enterprise management systems
    0       44       0       44  
                         
Totals
    149       185       71       405  
                         
Portfolio changes
      Acquisition and disposition activities also affect our results of operations, and are responsible for substantial fluctuations in our results from year to year. 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 described in Item 4, Information on the Company — History and Development of the Company. Our special items in connection with changes in our portfolio (other than those resulting from discontinued operations) had a net negative effect of 72 million in 2005 and 40 million in 2004, and a positive effect of 458 million in 2003.
      Our special items in connection with changes in our portfolio in 2005 were 71 million in costs for the integration of the consumer health business acquired from Roche, 13 million in charges relating to the LANXESS spin-off and a 12 million gain from the sale of business activities by Bayer Industry Services.
      Our special items in connection with changes in our portfolio in 2004, with a net negative effect of 40 million, included 77 million in charges for the stock exchange listing of LANXESS and 51 million in gains from sales of licenses.

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      Our special items in connection with changes in our portfolio in 2003, with a net positive effect of 458 million, comprised mainly the disposition of a large part of our global household insecticides business (256 million), the disposition of real estate in Germany, Belgium, Spain and the United States (109 million) and divestment of products in connection with the Aventis CropScience acquisition (46 million). The remaining 47 million primarily comprised the sale of our interest in the PolymerLatex Group and the sales of rights to brands.
Other charges
      Other charges in 2005 that we view as special, had a net negative effect of 289 million and consisted primarily of provisions established and other expenses incurred totaling 451 million. These provisions and other expenses relate to several legal matters discussed in Item 8, Financial Information — Legal Proceedings. The most significant charges related to the establishment of provisions in connection with antitrust proceedings for polymer products (336 million). In connection with HealthCare products we had litigation-related expenses totaling 105 million in 2005. Furthermore, we had one-time charges of 106 million arising from the termination of the co-promotion agreement with GlaxoSmithKline for Levitra® outside the United States. The charges were partially offset by a one-time non-cash gain of an aggregated 283 million due to changes to our pension plans in the United States and Germany.
      In 2005, Bayer continued the reorganization of its corporate pension systems around the world, particularly in Germany and the United States. In the United States defined-benefit plans were replaced with a pure defined-contribution plan. The changes resulted in one-time pre-tax gain of 283 million, after offsetting minor effects of the adjustment of pension systems in Germany. The amount impacts all segments. For further details on the changes, please refer to Note 28 to the consolidated financial statements presented elsewhere in this annual report.
      Our 2004 charges of 120 million primarily comprised provisions established and other expenses incurred totaling 139 million relating to a number of the legal matters discussed in Item 8, Financial Information — Legal Proceedings, including 47 million in Lipobay/ Baycol charges. The charges were partially offset by gains from curtailment of pension plans amounting to 48 million.
      The primary components of the other charges totaling 495 million in 2003 included a 300 million charge taken on the basis of the final agreement reached with the majority of insurers in connection with Lipobay/ Baycol. The remaining 195 million primarily comprised expenses incurred in relation with staff reductions through special early retirement and further Lipobay/ Baycol charges.
Changes in Exchange Rates
      Our net sales and our operating result are generally affected 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. 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. For further information on transaction and translation risk, see Item 11, Quantitative and Qualitative Disclosures about Market Risk — Currency Risk.

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      The following table sets forth the exchange rates for the euro of currencies important for our results of operations during 2005:
                                 
    Units of Foreign Currency per Euro
     
        Average For the
        Year Ended
    At December 31,   December 31,
         
    2004   2005   2004   2005
                 
Argentinean peso
    4.05       3.57       3.66       3.64  
Brazilian real
    3.62       2.76       3.64       3.04  
British pound
    0.71       0.69       0.68       0.68  
Canadian dollar
    1.64       1.37       1.62       1.51  
Japanese yen
    139.65       138.90       134.40       136.86  
Mexican peso
    15.23       12.59       14.04       13.58  
Swiss franc
    1.54       1.56       1.54       1.55  
U.S. dollar
    1.36       1.18       1.24       1.24  
      The translation effects of these exchange rate changes had a positive impact on our sales in 2005, increasing them by 0.3 billion (compared to a decrease of 1.0 billion in 2004 and 1.8 billion in 2003). The discussion of our operating results below includes sales figures adjusted for these translation effects. These adjusted sales figures represent the sales that we would have generated had the average exchange rates we used to translate our non-euro denominated revenues into euros remained constant in the year under review as compared with the previous year. For further information concerning our exchange rate exposure, see Item 11, Quantitative and Qualitative Disclosures about Market Risk.
Discontinued Operations
Reporting of Discontinued Operations
      In the financial statements and other financial information included in this annual report, LANXESS and our U.S. plasma activities are reported under discontinued operations in accordance with IFRS 5 and other applicable standards. IFRS 5 requires reporting to be based primarily on continuing operations, while “disposal groups” (groups of assets and liabilities, which we intend to dispose of in a single transaction) and discontinued operations are to be stated separately in a single line item on the balance sheet and income statement. The individual items of the income statement such as sales, functional costs and non-operating result therefore reflect only continuing operations of the Bayer Group.
      For further explanation on IFRS 5, please refer to Note 3 to the consolidated financial statements included elsewhere in this annual report.
LANXESS
      At the end of January 2005, we spun off the LANXESS subgroup to our stockholders, LANXESS thereupon ceased to be part of the Bayer Group. The shares of LANXESS AG have been listed on the Frankfurt Stock Exchange since January 31, 2005.
      In November 2003, Bayer announced that it intended to maintain its focus on its core businesses and therefore combined the former Bayer Chemicals segment (except for Wolff Walsrode and H.C. Starck) with certain parts of the former Bayer Polymers business in a new company. LANXESS was created with economic effect from July 1, 2004. Wolff Walsrode and H.C. Starck were grouped together with the remaining parts of the Bayer Polymers business in a wholly-owned subsidiary of the Bayer Group called Bayer MaterialScience. Throughout 2004, LANXESS businesses were operated as the LANXESS segment of the Bayer Group. This segment had a comprehensive product portfolio in polymers and basic, specialty and fine chemicals.
      The LANXESS subgroup was deconsolidated from the Bayer Group effective January 31, 2005 and is no longer included in the balance sheet as of December 31, 2005. For the comparative periods of 2004 and 2003,

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LANXESS is reported separately in balance sheet line items titled “Assets held for sale and discontinued operations” and “Liabilities directly related to assets held for sale and discontinued operations”. Net earnings of the LANXESS group for the month of January 2005 are recognized in Bayer Group net income for 2005. In the income and cash flow statements for 2005, as well as for the comparative periods of 2004 and 2003, LANXESS is reported under discontinued operations. Since February 1, 2005, sales from Bayer companies to LANXESS are reported as external net sales.
      LANXESS had net sales of 503 million in 2005 (for January only), 6,053 million in 2004 and 5,776 million in 2003. Operating results of LANXESS were 62 million in 2005 (for January only), 78 million in 2004 and minus 1,288 million in 2003. The 2003 result was diminished in particular by impairment charges of 988 million. The income from discontinued operations after taxes attributable to LANXESS was 38 million in 2005 (for January only), minus 4 million in 2004 and minus 973 million in 2003.
      In both 2004 and 2003 we reported expenses and income for LANXESS that we considered to be special items. In 2004, these items had a net effect of minus 99 million on our income statement and primarily comprised a 40 million provision for environmental protection measures and a 20 million litigation-related expense in connection with an investigation into prices for rubber products. In addition, the total amount included 68 million in impairment charges, which were partly offset by adjustments of 29 million in connection with the 2003 impairments relating to our former polymers and chemicals activities. In 2003, special items had a net effect of minus 1,204 million and primarily consisted of impairment charges of 988 million and charges of 97 million for personnel-related measurement.
      For a discussion of the risks and uncertainties that continue to face us in connection with the LANXESS spin-off, please see Item 3, Key Information — Risk Factors — Our transactions relating to LANXESS expose us to continuing liability and Item 10, Additional Information — Material Contracts.
Plasma activities
      At the end of March 2005, Bayer divested the U.S. plasma operations of its Biological Products division to two U.S. financial investors, Cerberus Capital Management, L.P., New York, New York and Ampersand Ventures, Wellesley, Massachusetts. The agreement covers the products, facilities and employees representing the plasma portion of the division. The remaining portion, consisting of our Kogenate® business, is not affected by this agreement and, effective January 1, 2006, forms part of our Pharmaceuticals division. All plasma activities in the United States were transferred to Talecris BioTherapeutics, Inc., a corporation newly formed by the two investors, that began operations on April 1, 2005. In most of the countries outside of the United States Bayer will continue to distribute plasma products.
      2005 net earnings from the discontinued U.S. plasma operations are included in Bayer Group net income through March 31, 2005. These results include adjustments in connection with the purchase price. To account for the final agreement signed at the end of March 2005, we adjusted the previous year’s presentation to show the continued non-U.S. distribution as part of our continuing operations. In our financial statements for 2005 only the U.S. plasma business is reflected in discontinued operations. Revenues from our marketing activities for plasma products outside the United States are reflected in sales from continuing operations of our Pharmaceuticals, Biological Products segment. The comparative periods 2004 and 2003 have been adjusted to reflect the inclusion of non-U.S. distribution in continuing operations.
      The U.S. plasma operations had net sales of 124 million in 2005 (through March 31 only), 427 million in 2004 and 374 million in 2003. Operating result of the U.S. plasma activities was minus 2 million in 2005 (through March 31 only), minus 97 million in 2004 and minus 392 million in 2003. The loss from discontinued operations after taxes attributable to the U.S. plasma operations was 1 million in 2005 (through March 31 only), 63 million in 2004 and 269 million in 2003.
      Expenses reported as special items in the previous annual report amounted to 71 million in losses and 24 million in write-downs in connection with the divestment of the plasma business in 2004 and an impairment charge of 317 million in 2003.

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      The following table sets forth net sales, operating result and income (loss) from discontinued operations after tax attributable to LANXESS and the U.S. activities of our former plasma business for the three years under review. For further information, refer also to Note 7.2 to the consolidated financial statements appearing elsewhere in this annual report.
                                                                         
    LANXESS   Plasma   Total Discontinued Operations
             
    2003   2004   2005   2003   2004   2005   2003   2004   2005
                                     
    (Euros in millions)   (Euros in millions)   (Euros in millions)
Net sales
    5,776       6,053       503       374       427       124       6,150       6,480       627  
Operating result
    (1,288 )     78       62       (392 )     (97 )     (2 )     (1,680 )     (19 )     60  
Special items
    (1,204 )     (99 )           (317 )     (95 )           (1,521 )     (194 )      
Net income (loss)
    (973 )     (4 )     38       (269 )     (63 )     (1 )     (1,242 )     (67 )     37  
Affected segments
 
(LANXESS)
 
Pharmaceuticals, Biological
Products
                       

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Bayer Group
      In accordance with the new accounting standard IFRS 5 and other applicable IFRS standards, the financial information presented for 2003, 2004 and 2005 only reflects continuing operations of the Bayer Group and its segments, except where specific reference is made to discontinued operations. Furthermore, the figures for 2003 and 2004 have been restated to give effect to a change in the reporting of funded pension obligations in accordance with revised IAS 19 (Employee Benefits) and adjusted to reflect a change in presentation of our former plasma business. Our non-U.S. plasma operations, which had previously been classified as “discontinuing operations”, are now included in “continuing operations” (For details, please refer to — Discontinued Operations). Moreover, the LANXESS spin-off in early 2005 and the acquisition of Roche’s Consumer Health business led to a shift in the relative sizes of our business in terms of sales, operating result and assets. We therefore changed our segment structure and reporting with effect from January 1, 2005. We restated our segment reporting for 2003 and 2004 to correspond to the new structure in compliance with IAS 14 (Segment Reporting).
      The following table shows sales and income for Bayer as a whole.
                                           
        Change from       Change from    
    2003(a)   Previous Year   2004(a)   Previous Year   2005(b)
                     
        (%)       (%)    
    (Euros in millions)
Net sales
    22,417       3.8       23,278       17.6       27,383  
Gross profit
    10,638       2.1       10,857       13.8       12,356  
 
as percentage of sales (%)
    47.5               46.6               45.1  
Selling expenses
    (5,515 )     5.0       (5,240 )     (9.0 )     (5,713 )
Research and development expenses
    (2,190 )     12.0       (1,927 )     2.1       (1,886 )
General and administrative expenses
    (1,410 )     (0.8 )     (1,421 )     (1.6 )     (1,444 )
Other operating income
    1,073       (31.0 )     740       7.3       794  
Other operating expenses
    (2,021 )     43.9       (1,134 )     (14.2 )     (1,295 )
Operating result
    575             1,875       50.0       2,812  
 
as percentage of sales (%)
    2.6               8.1               10.3  
Non-operating result
    (708 )     7.8       (653 )     6.1       (613 )
Income before income taxes
    (133 )           1,222       80.0       2,199  
Income from continuing operations after taxes
    (49 )           749       108.0       1,558  
Income from discontinued operations after taxes
    (1,242 )     94.6       (67 )           37  
Group net income (total)
    (1,303 )           685       133.1       1,597  
 
(a) 2003 and 2004 data have been restated to give effect to a change in the reporting of funded pension obligations in accordance with revised IAS 19 (Employee Benefits) and adjusted to reflect the LANXESS spin-off and the sale of the U.S. plasma operations in accordance with IFRS 5 and other applicable IFRS standards. For further information on these restatements, see — Discontinued Operations and Note 7.2 to the consolidated financial statements appearing elsewhere in this annual report.
(b) The Consumer Health business acquired from Roche is reflected in the income statement with effect from January 1, 2005.

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      The following table shows a geographical breakdown of our sales from continuing operations based on where we sold our products.
                                         
        Change from       Change from    
    2003   Previous Year   2004   Previous Year   2005
                     
        (%)       (%)    
    (Euros in millions)
Europe
    9,110       7.3       9,775       22.0       11,930  
North America
    6,981       (6.7 )     6,512       12.7       7,340  
Asia/Pacific
    3,625       9.3       3,962       15.5       4,578  
Latin America/ Africa/Middle East
    2,701       12.1       3,029       16.7       3,535  
2005 compared with 2004
Net Sales
      Net sales represent the gross inflow of economic benefits that are recognized upon the transfer of risk or rendering of services to third parties. 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 rose by 17.6 percent, or 4,105 million, to 27,383 million in 2005, compared with 23,278 million in 2004. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2005 as compared with 2004, our net sales would have increased by 16.4 percent. In comparison with 2004, price increases of 7.0 percent that were primarily attributable to MaterialScience led to an increase of 1,647 million in net sales. Changes in our portfolio of businesses, primarily relating to the Consumer Health business acquired from Roche and our spin-off of LANXESS (leading to a reclassification of sales to LANXESS from “inter-segment sales” to “external sales”), accounted for an increase of 2,070 million (8.9 percent) in our net sales.
Gross Profit
      Gross profit represents net sales after deducting cost of goods sold. Cost of goods sold include the production costs of goods sold and the cost of goods purchased for resale. The cost of goods sold and services provided increased by 21.0 percent in 2005 to 15,027 million, due mainly to the overall growth in our business, in particular in our MaterialScience business, and due to the changes in our portfolio, primarily relating to the acquisition of Roche’s Consumer Health business and the LANXESS spin-off (analogous to presenting sales to LANXESS as external sales, costs of goods sold increased because of related costs). The ratio of the cost of goods sold to total net sales was 54.9 percent, compared with 53.4 percent in the previous year. The single largest driver of this increase was higher raw material prices.
Operating Result
      Operating result represents gross profit after deducting selling expenses, research and development expenses, general administration expenses and other operating income and expenses.
      Selling expenses increased by 473 million, or 9.0 percent, to 5,713 million, primarily due to higher marketing and distribution costs in our HealthCare and MaterialScience businesses.
      Research and development expenses declined by 41 million, or 2.1 percent to 1,886 million, mainly because of our concentration on our strategic core businesses within Bayer HealthCare and Bayer CropScience.
      General administration expenses increased by 23 million, or 1.6 percent, to 1,444 million, due primarily to the acquisition of Roche’s Consumer Health business. The resulting increase in cost could only partly be offset by cost reduction measures.
      Other operating income increased by 54 million, or 7.3 percent, to 794 million, mainly due to gains from changes to our pension systems in the United States and Germany (283 million). In 2004, other operating income included 169 million gains relating to pension and 51 million in gains from sales of licenses.

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      Other operating expenses increased by 161 million, or 14.2 percent, to 1,295 million. The expenses included the establishment of provisions in connection with antitrust proceedings involving products in the polymers area (336 million) and litigation-related expenses in connection with HealthCare products (105 million). Other operating expenses in 2004 included provisions established and other expenses incurred totaling 139 million in connection with a number of legal matters. Moreover, in 2004 amortization of goodwill and intangible assets with indefinite useful lives under former IFRS regulations accounted for 185 million.
      Operating result improved by 50.0 percent, or 937 million, to 2,812 million in 2005, compared with 1,875 million in 2004. The largest contributions to the growth in operating result were made by the Materials (340 million) and Systems segments (388 million) and resulted largely from price increases. Special items had a net negative effect of 488 million on our operating result, compared with 242 million in 2004. For a breakdown of these special items, see — Introduction — Reconciliation from operating result to operating result before special items. Operating result before special items climbed by 55.9 percent to 3,300 million (2004: 2,117 million).
Non-Operating Result
      Non-operating result represents income and expenses from investments in affiliated companies, interest income and expenses, and other non-operating income and expenses. Non-operating result improved by 40 million, or 6.1 percent, to an expense of 613 million. Net loss from investments in affiliated companies declined significantly, while net interest expense rose due to the acquisition-related increase in net debt at the beginning of the year. The loss from affiliated companies mainly comprises an equity-method loss of 47 million (2004: 131 million) from two production joint ventures with Lyondell.
Income Before Income Taxes
      Income before income taxes represents operating result plus non-operating result. In 2005 we had positive income before income taxes of 2,199 million, as compared with 1,222 million in 2004.
Income Taxes
      Income taxes represent the income taxes paid or accrued in the individual countries, plus deferred taxes. We recognized an income tax charge of 641 million in 2005, as compared with 473 million in 2004. The tax rate for our Group was 29.1 percent in 2005. The tax result was composed of income taxes paid or payable of 541 million as well as deferred taxes that led to a net charge of 100 million.
Income from Discontinued Operations After Taxes
      According to IFRS 5 (Non-current Assets Held for Sale and Discontinued Operations) the post-tax profit or loss of discontinued operations and the post-tax gain or loss recognized on the measurement to fair value less costs to sell or on the disposal of the disposal group are reported separately in a single line item on the income statement.
      Income from discontinued operations after taxes amounted to income of 37 million in 2005, compared to a loss of 67 million in 2004. The 2005 figure includes the income from our former LANXESS segment for January 2005 as well as the income from the U.S. activities of our former plasma business for the first quarter 2005, including adjustments made in connection with the purchase price.
      For details refer to — Discontinued Operations or to Note 7.2 to the consolidated financial statement included elsewhere in this annual report.
Net Income
      Net income represents income from continuing operations after taxes plus income from discontinued operations after taxes minus minority stockholders’ interest. Group income rose by 912 million to 1,597 million from an net income of 685 million in 2004. Income from continuing operations after taxes amounted to

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1,558 million in 2005 and 749 million in 2004. Income from discontinued operations after taxes was 37 million in 2005 and minus 67 million in 2004.
2004 compared with 2003
Net Sales
      Net sales increased by 861 million, or 3.8 percent, to 23,278 million in 2004, compared with 22,417 million in 2003. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2004 as compared with 2003 rather than declining as they in fact did, our net sales would have increased by 1,807 million, or 8.0 percent. This increase was primarily due to volume growth. In comparison with 2003, price increases of an average of 0.8 percent led to 174 million of increased net sales. Changes in our portfolio of businesses (other than those resulting from discontinued operations) accounted for a 224 million reduction in our net sales. For details refer to — Introduction — Effects on net sales from acquisitions and divestitures.
Gross Profit
      The cost of goods sold and services provided increased by 5.5 percent in 2004 to 12,421 million, due mainly to the overall growth in our business, in particular in our MaterialScience business. Had the average exchange rates we used to translate our non-euro denominated costs into euros stayed constant in 2004, the increase would have been 9.9 percent.
Operating Result
      Selling expenses declined by 275 million, or 5.0 percent, to 5,240 million, primarily due to currency effects.
      Research and development expenses declined by 263 million, or 12.0 percent to 1,927 million, mainly because of our concentration on our strategic core businesses within Bayer HealthCare and Bayer CropScience and also due to currency effects.
      General administration expenses remained relatively constant with an increase of 11 million, or 0.8 percent, to 1,421 million.
      Other operating income decreased by 333 million, or 31.0 percent, to 740 million. The figure for 2004 included a 121 million net gain from a reduction in obligations to pay supplementary medical expenses for retirees in the United States, as well as 51 million in gains from sales of licenses and 48 million in gains resulting from pension curtailments, both of which we consider special items. Other operating income for 2003 included gains from the sale of the remaining part of the household insecticides business (256 million), the PolymerLatex group (28 million), the divestment of products in connection with the Aventis CropScience acquisition (46 million) and the disposition of real estate in Germany, Belgium, Spain and the United States (109 million).
      Other operating expenses decreased by 887 million, or 43.9 percent, to 1,134 million, primarily because the 2003 amount contained impairment charges and other write-downs of 622 million as well as 300 million charges taken on the basis of the final agreement reached with the majority of insurers in connection with Lipobay/ Baycol. Other operating expenses in 2004 included provisions established and other expenses incurred totaling 139 million in connection with a number of legal matters, including 47 million in Lipobay/ Baycol charges.
      Operating result improved by 1,300 million to 1,875 million, with special items having a 242 million net negative effect. For a breakdown of these special items, see — Introduction — Reconciliation from operating result to operating result before special items. Operating result before special items increased by 29.2 percent to 2,117 million.

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Non-Operating Result
      The non-operating result improved by 55 million, or 7.8 percent, to an expense of 653 million, largely because of a decrease in net interest expense mainly due to reduced net debt and lower interest rates, as well as lower write-downs of investments in subsidiaries. For a definition of our “net debt” measure, see — Liquidity and Capital Resources 2003, 2004 and 2005 — Cash Flows — Financing Activities.
Income Before Income Taxes
      In 2004 we had a positive income before income taxes of 1,222 million, as compared with a loss before income taxes of 133 million in 2003.
Income Taxes
      We recognized an income tax charge of 473 million in 2004, as compared with a benefit of 84 million in 2003. The tax rate for our Group was 39 percent in 2004. The tax result was composed of income taxes paid or payable of 490 million, partly offset by deferred taxes that led to a net credit of 17 million.
Income from Discontinued Operations After Taxes
      Income from discontinued operations after taxes amounted to a loss of 67 million in 2004 compared with a loss of 1,242 million in 2003. The 2003 result was primarily influenced by impairments and asset write-downs totaling 1,305 million.
      For details refer to — Discontinued Operations and to Note 7.2 to the consolidated financial statement appearing elsewhere in this annual report.
Net Income
      Group income rose by 1,988 million to 685 million from a net loss of 1,303 million in 2003. Income from continuing operations after tax increased from a loss of 49 million in 2003 to a positive income of 749 million. Income from discontinued operations after tax was at minus 67 million in 2004 compared to a loss of 1,242 million in 2003.
Segment Data
      The LANXESS spin-off in early 2005 and the acquisition of Roche’s Consumer Health business led to a shift in the relative sizes of our business in terms of sales, operating result and assets. We therefore changed our segment structure and reporting with effect from January 1, 2005. We restated our segment reporting for 2003 and 2004 to correspond to the new structure in compliance with IAS 14 (Segment Reporting).
      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. See — Introduction — Reconciliation from operating result to operating result before special items.

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Pharmaceuticals, Biological Products
      Effective January 1, 2006 the former Pharmaceuticals, Biological Products segment has been renamed the Pharmaceuticals segment.
                                         
        Change from       Change from    
    2003(1)   Previous Year   2004(1)   Previous Year   2005
                     
        (%)       (%)    
    (Euros in millions)
Net sales (external)
    4,371       (9.4 )     3,961       2.7       4,067  
Intersegment sales
    42       (9.5 )     38       52.6       58  
Operating result
    (16 )           399       19.0       475  
Special items
    (515 )           (53 )           (140 )
                               
Operating result before special items
    499       (9.4 )     452       36.1       615  
 
(1)  2003 and 2004 data have been restated to reflect the sale of the U.S. plasma operations in accordance with IFRS 5. As explained above under — Discontinued Operations, only our U.S. plasma operations are classified as “discontinued operations”. Our non-U.S. plasma operations, which had previously been classified as “discontinuing operations”, are now included in “continuing operations”. For further information on these restatements, see — Discontinued Operations and Note 7.2 to the consolidated financial statements appearing elsewhere in this annual report.
      The primary special items were as follows:
             
Year   Nature of special item   Income/ charge
         
        (Euros in millions)
2003
  Charges taken on the basis of the final agreement reached with the majority of
  insurers in connection with Lipobay/ Baycol
   
(300
)
    Closure of research and production facilities     (171 )
2004
  Charges in connection with restructuring pharmaceuticals research and
  development
   
(24
)
    Gain on a sale of a license     39  
    Charges in connection with Lipobay/ Baycol     (47 )
    Restructuring charges in connection with the Schering-Plough alliance     (45 )
    Pension curtailment in connection with the Schering-Plough alliance     24  
2005
  Charges in connection with the termination of the co-promotion agreement with
  GlaxoSmithKline for Levitra®
   
(106
)
    Litigation-related expenses in connection with Lipobay/ Baycol     (43 )
    One-time non-cash gain due to changes to our pension plans in the United States
  and Germany
    49  
    Restructuring of pharmaceutical activities in West Haven, Connecticut and
  Wuppertal, Germany
    (22 )
2005 compared with 2004
      Sales of the Pharmaceuticals, Biological Products segment rose by 106 million, or 2.7 percent, to 4,067 million in 2005. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2005 as compared with 2004, our net sales in this segment would have increased by 67 million or 1.7 percent.
      Sales of the Pharmaceuticals division receded by 58 million, or 1.8 percent, to 3,108 million. We achieved growth in our sales of specialty products, particularly Trasylol®, in the United States, and of Avelox® and Levitra® outside the United States. This enabled us partially to offset a 312 million decline in sales due to the expiration of the U.S. patent on our anti-infective Cipro® and the marketing of our primary care products in the United

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States by Schering-Plough. For further information on changes in sales of our major products, please refer to the relevant segment discussion in Item 4 — Business.
      In the Biological Products division, sales rose by 164 million, or 20.6 percent, to 959 million. Our sales of Kogenate® expanded, mostly in Europe and the United States, by 100 million, or 17.8 percent, to 663 million. In Europe and Canada, we benefited from the market introduction of our Bio-Set® delivery device for more convenient infusion.
      Operating result of the Pharmaceuticals, Biological Products segment improved by 76 million, or 19.0 percent, to 475 million. Operating result before special items rose by 163 million, or 36.1 percent, to 615 million, due mainly to improved cost structures and increases in sales discussed above.
      Special items in 2005 had a net negative effect of 140 million, primarily comprising charges in connection with the termination of our co-promotion agreement with GlaxoSmithKline for Levitra® outside the United States (106 million), further charges for Lipobay/ Baycol (43 million) and measures relating to restructuring projects and unscheduled amortization in the United States and Germany (40 million). Charges were partially offset by a one-time non-cash gain of 49 million due to changes to our pension plans in the United States and Germany. Special items in 2004 comprised mainly restructuring charges, Lipobay/ Baycol charges, gains from a license sale and curtailment of pension plans.
2004 compared with 2003
      Sales of our Pharmaceuticals, Biological Products segment declined by 410 million, or 9.4 percent, to 3,961 million. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2004 as compared with 2003, our net sales in this segment would have decreased by 259 million, or 5.9 percent, in 2004.
      Sales of the Pharmaceuticals division declined by 469 million, or 12.9 percent, to 3,166 million. This was mostly due to the expiration of our U.S. patent for the anti-infective Cipro®. Total sales of Ciprobay®/Cipro® (active ingredient: ciprofloxacin) fell by 574 million, or 40.7 percent. As part of the realignment of our pharmaceuticals business, we signed an extensive cooperation agreement in September 2004 under which Schering-Plough now markets selected primary care products in the United States in return for sales-dependent license payments or, in the case of Levitra®, in return for a share of the earnings realized. Those license payments together with our share of the earnings now represent the bulk of our sales in the United States. As license payments are only a share of sales to market, our sales declined compared to 2003. Sales of our erectile dysfunction treatment Levitra® rose by 49 million, or 34.0 percent, to 193 million; a smaller increase than we had anticipated. Sales of our respiratory antibiotic Avalox®/Avelox® continued to advance in a highly competitive environment, increasing by 6.4 percent to 318 million. Despite keen competition from generics, sales of our antihypertensive drug Adalat® remained steady. Further growth was achieved by Aspirin® Cardio (heart attack and stroke prophylaxis), Trasylol® (used in open-heart surgery) and Glucobay® (diabetes).
      Sales of the Biological Products division rose by 8.0 percent to 795 million, with sales growing by 10.4 percent when using 2003 exchange rates. Sales of our hemophilia drug Kogenate® grew primarily in Europe, with a considerable increase in volumes. Revenues from our marketing activities for plasma products outside the United States declined by 3.2 percent to 232 million. Especially in Japan the plasma business receded due to fierce competition and regulatory changes.
      Operating result of the Pharmaceuticals, Biological Products segment improved from minus 16 million to 399 million. Operating result before special items decreased by 9.4 percent to 452 million. The decline was in particular due to the expiration of our U.S. patent for Cipro®, and was only partially offset by the higher sales of the Biological Products division and further cost savings.
      Special items in 2004 amounted to minus 53 million in aggregate, and are primarily comprised of charges of 47 million for Lipobay/ Baycol, 21 million in restructuring charges partially offset by a gain from curtailment of pension plans in connection with the Schering-Plough alliance, 24 million related to restructuring charges in connection with the realignment of our pharmaceuticals research and development and a 39 million gain from

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the sale of a license. Special items in the previous year mainly comprised expenses relating to accounting measures concerning Lipobay/ Baycol.
Consumer Care
                                         
        Change from       Change from    
    2003   Previous Year   2004   Previous Year   2005(a)
                     
        (%)       (%)    
    (Euros in millions)
Net sales (external)
    1,403       (4.8 )     1,336       76.3       2,355  
Intersegment sales
    7       128.6       16       (12.5 )     14  
Operating result
    486       (62.3 )     183       (4.9 )     174  
Special items
    288             (30 )           (118 )
                               
Operating result before special items
    198       7.6       213       37.1       292  
 
(a)  The consumer health business acquired from Roche is reflected in the income statement with effect from January 1, 2005.
      The primary special items were as follows:
             
Year   Nature of special item   Income/ charge
         
        (Euros in millions)
2003
  Divestment of household insecticides business     256  
2004
  Provision for litigation     (16 )
    Expenses relating to the integration of the Roche Consumer Health
  business
    (14 )
2005
  Expenses relating to the integration of the Roche Consumer Health
  business
   
(71
)
    Provision for litigation     (62 )
2005 compared with 2004
      Sales of the Consumer Care segment rose by 1,019 million, or 76.3 percent, to 2,355 million in 2005. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2005 as compared with 2004, our net sales in this segment would have increased by 75.2 percent. Without taking into account the sales attributable to the acquired Consumer Health business from Roche, our segment sales declined by 3.1 percent.
      The integration of the acquired Consumer Health business proceeded more favorably than expected. High sales increases were recorded by products integrated into our portfolio resulting from the Roche acquisition, especially Bepanthen®/Bepanthol®, Rennie® and Supradyn®, with the new activities accounting for sales of 1,061 million in 2005. For further information on changes in sales of our major products, please refer to the segment discussion in Item 4 — Business.
      Operating result of the Consumer Care segment fell by 9 million, or 4.9 percent, to 174 million. This was after the effect of acquiring inventories from Roche at selling prices, which diminished margins by 57 million. Operating result before special items climbed by 37.1 percent, or 79 million, to 292 million, with a major earnings contribution from the newly-acquired Consumer Health business. Special items amounted to charges of 118 million in 2005 and 30 million in 2004. In both years, special items related to the integration of the business acquired from Roche and to litigation-related expenses.
2004 compared with 2003
      Sales in the Consumer Care segment fell by 4.8 percent to 1,336 million. Had the average exchange rates we used to translate our non-euro denominated revenues into euros stayed constant in 2004 as compared with 2003 rather than declining as they in fact did, our net sales would have increased by 1.4 percent. Business in

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Europe, particularly Italy, Germany and the United Kingdom, continued to expand because of the launch of new products such as Aspirin® Complex. In Latin America, Aspirin® sales increased. By contrast, our Consumer Health business in North America was level with the previous year.
      Operating result of the Consumer Care segment dropped by 303 million to 183 million. However, before special items — consisting of litigation-related charges of 16 million and expenses for the integration of the Roche Consumer Health business of 14 million in 2004 — operating result for the segment increased to 213 million (plus 7.6 percent) mainly due to cost savings initiatives. The principal special item in 2003 was a gain of 256 million from the sale of the household insecticides business.
Diabetes Care, Diagnostics
                                         
        Change from       Change from    
    2003   Previous Year   2004   Previous Year   2005
                     
        (%)       (%)    
    (Euros in millions)
Net sales (external)
    1,933       2.2       1,975       8.9