Edgar Filing: BAYER AKTIENGESELLSCHAFT

e6vk

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 6-K

REPORT OF FOREIGN PRIVATE ISSUER
PURSUANT TO RULE 13a-16 OR 15d-16
OF THE SECURITIES EXCHANGE ACT OF 1934

For the month of March 2006

Bayer Aktiengesellschaft
Bayer Corporation*

(Translation of registrant’s name into English)

Bayerwerk, Gebaeude W11
Kaiser-Wilhelm-Allee
51368 Leverkusen
Germany
(Address of principal executive offices)

Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.

Form 20-F X Form 40-F

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101 (b)(1): N/A

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101 (b)(7): N/A

Indicate by check mark whether, by furnishing the information contained in this form, the registrant is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes No X

If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): N/A


*		Bayer Corporation is also the name of a wholly-owned subsidiary of the registrant in the United States.


		Science For A Better Life Annual Report 2005


Financial Calendar
2005 Annual Report Monday, March 6, 2006	Q2 2006 Interim Report Tuesday, August 1, 2006
Q1 2006 Interim Report Thursday, April 27, 2006	Q3 2006 Interim Report Tuesday, October 31, 2006
Annual Stockholders’ Meeting 2006 Friday, April 28, 2006	Annual Stockholders’ Meeting 2007 Friday, April 27, 2007
Payment of Dividend Tuesday, May 2, 2006	Payment of Dividend Monday, April 30, 2007

Operations Overview


		Bayer

Strategic management in the Bayer Group is kept separate from everyday business activities. The subgroups and service companies operate independently under the leadership of the management holding company Bayer AG, which defines common values, goals and strategies for the entire enterprise and is headed by the four-member Group Management Board. The Corporate Center supports the Group Management Board in its tasks and also performs certain common functions for the subgroups.

Bayer HealthCare

Bayer HealthCare plays a major role in improving the health of people and animals by researching, developing, manufacturing and marketing innovative products for disease prevention, diagnosis and treatment. Following the merger of the Biological Products and Pharmaceuticals divisions to form a new organizational unit effective January 1, 2006, the activities of Bayer HealthCare are now organized in five divisions: Animal Health, Consumer Care, Diabetes Care, Diagnostics and Pharmaceuticals. The company’s Animal Health and Consumer Care divisions and its diagnostic systems hold leading positions on the world market.


Bayer HealthCare	2004		2005		Change
€ million					%
Net external sales		8,058		9,429		+ 17.0

Operating result [EBIT]		956		1,102		+ 15.3

Gross cash flow		943		1,138		+ 20.7

Net cash flow		1,053		1,351		+ 28.3

Capital expenditures		301		330		+ 9.6

Operating Result [EBIT] 2005
€ million

Bayer CropScience

Bayer CropScience is a global leader in crop protection and non-agricultural pest control. This company, with its highly effective products, pioneering innovations and keen customer focus, is aiming for further growth in the future. It is organized in three business groups – Crop Protection, Environmental Science and BioScience. Bayer CropScience markets a balanced range of crop protection products and is among the leading suppliers of insecticides, fungicides, herbicides and seed treatments. It has a strong presence in all regions of the world.


Bayer CropScience	2004		2005		Change
€ million					%
Net external sales		5,946		5,896		- 0.8

Operating result [EBIT]		492		690		+ 40.2

Gross cash flow		893		964		+ 8.0

Net cash flow		778		904		+ 16.2

Capital expenditures		209		201		- 3.8

Operating Result [EBIT] 2005
€ million

Bayer MaterialScience

Bayer MaterialScience is a renowned supplier of high-performance materials and innovative system solutions used in a wide range of products for everyday life. Products with leading positions on the world market account for a major share of sales. Principal customers are the automotive and construction industries, the electrical/electronics sector and manufacturers of sports and leisure articles, packaging and medical equipment. Operations comprise five business units: Coatings, Adhesives and Sealants; Polycarbonates; Polyurethanes; Thermoplastic Polyurethanes and Inorganic Basic Chemicals, along with two independent companies, H.C. Starck and Wolff Walsrode.


Bayer MaterialScience	2004		2005		Change
€ million					%
Net external sales		8,597		10,695		+ 24.4

Operating result [EBIT]		641		1,369		+ 113.6

Gross cash flow		884		1,402		+ 58.6

Net cash flow		498		1,388		+ 178.7

Capital expenditures		332		715		+ 115.4

Operating Result [EBIT] 2005
€ million

Bayer Business Services

Bayer Business Services is the Bayer Group’s international competence center for IT-based services. The company’s objective is to contribute lastingly to its customers’ value creation with high-performance solutions and new ideas. Its product offering is focused on four core areas: IT and telecommunications; procurement and logistics; human resources and executive personnel services; and finance and accounting. The service spectrum ranges from consultancy through the development and implementation of system solutions to the handling of entire business processes. For industry and public-sector customers, Bayer Business Services positions itself as a business process outsourcing partner; for Bayer, as a shared service center.

Bayer Technology Services

Bayer Technology Services, the technological backbone of the Bayer Group, is engaged in process development and in process and plant engineering, construction and optimization. This company also develops innovative technology platforms that contribute substantially to the efficiency of Bayer’s operating units. Bayer Technology Services offers integrated solutions throughout the life cycle of facilities, processes and products.

Bayer Industry Services

Bayer Industry Services is the operator of Germany’s largest chemical park, with sites at Leverkusen, Dormagen and Krefeld-Uerdingen. The company provides the foundation for the smooth operation of facilities at these sites, offering a customized service portfolio ranging from technology through environmental protection, waste management, utility supply, analytics, infrastructure, safety and security to vocational training and continuing education courses. Bayer Industry Services also markets fully developed land and buildings to companies interested in setting up operations within the chemical park.

Working to Create Value through Innovation and Growth

Bayer is a global enterprise with core competencies in the fields of health care, nutrition and high-tech materials. Our products and services are designed to benefit people and improve their quality of life. At the same time we want to create value through innovation, growth and improved earning power.

We have successfully reorganized the Bayer Group and further streamlined our portfolio to create a new Bayer that is focused on its corporate strengths, its customers and the markets of the future. To help us achieve this goal, we carried out a strategic realignment that concentrates our activities in three high-potential, agile subgroups with largely independent operations: HealthCare, CropScience and MaterialScience, supported by three service companies. Our operating companies give us the access we need to the growth markets of the future.

As an inventor company, we plan to continue setting trends in research-intensive areas. Innovation is the foundation for competitiveness and growth, and thus for our company’s success in the future.

We believe our technical and commercial expertise entails a duty to contribute to sustainable development – a principle we wholeheartedly endorse, mindful of its social, ethical and environmental elements. In awareness of our responsibilities as a corporate citizen, we define economy, ecology and social commitment as objectives of equal rank.

We seek to retain society’s confidence through performance, flexibility and open communication as we work in pursuit of our overriding corporate goals: to steadily create corporate value and generate high value-added for the benefit of our stockholders, our employees and the community in every country in which we operate.


		Science For A Better Life

2 Contents

Bayer: Science For A Better Life

Products and services that benefit people and improve the quality of their lives – that’s what the slogan “Bayer: Science For A Better Life” stands for. The examples from the HealthCare, CropScience and MaterialScience subgroups presented in this Annual Report illustrate the true meaning of this slogan. The articles feature testimony both from our customers and from our own research and development experts. As you browse through these pages, you’ll also learn more about Bayer’s innovative products and research activities. Three examples of customer focus and innovation. Three products representing countless others. Three solutions from the inventor company Bayer.

BAYER HEALTHCARE “Aspirin, long hailed as a wonder drug, is constantly opening up new possibilities and indications,” says Dr. Gisela Latta (photo), Senior Science Manager for Bayer HealthCare’s Consumer Care Division. Of particular note according to Latta is the drug’s highly successful use in the prevention of secondary heart attack and stroke, because in this way it can extend lives – including potentially that of Angelika Franz, who suffers from heart disease.

Read more on page 10

BAYER CROPSCIENCE In the cotton seed business, customer satisfaction has a lot to do with harvest yields as well as product quality. Dr. Tony Arioli and Dr. Stephan Soyka (photo, from left), scientists at Bayer CropScience, are well aware of this as they further develop the highly successful cotton seed FiberMax^{^®}. Using the latest biotechnological methods, they are working to ensure that FiberMax^{^®}continues to deliver value well beyond many growers’ expectations. Says U.S. cotton farmer Jerry Mimms: “FiberMax enables me to compete in cotton production today.”

Read more on page 64

BAYER MATERIALSCIENCE Its name is doubly true: the new soccer ball from adidas is called +Teamgeist™ – “Team Spirit” – and it’s designed to help the best eleven win the World Cup. Winning a game is of course a team effort – and so was the development of a ball like this one, as global key account manager Dr. Thorsten Bestvater (left) and Thomas Michaelis of Bayer MaterialScience can readily testify. Bayer Leverkusen soccer player Bernd Schneider is positive in his assessment: “This ball is a boon to everyone on the team.”

Read more on page 192

Contents 3


4	Chairman’s Letter
8	Board of Management

	Management Report
14	Overview of Sales, Earnings and Financial Position	32 33	Earnings Performance Asset and Capital Structure	50 58	Risk Management Subsequent Events
16	Operating Environment in 2005	35	Proposal for Distribution of the Profit	59	Future Perspectives
17	Performance by Subgroup and Segment	35 37	Employees Procurement and Distribution	59 60	Economic Outlook Business Strategy
26	Performance by Region	39	Research and Development	62	Objectives for 2006
27	Value Management	46	Sustainable Development
29	Liquidity and Capital Resources	49	Corporate Social Responsibility

68	Investor Information
72	Corporate Governance

	Consolidated Financial Statements of the Bayer Group		Notes to the Consolidated Financial Statements of the Bayer Group	77	Detailed Table of Contents for the Consolidated Financial Statements
78	Management’s Statement of Responsibility for Financial Reporting	84	Key Data by Segment and Region
79	Independent Auditor’s Report	121	Notes to the Statements of Income
80	Consolidated Statements of Income	131	Notes to the Balance Sheets
81	Consolidated Balance Sheets	184	Notes to the Statements of Cash Flows
82	Consolidated Statements of Cash Flows
83	Consolidated Statements of Recognized Income and Expense

189	Report of the Supervisory Board

	Further Information
196	Bayer News
200	Awards
202	Governance Bodies
205	Organization Chart
206	Group Leadership Circle
209	Glossary
213	Index
216	Masthead


4 Chairman’s Letter		Bayer Annual Report 2005

“Our efforts have paid off”

Dear Stockholders:

I look back on 2005 with the greatest satisfaction I have felt since becoming Chairman. Last year was among the most successful in Bayer’s history. We had forecasted a 20 percent rise in earnings, but actually far exceeded those expectations, ending 2005 with underlying EBIT up 56 percent from the previous year, at €3.3 billion.

Our underlying EBITDA margin of 18.6 percent already put us very close to our 2006 target of 19 percent, a year ahead of schedule.

The other key data also underscore our focus on growth:

•		Sales rose 18 percent to €27.4 billion

•		Net income jumped 133 percent to €1.6 billion

•		Net cash flow advanced 57 percent to €3.5 billion

•		Cash flow return on investment (CFROI) reached the record level of 12.4 percent

That last number is particularly important for me. It means we have created substantial value for you, our stockholders.

We are pleased that the capital market is rewarding our success. With a 51 percent increase in the share price in 2005, Bayer was among the best-performing equities in the German stock index DAX. Our market capitalization rose by €8.7 billion in the space of twelve months.

All this clearly illustrates that our strategic realignment toward innovation and growth has lastingly improved the Bayer Group’s performance capability.

We made further progress last year not only operationally, but also strategically – from the LANXESS spin-off through the successful integration of the Roche consumer health business to the repositioning of our Pharmaceuticals Division.

We completed the most extensive restructuring process in Bayer’s history within an extremely short period, the final step in that process being the successful listing of LANXESS on the stock market early in the year. The strong upward trend in the price of both companies’ shares shows that we made the right decisions.

Our new strategy not only laid the foundation for a successful 2005, but has also put the entire enterprise on track for the future.

Let me start with Bayer HealthCare – Germany’s biggest health care company, with sales of €9.4 billion. We gave this subgroup a new focus, and it fared outstandingly last year. The aim is to continue matching or outpacing market growth in all areas.


Bayer Annual Report 2005		Chairman’s Letter 5

The Pharmaceuticals Division has a new identity, with a stronger concentration on the specialties business and on a restructured and optimized primary care business. The division’s performance in recent months has been very encouraging.

Our specialty products, including in particular the biotechnologically manufactured hemophilia drug Kogenate, have considerable growth potential. We believe our new cancer drug, Nexavar, could eventually exceed €1 billion in annual sales. The same applies to our oral antithrombotic Factor Xa inhibitor, which entered phase III clinical testing at the end of 2005 for the prevention of venous thromboembolism. Our Pharmaceuticals Division also has twelve projects in phase I trials and another eleven in preclinical development. We plan to further support the business with external growth, for example through inlicensing.

We have strengthened the other parts of the HealthCare subgroup as well. Following the acquisition of the Roche consumer health activities, our Consumer Care Division is now among the world’s top three suppliers in the self-medication business. The newly acquired products Bepanthen, Rennie and Supradyn have performed particularly well, bringing us a significant step closer to our goal of becoming the leading supplier in this segment. We integrated the acquisition more quickly than we had previously thought possible.

And the other HealthCare divisions – Animal Health, Diagnostics and Diabetes Care – also hold strong positions in their respective markets. We plan to expand all of these businesses faster than the market average.


6 Chairman’s Letter		Bayer Annual Report 2005

We continue to see considerable potential at Bayer CropScience. This company is the world market leader in conventional crop protection and in the environmental science and seed treatment businesses. While it is on the right track in terms of performance, we have not yet reached our goal. We nevertheless believe that we can set the industry standard in the medium term.

In a market characterized by only moderate expansion, we consider our own innovative capability to be the main factor for organic growth in this area. The years since 2000 have seen the launch of sixteen new active ingredients. Including ten further substances that we plan to introduce by 2011, we anticipate total sales potential of up to €2 billion from our CropScience pipeline. We also expect to achieve faster-than-average growth through the expansion of our environmental science, seed treatment and plant biotechnology franchises.

Regarding MaterialScience, we remain in confident mood following a record-breaking year. This subgroup is a global leader in terms of market positions and technologies, occupying first place in both polyurethanes and coating raw materials, and the number two slot in polycarbonates. We envisage a major opportunity in the development of the Asian markets, and therefore plan to invest about US$1.8 billion in world-scale polymer facilities in China alone through 2009.

At MaterialScience, too, we are pursuing a strategy of growth through innovation. Some 20 percent of this subgroup’s total revenues already come from new products and applications introduced within the past five years, and that ratio is set to increase.

To expedite growth and foster a high level of innovation in the future, we have earmarked €1.5 billion for capital expenditures on property, plant and equipment this year and, as in 2005, we plan to spend roughly €1.9 billion on research and development. This is by far the largest research budget of any chemical and pharmaceutical company in Germany.

To further support the innovation process, we have launched a global initiative named “Triple-i” – the three i’s standing for inspiration, ideas and innovation. The initiative is designed to boost our employees’ willingness and ability to submit creative ideas and suggestions for consideration and possible commercialization by units of the Bayer Group. To this end a special innovation support procedure has been developed. The first part of the money to be made available under this program will go for our project to manufacture plant-based pharmaceutical active ingredients.

I firmly believe that innovation and growth are the key success factors in the globalized business arena, and I am therefore certain that our realignment has paved the way to a bright future for our company.

The efforts we put into restructuring the Bayer Group have paid off. Since the beginning of 2003, we have steadily improved year-on-year earnings before special items – our actual operating performance – in twelve consecutive quarters.


Bayer Annual Report 2005		Chairman’s Letter 7

Of course we want you, our stockholders, to benefit from our economic success. We therefore propose to raise the dividend for 2005 by more than 70 percent to €0.95.

And what do we have planned for the current year?

We aim to continue expanding and to further improve our operating performance. Our goal is to grow with, or faster than, all of our markets, and to achieve total Group sales in excess of €28 billion.

We are targeting a small further improvement in underlying EBIT and underlying EBITDA, and thus a record earnings level.

While we remain oriented toward profitability, I am also personally committed to ensuring that Bayer embraces the principle of good corporate citizenship. For example, we are involved in more than 300 social responsibility projects worldwide – from initiatives to combat hunger in Brazil through our joint environmental efforts with the United Nations to the fight against AIDS and sleeping sickness in Africa. We play a pioneering role in such activities throughout the world, and intend to expand that role in the future.

My colleagues and I on the Board of Management would like to thank you for the trust you have placed in Bayer. Our special thanks also go to our employees. Together, we have achieved a great deal over the past year. I am very pleased that the broad majority of respondents to our most recent managerial employees’ survey said they are proud to work for Bayer. I agree with them: we can all be proud that we have put Bayer back on track following difficult years of reorganization and realignment.

We will continue to work very hard to remain on the successful course we have set for our company, at the same time helping to sustainably improve people’s health, nutrition and quality of life through our products – true to the slogan we chose for our new mission statement: “Bayer: Science For A Better Life.”

Sincerely,

/s/ Werner Wenning


8 Board of Management		Bayer Annual Report 2005

DR. RICHARD POTT

The member responsible for Strategy and Human Resources and the North, Central and South America regions, Dr. Richard Pott is also Bayer AG’s Labor Director. Born in 1953, Richard Pott studied physics at the University of Cologne, Germany, where he also obtained his doctorate. In 1984 he joined the company’s Central Research Division. After holding various positions in the Corporate Staff Division he became Head of the former Specialty Products Business Group in 1999. Pott was appointed to the Bayer AG Board of Management in May 2002.

WERNER WENNING

Chairman of the Bayer AG Board of Management since April 2002. Born in 1946, Werner Wenning joined the company in 1966 as a commercial trainee. He held a number of positions with Bayer in Germany and abroad, serving as managing director of Bayer subsidiaries in Peru and Spain and later as Head of the Corporate Planning and Controlling Division. Wenning was appointed to the Board of Management as Chief Financial Officer in February 1997. Since September 2005 he has also been President of the German Chemical Industry Association.

KLAUS KÜHN

Chief Financial Officer and responsible for the Europe, Africa and Middle East regions. Born in 1952, Klaus Kühn studied mathematics and physics at the Technical University of Berlin, Germany, gaining a mathematics degree in 1978. He also studied in the United States, where he obtained a Master of Business Administration degree. Kühn joined Bayer in 1998 as Head of the Finance Section, and shortly afterwards was made Head of the Group Finance Division. He was appointed to the Bayer AG Board of Management in May 2002.

DR. UDO OELS

Responsible for Innovation, Technology and Environment and the Asia region. Born in 1944, Udo Oels studied chemistry at the Technical University of Hanover, Germany. He joined Bayer AG as a research chemist in 1976 and held a number of positions with Bayer in Germany and abroad, including those of polycarbonate production manager at the Bayer site in Baytown, Texas, and Head of Research and later General Manager of the former Organic Chemicals Business Group. Oels was appointed to the Bayer AG Board of Management in February 1996.

Dr. Wolfgang Plischke was appointed to the Bayer AG Board of Management effective March 1, 2006.


Bayer Annual Report 2005		Board of Management 9


10 Bayer HealthCare		Bayer Annual Report 2005


Bayer Annual Report 2005		Bayer: Science For A Better Life 11


12 Bayer HealthCare		Bayer Annual Report 2005

What started out as a simple remedy to alleviate the symptoms of rheumatism has since become one of the world’s best-known medicines. And the unparalleled career of acetylsalicylic acid is far from over. Almost every day there are reports of new potential indications and mechanisms of action.

An outstanding example is in the area of heart attack and stroke prophylaxis. For secondary prevention, scientists at Bayer HealthCare developed Aspirin^{^®} Cardio, a low-dosage tablet that is resistant to gastric juices and releases the active ingredient gradually.

The product is currently showing growth rates of up to 30 percent. In Switzerland, where it was first launched, Aspirin^{^®} Cardio now holds a significant share in the market, and in Japan, too, it is the market leader in its segment. Aspirin^{^®} Cardio is approved in more than 35 countries – from Argentina to Taiwan – for reducing the risk of secondary heart attack or stroke.

However, extending the life cycles of established medicines through selective post-marketing development is only one factor in the company’s commercial achievements. About half of Bayer’s research expenditures are currently made to develop new health care products – and with great success.

At the end of 2005, Bayer HealthCare was granted marketing authorization in the United States for Nexavar^{^®}, a new medicine to treat advanced kidney cancer. Nexavar^{^®} is expected to be approved in Europe in the second half of 2006 (see cover picture caption), and Bayer plans to develop the active ingredient for the therapy of other tumors as well. The product is considered to have “blockbuster” potential, which means it could achieve total annual sales of over €1 billion. A new oral drug to prevent and treat thromboembolic diseases is believed to have similar potential. This substance is currently in phase III clinical testing for a once-daily dose.

Bayer is also optimistic for its early-stage development candidates. Three of these projects are expected to be transferred to phase III clinical testing by the end of 2006.


Bayer Annual Report 2005		Bayer: Science For A Better Life 13


14 Management Report		Bayer Annual Report 2005

New strategic alignment pays off

2005 a successful year for Bayer

•		Strong growth: sales increase 18 percent to €27.4 billion

•		EBIT before special items advances 56 percent to €3.3 billion

•		Group net income jumps from €0.7 billion to €1.6 billion

•		Strong cash flow performance – return on capital at record level

•		Growth continues unabated in the fourth quarter

•		Dividend of €0.95 per share proposed (+ 73 percent)

•		Further performance improvement targeted for 2006

Overview of Sales, Earnings and Financial Position

Bayer had an extremely successful year in 2005. We made significant gains in our key indicators, including sales, earnings and cash flow performance. Our return on capital (CFROI) was at a record level. The strategic realignment toward innovation and growth has fundamentally improved the Group’s operating performance and earning power. Our cost-containment and efficiency programs have boosted profitability.


Change in Sales	2004		2005
%
Total		+ 4		+ 18

Volumes		+ 8		+ 1

Prices		+ 1		+ 7

Exchange rates		- 4		+ 1

Portfolio changes		- 1		+ 9

Sales of the Bayer Group rose by 17.6 percent year on year to €27,383 million. Growth was chiefly attributable to the HealthCare and MaterialScience subgroups, where sales advanced by 17.0 percent and 24.4 percent, respectively. CropScience sales remained at the previous year’s level, largely because of difficult market conditions in Brazil. Adjusted for the effects of currency and portfolio changes, Group sales rose by 7.5 percent. The portfolio effects mainly relate to the consumer health business acquired from Roche and sales to LANXESS following its spin-off from Bayer.

The positive business trend led to a considerable improvement in the operating result. EBIT before special items climbed by 55.9 percent to €3,300 million (2004: €2,117 million). All three subgroups contributed to this increase. The largest EBIT contributions came from MaterialScience (€1,404 million) and HealthCare (€1,319 million). While the exceptionally strong growth in EBIT at MaterialScience (+ 110.2 percent) resulted largely from selling price increases, the improvement at HealthCare (+ 26.9 percent) was driven primarily by the fast-growing pharmaceuticals business and a very strong performance by the newly acquired products of the Consumer Care Division. At Crop-Science, where EBIT advanced by 31.2 percent to €685 million, the main positive effect came from the absence of goodwill amortization.

EBITDA before special items moved ahead by 24.9 percent to €5,082 million (2004: €4,069 million), yielding an underlying EBITDA margin of 18.6 percent in 2005 that fell only slightly short of the target for 2006.

There were, however, a number of special items that diminished EBIT by €488 million on aggregate, compared with net special charges of €242 million in the prior year. The special charges in 2005 included, in particular, €336 million relat-


Bayer Annual Report 2005		Management Report 15

ed to antitrust proceedings in the polymers field, €105 million in litigation-related charges at Bayer HealthCare, €106 million in expenses arising from the termination of the co-promotion agreement for Levitra^{^®} outside the United States, and €71 million for the integration of the acquired consumer health business. Total charges of €127 million were taken for restructuring measures in all subgroups. Chief among the positive special items that partially offset these charges was a one-time net gain of €283 million from changes in our pension systems in the United States and Germany.

EBIT after special items improved in 2005 by 50.0 percent to €2,812 million (2004: €1,875 million). EBITDA rose by 21.2 percent year on year to €4,647 million (2004: €3,834 million).

After a non-operating result of minus €613 million, pre-tax income climbed by 80.0 percent to €2,199 million. After tax expense of €641 million and minority stockholders’ interest, net income of the Bayer Group rose by €912 million to €1,597 million. Earnings per share thus improved from €0.94 to €2.19.

The growth in earnings in 2005 was also reflected in the gross cash flow, which advanced by 20.5 percent to €3,477 million (2004: €2,885 million). Net cash flow rose even more strongly, gaining 56.6 percent to €3,542 million.

Thanks to the higher cash flow, the increase in net debt at the beginning of the year due to the acquisition of the Roche consumer health business had been largely offset by year end. Net debt from continuing operations came to €5,494 million on December 31, 2005, exceeding the prior-year figure of €4,891 million by €603 million.

Cash flow return on investment (CFROI) – at 12.4 percent – was at a record level. We thus exceeded our internal hurdle for capital costs including reproduction by 2.7 percentage points, or €823 million, creating substantial additional value for our stockholders.

Our success in 2005 as a whole was also bolstered by a continuing positive business trend in the fourth quarter, the strongest quarter of 2005 in terms of sales. Business expanded by 16.1 percent year on year to €7,095 million thanks to major expansion in HealthCare (+ 24.0 percent) and continued dynamic growth in MaterialScience (+ 15.7 percent). CropScience sales dipped due to low business volumes in Brazil.

EBIT before special items climbed by 54.5 percent from the final quarter of 2004, to €615 million, even after a significant increase in marketing expenditures, particularly at Bayer HealthCare, to support future growth. After special items, which mainly included €322 million related to antitrust proceedings in the polymers field, €26 million in litigation-related charges in HealthCare and €20 million in integration costs for the consumer health business, EBIT fell by 44.3 percent to €192 million. Net cash flow increased by 51.7 percent to €1,315 million, partly as a result of a substantial decline in working capital in all subgroups, particularly MaterialScience.


16 Management Report		Bayer Annual Report 2005

Operating Environment in 2005

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. Several sharp rises in the price of oil, particularly in the first half of the year, failed to impair the positive underlying trend. The world’s two major growth engines, the United States and China, once again performed very well, stimulating other countries’ economies with their thirst for imports. The business environment in the industrialized countries was further buoyed by favorable monetary conditions.

The pace of growth in the United States was practically undiminished in spite of adverse monetary and fiscal factors, and the hurricanes in the fall only temporarily impacted the economy. With the trade balance providing hardly any growth impetus, the economy was supported mainly by robust domestic demand. Higher corporate earnings triggered brisk investment activity.

Economic development in Europe was considerably more restrained. The euro zone fell behind the other major regions in terms of growth, although the economy picked up somewhat in the last few months of the year thanks to increasing domestic demand and a positive trade balance. Expansion was hampered by the high price of oil, the main effect of which was to hold back consumer demand. The moderate rise in output was solely the result of high demand for exports. While consumer sentiment remained downbeat, industry confidence rose toward year end and the overall economic outlook became a little brighter.

The Japanese economy continued to expand at a moderate rate during the year. The upswing was reinforced in the first half by the effects of positive political indicators on private consumption, and also by brisk export demand. Corporate investment also continued to increase in light of improved sales and earnings forecasts and high replacement demand. While economic activity had slowed somewhat by the end of the year, the overall trend remained positive.

Outside of the industrialized countries, production continued to expand steadily in 2005, if not quite as briskly as in the previous year. The Asian threshold economies developed well. Most of the major Asian countries registered strong growth in exports, with domestic demand also picking up. China continued to forge ahead thanks to higher exports and brisk domestic demand. Even the steps taken by the government to cool the economy have had little effect so far.

The economies of Latin America continued to grow thanks to relatively high raw material prices, although the upswing lost some of its momentum. This growth was driven primarily by raw material exports. Domestic demand picked up, contributing to the favorable overall picture.


Bayer Annual Report 2005		Management Report 17

Performance by Subgroup and Segment

Our realigned business activities are grouped into the HealthCare, CropScience and MaterialScience subgroups. In view of the portfolio changes that took place in the Bayer Group at the beginning of 2005, including in particular the spin-off of LANXESS and the acquisition of the Roche consumer health (OTC) business, we altered the presentation of our segment reporting at the beginning of the first quarter of 2005 as shown below: (see also Note 6 to the financial statements on page 110 ff.).

In accordance with the new requirements of the International Financial Reporting Standards (IFRS), the information in this annual report relates primarily to continuing operations.


Sales by Subgroup and Segment		2004		2004 share		2005		2005 share
				of Group				of Group
€ million				%				%
HealthCare			8,058		35		9,429		34

	Pharmaceuticals, Biological Products		3,961		17		4,067		15

	Consumer Care		1,336		6		2,355		8

	Diabetes Care, Diagnostics		1,975		9		2,151		8

	Animal Health		786		3		856		3


CropScience			5,946		25		5,896		22

	Crop Protection		4,957		21		4,874		18

	Environmental Science, BioScience		989		4		1,022		4


MaterialScience			8,597		37		10,695		39

	Materials		3,248		14		4,086		15

	Systems		5,349		23		6,609		24


Reconciliation			677		3		1,363		5


Bayer Group	Continuing operations		23,278		100		27,383		100


18 Management Report		Bayer Annual Report 2005

Bayer HealthCare

Sales of the Bayer HealthCare subgroup rose by 17.0 percent from the previous year, to €9,429 million. Growth was attributable mainly to the consumer health business acquired from Roche, which contributed €1,061 million to revenues. Adjusted for currency effects and portfolio changes, sales were up by 2.9 percent year on year, despite the significant decline in sales of Cipro^{^®} following the expiration of its U.S. patent.

EBIT came to €1,102 million, which was €146 million, or 15.3 percent, more than in the previous year. A number of special items diminished earnings by €217 million on aggregate. This figure includes in particular charges relating to the transfer of co-promotion rights for Levitra^{^®} back to Bayer, litigation-related expenses, and the cost of integrating the acquired OTC business. These charges were partially offset by a one-time gain from changes in our pension plans. EBIT before special items advanced by €280 million, or 26.9 percent, to €1,319 million.

Bayer HealthCare

2004

2005

Change

€ million

Sales

8,058

9,429

+ 17.0

EBITDA*

1,392

1,612

+ 15.8

Operating result [EBIT]

956

1,102

+ 15.3

of which special items

(83

)

(217

)

Gross cash flow*

943

1,138

+ 20.7

Net cash flow*

1,053

1,351

+ 28.3


*		for definition see Bayer Group Key Data on front flap


Best-Selling Bayer HealthCare Products	2004			2005			Change
€ million							%
Ascensia^{^®}product line (Diabetes Care)		627			701			+ 11.8

Kogenate^{^®}(Biological Products)		563			663			+ 17.8

Adalat^{^®}(Pharmaceuticals)		670			659			- 1.6

Aspirin^{^®}(Consumer Care/Pharmaceuticals)		601			630			+ 4.8

Ciprobay^{^®}/Cipro^{^®}(Pharmaceuticals)		837			525			- 37.3

Advia Centaur^{^®}system (Diagnostics)		441			512			+ 16.1

Avalox^{^®}/Avelox^{^®}(Pharmaceuticals)		318			364			+ 14.5

Glucobay^{^®}(Pharmaceuticals)		278			295			+ 6.1

Levitra^{^®}(Pharmaceuticals)		193			260			+ 34.7

Advantage^{^®}/Advantix^{^®}(Animal Health)		206			249			+ 20.9

Trasylol^{^®}(Pharmaceuticals)		171			230			+ 34.5

Aleve^{^®}/naproxen (Consumer Care)		90			178	*		+ 97.8

Baytril^{^®}(Animal Health)		160			163			+ 1.9

Rapidlab^{^®}/Rapidpoint^{^®}(Diagnostics)		153			163			+ 6.5

Clinitek^{^®}Urinalysis (Diagnostics)		147			152			+ 3.4

Total		5,455			5,744			+ 5.3

Proportion of Bayer HealthCare sales		68	%		61	%


*		sales after acquisition of the remaining interest in our U.S. joint venture


Bayer Annual Report 2005		Management Report 19

Pharmaceuticals, Biological Products

Sales of the Pharmaceuticals, Biological Products segment rose by €106 million, or 2.7 percent, to €4,067 million.

Sales of the Pharmaceuticals Division receded by €58 million, or 1.8 percent, to €3,108 million. In our U.S. specialties business we achieved pleasing growth in sales of Trasylol^{^®}. Outside the United States, Avelox^{^®} and Levitra^{^®} made strong gains in the market. This enabled us to partly offset a €312 million decline in U.S. sales due to expiration of the patent on our anti-infective Cipro^{^®} and the marketing of our primary care products in the United States by Schering-Plough.

In the Biological Products Division, sales rose by €164 million year on year to €959 million. Kogenate^{^®} made encouraging sales gains, particularly in Europe and the United States, totaling €100 million. In Europe and Canada, we benefited from the successful market introduction of our BioSet^{^®} delivery device for more convenient infusion.

EBIT of the Pharmaceuticals, Biological Products segment moved ahead by €76 million year on year to €475 million, after net special charges of €140 million. Adjusted for special items, EBIT rose by 36.1 percent to €615 million, mainly because of improved cost structures and the growth in sales.

Consumer Care

Sales of the Consumer Care segment climbed by 76.3 percent to €2,355 million. The integration of the OTC business acquired from Roche went even better than expected. A very positive performance

Pharmaceuticals, Biological Products

2004

2005

Change

€ million

Sales

3,961

4,067

+ 2.7

Pharmaceuticals

3,166

3,108

- 1.8

Biological Products

795

959

+ 20.6

EBITDA*

573

663

+ 15.7

Operating result [EBIT]

399

475

+ 19.0

of which special items

(53

)

(140

)

Gross cash flow*

386

449

+ 16.3

Net cash flow*

261

481

+ 84.3

Consumer Care

2004

2005

Change

€ million

Sales

1,336

2,355

+ 76.3

EBITDA*

252

294

+ 16.7

Operating result [EBIT]

183

174

- 4.9

of which special items

(30

)

(118

)

Gross cash flow*

161

223

+ 38.5

Net cash flow*

279

323

+ 15.8


*		for definition see Bayer Group Key Data on front flap


20 Management Report		Bayer Annual Report 2005

was recorded by products such as Bepanthen^{^®}/ Bepanthol^{^®} (+ 18.8 percent), Rennie^{^®} (+ 7.2 percent) and Supradyn^{^®} (+ 19.0 percent), with the newly acquired business accounting for sales of €1,061 million.

EBIT 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. Earnings were diminished by a total of €118 million in special charges related to the integration of the business acquired from Roche and by litigation-related expenses. EBIT before special items climbed by 37.1 percent to €292 million, with a major earnings contribution coming from the newly acquired OTC business.

Diabetes Care, Diagnostics

Sales of the Diabetes Care, Diagnostics segment grew by €176 million, or 8.9 percent, to €2,151 million.

In the Diabetes Care Division, sales advanced by 10.0 percent to €718 million as a result of strong growth in Europe. Sales of the Diagnostics Division rose by 8.4 percent to €1,433 million, thanks mainly to our Advia Centaur^{^®} laboratory testing systems.

EBIT of the segment improved by €57 million to €274 million, including net special gains of €34 million. EBIT before special items rose by €23 million, or 10.6 percent, to €240 million.

Animal Health

Sales of the Animal Health segment rose by a gratifying 8.9 percent, to €856 million, the increase being mainly the result of a strong performance by our Advantage^{^®} product line in the United States. Also contributing to growth were the market introductions of our parasiticides Advocate^{^®} in Europe and Canada, and Profender^{^®} in Europe.

EBIT of the Animal Health segment advanced by €22 million, or 14.0 percent, from the previous year to €179 million. Before special gains of €7 million, EBIT improved by 9.6 percent to €172 million.

Diabetes Care, Diagnostics

2004

2005

Change

€ million

Sales

1,975

2,151

+ 8.9

Diabetes Care

653

718

+ 10.0

Diagnostics

1,322

1,433

+ 8.4

EBITDA*

387

452

+ 16.8

Operating result [EBIT)

217

274

+ 26.3

of which special items

Gross cash flow*

287

320

+ 11.5

Net cash flow*

388

373

- 3.9

Animal Health

2004

2005

Change

€ million

Sales

786

856

+ 8.9

EBITDA*

180

203

+ 12.8

Operating result [EBIT]

157

179

+ 14.0

of which special items

Gross cash flow*

109

146

+ 33.9

Net cash flow*

125

174

+ 39.2


*		for definition see Bayer Group Key Data on front flap


Bayer Annual Report 2005		Management Report 21

Bayer CropScience

Sales of the Bayer CropScience subgroup, at €5,896 million, were about level with the previous year. Adjusted for currency and portfolio changes, business was down by 4.2 percent. The lower sales in Crop Protection were partly offset by growth in the Environmental Science, BioScience segment.

EBIT advanced by 40.2 percent to €690 million. Before special items, EBIT rose by €163 million to €685 million. This was due to the absence of the €134 million in goodwill amortization charges taken in 2004 and improved operating efficiencies in the Environmental Science, BioScience segment.

Bayer CropScience

2004

2005

Change

€ million

Sales

5,946

5,896

- 0.8

EBITDA*

1,219

1,284

+ 5.3

Operating result [EBIT]

492

690

+ 40.2

of which special items

(30

)

Gross cash flow*

893

964

+ 8.0

Net cash flow*

778

904

+ 16.2


*		for definition see Bayer Group Key Data on front flap


Best-Selling Bayer CropScience Products*	2004			2005			Change
€ million							%
Confidor^{^®}/Gaucho^{^®}/Admire^{^®}/Merit^{^®} (Insecticides/Seed Treatment/Environmental Science)		603			587			- 2.7

Folicur^{^®}/Raxil^{^®}(Fungicides/Seed Treatment)		411			339			- 17.5

Basta^{^®}/Liberty^{^®}(Herbicides)		197			219			+ 11.2

Puma^{^®}(Herbicides)		227			205			- 9.7

Flint^{^®}/Stratego^{^®}/Sphere^{^®}(Fungicides )		240			193			- 19.6

Decis^{^®}/K-Othrine^{^®}(Insecticides/Environmental Science)		172			159			- 7.6

Atlantis^{^®}(Herbicides)		97			142			+ 46.4

Betanal^{^®}(Herbicides)		144			128			- 11.1

Fenikan^{^®}(Herbicides)		118			119			+ 0.8

Poncho^{^®}(Seed Treatment)		57			110			+ 93.0

Total		2,266			2,201			- 2.9

Proportion of Bayer CropScience sales		38	%		37	%


*		Figures are based on active ingredient class. For the sake of clarity, only the principal brands and business units are listed.


22 Management Report		Bayer Annual Report 2005

Crop Protection

Sales in the Crop Protection segment dipped by 1.7 percent from the prior year, to €4,874 million.

In the Insecticides business unit, business was down by 4.9 percent to €1,311 million. The continuing drought in southern Europe, Brazil and Australia led to lower sales of some products. Business was also hampered by significantly lower pest infestation, particularly in Asia. We successfully launched another substance from the ketoenols class under the tradename Oberon^{^®} in important markets such as the United States and the Netherlands.

Sales in the Fungicides business unit declined by 2.3 percent to €1,248 million. Although Asian rust, a disease of soybeans, persisted in large areas of Brazil, business with our Flint^{^®} and Folicur^{^®} fungicides shrank considerably due to the extremely long drought in the south of the country and its effects on the farm economy. Sales of our Proline^{^®} family of cereal fungicides rose strongly throughout Europe in the second year following their launch.

The Herbicides business unit recorded sales of €1,840 million, which was just 0.8 percent below the previous year. While business was hurt by adverse weather conditions in southern Europe, our new products Atlantis^{^®}, Hussar^{^®}, MaisTer^{^®} and Olympus^{^®} made very good progress, their sales increasing by more than 16 percent on aggregate. Basta^{^®}/Liberty^{^®} also posted strong gains, particularly in North America.

Sales of the Seed Treatment business unit rose by 6.3 percent to €475 million, largely due to the 2004 acquisition of the remaining 50 percent interest in Gustafson. Significant gains for the seed treatment Poncho^{^®} more than offset lower sales of fungicidal seed treatment formulations.

Crop Protection

2004

2005

Change

€ million

Sales

4,957

4,874

- 1.7

Insecticides

1,378

1,311

- 4.9

Fungicides

1,277

1,248

- 2.3

Herbicides

1,855

1,840

- 0.8

Seed Treatment

447

475

+ 6.3

EBITDA*

978

1,026

+ 4.9

Operating result [EBIT]

386

532

+ 37.8

of which special items

(42

)

Gross cash flow*

739

762

+ 3.1

Net cash flow*

637

699

+ 9.7


*		for definition see Bayer Group Key Data on front flap


Bayer Annual Report 2005		Management Report 23

EBIT of the Crop Protection segment grew by €146 million, or 37.8 percent, to €532 million. Before special items, EBIT advanced by €97 million to €525 million. The earnings improvement was due to the absence of goodwill amortization.

Environmental Science, BioScience

Sales of the Environmental Science, BioScience segment rose by 3.3 percent in 2005 to €1,022 million.

The Environmental Science Business Group saw business expand by 2.4 percent to €694 million, due in part to higher sales of Premise^{^®} (insecticide), Revolver^{^®} (herbicide) and K-O Tab^{^®} for vector control. Sales of Consumer Products held steady year on year.

In the BioScience Business Group, sales advanced by 5.5 percent to €328 million, the main contributions to growth coming from InVigor^{^®} (canola seed) in North America, FiberMax^{^®} (cotton seed) in the United States and Europe, and the vegetable seeds business.

EBIT of the Environmental Science, BioScience segment improved by €52 million to €158 million. EBIT before special items climbed by €66 million, or 70.2 percent, from the prior year. Earnings growth was bolstered by strong sales of Professional Products and the absence of goodwill amortization.

Environmental Science, BioScience

2004

2005

Change

€ million

Sales

989

1,022

+ 3.3

Environmental Science

678

694

+ 2.4

BioScience

311

328

+ 5.5

EBITDA*

241

258

+ 7.1

Operating result [EBIT]

106

158

+ 49.1

of which special items

)

Gross cash flow*

154

202

+ 31.2

Net cash flow*

141

205

+ 45.4


*		for definition see Bayer Group Key Data on front flap


24 Management Report		Bayer Annual Report 2005

Bayer MaterialScience

Sales of the Bayer MaterialScience subgroup advanced in 2005 by 24.4 percent to €10,695 million. Adjusted for currency and portfolio changes, business expanded by 19.4 percent. The higher revenues were mainly the result of price increases implemented in all business units and regions.

EBIT of this subgroup, at €1,369 million, posted a substantial €728 million improvement from the previous year after net special charges of €35 million. The special items included gains from changes to our pension plans in the United States and Germany, various special expenses for the reorganization of our polyurethanes business, and provisions recorded in connection with the settlement of civil antitrust suits in the polymers field. EBIT before special items climbed substantially to €1,404 million. Our “price before volume” strategy enabled us to offset the sharp rise in raw material costs and improve our margins.

Materials

Sales in the Materials segment moved ahead by €838 million, or 25.8 percent, to €4,086 million, with increases of around 30 percent in Polycarbonates and at H.C. Starck. Higher selling prices, in particular, contributed to the increase. There was also a slight further improvement in volumes.

EBIT of the Materials segment more than doubled, climbing by 116.0 percent to €633 million. Raising selling prices enabled us not only to offset higher material costs, but also to widen our margins. EBIT before special items rose by €313 million to €606 million.

Bayer MaterialScience

2004

2005

Change

€ million

Sales

8,597

10,695

+ 24.4

EBITDA*

1,216

1,914

+ 57.4

Operating result [EBIT]

641

1,369

+ 113.6

of which special items

(27

)

(35

)

Gross cash flow*

884

1,402

+ 58.6

Net cash flow*

498

1,388

+ 178.7


*	for definition see Bayer Group Key Data on front flap


Bayer Annual Report 2005		Management Report 25

Systems

Sales of the Systems segment amounted to €6,609 million in 2005, exceeding the prior-year level by €1,260 million, or 23.6 percent. The increase was primarily driven by our Polyurethanes business, where we were able to substantially raise selling prices. The expansion in Inorganic Basic Chemicals resulted mainly from product sales to LANXESS and higher market prices for sodium hydroxide solution.

EBIT of the Systems segment also showed a major improvement, increasing by €388 million to €736 million. EBIT before special items rose by €423 million to €798 million. Here, too, we successfully passed on raw material cost increases in our selling prices, boosting margins considerably.

Materials

2004

2005

Change

€ million

Sales

3,248

4,086

+ 25.8

Polycarbonates

2,035

2,645

+ 30.0

Thermoplastic Polyurethanes

182

192

+ 5.5

Wolff Walsrode

328

329

+ 0.3

H.C. Starck

703

920

+ 30.9

EBITDA*

542

858

+ 58.3

Operating result [EBIT]

293

633

+ 116.0

of which special items

Gross cash flow*

400

621

+ 55.3

Net cash flow*

209

517

+ 147.4

Systems

2004

2005

Change

€ million

Sales

5,349

6,609

+ 23.6

Polyurethanes

3,872

4,792

+ 23.8

Coatings, Adhesives, Sealants

1,237

1,330

+ 7.5

Inorganic Basic Chemicals

218

380

+ 74.3

Other

107

•

EBITDA*

674

1,056

+ 56.7

Operating result [EBIT]

348

736

+ 111.5

of which special items

(27

)

(62

)

Gross cash flow*

484

781

+ 61.4

Net cash flow*

289

871

•


*	for definition see Bayer Group Key Data on front flap


26 Management Report		Bayer Annual Report 2005

Performance by Region

Bayer’s business expanded considerably in 2005, with sales advancing by €4,105 million, or 17.6 percent, to €27,383 million. More than half of this growth was achieved in Europe, where sales rose by €2,155 million, or 22.0 percent. The increase in Germany was above the average for the region as a whole, with sales moving ahead by €1,137 million, or 37.4 percent, to €4,176 million. When adjusted for the effects of portfolio changes – mainly sales to LANXESS – the increase was about 10 percent in Germany and 6 percent in Europe as a whole. This expansion was chiefly attributable to the Material-Science and HealthCare subgroups.

In North America, sales advanced by 12.7 percent in 2005 to €7,340 million. The biggest gain was recorded by the MaterialScience subgroup’s polyurethanes business. In HealthCare, pleasing growth in Kogenate^{^®} sales and the diagnostics business more than offset the expected decline in revenues due to expiration of the patent on Cipro^{^®} and the marketing of our primary care products by Schering-Plough.

Sales in the Asia/Pacific region grew by 15.5 percent to €4,578 million. The biggest contribution to this increase came from China, where sales climbed by 39 percent. Our largest subgroup in the Asia/Pacific region is MaterialScience, whose sales rose by 21.1 percent to €2,143 million thanks to higher prices and volumes. Sales of Consumer Care in Asia more than tripled, mainly because of our acquisition of the Roche consumer health business.

We improved sales in Latin America/Africa/Middle East by 16.7 percent to €3,535 million. In this region, above-average increases in the HealthCare and MaterialScience subgroups more than compensated for lower sales in CropScience in 2005, which were partly due to the prolonged drought and the weakness of the farm economy in Brazil.

Sales by Region and Segment (by market)

Europe

North America

Asia/Pacific

Latin America/Africa/Middle East

Total Segment

2004

2005

% yoy

adj.% yoy

2004

2005

% yoy

adj.% yoy

2004

2005

% yoy

adj.% yoy

2004

2005

% yoy

adj.% yoy

2004

2005

% yoy

adj.% yoy

€ million

Bayer HealthCare

3,008

3,719

+ 23.6

2,907

3,001

+ 3.2

+ 2.2

1,260

1,450

+ 15.1

+ 14.4

883

1,259

+ 42.6

+ 36.3

8,058

9,429

+ 17.0

+ 16.0

Pharmaceuticals, Biological Products

1,577

1,600

+ 1.5

1,172

1,129

-3.7

-5.5

851

900

+ 5.8

+ 5.7

361

438

+ 21.3

+ 16.3

3,961

4,067

+ 2.7

+ 1.7

Consumer Care

401

1,019

+ 154.1

+ 153.5

616

665

+ 8.0

+ 7.7

132

•

279

539

+ 93.2

+ 85.4

1,336

2,355

+ 76.3

+ 75.2

Diabetes Care, Diagnostics

785

848

+ 8.0

824

893

+ 8.4

+ 7.6

249

277

+ 11.2

+ 10.3

117

133

+ 13.7

+ 8.6

1,975

2,151

+ 8.9

+ 8.1

Animal Health

245

252

+ 2.9

+ 2.7

295

314

+ 6.4

+ 6.3

120

141

+ 17.5

+ 14.0

126

149

+ 18.3

+ 11.1

786

856

+ 8.9

+ 7.1

Bayer CropScience

2,238

2,241

+ 0.1

- 0.5

1,412

1,528

+ 8.2

+ 7.1

927

933

+ 0.6

- 0.5

1,369

1,194

- 12.8

- 20.0

5,946

5,896

- 0.8

- 3.2

Crop Protection

1,898

1,901

+ 0.2

- 0.6

979

1,076

+ 9.9

+ 8.8

820

811

- 1.1

- 2.3

1,260

1,086

- 13.8

- 21.2

4,957

4,874

- 1.7

- 4.3

Environmental Science, BioScience

340

+ 0.0

0.0

433

452

+ 4.4

+ 3.3

107

122

+ 14.0

+ 12.6

109

108

- 0.9

- 6.5

989

1,022

+ 3.3

+ 2.1

Bayer MaterialScience

3,876

4,732

+ 22.1

2,186

2,792

+ 27.7

+ 27.2

1,769

2,143

+ 21.1

+ 20.8

766

1,028

+ 34.2

+ 29.9

8,597

10,695

+ 24.4

+ 23.8

Materials

1,382

1,697

+ 22.8

+ 22.9

703

901

+ 28.2

+ 27.8

947

1,164

+ 22.9

+ 22.6

216

324

+ 50.0

+ 47.7

3,248

4,086

+ 25.8

+ 25.5

Systems

2,494

3,035

+ 21.7

1,483

1,891

+ 27.5

+ 27.1

822

979

+ 19.1

+ 18.3

550

704

+ 28.0

+ 22.7

5,349

6,609

+ 23.6

+ 22.8

Total regions (incl. reconciliation)

9,775

11,930

+ 22.0

+ 21.9

6,512

7,340

+ 12.7

+ 11.9

3,962

4,578

+ 15.5

+ 14.8

3,029

3,535

+ 16.7

+ 10.4

23,278

27,383

+ 17.6

+ 16.4


adj.		= currency-adjusted


Bayer Annual Report 2005		Management Report 27

Value Management

“Our goal is to steadily increase Bayer’s enterprise value and generate high value-added for the benefit of our stockholders, our employees and society as a whole. The basis for this value creation is innovation, growth and improved profitability.”

WERNER WENNING, CHAIRMAN OF THE BOARD OF MANAGEMENT OF BAYER AG

CVA-based system

One of the prime objectives of the Bayer Group is to sustainably increase enterprise value. In 1994 we became one of the first German companies to embark on the development of a value management system, which we introduced throughout the Group in 1997. The system is used for the planning, controlling and monitoring of our businesses. Our basic controlling parameter is the cash value added (CVA), which indicates the degree to which the cash flows needed to cover the costs of equity and debt and of reproducing depletable assets have been generated. If the CVA is positive, the company or business entity concerned has created additional value. If it is negative, the anticipated capital and asset reproduction costs have not been earned. Gross cash flow (GCF) and CVA are profitability indicators for a single reporting period. For a year-on-year comparison we therefore use the delta CVA, which is the difference between the CVAs of two consecutive periods. A positive delta CVA shows that value creation has increased from one period to the next.

Calculating the cost of capital

Bayer calculates the cost of capital according to the debt/equity ratio by the weighted average cost of capital (WACC) formula. The return expected by our stockholders is computed from capital market information. The cost of debt used in calculating WACC is based on the terms for a ten-year corporate bond issue.

To take into account the different risk and return profiles of our principal businesses, we calculate the cost of capital after taxes for each of our subgroups. In 2005 this was 8.0 percent for Bayer HealthCare, 6.5 percent for Bayer CropScience


28 Management Report		Bayer Annual Report 2005

and 6.0 percent for Bayer MaterialScience. The minimum return required for the Bayer Group as a whole was 7.0 percent.

Gross cash flow, cash flow return on investment, and cash value added as performance yardsticks

The GCF, as published in our cash flow statement, is the measure of our internal financing capability. Bayer has chosen this parameter because it is relatively free of accounting influences and thus a more meaningful performance indicator.

The profitability of the Group and of its individual business entities is measured by the cash flow return on investment (CFROI). This is the ratio of the GCF to the capital invested (CI). The CI can be derived from the balance sheet and basically comprises the property, plant and equipment and intangible assets required for operations – stated at cost of acquisition or construction – plus working capital, less interest-free liabilities (such as short-term provisions). To allow for fluctuations during the year, the CFROI is computed on the basis of the average CI for the respective year.

Taking into account the costs of capital and of reproducing depletable assets, we determine the GCF hurdle. If the GCF hurdle is equaled or exceeded, the required return on equity and debt plus the cost of asset reproduction has been earned. The CFROI hurdle for 2005 was 9.7 percent, while the corresponding GCF hurdle was €2,654 million.

Actual GCF came in at €3,477 million, exceeding the hurdle by 31 percent. Thus in 2005 we earned our entire capital and asset reproduction costs, and the positive CVA of €823 million shows we created additional value. Given the previous year’s CVA of €187 million, the Bayer Group therefore achieved a delta CVA of €636 million, which means we improved value creation by this amount in 2005 compared to 2004.

With an acquisition-related increase in capital invested but an even larger percentage rise in GCF, the CFROI increased from 10.8 percent in 2004 to 12.4 percent in 2005 and thus was at the record level of the year 2000.

All the subgroups exceeded their target returns including asset reproduction, with CropScience improving from 10.9 to 11.2 percent and MaterialScience from 10.3 to 16.4 percent. The figure for HealthCare declined from 17.3 in the previous year to 14.9 percent due to the acquisition.


	HealthCare						CropScience						MaterialScience						Bayer Group
Value Management Indicators by Subgroup	2004			2005			2004			2005			2004			2005			2004			2005
€ million
Gross cash flow hurdle		720			898			901			935			836			721			2.698			2.654

Gross cash flow*		943			1,138			893			964			884			1,402			2,885			3,477

Cash value added		223			240			(8	)		29			48			681			187			823

Cash flow return on investment		17.3	%		14.9	%		10.9	%		11.2	%		10.3	%		16.4	%		10.8	%		12.4	%

Average capital invested		5,447			7,635			8,209			8,618			8,549			8,553			26,695			28,071


2004 figures restated

*		for definition see Bayer Group Key Data on front flap


Bayer Annual Report 2005		Management Report 29

Liquidity and Capital Resources

Net cash provided by operating activities (Net cash flow)

Our gratifying business performance in 2005 led to a considerable improvement in gross cash flow. Despite substantially higher pre-tax earnings, income tax payments were only slightly above the previous year, partly due to utilization of loss carryforwards. The gains from the changes in our company pension plans in the United States and Germany were non-cash items. Gross cash flow improved by 20.5 percent to €3,477 million, from €2,885 million in the previous year. Net cash flow from continuing operations climbed by 56.6 percent to €3,542 million (2004: €2,262 million). All of the subgroups posted significant year-on-year growth in cash flow.

Net cash of €40 million was used in operating activities of discontinued operations, including inflows and outflows from the divested plasma business and LANXESS. Total net cash flow thus amounted to €3,502 million (2004: €2,450 million).

Net cash used in investing activities

There was a net cash outflow of €1,741 million for investing activities, compared to €814 million in the previous year. Disbursements for acquisitions amounted to €2,188 million, including about €1.9 billion for the consumer health business of Roche, an initial payment of roughly €200 million having been made in this connection at the end of 2004. This global business has been part of the Consumer Care Division of Bayer HealthCare, except in Japan, since January 1, 2005. Further disbursements related mainly to the purchase of marketing rights in connection with a license agreement and a co-marketing and distribution agreement in the CropScience and HealthCare subgroups, respectively. Capital expenditures for property, plant, equipment and for other intangible assets came to €1,389 million (2004: €1,251 million).

Receipts related to investments came to €1,189 million. This figure primarily included the scheduled repayment of loans following the spin-off of LANXESS,


Bayer Group Summary Cash Flow Statements	2004			2005
€ million
Gross cash flow*		2,885			3,477

Changes in working capital/other non-cash items		(623	)		65

Net cash provided by (used in) operating activities (net cash flow from continuing operations)		2,262			3,542

Net cash provided by (used in) operating activities (net cash flow from discontinued operations)		188			(40	)

Net cash provided by (used in) operating activities (net cash flow, total)		2,450			3,502

Net cash used in investing activities (total)		(814	)		(1,741	)

Net cash used in financing activities (total)		(761	)		(1,881	)

Change in cash and cash equivalents due to business activities		875			(120	)

Cash and cash equivalents at beginning of year		2,734			3,570

Change due to exchange rate movements and to changes in scope of consolidation		(39	)		(160	)

Cash and cash equivalents at end of year		3,570			3,290

Marketable securities and other instruments		29			233

Liquid assets as per balance sheets		3,599			3,523


2004 figures restated

*		for definition see Bayer Group Key Data on front flap


30 Management Report		Bayer Annual Report 2005

the expiration of currency-hedging derivatives and the sale of the LANXESS convertible bond with a nominal volume of €200 million. Receipts from sales of property, plant and equipment totaled €398 million, including approximately €230 million from the divestment of the plasma business in the first quarter of 2005.

Net cash used in financing activities

The net cash outflow of €1,881 million (2004: €761 million) for financing activities included €440 million in dividend payments, €787 million in interest payments and €654 million in net repayments of borrowings. In the third quarter, taking advantage of favorable market conditions, we successfully placed a subordinated 100-year hybrid bond in the nominal amount of €1.3 billion, bearing a 5 percent coupon. At the same time, part of the 5.375 percent Eurobond due on April 10, 2007 was repurchased early. The repurchased volume had a face value of approximately €860 million. The increase in interest paid was primarily due to one-time charges of €56 million incurred on this transaction.

Including marketable securities and other instruments, the Group had liquid assets of €3,523 million on December 31, 2005. This total includes an amount of €253 million that was deposited in escrow accounts to be used exclusively for payments relating to antitrust fines and civil law settlements. (See Note [35] to the financial statements on page 179 ff.). In view of the restriction on its use, the €253 million liquidity in these escrow accounts was not deducted when calculating net debt.

Net debt

The noncurrent financial liabilities include the 100-year hybrid bond issued in 2005. In comput-


Net Debt	Dec. 31, 2004		Dec. 31, 2005
€ million
Noncurrent financial liabilities as per balance sheets (including derivatives)		7,025		7,185

Current financial liabilities as per balance sheets (including derivatives)		2,166		1,767

– Derivative receivables		701		188

Financial liabilities from continuing operations		8,490		8,764

– Liquid assets as per balance sheets less amount not freely available		3,599		3,270	*

Net debt from continuing operations		4,891		5,494

Net debt from discontinued operations		531		0

Total net debt		5,422		5,494


*		€3,270 million = €3,523 million – €253 million


Bayer Annual Report 2005		Management Report 31

ing debt indicators, rating agencies generally only apportion part of this type of bond to financial liabilities (e.g. Moody’s: 25 percent) and allocate the remainder to stockholders’ equity. This bond thus supports the Group’s rating-specific debt indicators.

The Roche OTC acquisition was financed out of existing liquidity without additional borrowing. The cash disbursement therefore led to a substantial short-term increase in net debt. This was largely offset, chiefly by our operating cash flow, the proceeds of loan repayments and assumptions of debt by LANXESS, reducing net debt to below €5.5 billion by December 31, 2005.

Financial strategy

The financial management of the Bayer Group is conducted by the management holding company Bayer AG. Finance is a global resource, generally procured centrally and distributed within the Group. The foremost objectives of our financial management are to ensure sufficient liquidity and help bring about a sustained increase in corporate value. With these goals in mind we aim to optimize our capital structure, manage risks effectively and reduce financing costs.

Standard & Poor’s currently gives Bayer a long-term A rating, while Moody’s rates us at A3. The short-term ratings are A-1 (Standard & Poor’s) and P-2 (Moody’s). Our financial strategy is geared toward maintaining a credit rating that reflects high solvency.

We generally pursue a prudent debt management strategy aimed at ensuring flexibility. We consider it important to draw on a balanced mix of capital resources to finance our activities. Chief among these resources – in keeping with our requirements – are a syndicated credit facility, a multi-currency commercial paper program and a multi-currency Euro Medium Term Note program. We also supplement our financing with various structured products, such as an asset-backed securities program.

The situation on the international financial markets of relevance to the Bayer Group was again positive in 2005. We took advantage of this favorable market environment to considerably improve the conditions of our syndicated credit line. We do not expect this positive market environment to change significantly in the short term.

We use financial derivatives to hedge against risks arising from business operations or related financial transactions, but do not employ contracts in the absence of an underlying transaction. It is our policy to diminish the default risk by selecting trading partners with a high credit standing. We closely monitor the execution of all transactions, which are conducted according to Group-wide guidelines.

Further details of our risk management objectives and the ways in which we hedge all the major types of transaction to which hedge accounting is applied, along with procurement market, credit, liquidity and cash flow risks, as they relate to our use of financial instruments, are given in Note [33] to the financial statements on page 173 ff.


32 Management Report		Bayer Annual Report 2005

Earnings Performance

Net sales of the Bayer Group increased by 17.6 percent, or €4,105 million, from the previous year to €27,383 million. In local currencies and adjusted for portfolio effects, sales rose by 7.5 percent.

The cost of goods sold increased by 21.0 percent to €15.0 billion, mainly as a result of the growth in business but also due to higher raw material 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. To support our growth strategy we increased selling expenses, mainly at HealthCare and MaterialScience, by 9.0 percent overall to €5.7 billion. Reasons for the increase in the negative balance of other operating income and expenses included expenses related to settlements of antitrust proceedings in the polymers field, and legal and defense costs for product liability suits in HealthCare. These charges were partially offset by gains from changes to our pension systems in the United States and Germany.

EBIT in 2005 amounted to €2,812 million. Before net special charges of €488 million (2004: €242 million), EBIT climbed by 55.9 percent to €3,300 million.

The non-operating result improved by €40 million to minus €613 million. Net expense from investments in affiliated companies declined significantly, while net interest expense rose, due particularly to the acquisition-related increase in net debt at the beginning of the year.

Income taxes for continuing operations in 2005 came to €641 million (2004: €473 million). While the higher tax expense was due to the improvement in earnings, the effective tax rate declined to 29.1 percent, from 38.7 percent in the prior year.

Including the result of discontinued operations, Group net income in 2005 improved by €912 million to €1,597 million.


Bayer Group Summary Income Statements	2004			2005			Change
€ million							%
Net sales		23,278			27,383			+ 17.6

Cost of goods sold		(12,421	)		(15,027	)		+ 21.0

Selling expenses		(5,240	)		(5,713	)		+ 9.0

Research and development expenses		(1,927	)		(1,886	)		- 2.1

General administration expenses		(1,421	)		(1,444	)		+ 1.6

Other operating income and expenses — net		(394	)		(501	)		+ 27.2

Operating result [EBIT]		1,875			2,812			+ 50.0

Non-operating result		(653	)		(613	)		- 6.1

Income before income taxes		1,222			2,199			+ 80.0

Income taxes		(473	)		(641	)		+ 35.5

Income (loss) from discontinued operations		(67	)		37			•

Income after taxes		682			1,595			+ 133.9

of which attributable to minority interest		(3	)		(2	)		- 33.3

of which attributable to Bayer AG stockholders (net income)		685			1,597			+ 133.1


2004 figures restated


Bayer Annual Report 2005		Management Report 33

Asset and Capital Structure

Total assets decreased by €0.9 billion from the end of the previous year, to €36.7 billion, mainly because of the spin-off of LANXESS. Assets of our continuing operations increased by €3.9 billion compared to the end of 2004, chiefly due to the acquisition of the Roche OTC business and to currency translation effects. The goodwill and other intangible assets reflected in noncurrent assets rose by €1.7 billion overall. Of this amount, brands acquired as a result of the Roche otc acquisition, such as Aleve^{^®}, Bepanthen^{^®}, Redoxon^{^®}, Rennie^{^®} and Supradyn^{^®}, accounted for about €1.1 billion, and goodwill for €0.6 billion.

Current assets showed a slight 3.9 percent increase, due primarily to the currency-related – and thus non-cash – increase in inventories and receivables.

Stockholders’ equity expanded by €0.2 billion to €11.2 billion. The spin-off of LANXESS early in the year resulted in a reduction of €1.1 billion, while the dividend payment diminished stockholders’ equity by €0.4 billion and the change in pension provisions, which did not affect the income statement, led to a €0.7 billion decline. Group net income came to €1.6 billion, while positive currency effects added €0.9 billion to stockholders’ equity. Equity coverage of total assets for 2005 thus came to 30.4 percent on December 31, 2005 (2004: 29.1 percent).

Liabilities from continuing operations grew by €1.3 billion compared to December 31, 2004, to €25.6 billion, the largest factor here being the €1.0 billion increase in pension provisions. The changes in actuarial losses in 2005 (IAS 19 revised) accounted for €1.3 billion. These losses were due mainly to the decrease in the interest rates used for discounting purposes in 2005. Current liabilities rose by €0.1 billion, or 1.2 percent. While total financial liabilities declined, there were increases in the other provisions and in trade accounts payable.

Bayer Group Summary Balance Sheets

Dec. 31, 2004

Dec. 31, 2005

Change

€ million

Noncurrent assets

16,859

20,130

+ 19.4

Current assets

15,972

16,592

+ 3.9

Assets held for sale and discontinued operations

4,757

•

Total current assets

20,729

16,592

- 20,0

Assets

37,588

36,722

- 2.3

Stockholders’ equity

10,943

11,157

+ 2.0

Noncurrent liabilities

15,295

16,495

+ 7.8

Current liabilities

8,963

9,070

+ 1.2

Liabilities directly related to assets held for sale and discontinued operations

2,387

•

Total current liabilities

11,350

9,070

- 20,1

Stockholders’ equity and liabilities

37,588

36,722

- 2.3


2004 figures restated


34 Management Report		Bayer Annual Report 2005


Balance Sheet Ratios and Financial Indicators				2004		2005
	Cost of goods sold	(	%)		53.4		54.9

	Net sales

	R&D expenses	(	%)		8.3		6.9

	Net sales

	Cost of goods sold				2.6		2.7

	Inventories

	Net sales				5.2		5.3

	Trade accounts receivable

	Operating result (EBIT)	(	%)		8.1		10.3

	Net sales

	Property, plant, equipment and intangible assets	(	%)		41.5		43.6

	Total assets

	Depreciation and amortization	(	%)		197.9		126.7

	Capital expenditures

	Current liabilities	(	%)		36.9		35.5

	Total liabilities

	Income before income taxes and interest expense	(	%)		5.7		8.9

	Average total assets

	Income after taxes*	(	%)		6.1		14.4

	Average stockholders’ equity*

	Stockholders’ equity*	(	%)		29.1		30.4

	Total assets*


2004 figures restated

* continuing and discontinued operations


Bayer Annual Report 2005		Management Report 35

Proposal for Distribution of the Profit

Under German law, the dividend payment is based on the balance sheet profit of the parent company, which amounted to €694 million in 2005:


Bayer AG Summary Income Statements	2004			2005
€ million
Net sales		233			197

Cost of goods sold		(184	)		(134	)

Gross profit		49			63

Selling and administration expenses		(189	)		(215	)

Other operating income and expenses – net		(76	)		110

Operating result		(216	)		(42	)

Non-operating result		508			719

Income before income taxes		292			677

Income taxes		(18	)		(64	)

Net income		274			613

Decline in assets due to the spin-off		(836	)		0

Allocation from retained earnings		964			81

Balance sheet profit		402			694

We will propose to the Annual Stockholders’ Meeting on April 28, 2006 that the balance sheet profit be used to pay a dividend of €0.95 per share (730,341,920 shares) on the capital stock of €1.9 billion entitled to the dividend for 2005.

Employees

On December 31, 2005 there were 37,600 employees in the Bayer Group in Germany and 93,700 worldwide. When the spin-off of LANXESS is taken into account, this was 2,000 more than at the beginning of the year. The average number of employees, at about 93,000, was above the 2004 level. A breakdown of employees by segment and region is provided in the notes to the financial statements on page 84 ff. Personnel expenses decreased by 1.9 percent in 2005 to €5,912 million, equivalent to 21.6 percent of sales. The value added per employee increased to €102,487.

The total number of employees rose once again, particularly in the Asia-Pacific and Latin America regions, and our personnel structure improved through new hirings. At our German sites alone, about 200 university graduates were given jobs in 2005, while a further 1,000 young people entered company-sponsored vocational training programs and some 600 trainees were given full-time positions.

In 2005 our human resources policy focused on measures designed to enhance and make full use of the performance potential of our employees. We received awards in several countries for our numerous programs and activities aimed at helping employees reconcile family and career demands, motivating the workforce, improving human resources development, recruiting new talent and retaining employees within our company. For ex-


36 Management Report		Bayer Annual Report 2005

ample, our companies in Argentina, Australia, New Zealand and Belgium were listed among the top employers in those countries by respected financial magazines and human resources consultants. In the United States, Bayer in 2005 was named one of the best employers for working mothers for the third time. And in Austria, the Federal Ministry of Economics and Labor presented us with the national “Knewledge 2005” prize, which is awarded to companies for outstanding achievements in human resources development and advancement.

At the beginning of 2006, the German Minister for Labor and Social Affairs awarded Bayer the “Shaping Employment — Companies Demonstrate Responsibility” award in the category “Prospects for Young People” in recognition of the company’s commitment to vocational training. The jury singled out Bayer for the award because of its special program to prepare socially and educationally disadvantaged young people for vocational training courses.

We renewed our range of social benefits in 2005 and adapted them to current requirements. These benefits include counseling offers that are available to our employees in Germany and the United States for dealing with personal and job-related problems, preventive health care programs and a company pension plan that we offer to our employees in nearly every country in which we operate.

In shaping our company pension plans, we take account of both social responsibility aspects and the distribution of risk. We have therefore pursued the successive conversion of our global pension plans from defined benefit to defined contribution systems. This process reached a preliminary conclusion in 2005 with conversion of the systems in the United States, Canada and Brazil. In Germany, too, we correspondingly adjusted components of our pension systems.

During the reporting period we further developed our variable income component systems based on corporate performance – a core component of our remuneration policy – and harmonized these systems internationally. The budget for these is now dependent on the attainment of economic targets at all levels. Non-earnings-based one-time payments were consistently scaled back.

We also restructured the stock-based programs for our employees in 2005. With the launch last year of a new program named “Aspire”, we introduced a uniform Group-wide system for the executive management level. Under this program, participants can receive cash payments based on the performance of Bayer stock over a three-year period.

At the European level, the employees’ representatives met with Group management at the 14th Bayer European Forum to continue their cross-border information exchange and consultation process.

Accompanied by numerous measures around the world throughout 2005, we made our mission statement “Bayer: Science For A Better Life” the benchmark for our entrepreneurial activities. The values enshrined in the mission statement and the leadership principles derived from them have been integrated into our daily operations.

In October 2005 we once again conducted a survey of our managerial staff in which more than 10,000 managerial employees in all countries participated. The survey found that the mood within the company had once again improved significantly over the previous year and a half.


Bayer Annual Report 2005		Management Report 37

Procurement and Distribution

Bayer HealthCare

The Pharmaceuticals Division generally procures the raw materials for manufacturing the active ingredients of its prescription medicines from external suppliers. We hold strategic reserves to prevent supply bottlenecks and possible dependence on suppliers. We mitigate major price fluctuations by purchasing the intermediates required to manufacture our principal active ingredients from several suppliers on the basis of global contracts. The active ingredients of our prescription medicines are currently manufactured almost entirely in Wuppertal, Germany, for Bayer production facilities worldwide. Our most important pharmaceutical production plants are located in Leverkusen, Germany; Berkeley, California, United States; Garbagnate and Rosia, Italy; and Shiga, Japan. Our products are primarily distributed through wholesalers, pharmacies and hospitals.

Since we actively compete with other drug suppliers worldwide, we seek to reinforce our external distribution network with co-promotion and co-marketing arrangements. In September 2004 we entered into a strategic alliance with Schering-Plough under which that company distributes our primary care products in the United States. At the same time, we market cancer drugs from Schering-Plough in selected countries. Bayer and Schering-Plough also plan to jointly market Schering-Plough’s product Zetia^{^®} in Japan, where it is currently involved in the registration process. In October 2005 we signed a strategic cooperation agreement with Johnson & Johnson under the terms of which Johnson & Johnson is supporting the development of our antithrombotic drug BAY 59-7939. It is intended that Johnson & Johnson market the newly developed drug in the United States at a later date. Furthermore, Bayer and Johnson & Johnson will jointly market Johnson & Johnson’s urology drug Elmiron^{^®} in the United States.

The activities of our Consumer Care Division are focused on over-the-counter medicines that patients can generally purchase without a prescription. Consumer Care procures extensive volumes of certain raw materials from within the Bayer Group. The most important raw materials that we buy in bulk from third parties are ascorbic acid, citric acid, paracetamol, sodium citrate and tartaric acid. These are generally readily available. To minimize business risks, we diversify our raw material procurement sources worldwide and conclude long-term supply agreements. The division’s sales and distribution channels outside Europe are typically supermarket chains, drugstores and other wholesalers. In Europe, pharmacies are the primary distribution channel.

The Diagnostics Division manufactures or assembles most of its products itself. We operate a supplier management process and procure raw materials, components and finished products on an OEM (original equipment manufacturer) basis. The materials we purchase directly are generally not subject to significant fluctuations in price or availability. Our diagnostic systems are marketed directly to reference laboratories, private laboratories and hospitals, as well as through a network of distribution companies.

The sole production facility in the Diabetes Care Division is located in Mishawaka, Indiana, United States. About one third of products are manufactured or assembled directly by Bayer, while the rest are procured from OEM suppliers. The delivery of raw materials, components and finished products is based on a supplier management process. Access to most of the materials is thus safeguarded through contractual agreements, and they are therefore not subject to major fluctuations in price or availability. Delivery bottlenecks for some direct or OEM materials would have negative consequences for the earnings performance of Diabe-


38 Management Report		Bayer Annual Report 2005

tes Care. These items include customer-specific, integrated circuits and sensors for producing the Ascensia^{^®} blood glucose measurement system. We therefore hold strategic reserves of certain direct materials or finished products in order to be able to supply our customers consistently and reliably. Furthermore, we maintain a global supplier network. Our Diabetes Care products are marketed to consumers through distribution companies and large drugstore and retail chains.

The Animal Health Division procures pharmaceutical ingredients for its veterinary medicines both from within the Bayer Group and from external suppliers throughout the world. Depending on local regulatory frameworks, animal health products may be available to end users over the counter or with a prescription issued by a veterinarian.

Bayer CropScience

Crop Protection procures most of its raw materials from external companies. The cost of some raw materials depends on fluctuating oil and energy prices and freight charges. As most of our sales are generated in the northern hemisphere, the business depends especially on the growing seasons for the relevant crops and the respective distribution cycles. The products of Crop Protection are marketed either to wholesalers or directly to retailers through a two- or three-tier distribution system, according to local market conditions.

Our Environmental Science Business Group markets its products to both professional users and amateur gardeners through various distribution channels. Our green industry, pest control and barn hygiene products are marketed directly to professional users, while home and garden products are sold through specialist dealers.

BioScience makes its seed products available to end users, distributors and processing industries. Traits developed using plant biotechnology are either outlicensed to other seed companies for use in their products or sold through our own seed companies. Important brands here include InVigor^{^®} and FiberMax^{^®}. In some cases we make plant traits available to other companies for use in their own research and products.

Bayer MaterialScience

The Polycarbonates Business Unit of Bayer MaterialScience sells its products primarily to injection molding and extrusion processors for the manufacture of plastics components used predominantly in the automotive, electronics, construction, data systems, medical equipment and leisure sectors. The key petrochemical raw materials used by our Polycarbonates business unit are acetone and phenol. With raw material costs affected mainly by the volatility of oil and benzene prices, we generally conclude long-term supply agreements containing cost-based and market-price-oriented adjustment formulas. Our products are marketed chiefly through regional distribution channels. We also use trading houses and sell to smaller customers through local distributors.

The activities of Wolff Walsrode focus on building materials, industrial coatings, printing inks for soft packaging, and the health care market. In Germany and the United States, Wolff Walsrode normally sells its cellulose products directly. Elsewhere, products are marketed through Bayer’s global sales organization. The principal raw material for our cellulose derivatives is chemical-grade cellulose produced from raw cellulose and cotton. We regard our procurement risk for this material as low.


Bayer Annual Report 2005		Management Report 39

H.C. Starck supplies materials and components for the electronics, optics, aviation, aerospace and medical technology industries. As we operate our own tungsten recycling facilities, we are only partially dependent on Chinese imports. The supply of raw materials is covered by long-term agreements which mostly run for three to five years. H.C. Starck maintains its own international sales organizations and liaison offices worldwide. This subsidiary also makes use of other sales organizations that are responsible for maintaining direct contact with customers. For example, Ampere^{^®} products are jointly marketed with Dutch-based Flame Spray Technologies.

The polyurethane products of the Polyurethanes business unit, which are based on isocyanate-polyol systems, are used in the automotive, construction, electronics and furniture industries and in leisure articles. The primary raw materials are petrochemical feedstocks, which we mostly procure on the open market through long-term agreements. A global joint venture with Lyondell provides a supply source for propylene oxide, one of our most important raw materials. These petrochemical feedstocks are subject to price fluctuations on the crude oil and derivatives markets. We mostly sell our isocyanate and polyol products directly to customers. Europe, the NAFTA countries and Asia are the primary markets for our polyurethanes business, with the Asian market continuing to show the highest growth rates.

Our Coatings, Adhesives, Sealants business unit is a leading manufacturer of raw materials for coatings and adhesives used primarily in the automotive, furniture, plastics and construction industries. Temporary fluctuations in prices for oil or utilities, for example, can heavily impact the cost of our raw materials. For this reason, supplies of the principal chemical raw materials are secured through long-term agreements. Bulk customers with global operations are serviced directly by our key account managers.

Research and Development

In 2005 Bayer invested a total of €1,886 million in research and development. It is particularly important for us to continuously optimize our product portfolio and manufacturing processes, while at the same time developing new products aimed at strengthening our core businesses.

Research and Development Expenses 2005
by subgroup in %

Other research focuses are enabling technologies such as biotechnology and nanotechnology, which offer enormous potential for developing new products and businesses.

For innovation projects in particular, we depend on our network of collaborations with leading universities, public-sector research institutes and partner companies. These collaborations allow the pooling of expertise in order to rapidly translate new ideas into successful products.

In order to further strengthen the company’s innovative power, Bayer has launched a Group-wide innovation initiative entitled “Triple-i”, which stands for “inspiration, ideas, innovation”. This long-term initiative is designed to encourage Bayer’s employees around the world to put forward creative ideas and suggestions that can be utilized for the company’s benefit through a special innovation process that has been put in place for this purpose. Particular emphasis will be placed on examining


40 Management Report		Bayer Annual Report 2005

ideas and options that lie outside the existing business areas of our subgroups or at the interface between them.

Bayer HealthCare

In 2005, €954 million, or roughly 51 percent of the Bayer Group’s research and development budget, was spent by Bayer HealthCare. With this investment, the subgroup is laying the foundation in the Pharmaceuticals, Consumer Care, Diagnostics, Diabetes Care and Animal Health divisions for the introduction of further innovative products in expanding markets.

In connection with the realignment of the Pharmaceuticals Division, we have adjusted our global pharmaceutical research and development activities to reflect changing business conditions. This is reflected in the division’s modified research and development structure with the newly created units Global Active Substances Research and Global Development. The purpose of the realignment, which took effect in January 2006, is to enable early evidence of the efficacy of new medicines in humans (proof of concept). Our global active substances research is focused on oncology at the site in West Haven, Connecticut, and on cardiovascular disease at the research center in Wuppertal, Germany. The research and development facilities for the expansion of our Kogenate^{^®} product line are located at our site in Berkeley, California.

Bayer HealthCare has carved its anti-infective research activities out of the Pharmaceuticals Division and placed them into a new company in which Santo Holding (Deutschland) AG of Stuttgart, Germany, will hold a majority interest and Bayer HealthCare a minority interest of 12 percent. The anti-infectives research activities are expected to be fully independent by March 2006.

In addition to focusing on new active substances, we have intensified post-marketing research in the Pharmaceuticals Division. We aim to expand the applications spectrum of products that are already on the market by identifying additional indications and developing improved formulations. A particularly good example of this is the life cycle management of our product Adalat^{^®}, which contributed €659 million in sales in 2005 even after many years on the market.

Our development product BAY 59-7939, an oral inhibitor of the blood coagulation Factor Xa, is currently being investigated for the prevention and therapy of thromboembolic diseases, where there is a clear medical need for improved treatment options. In October 2005, Bayer HealthCare and Johnson & Johnson subsidiary Ortho-McNeil Pharmaceutical, Inc. concluded an agreement to jointly develop BAY 59-7939. Phase III trials for the prevention of venous thromboembolism (VTE) after major orthopedic surgery began in December 2005. Phase II trials for acute VTE treatment and stroke prevention in atrial fibrillation are currently ongoing.

Our new cancer drug Nexavar^{^®} (sorafenib) was approved by the U.S. Food and Drug Administration in December 2005 for the treatment of patients with advanced renal cell carcinoma (RCC). Nexavar^{^®} is based on a novel active ingredient developed jointly with Onyx Pharmaceuticals Inc. that is designed to inhibit tumor growth by simultaneously blocking several serine/threonine and receptor tyrosine kinases in tumor cells. The drug also cuts off the supply of blood to the tumor. Nexavar^{^®} was shown in clinical studies to double progression-free survival in patients with advanced RCC. The product has received orphan drug status in the European Union from the Committee for Orphan


Bayer Annual Report 2005		Management Report 41

Medicinal Products (COMP) of EMEA, the European regulatory body. We have also filed with EMEA for regulatory approval of Nexavar^{^®} in the treatment of advanced kidney cancer. To expand the product’s spectrum of indications, we and Onyx Pharmaceuticals launched phase III trials in 2005 for patients with advanced liver and skin cancer, as well as further phase II studies for other tumor types. Furthermore, in December 2005 we announced the beginning of a phase III clinical trial in non-small-cell lung cancer (NSCLC).

Our research and development efforts in the Biological Products Division are centered around strengthening and expanding our recombinant Factor VIII product Kogenate^{^®}. We have identified five new protein variants for potential development of the next Kogenate^{^®} generation whose optimization is expected to be completed by the end of 2006. In addition, we are currently evaluating technologies that can also be used in the development of the next generation of Kogenate^{^®}. In this connection, Bayer HealthCare has signed an exclusive, worldwide license agreement with Dutch-based company Zilip-Pharma concerning the development and marketing of a new, longer-acting Kogenate^{^®} formulation based on patented pegylated liposome technology. In April 2005, Bayer completed an Investigational New Drug filing with the FDA for a phase I clinical study involving the new formulation.

In May 2005 we entered into a research agreement with Asklepios Biopharmaceutical concerning the evaluation of gene therapy for the treatment of hemophilia B.

The continuous optimization of Kogenate^{^®} also includes the development of Kogenate^{^®}-FS with Bio-Set^{^®}, a needle-free system for our recombinant Factor VIII product that minimizes the risk of needle-stick injuries. The Bio-Set^{^®} system was launched in the European Union in mid-2005. Bayer received FDA approval for the product at the end of the year, and Bio-Set^{^®} was introduced to the U.S. market at the beginning of 2006.

To strengthen our activities in the fields of cardiovascular disease and hematology, we signed two agreements effective January 2006. One of these agreements concerns the acquisition from GlaxoSmithKline of European marketing rights for the antihypertensive agent telmisartan (trade names: Pritor^{^®} and PritorPlus^{^®}). The other covers a collaboration with Nuvelo for the development and commercialization of that company’s blood clot dissolver alfimeprase. Following the completion of ongoing phase III clinical development and the product’s subsequent registration, Bayer HealthCare will hold marketing rights for alfimeprase outside the United States. In January 2006 Nuvelo was granted fast track status for alfimeprase from the FDA.

Development activities of the Consumer Care Division focus on the identification, development and market introduction of non-prescription products. Further initiatives focus on the expansion of indications to support existing brands and on the reclassification of current prescription medicines as over-the-counter products. One example is the joint development program with Bristol-Myers Squibb for Pravachol^{^®} (pravastatin), the goal of which is to register Pravachol^{^®} in the United States as an over-the-counter cholesterol-lowering drug.


42 Management Report		Bayer Annual Report 2005

R&D activities in the Diagnostics Division concentrate on strengthening core product lines for Laboratory Testing and Near Patient Testing, and on expanding nucleic-acid-based tests. Our product line has been strengthened by the launch of the Advia Centaur^{^®} CP Immunoassay System in November 2005 and by the adaptation and implementation of new diagnostic tests for the indications infectious diseases and oncology. Our product range in Near Patient Testing was supplemented in mid-2005 by the improvement of the DCA 2000+^{^®}Analyzer diabetes management platform. The expanded test menu for the Clinitek Status^{^®} analyzer also helped to strengthen this segment. Through a license agreement signed with CIS Biotech Inc. in September 2005, we secured development and marketing rights for an automated assay for stroke diagnosis. In addition, in November 2005 we acquired development rights from Inverness Medical Innovations concerning the development of new cardiovascular diagnostic tests. We concluded a further agreement with that company concerning the use of a hybridoma cell line capable of producing monoclonal antibodies against the envelope protein of the Hepatitis B virus. We plan to steadily expand our portfolio for both the clinical diagnostics and molecular testing markets.

In the Diabetes Care Division, we are working to strengthen core product lines and expand into market segments characterized by strong growth and margins. We aim to achieve this through the development of user-friendly blood glucose measurement devices that meet the individual needs of diabetic patients. We are also investing in technologies designed to enable continuous monitoring of blood glucose levels and, in the longer term, blood-free glucose monitoring. In this connection we extended a license agreement with Sontra Medical Corporation, whose ultrasonic SonoPrep^{^®} technology increases skin permeability and is thus intended to obviate the need for blood samples.

In the Animal Health Division, our research efforts focus on antibiotics, parasiticides and active ingredients to treat non-infectious diseases such as liver failure, cancer and congestive heart failure. Our active ingredient pradofloxacin, which is currently undergoing clinical development for the antimicrobial treatment of dogs and cats, has been submitted to the E.U. regulatory authorities for registration. Also undergoing the registration process are our Baycox^{^®} parasiticide for use in calves and Baytril^{^®} for antimicrobial therapy in pigs.

Bayer CropScience

In 2005, €664 million – or about 35 percent of the Bayer Group’s R&D budget – was spent at Bayer CropScience.

Crop Protection has at its disposal a global network of research and development facilities: these are located at Monheim (corporate headquarters) and Frankfurt, Germany; Lyon and Sophia Antipolis, France; Stilwell, Kansas, and Raleigh, North Carolina, in the United States; and Yuki City, Japan.

While our crop protection research is concentrated at certain sites, development activities take place both in our central facilities and in numerous field testing stations around the world to ensure that future products are tested under regional climate conditions.

Our R&D efforts are geared toward the identification and development of innovative, safe and commercially sustainable products in the area of crop protection.

Research activities encompass all measures aimed at identifying new active ingredients which could be developed into insecticides, fungicides or herbicides. In addition to conventional chemistry, biology and biochemistry, we make use of modern technologies such as genomics, high-throughput


Bayer Annual Report 2005		Management Report 43

screening, bioinformatics and combinatorial chemistry to identify new lead structures. Cooperation agreements with external research companies supplement our own activities.

We actively expand the applications spectrum of our products through continuous life cycle management. This includes the development of new formulations for active ingredients and products already on the market so that they can be used for other crops or to improve their handling.

The following new active ingredients were introduced to the market in 2004 and 2005 or are expected to be launched in 2006, provided they receive regulatory approval.

Fluoxastrobin is a systemic broad-spectrum strobilurin for leaf application with curative and protective properties. Products containing fluoxastrobin are designed for spray application (Fandango^{^®}) and seed treatment (Bariton^{^®}, Scenic^{^®}) in cereals, potatoes, vegetables, peanuts and other crops.

Spiromesifen (Oberon^{^®}) belongs to a new chemical class called tetronic acids. Oberon^{^®} is a new insecticide/mite control product for spray application to control white flies, mites and jumping plant lice, which affect annual crops. Oberon^{^®} was developed for global use in vegetables, fruit, cotton, corn, beans, tea and certain ornamentals.

Ethiprole (Curbix^{^®} and Kirappu^{^®}) belongs to the chemical class called phenylpyrazoles. It is effective against a large number of biting and sucking insects such as thripses, stink bugs, grasshoppers and aphids. The product is used in rice, tea and fruit.

Fluopicolide (Infinito^{^®}) belongs to a new chemical class called acylpicolides. Products from this substance class are used to treat oomycete diseases in potatoes, vegetables and ornamental plants. The new mechanism of action will enable farmers to also control oomycete strains that are already resistant to standard fungicides.

Active ingredients discovered by our crop protection researchers are also tested and evaluated by Environmental Science to determine whether they have potential for further development. We also test active ingredients from external companies and acquire them should these tests prove positive. Development projects include so-called passive treatments (gels, baits), pest control formulations, and new herbicide products and fungicidal combinations for the lawn care and ornamental plants sectors.

In 2005 we introduced to the market the insecticide Allectus^{^®} (imidacloprid) and the fungicide Armada^{^®} (trifloxystrobin with triadimefon) for green industry applications, as well as the insecticide tablet K-O Tab^{^®}1-2-3 (deltamethrin) for impregnating mosquito nets. In 2006 we expect to launch the insecticide Forbid^{^®} (spiromesifen) for the green industry segment and, in professional pest control, Quickbayt^{^®} spray (imidacloprid) to control flies.


New active ingredient	Indication	Status
Fluoxastrobin	Fungicide	Market introduction 2004/2005*

Spiromesifen	Insecticide	Market introduction 2004/2005*

Ethiprole	Insecticide	Market introduction 2005

Fluopicolide	Fungicide	Market introduction expected in 2006


* “2004/2005” indicates that the new active ingredient was first registered in an important country at the end of 2004, but that the first significant sales were registered in 2005.


44 Management Report		Bayer Annual Report 2005

In addition to conventional crop protection research, Bayer CropScience also conducts research in the BioScience Business Group, which is active primarily in plant biotechnology. The research and development sites for this unit are located in Lyon, France; Haelen, Netherlands; Ghent, Belgium; and Potsdam, Germany.

R&D in the field of plant biotechnology is mainly geared toward improving the agronomic and qualitative properties of crops. From the identification of a target gene to the development of a plant, the technologies employed for this purpose comprise all relevant tools required to improve important crops such as cotton, canola and rice for producers and industry partners. Activities range from research into novel agronomic traits to the discovery of new plant-based specialty products for the areas of nutrition, health care and biomaterials. These include plants with increased stress tolerance (to resist drought conditions, for example), health-promoting canola oils and renewable raw materials for non-food products.

Our growth is supported by the continuous introduction of new products. In 2005 we introduced four new cotton grades and a new canola type; we expect to launch additional new cotton grades in 2006.

Bayer MaterialScience

In 2005 Bayer MaterialScience spent €251 million, not including joint development activities with customers, to further expand its position as a technology leader and global supplier of customized, high-quality materials and systems solutions. This corresponds to 13 percent of the Group’s research and development expenses.

In the five Bayer MaterialScience business units – Polyurethanes; Polycarbonates; Coatings, Adhesives, Sealants; Thermoplastic Polyurethanes; and Inorganic Basic Chemicals – ultra-modern technologies and production processes are used to implement new products and applications in close cooperation with our external partners and customers.

The Polycarbonates business unit, for example, is working to optimize the melt-polycarbonate process at our new facility in Caojing, China, which is being equipped with ultra-modern production technologies. An outstanding example of a new product application is our diffuser sheets, which ensure the even distribution of light for rear illumination of LCD flat screens.

In the Polyurethanes business unit, we are concentrating on steadily improving existing manufacturing processes for aromatic isocyanates and polyethers, as well as on developing new products for new applications. In the area of high-performance composites, in which polyurethanes play a key role, we have succeeded in developing a new Baydur^{^®} formulation for exterior body parts for large vehicles that is superior to the currently used material in terms of heat resistance and strength.

The Coatings, Adhesives, Sealants business unit is another showcase for our innovative capability. Its researchers are concentrating on the development of polyurethane raw materials for the formulation of high-grade products. Raw materials for more environmentally friendly low-solvent systems are an important focus and include thermoformable soft-feel coatings with a velvety feel.

Innovation also plays an important role at our subsidiaries Wolff Walsrode and H.C. Starck. Research activities at Wolff Walsrode aim at exploiting the unique structural and chemical properties of cellulose and other polysaccharides, which are important renewable raw materials, in order to manufacture a wide variety of products for the


Bayer Annual Report 2005		Management Report 45

construction, food and pharmaceutical industries, for example. New developments at H.C. Starck include precursors and components that Staxera, a 50:50 joint venture with Webasto, uses to produce high-temperature fuel cells for mobile applications such as trucks and boats.

To exploit profitable fields of activity for the future, the New Business section of Bayer MaterialScience constantly tracks and evaluates new technological and market trends. The most promising ideas are channeled into research and development projects. These projects are then either implemented in cooperation with the business units or developed within independent companies as part of the so-called greenhouse concept. Here we place great emphasis on global cooperation with universities, other institutes and start-up companies. For example, we have signed a joint development agreement with InPhase Technologies concerning holographic data storage media with a capacity of up to 1.6 terabytes.

Bayer Technology Services

For engineering and technological issues, particularly in the area of process technology, all subgroups work closely together with Bayer Technology Services. This service company develops innovative technology platforms for the Bayer Group, helping the subgroups to sustain their performance. These enabling technologies shorten development times and support the manufacture of new products, system solutions and production processes in the subgroups.

A strategic core element in this connection is international insourcing, which involves the acquisition of know-how. This ranges from country-specific expertise in the implementation of capital expenditure projects through the global exploitation of innovations and public research funding to the recruitment of top international experts and the establishment of collaborations with other companies and research institutes. One example is the acquisition of Zeptosens AG, a spin-off of Novartis whose highly sensitive biochip systems can considerably reduce development times for the active substances of Bayer HealthCare and Bayer CropScience.

Bayer Innovation

Responsibility for the development of innovative products and new fields of business outside of the subgroups’ existing core activities lies with Bayer Innovation GmbH (BIG). The goal of this company is to add to Bayer’s business portfolio and facilitate access to new growth markets. The current focus is on medical technology, the manufacture of certain pharmaceutical active ingredients in plants, and security technology.

One example of the targeted exploitation of intradisciplinary synergies is medical technology, where expertise in new materials and active substances development, combined with knowledge of human physiology and diseases, is crucial in creating novel and promising products. Such applications can include chronic wound dressings made from materials which contain pharmaceutical active ingredients to help prevent infections, stop undesirable cell growth and accelerate the healing process.

big also consolidates Bayer’s activities for producing specific pharmaceutical substances in plants (plant-made pharmaceuticals or PMPs). Building on expertise from the BioScience Business Group, this technology utilizes the natural protein production process in plants to manufacture therapeutically active substances. In this connection, BIG in January 2006 acquired biotech company Icon Genetics AG, which provides a promising technology platform for this application.


46 Management Report		Bayer Annual Report 2005

Sustainable Development

Linking innovation and values to sustainability

We steer sustainability within the Bayer Group on the basis of our mission statement, values and leadership principles. In 2005, we again adapted to changing framework conditions and new questions.

We strategically realigned our existing committees for sustainable development and for health, safety and environmental issues in 2005, focusing particularly on the adjustment of our structures in Asia in order to adequately accompany economic development in that region and create scope for future perspectives. The global Responsible Care initiative of the chemical industry was actively embraced and supported at our sites through a wide variety of programs. In addition, we further refined our established HSEQ management systems. The regular evaluation of these systems is governed by a Group-wide audit guideline.


Category		Key Performance Indicator	2004		2005
Environment, health and safety	Health and safety	Industrial injuries to Bayer employees resulting in at least one day’s absence (MAQ* value)		2.7		2.7

		Reportable industrial injuries to Bayer employees (MAQ* value)		4.7		4.1

		Environmental or damage-causing incidents		6		2

		Number of transportation incidents		11		3

	Emissions and solid waste	Emissions to the atmosphere

		Climate-relevant gases (million metric tons CO₂ equivalent per year)		4.2		3.9

		Volatile organic compounds (thousand metric tons per year)		4.5		3.6
		Emissions into water

		Total phosphorus (thousand metric tons per year)		0.8		0.7

		Total organically bound carbon (thousand metric tons per year)		2.2		1.8

		Total nitrogen (thousand metric tons per year)		0.9		0.7

		Hazardous waste

		Generated (million metric tons per year)		0.3		0.4

		Landfilled (million metric tons per year)		0.1		0.2

	Resource consumption	Water consumption (million cubic meters per day)		1.3		1.2

		Energy consumption (petajoules [= 10¹⁵joules] per year)		97		87


Employees and society	Diversity and opportunity	Percentage of women in Bayer Group senior management		**		3.9

		Number of nationalities in Bayer Group senior management		**		17

	Training and development	Training and development expenses in percent of personnel expenses		**		2.3

	Employment	Number of employees by region (permanent and temporary contracts)

		Europe		51,400		52,400

		North America		17,800		16,200

		Asia/Pacific		12,200		13,900

		Latin America/Africa/Middle East		10,300		11,200


*		MAQ = million-working-hour quota = number of injuries per million hours worked that resulted in at least one day’s absence

**		global data not collected prior to 2005


Bayer Annual Report 2005		Management Report 47

At the end of 2004, Bayer became an Organizational Stakeholder of the Global Reporting Initiative (GRI) established by the United Nations. Here we participate in the multi-stakeholder process aimed at establishing globally accepted guidelines for sustainability reporting. The focus in 2005 was on the G3 guideline revision process.

Furthermore, we continued to develop our reporting and began annual publishing of our global environmental and safety data on the Internet in 2005. Our performance data for the most important safety and environmental issues, the so-called key performance indicators (KPIs), were supplemented by a number of new aspects that now more specifically describe our social commitment. In this way we are responding to the increased significance of corporate social responsibility, as well as illustrating the areas we consider to be particularly important and that we use as indicators for managing our corporate HSE activities (see table at left).

During the reporting period, we further improved or at least matched most of the KPIs from the previous year. Only the volume of waste classified as hazardous increased as a result of temporary renaturization and remediation activities.

It is important to us to participate in the shaping of framework conditions. Bayer is keenly involved in both national and international debates on environmental and consumer protection strategies and regulations. We support the goals of a modern chemicals policy for the European Union and contribute to constructive solutions in this area.

However, we need practicable and target-oriented instruments to quickly and effectively achieve better protection for consumers and the environment and at the same time ensure that companies remain competitive. The competitiveness of European industry must not be jeopardized by overregulation.

We endorse the goals of the E.U. strategy for improving health and the environment (SCALE), which focuses particularly on children’s health. However, it is essential that all relevant influencing factors, and especially genuine health problems, be taken into account. The scientific assessment of risks must remain the basis for decision-making, and existing regulations should be kept in mind.

Biotechnology and nanotechnology will have a key impact on advances in science and process engineering. We view them as indispensable options for the development of innovative products. In keeping with our motto “Bayer: Science For A Better Life”, these new technologies can be used to improve the performance of existing products and open up new markets. They also offer new approaches for the conservation of resources and for environmental protection. The statements contained in our Guidelines for Responsible Care in Environmental Protection, Health Protection and Safety also apply to the use of biotechnology and nanotechnology at Bayer. This means in particular that safety and environmental protection have the same standing as quality and cost-effectiveness.

Working for climate protection

Climate protection and operations based on the conservation of resources are two themes that have been particularly important to us for many years. It is not surprising, therefore, that we have undertaken significant efforts to continuously reduce direct emissions of carbon dioxide and other greenhouse gases at all of our sites worldwide.

In 2005, the Carbon Disclosure Project honored Bayer’s climate protection activities over many years by including the company in the Climate Leadership Index. This initiative represents large institutional investors and has the goal of influ-


48 Management Report		Bayer Annual Report 2005

encing the impact that large enterprises have on climate change through their activities. Companies included in the Climate Leadership Index are recognized as being better positioned than other companies in the same industry in terms of the financial effects to which they will be subjected as climate change progresses. In addition, Bayer received the Low Carbon Leaders Award in December 2005 at the international Climate Summit in Montreal, Canada. The company was rated “Best in Class” by an international jury of experts appointed by The Climate Group, a climate protection organization, and made up of representatives from politics, non-governmental organizations and industry. Bayer was the only German company to receive this highest accolade, which is presented to only five companies in all. In the global climate protection ranking, Bayer was rated third.

At the European level we advocate an emissions trading system that does justice both to the interests of industry and the need to protect the Earth’s climate. In this connection, we propose that comparable production facilities should be allocated the same number of emission certificates in the future and that allocation rules should be harmonized throughout the European Union.

In the United States, Bayer is voluntarily taking part in the four-year emissions trading pilot project of the Chicago Climate Exchange (CCX). We also plan to participate in phase II of the CCX, which runs through 2010.

To ensure continued commercial success in the future, great emphasis will be placed on linking the themes of innovation, values and sustainability. Prior to major capital expenditure decisions, for example, we conduct systematic analyses of the effects that products and processes will have on the environment and health. In this connection, we evaluate the production process at the site and the product’s entire life cycle, from manufacture through to disposal. The same standards apply worldwide for this procedure.

Sustainable investment

Sustainability is an increasingly important criterion for investment decisions, and Bayer stock is represented in relevant indices. In 2005, for example, Bayer shares were again listed in the Dow Jones Sustainability World Index (DJSI World) and the European Dow Jones STOXX Sustainability Index (DJSI STOXX). Norwegian-based Storebrand Investments also once again included Bayer stock in the Storebrand Principal Funds in 2005 with the rating “Best in Class – Environmental and Social Performance”. In addition, our shares last year were again listed in the French ASPI Eurozone Index. British financial services provider FTSE included Bayer stock in its FTSE4Good series of indices, which contains the shares of companies that are particularly committed to environmental protection, human rights and social standards.

Value-added

The Group’s total operating performance increased by 18.2 percent in 2005, to €28.8 billion. Value-added rose by 18.9 percent to €9.6 billion, primarily due to the gratifying expansion of sales, which advanced by 17.6 percent year on year to €27.4 billion. Stockholders received €0.7 billion, employees €5.9 billion, governments €0.9 billion and lenders €0.9 billion. The remainder was retained by the company. Value-added indicates how the various stakeholders and Bayer itself participate in the company’s commercial success.


Bayer Annual Report 2005		Management Report 49


Value-Added

Source	2005		Change
€ million			%
Net sales		27,383		+ 17.6

Other income		1,390		+ 30.0

Total operating performance		28,773		+ 18.2

Cost of materials		9,726		+ 9.6

Depreciation		1,835		- 6.3

Other expenses		7,609		+ 39.9

Value-added		9,603		+ 18.9


Distribution	2005		Share
€ million			%
Stockholders		694		+ 7.2

Employees		5,912		+ 61.6

Governments		889		+ 9.3

Lenders		913		+ 9.5

Earnings retention		1,195		+ 12.4

Value-added		9,603		+ 100.0

Corporate Social Responsibility

In the context of its corporate social responsibility, the Bayer Group continued developing existing programs, established additional projects and took part in important initiatives. As an official sponsor of World Youth Day 2005 in Germany, the company supported this event in various ways. At the heart of these activities were three major assemblies at the BayArena soccer stadium in Leverkusen attended by tens of thousands of helpers and pilgrims.

Young people play a special role in all social initiatives sponsored by Bayer. In the second year of its partnership with the United Nations Environment Programme (UNEP), the company implemented and supported a dozen environmental projects for young people around the globe. With Bayer’s support, for example, UNEP was able to set up regional youth networks in Asia and organize the Tunza International Youth Conference, the second world youth environmental summit, from October 12 to 18, 2005, in Bangalore, India. This congress gave 150 youth representatives of national environmental organizations from 67 countries the opportunity not just to further improve their environmental knowledge and build networks, but also to formulate interests that young people around the world associate with the topic of environmental protection. These interests are communicated to the political decision-making bodies of UNEP.

The two partners are now also jointly and successfully implementing youth environmental projects originally established by Bayer. For example, students of various disciplines from nine countries in the Asia-Pacific region took part in the Eco-Minds sustainability forum in the Philippine capital of Manila in order to jointly develop practical solutions to environmental problems in that part of the world. As a guest of honor on the opening day of the event, Bayer Management Board member Dr. Udo Oels welcomed Philippine President Gloria Macapagal-Arroyo, as well as more than 200 representatives of industry, politics, academia and society. The visit by the Young Environmental Envoys to Leverkusen in the fall of 2005 rounded out the joint activities of Bayer and UNEP. At Bayer’s invitation, 50 particularly dedicated young people from 14 countries in Asia, eastern Europe, Latin America and – for the first time – Africa traveled to Germany for one week in order to learn first-hand about environmental protection.

One of the many initiatives established by Bayer to promote science literacy celebrated the 10th anniversary of its founding in 2005. Initially introduced in the United States, the Making Science Make Sense program has since been expanded to the United Kingdom, Ireland and Japan. As part of this program, more than 1,200 Bayer employees in the United States alone volunteer their time to visit elementary schools, where they make science more attractive to the children through exciting experiments designed to explain everyday things. At the beginning of 2006, Bayer received


50 Management Report		Bayer Annual Report 2005

the prestigious Ron Brown Award for Corporate Leadership – the only U.S. presidential award to honor companies for their activities in the social sector – for Making Science Make Sense. This was the first time the award had been given to a company with global headquarters outside the U.S. and also to a chemical company.

In the area of social and health advancement, Bayer has established several new projects aimed at meeting the basic needs of people in the newly industrializing countries in particular. Together with the Washington, D.C.-based National Geographic Society, the world’s largest charitable organization in the scientific field, Bayer has set up the Global Exploration Fund in order to promote innovative drinking water and freshwater research. This makes Bayer the first private-sector partner from outside the United States to enter a long-term collaboration with National Geographic.

In the fight against epidemic diseases, Bayer has formed a partnership with the U.S.-based non-profit organization Global Alliance for Tuberculosis Drug Development (TB Alliance). The goal of this partnership is to develop a tuberculosis application for the existing antibiotic moxifloxacin in order to shorten the duration of treating the disease, which currently lasts six months. Should studies prove successful, the new product will be provided to patients in developing countries at affordable prices.

Bayer quickly aided victims of the recent natural disasters through financial, medical and material donations. In addition, numerous Bayer employees participated with tremendous personal dedication in relief efforts mounted in the areas hit by flooding in the United States, as well as in those regions struck by earthquakes and in the Asian countries devastated by the tsunami in late 2004. The company made relief shipments worth €13 million to assist victims of the tsunami alone and has since supported various reconstruction projects in the region.

Risk Management

Risk management is an integral part of all decisions and business processes in the Bayer Group. The management structure, the planning system, and the detailed reporting and information systems, in particular, form the basis for the organizational integration of risk management into business processes.

As a global company, Bayer is exposed to a wide variety of risks in the course of its worldwide activities. Even before Germany’s “Law on Corporate Supervision and Transparency” came into force on May 1, 1998, Bayer AG operated an effective system for identifying, communicating and dealing with risks at an early stage. The principles behind that system are spelled out in the Risk Management Guidelines valid throughout the Bayer Group. The goal is to identify the potential risks associated with our activities as early as possible by recording them in a central database, evaluate them according to set criteria, assess the possible quantitative and qualitative consequences of their occurrence, and take suitable measures to mitigate them. The various processes and instruments used depending on the respective risk profile are constantly being improved, supplemented and optimized in line with statutory requirements.

Reporting plays a key role in monitoring the economic risks of our everyday business. It must ensure that the business performance of individual Group companies is described and explained according to uniform guidelines. In addition to the data on which external reports are based, internal reports are produced each month to ensure that the Group Management Board and the various


Bayer Annual Report 2005		Management Report 51

management levels are fully alerted to possible risks in a timely fashion. Group accounting and controlling functions support these activities and work to increase the responsiveness and efficiency of the reporting system. Our risk management system is supported by monitoring and control mechanisms based on established standard software. These mechanisms are the subject of continuous improvement and are adjusted to changes in circumstances.

The internal audit department examines at regular intervals the risk management system’s efficiency and functionality. Additionally, our external auditors regularly evaluate the system’s functionality and brief the Group Management Board and the Supervisory Board on the results of these evaluations. The Audit Committee of the Supervisory Board consults regularly on risk management.

To counter risks that could arise from the numerous tax, competition, patent, antitrust, capital market and environmental regulations and laws, we make our decisions and engineer our business processes on the basis of comprehensive legal advice provided both by our own experts and by acknowledged external specialists. We establish provisions in the balance sheet, and regularly evaluate the adequacy thereof, for legal risks relating to past events.

Overall business risk

The development of our business and the related fiscal objectives depends in part on the performance of the economy in those countries and regions which are relevant to our operations. The early identification of economic trends is a particularly important element in the management of our business. Continuous observation of the economic situation in the most important countries and regions is essential in this context. Our analyses of the global economy and forecasts of medium-term economic development are documented in detail on a quarterly basis and used to support operative business planning. For a summary forecast, see Future Perspectives – Economic Outlook on page 59.

Industry risk

The sales and earnings of the Bayer Group’s industrial businesses, and particularly the Materials and Systems reporting segments, are impacted by the business cycles of their customer industries. These include in particular the plastics processing, automotive supply, construction, electronics and electrical industries. In times of rapid economic growth in the respective downstream industries, chemical companies generally expand capacities in order to maximize revenues. In the past, capacity expansions in some areas have exceeded market growth, which has resulted in surplus capacities worldwide. During an extended phase of economic weakness, excess capacities can lead to a decline in prices. These factors can result in volatile margins and perhaps also operating losses for the Bayer Group.

In the agrochemicals business, Bayer Group sales are subject mainly to seasonal and weather-related effects as well as to fluctuations in selling prices for agricultural products. New agrochemical substances can increase competitive pressure and reduce sales of our products. In addition, the increasing importance of biotechnology in the crop science industry could lead to lower demand for some of our agrochemical products and, if there are other suppliers in the market, to declining sales.


52 Management Report		Bayer Annual Report 2005

In the agrochemical and pharmaceutical industries, patent-protected products compete only with alternative products or applications. Following the expiration of patent protection, a previously protected product is generally subjected to intensified competition due to the market entrance of generic suppliers. This can cause a loss of market share and declining sales for the Bayer Group.

Procurement market risk

As a manufacturing company active in numerous areas of the health care and chemicals industry, we procure significant quantities of aromatics (benzene, toluene), propylene, gas, coal and electrical energy for the manufacture of our products. In this context, we are subject to the risk that the raw materials and utilities we need may not be available, or that the quality or quantity may not satisfy our requirements. Moreover, market prices may fluctuate considerably depending on the supply of and demand for these raw materials.

The ongoing development of the procurement system into a flexible network structure allows Bayer to more easily identify risks on the procurement markets at an early stage, respond to changes and ensure a constant supply of raw materials. The holding company also ensures that Bayer can leverage its position as a single enterprise to achieve more favorable prices and supply terms for the Group as a whole.

Exchange and interest rate risks

We guard against exchange and interest rate risks by financing our business in local currencies or by hedging currency and interest positions using derivative financial instruments that serve no other purpose. Such instruments are employed according to the respective risk assessments and on the basis of detailed guidelines. See page 173 ff. for a detailed explanation of the use of derivative financial instruments.

Risk to pension obligations through capital market developments

Changes and developments on the stock, pension, real estate and other markets could lead to considerable changes in the value of plan assets. In addition, changes in earnings expectations would affect the cash value of our pension obligations. Furthermore, changes in expectations as regards our pension systems, for example with respect to wage and remuneration increases, the ratio of contributors to recipients, mortality, the development of health care costs and other factors, can lead to a significant increase or decrease in obligations for pensions or other post-employment benefits. This in turn would affect plan assets and could have a negative impact on pension costs, future contributions and stockholders’ equity. Please refer to note [28] to the financial statements (page 145 ff.) for more information on the funding of pensions and other post-employment benefits from pension systems.

We cannot rule out that charges or contributions that may become necessary in the future in connection with pensions and other post-employment benefits could have a significant negative effect on the Bayer Group’s liquidity and earnings performance.

Product and environmental risks

We address product and environmental risks by way of suitable quality assurance measures. These include certifying our operations to international standards, continuously upgrading our plants and processes, and developing new and improved products. Strict quality requirements are met by applying uniform standards throughout the world. We


Bayer Annual Report 2005		Management Report 53

place great importance on the safety of our products and their proper usage by customers. We are committed to the international Responsible Care initiative of the chemical industry and to our own safety and environmental management system, which we report on at regular intervals. Specially developed guidelines on product stewardship, occupational safety and environmental protection are designed to ensure that all of our employees act competently and responsibly.

To guard against possible liability risks and compensation claims, we have concluded insurance agreements to keep the potential consequences within reasonable limits or exclude them completely. The level of insurance coverage is continuously re-examined.

Legal risks

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, competition and antitrust law, patent disputes, tax assessments, and environmental matters. The outcome of any current or future proceedings cannot be predicted with certainty. It is therefore possible that legal or regulatory judgments could give rise to expenses that are not covered, or not fully covered, by insurers’ compensation payments and could significantly affect our revenues and earnings.

Legal proceedings currently considered to involve material risks are outlined below. The litigation referred to does not necessarily represent an exhaustive list.

Lipobay/Baycol: As of January 13, 2006, the number of Lipobay/Baycol cases pending against Bayer worldwide was approximately 6,000 (approximately 5,900 of them in the United States, including several class actions). As of January 13, 2006, Bayer had settled 3,082 Lipobay/Baycol cases worldwide without acknowledging any liability and resulting in settlement payments of approximately US$1,147 million. Bayer will continue to offer fair compensation to people who experienced serious side effects while taking Lipobay/Baycol on a voluntary basis and without concession of liability. In the United States five cases have been tried to date all of which were found in Bayer’s favor.

After more than four years of litigation we are currently aware of fewer than 50 pending cases in the United States that in our opinion hold a potential for settlement, although we cannot rule out the possibility that additional cases involving serious side effects from Lipobay/Baycol may come to our attention. In addition, there could be further settlements of cases outside of the United States.

In the fiscal years 2003 and 2004, Bayer recorded a total €347 million charge to the operating result beyond the insurance coverage. A further €43 million charge to the operating result was recorded in 2005, in respect of settlements already concluded or expected to be concluded and anticipated defense costs.

A group of stockholders has filed a class-action lawsuit claiming damages against Bayer AG and Bayer Corporation and two current or former managers. The suit alleges that Bayer violated U.S. securities laws by making misleading statements, prior to the withdrawal of Lipobay/Baycol from the market, about the product’s commercial prospects and, after its withdrawal, about the related potential financial liability. In September 2005 the court dismissed with prejudice the claims of non-U.S. purchasers of Bayer AG stock on non-U.S. exchanges. Bayer believes it has meritorious defenses and will defend itself vigorously.


54 Management Report		Bayer Annual Report 2005

PPA: Bayer is a defendant in numerous product liability lawsuits relating to phenylpropanolamine (PPA), which was previously contained in a cough/cold product of the company supplied in effervescent-tablet form. The first PPA lawsuits were filed after the U.S. Food and Drug Administration recommended in the fall of 2000 that manufacturers voluntarily cease marketing products containing this active ingredient. Plaintiffs are alleging injuries related to the claimed ingestion of PPA.

As of January 13, 2006, 286 lawsuits were pending in U.S. federal and state courts against Bayer, of which 136 name Bayer as the only manufacturing defendant. An additional 295 cases are on appeal in federal court after the plaintiffs’ claims had been dismissed for failure to comply with procedural requirements. No lawsuits have been filed outside the United States.

Three state cases have proceeded to trial. Two have resulted in defense verdicts for Bayer. In one case, the plaintiff was awarded damages of US$400,000. This case was settled in July 2005 while on appeal.

As of January 13, 2006, Bayer had settled 247 cases resulting in payments of approximately US$42 million, without acknowledging any liability. In the fiscal year 2005, Bayer recorded expenses in the amount of €62 million for settlements already concluded or expected to be concluded and expected defense costs.

Bayer will defend itself vigorously in all Lipobay/Baycol and PPA cases in which in our view no potential for settlement exists or where an appropriate settlement cannot be achieved. Due to the considerable uncertainty associated with these proceedings, it is currently not possible to further estimate potential liability.

Since the existing insurance coverage is exhausted (insurance coverage for PPA exists for up to 5 percent of future costs), it is possible – depending on the future progress of the litigation – that Bayer could face further payments that are not covered by the accounting measures already taken. We will regularly review the possibility of further accounting measures depending on the progress of the litigation.

Cipro^{^®}: 39 putative class action lawsuits, one individual lawsuit and one consumer protection group lawsuit (which has been dismissed) against Bayer involving the medication Cipro^{^®} have been filed since July 2000 in the United States. The plaintiffs are suing Bayer and other companies also named as defendants, alleging that a settlement to end patent litigation reached in 1997 between Bayer and Barr Laboratories, Inc. violated antitrust regulations. The plaintiffs claim the alleged violation prevented the marketing of generic ciprofloxacin as of 1997. In particular, they are seeking triple damages under U.S. law. After the settlement with Barr the patent was the subject of a successful re-examination by the U.S. Patent and Trademark Office and of successful defenses in U.S. Federal Courts. It has since expired.


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All the actions pending in federal court were consolidated in federal district court in New York in a multidistrict litigation (MDL) proceeding. On March 31, 2005, the court granted Bayer’s motion for summary judgment and dismissed all of plaintiffs’ claims in the MDL proceeding. The plaintiffs are appealing this decision. Further cases are pending before various state courts. Bayer believes that it has meritorious defenses and intends to defend these cases vigorously.

Rubber, polyester polyols, urethane:

Proceedings involving the former rubber-related lines of business

Investigations by the E.U. Commission and the U.S. and Canadian antitrust authorities for alleged anticompetitive conduct involving certain products in the rubber field are pending. In two cases Bayer AG has already reached agreements with the U.S. Department of Justice to pay fines, amounting to US$66 million for antitrust violations relating to rubber chemicals and US$4.7 million for those relating to acrylonitrile-butadiene rubber (NBR). In December 2005, the E.U. Commission imposed a fine of €58.9 million for antitrust violations in the area of rubber chemicals. Further investigations by the named authorities are ongoing.

Numerous civil claims for damages including class actions are pending in the United States and Canada against Bayer AG and certain of its subsidiaries as well as other companies. The lawsuits involve rubber chemicals, EPDM, NBR and polychloroprene rubber (CR). Bayer has reached agreements or agreements in principle to settle a number of these court actions. Some of these agreements or agreements in principle remain subject to court approval. These settlements do not resolve all of the pending civil litigation with respect to the aforementioned products, nor do they preclude the bringing of additional claims.

Proceedings involving polyester polyols, urethanes and urethane chemicals

Bayer Corporation has reached agreement with the U.S. Department of Justice to pay a fine of US$33 million for antitrust violations in the United States relating to adipic-based polyester polyols. A similar investigation is pending in Canada.

A number of civil claims for damages including class actions have been filed in the United States against Bayer involving allegations of unlawful collusion on prices for certain polyester polyols, urethanes and urethane chemicals product lines. Similar actions are pending in Canada with respect to polyester polyols.

Proceedings involving polyether polyols and other precursors for urethane end-use products

Bayer has been named as a defendant in multiple putative class action lawsuits involving allegations of price fixing of, inter alia, polyether polyols and certain other precursors for urethane end-use products. Bayer has reached an agreement in principle, subject to court approval, to settle all of the class action cases relating to claims from direct purchasers of polyether polyols, MDI or TDI (and related systems). The foregoing settlements do not resolve all of the pending civil litigation with respect to the aforementioned products, nor do they preclude the bringing of additional claims. Bayer was served with a subpoena from the U.S. Department of Justice seeking information relating to the manufacture and sale of these products.


56 Management Report		Bayer Annual Report 2005

Impact of antitrust proceedings on Bayer

In consideration of the portion allocated to LANXESS, expenses in the amount of €336 million were accrued in the course of 2005 which led to the establishment of a provision for the previously described civil proceedings in the amount of €285 million as of December 31, 2005. Bayer created a provision of €80 million as of December 31, 2005 in respect of the rubber-related E.U. proceedings noted above, although a reliable estimate cannot be made as to the actual amount of any expected additional fines.

These provisions taken may not be sufficient to cover the ultimate outcome of the above-described matters. The amount of provisions established in 2005 for civil proceedings was based on the expected payments under the settlement agreements described above. In the case of proposed settlements in civil matters which have been asserted as class actions, members of the putative classes have the right to “opt out” of the class, meaning that they elect not to participate in the settlement. Plaintiffs that opt out are not bound by the terms of the settlement and have the right to independently bring individual actions in their own names to recover damages they allegedly suffered. We cannot predict the size or impact of the opt-out groups on the settlement agreements.

Bayer will continue to pursue settlements that in its view are warranted. In cases where settlement is not achievable, Bayer will continue to defend itself vigorously.

The financial risk associated with the proceedings described above beyond the amounts already paid and the financial provisions already established is currently not quantifiable due to the considerable uncertainty associated with these proceedings. Consequently, no provisions other than those described above have been established. The Company expects that, in the course of the regulatory proceedings and civil damages suits, additional charges will become necessary.

Patent and contractual disputes:

Further risks arise from patent disputes in the United States. Bayer is alleged to have infringed third-party patents relating to the blood coagulation factor Kogenate^{^®}. In another dispute, Bayer has filed suit against several companies, alleging patent infringement in connection with moxifloxacin. These companies are defending the action, claiming, among other things, that the patents are invalid and not enforceable.

In August 2005, Abbott filed suit against, among others, Bayer for alleged patent infringement in connection with blood glucose monitors. The Japanese manufacturer of the product Ascensia^{^®} Contour^{^®} system is contractually obligated to indemnify Bayer against the potential liability.

Risks also exist in connection with court or out-of-court proceedings in which Bayer is alleged to have violated contractual or pre-contractual obligations. For example, Aventis Behring LLC alleges that Bayer violated contractual obligations relating to the supply of Helixate^{^®} and is seeking damages.

Limagrain Genetics Corporation has filed suit against Bayer – as legal successor to Rhône-Poulenc – for indemnity against liabilities to third parties arising from breach of contract.

Bayer and Lyondell Group have asserted claims against each other in a binding arbitration proceeding arising from a joint venture agreement in the manufacture of propylene oxide generally relating to differences in contractual interpretation.

Bayer believes it has meritorious defenses in these patent and contractual disputes and will defend itself vigorously.


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Product liability and other litigation:

Legal risks also arise from product liability lawsuits other than those concerning Lipobay/Baycol and PPA. Numerous actions are pending against Bayer seeking damages for plaintiffs resident outside of the United States who claim to have been become infected with HIV or HCV (hepatitis C virus) through blood plasma products. Further actions have been filed by U.S. residents who claim to have become infected with HCV. Bayer is also a defendant in cases in which plaintiffs are asserting claims alleging damage to health from the substance thimoseral, used especially in immunoglobulin therapies.

Bayer, together with other manufacturers, wholesalers and users is a defendant in the U.S. state of Alabama in cases seeking damages, including one nationwide putative class action, for personal injuries alleging health damages through exposure to diphenylmethane diisocyanate (MDI) used in coal mines.

Bayer, like a number of other pharmaceutical companies in the United States, has several lawsuits pending against it in which plaintiffs, including states, are seeking damages, punitive damages and/or disgorgement of profits, alleging manipulation in the reporting of wholesale prices and/or best prices.

A further risk may arise from asbestos litigation in the United States. In the majority of these cases, the plaintiffs allege that Bayer and co-defendants employed third parties on their sites in past decades without providing them with sufficient warnings or protection against the known dangers of asbestos. One Bayer affiliate in the United States is the legal successor to companies that sold asbestos products until 1976. Should liability be established, Union Carbide has to completely indemnify Bayer.

Bayer, among others, is named as a defendant in a putative nationwide class action pending in federal court in North Carolina in the United States which alleges violations of antitrust laws in the marketing of the pest control product Premise^{^®}.

Bayer believes it has meritorious defenses in these product liability and other proceedings and will defend itself vigorously.

Liability considerations following the LANXESS spin-off

The liability situation following the spin-off of the LANXESS subgroup 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 ceases to be liable for such obligations after a five-year period.

Under the Master Agreement, Bayer AG and LANXESS AG shall release the other party from those liabilities each has assumed as principal debtor according to the Spin-Off Agreement 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. The Master Agreement applies to all activities of Bayer and LANXESS units throughout the world, subject to certain conditions for the United States.


58 Management Report		Bayer Annual Report 2005

Subsequent events

With effect from January 1, 2006, the Pharmaceuticals, Biological Products reporting segment was renamed Pharmaceuticals. The activities of the Biological Products Division, which existed until December 31, 2005, are now part of the Pharmaceuticals Division.

On January 3, 2006, Bayer HealthCare announced its acquisition from GlaxoSmithKline of the European business for the blood pressure treatment telmisartan, which is marketed under the trade names Pritor^{^®} and PritorPlus^{^®}. The acquired business achieved sales of approximately €65 million in 2005. With this acquisition, we gained the right to market the drug in Italy, Spain, France, Greece, Portugal and additional European markets. It was agreed not to disclose the financial terms of the transaction.

In addition, Bayer HealthCare and Nuvelo Inc. announced on January 5, 2006 that they had entered into a collaboration agreement for the development and commercialization of alfimeprase, a novel blood clot dissolver which is currently in clinical phase III development. Because of the late-stage development status of alfimeprase, Nuvelo received a US$50 million up-front cash payment in January 2006. The company could additionally receive up to US$335 million in milestone payments. Bayer HealthCare will bear 40 percent, and Nuvelo 60 percent, of the global development costs. Nuvelo will conduct the clinical development program.

On January 9, 2006, Bayer Innovation GmbH acquired the biotech company Icon Genetics AG, headquartered in Munich, Germany. Icon Genetics discovers innovative methods for the development and use of engineered plants in the manufacture of therapeutically active substances.

Two studies published in the medical literature in January 2006 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. Relevant regulatory authorities are currently reviewing these reports. Based upon the results of these reviews, the authorities will determine what actions may be warranted. Bayer believes that Trasylol^{^®} is a safe and effective treatment when used in accordance with the product labeling.

Dr. Wolfgang Plischke was appointed to the Board of Management of Bayer AG with effect from March 1, 2006. Until that date he served as a member of the Bayer HealthCare Executive Committee and head of the Pharmaceuticals Division. Dr. Plischke will succeed Dr. Udo Oels, who ends his active duty following the Annual Stockholders’ Meeting on April 28, 2006.


Bayer Annual Report 2005		Management Report 59

Future Perspectives

Economic outlook

Despite the strong headwind resulting from ongoing high raw material and energy prices, we once again expect robust economic growth worldwide for 2006, albeit with declining momentum. Although the central banks will continue to slowly and gradually rein in their expansionary monetary policies, the global economy will most likely still benefit from low financing costs and relatively good corporate earnings performances. However, we are not underestimating the risks that the economy could face as a result of global trade imbalances, a stronger increase in raw material prices or a considerable slowdown in the real estate market. In the short-term, rising energy prices will most likely present the biggest risk to growth.

We continue to rate the perspectives for economic development in the United States as positive. Economic growth will most likely remain strong and support the global economy. However, a further tightening of monetary policy could gradually weaken the pace of economic growth. The Federal Reserve (FED) is expected to at first continue its policy of moderate interest rate hikes and thus further reduce the stimulating effect of monetary policy. Private consumption probably will not increase as strongly as in 2005 due to the expected cooling of the real estate market, but will most likely remain robust as employment rates continue to rise. We also expect that investment activity will be spurred in part by favorable corporate earnings performances and increasing capacity bottlenecks in various sectors.

The economic recovery that became apparent in Europe in the final months of 2005 will most likely strengthen in 2006. However, the growth rate will likely be weaker than in other regions. In the euro zone we anticipate that the pace of expansion will accelerate slightly, buoyed by growth in exports and improved corporate competitiveness. However, we do not yet see a turnaround toward sustained stronger growth. We expect that equipment investments will increase significantly over the course of the year due to continued low interest rates and positive earnings forecasts. On the other hand, the growth in private consumption will most likely be restrained, although somewhat stronger than in 2005. Despite the slightly more positive overall trends, rising energy prices and continuing weak consumer confidence could continue to dampen the economy.

We believe that the recovery of the Japanese economy will continue, driven by the favorable situation on the employment market and by robust corporate investment activity. Private consumption is expected to continue to expand moderately, although the increase in demand could slow down somewhat due to a restrictive financial policy coupled with high national debt. Exports will probably rise sharply in the short term, but the pace of growth could ease later on.

In the east Asian threshold countries, the pace of economic growth will weaken somewhat due to the slowdown in China. In our estimation, however, the outlook remains positive overall. Despite a reduction in the pace of growth, the Chinese economy is likely to continue to spur trade within the region. This will enable most countries to remain on a strong expansion course due to export growth and higher domestic demand.

In our opinion, the Latin American economy will most likely sustain robust growth in view of continued strong exports, persistently high raw material prices and the strengthening of domestic demand. Growth is expected to be slightly below that of the past two years overall, however.


60 Management Report		Bayer Annual Report 2005

Business strategy

The Bayer Group is focusing on the fast-growing, innovation-driven health care, nutrition and high-tech materials businesses in line with its mission statement: “Bayer: Science For A Better Life.” By strategically aligning ourselves to these attractive markets and concentrating on our core competencies, we aim to invest more intensively in growth areas and innovative technologies in order to achieve a leadership role or expand our already strong market positions. We will also press ahead with cost-containment and efficiency-improvement efforts in order to further increase the company’s value over the long term. For a detailed description of our financial strategy, please consult the Liquidity and Capital Resources section on page 29 ff.

Bayer HealthCare

Bayer HealthCare’s goal is to match or exceed market growth in all divisions.

Our biggest HealthCare division, Pharmaceuticals, comprises both Specialty Care and Primary Care activities. In addition to products emerging from our own research and development laboratories, our strategy for strengthening our portfolio also includes inlicensing and life cycle management. We also regularly examine options for expanding our business through collaborations or acquisitions.

Our primary goal in Specialty Care, which concentrates on the growth and development indications oncology and hematology/cardiology, is the global expansion of our business. In this field, which is characterized by a high demand for innovation, Bayer offers a number of successful products, such as Kogenate^{^®} and Trasylol^{^®}, and promising new brands and development projects, such as Nexavar^{^®} and the Factor Xa inhibitor BAY 59-7939. The introduction of Nexavar^{^®} in the United States at the end of 2005 for the treatment of renal cell carcinoma was an important step in strengthening our pharmaceutical specialties business.

Our Primary Care business offers products for general practitioners, such as our young Levitra^{^®} brand and more established brands like Adalat^{^®}, Avelox^{^®}, Cipro^{^®} and Glucobay^{^®}. While we have formed a marketing alliance with Schering-Plough in the United States, we handle business in the other regions ourselves. Here we aim to further strengthen our activities through targeted inlicensing.

The goal of our Consumer Care Division is to expand our leading position in the OTC market. Following the successful integration of Roche Consumer Health, we aim to fully exhaust the growth potential of our well-known brands such as Alka-Seltzer^{^®}, Aspirin^{^®}, Bepanthen^{^®}, One-A-Day^{^®} and Rennie^{^®} through intensive marketing and product management. We also plan to further expand our position through external growth.

Our Diagnostics Division is working toward taking a place among the world’s leading suppliers. Here we are focusing on the immunoassay, clinical chemistry and molecular testing market segments. Our strategy is focused on achieving growth by reaching new customer groups and offering cost-effective system solutions and services. We are also investing in the expansion of our position in growing markets such as Asia.

Our Diabetes Care Division aims to expand its competitive position in the area of blood glucose measurement. To this end, we are expanding our product range by developing new measurement systems and test strips to enable even more user-friendly blood sugar monitoring for diabetics. We intend to enhance our competitiveness through cost-containment measures and the more efficient use of our resources. Our strategy also includes increasing our expertise through strategic partnerships.


Bayer Annual Report 2005		Management Report 61

In the Animal Health Division we aim to become a preferred partner and solutions provider. Our strategy is directed primarily at strengthening the division through organic growth and the focus on attractive markets. In order to supplement our product range, Animal Health regularly evaluates options for acquisitions or strategic alliances.

Bayer CropScience

The Bayer CropScience subgroup, which is comprised of the Crop Protection and Environmental Science, BioScience segments, aims to strengthen its leading market position. Here we plan to further develop our existing portfolio in order to achieve sustained profitable growth. We will evaluate external growth options particularly in the Environmental Science, BioScience segment. Bayer CropScience intends to achieve its earnings targets primarily by introducing new products, keeping tight control on costs and consolidating its portfolio. We aim to further increase efficiency in all areas of Bayer CropScience through cost-containment and the improvement of internal business processes.

Our Crop Protection segment is committed to defending its leading market position. Here we are relying in particular on our strong global presence and on our innovative portfolio of high-performance insecticides, fungicides, herbicides and seed treatment products. We are also focusing on the continuous introduction of new products from our research and development pipeline and on consistent life cycle management.

Environmental Science is one of the world’s leading suppliers of non-agricultural pest control products. Our goal is to further expand this market position by developing and marketing high-quality products. We also aim to build strong partnerships with our customers and offer made-to-measure, customer-oriented innovations that generate strong brand loyalty.

BioScience is internationally active in seed research, development and marketing. The business unit offers solutions based on plant biotechnology and breeding, concentrating on canola, cotton, rice and vegetables. We also develop innovative, plant-based materials for applications in health care, biomaterials and nutrition.

Bayer MaterialScience

The Bayer MaterialScience subgroup aims to further expand its global market position. Here we are relying in particular on our technological know-how, new applications for our products and the targeted expansion of our presence in the growth markets of Asia.

Our portfolio is focused mainly on polycarbonates and polyurethanes. Here we concentrate on world-scale facilities featuring state-of-the-art technology, and pursue an organic growth strategy. In addition to our activities in the growth market of China, we constantly evaluate business options in other regions in order to expand our market coverage.

We rely on products and applications emerging from our R&D laboratories for the further development of our businesses. To access innovative markets, Bayer MaterialScience identifies new technology and market trends, evaluates them and transfers the most promising ideas to research and development projects. We also support our growth strategy by examining strategic partnerships and opportunities for forward integration.


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Objectives for 2006

Planning assumptions

We continue to predict a supportive business environment. Our planning for the next two years is based on the assumption that the world economy will grow at an annual rate of about 3 percent and that our most important customer industries and markets will develop favorably. We have budgeted for an exchange rate of US$1.30 to the euro.

Risks to this forecast stem mainly from the potentially adverse economic effects of trends in raw material and energy prices.

Group sales and earnings forecast

Fiscal 2005 was among the most successful years in Bayer’s history, with EBIT at a record high. Our underlying EBITDA margin of 18.6 percent already put us very close to our 2006 target a year ahead of schedule. We intend to build on this positive development.

In 2006 we aim to grow at least with the market in all areas and again improve our overall operating performance. We expect Group sales in 2006 to exceed €28 billion, which would mean an increase of about 5 percent on a currency- and portfolio-adjusted basis. The high earnings level of 2005 will be the yardstick for our performance in 2006. We plan to achieve a slight further improvement in EBIT before special items and in underlying EBITDA. Earnings growth is likely to come mainly from the HealthCare and CropScience subgroups, while profitability in MaterialScience could fall short of the excellent 2005 level.

In 2006 we are targeting an underlying EBITDA margin of approximately 19 percent, to continue the upward trend of recent years.

We are budgeting for special charges of less than €100 million. This amount does not include potential litigation-related expenses or charges for possible further restructuring in the CropScience subgroup.

To safeguard growth, we are planning capital expenditures of €1.7 billion, including €1.5 billion for property, plant and equipment. We anticipate that depreciation and amortization will total roughly €1.7 billion, with property, plant and equipment accounting for €1.1 billion of this amount. We plan to spend €1.9 billion on research and development.

In 2007 – based on currently available information and the aforementioned planning assumptions – we expect to record a positive business performance and a further increase in earning power.

Subgroups’ sales and earnings forecasts

Bayer HealthCare

We expect the market environment for our Healthcare activities to remain favorable. All divisions should be able to expand at least with the market, given the high growth potential of our portfolio and the new products it includes. We believe this subgroup can improve EBIT before special items by more than 10 percent. Crucial to this significant planned increase will be higher product sales combined with enhanced efficiencies in Consumer Care and Pharmaceuticals. Overall we aim to further improve on the current underlying EBITDA margin of 19 percent.


Bayer Annual Report 2005		Management Report 63

Bayer CropScience

Following the decline in the crop protection market in 2005, we predict a modest overall increase in 2006. Drawing on our portfolio of new active ingredients, we plan to grow above market and increase EBIT before special items. The underlying EBITDA margin should continue to improve.

Against a background of adverse market developments, particularly in Brazil, we will not yet meet our original target of a 25 percent EBITDA margin in 2006. Further restructuring will be carried out to enhance profitability.

Bayer MaterialScience

Following a very successful 2005, we believe the general market environment for the MaterialScience business will remain positive and that we can continue to grow in 2006. Our planning assumes an increase in global production capacities and higher energy costs, with raw material costs remaining steady at a high level. In view of these conditions, we again expect to post excellent EBIT before special items, though possibly below the 2005 level. In 2005 we already achieved the EBITDA margin of 18 percent targeted for 2006. This figure is now likely to decline slightly in 2006.


64 Bayer CropScience		Bayer Annual Report 2005


Bayer Annual Report 2005		Bayer: Science For A Better Life 65


66 Bayer CropScience		Bayer Annual Report 2005

Jerry Mimms is among the many cotton farmers in the United States who have come to rely on FiberMax^® seed, which has been very successful in the U.S. and several other countries. And with good reason: this seed yields top-quality fibers.

Each year roughly 23 million tons of cotton fiber – worth more than €20 billion – is produced globally. Yet only ten percent of this yield is of peak quality, with extremely fine, long and strong fibers. Before FiberMax^® came on the scene, cotton of this quality could be grown only in areas such as Egypt, California and Australia.

The development of high-quality seed such as FiberMax^® is at the focus of the company’s biotech research. Bayer CropScience hopes to offer cotton seed that yields not only longer fibers but also other useful properties such as fire retardancy, wrinkle-free characteristics and better dye fastness.

For Bayer, plant biotechnology is among the most important technologies of the twenty-first century. Apart from developing seed products, Bayer is also planning to manufacture products and active ingredients for the health care and nutrition fields, as well as for industrial applications that have a key role to play in the development of renewable resources.

Today, Bayer CropScience not only develops leading quality seed products, it is the world leader in crop protection and has innovative active ingredients under development that should ensure that the company maintains this position. Since 2000, a total of 16 new active ingredients have been introduced to the market, with ten more substances due to be added to the BCS portfolio by 2011.


Bayer Annual Report 2005		Bayer: Science For A Better Life 67


68 Investor Information		Bayer Annual Report 2005

Bayer stock posts record performance of 54 percent

Bayer ranked among the best equities in the DAX index in 2005, with a performance* of 54 percent on the year. The stock closed the year at €35.29, its highest year-end price since 2000. The dividend of €0.95 per share for 2005 to be proposed to the Annual Stockholders’ Meeting represents a 73 percent increase from the previous year.

A very good year on the stock market

2005 was a very good year for equity investors. On December 30, 2005, the German stock index DAX closed up 27.1 percent at 5,408 points. Until May, the DAX moved mainly sideways against a background of uncertainty caused by rising oil prices and other factors. The turning point came in May when the German government announced an early parliamentary election. In the weeks that followed, the DAX showed a marked upward trend, temporarily dampened by the terrorist attacks in London in July. On September 7 the DAX reached 5,000 points for the first time since May 2002. The EURO STOXX 50, which contains the 50 leading blue chips in the euro zone, including Bayer, ended the year up 24.3 percent.

Bayer stock clearly outperformed the DAX in 2005

Bayer stock significantly outperformed the DAX index in 2005, ending the year up 50.5 percent at €35.29, the highest year-end price since 2000. Including the 2004 dividend of €0.55 per share paid in 2005, our stock achieved a performance of 53.7 percent. Market capitalization (the number of shares multiplied by the year-end price) was €25.8 billion, €8.7 billion higher than the year before.

Having hit its low for the year in January (closing price on January 12, 2005: €22.11), the price of Bayer stock advanced more or less steadily throughout 2005. In the early part of the year the improvement was mainly driven by the spin-off of LANXESS. The first quarter’s results were very well received by the capital market, bolstering the upward trend, with further support coming from the release of positive data on the clinical trials for our cancer drug Nexavar^{^®}. The alliance with Johnson & Johnson for our Factor Xa inhibitor, along with very strong third-quarter figures, provided a further sharp boost to the share price toward the end of the year.

High demand for innovative hybrid bond

To finance its activities, Bayer issues bonds under rule 144a in the U.S. and under a European Medium Term Notes (EMTN) program. The larger bond issues of Bayer AG under the EMTN program are listed in major bond indices in light of their high issuance volume and liquidity.

Last year the Bayer Group once again offered bond investors attractive investment opportunities, including an innovative hybrid bond. This


*	growth in share price plus reinvested dividend


Bayer Annual Report 2005		Investor Information 69

subordinated bond has a 100-year term, and Bayer has a quarterly call option at par after ten years. In addition the bond contains certain coupon deferral mechanisms. In return, investors were offered a high nominal interest rate of 5 percent p.a. This hybrid bond is treated as debt for accounting purposes but is regarded mainly as equity by the rating agencies and thus improves the Group’s debt coverage ratios. Demand for the bond was so high that an issuance volume of €1.3 billion was placed at the lowest new issue spread achieved to date for any corporate hybrid bond.


Bayer Stock Data			2004			2005

Dividend		€		0.55			0.95

Earnings per share		€		0.94			2.19

Gross cash flow per share		€		3.95			4.76

Equity per share		€		14.98			15.28



Year-end price*		€		23.45	**		35.29

High for the year*		€		23.92	**		35.92

Low for the year*		€		18.33	**		22.11



Shares issued as of year end	million			730.34			730.34

Average daily share turnover on German stock exchanges	million			3.9			4.1

Market capitalization at year end	€ billion			17.1			25.8



Total dividend payment	€ million			402			694

Price/earnings ratio				24.9			16.1

Price/cash flow ratio				5.9			7.4

Dividend yield		%		2.3			2.7


*	XETRA closing prices; Source: Bloomberg

**	2004 prices adjusted for the spin-off of LANXESS


70 Investor Information		Bayer Annual Report 2005

For the successful structuring and placement of this hybrid bond, Bayer received awards for the best corporate bond issue of 2005 from both the International Financing Review (ifr) and the financial journal EuroWeek.

Bayer’s high credit standing maintained

Both Standard & Poor’s and Moody’s confirmed the company’s high creditworthiness on several occasions last year, upholding their previous ratings.

Long-term

Short-term

rating

Outlook

Since

Moody’s

P-2

stable

June 2003

S&P

A-1

stable

July 2004

Dividend raised to €0.95

The Board of Management and the Supervisory Board will propose to the Annual Stockholders’ Meeting that a dividend of €0.95 per share be paid for fiscal 2005 – up €0.40, or 73 percent, from the previous year. The dividend yield calculated on the year-end price of the stock is 2.7 percent.

This substantial increase in the dividend is intended to ensure that our stockholders benefit appropriately from our very pleasing results for 2005 and expresses our confidence in the future development of the enterprise.

Dialogue with the capital market stepped up further

In 2005 our investor relations activities continued to focus on providing timely and reliable information to financial analysts, institutional investors, rating agencies and private investors.

We addressed analysts and institutional investors and responded to their questions at more than 40 roadshows and investor conferences in the financial centers of Europe, North America and Asia. Principal topics included the status of the development candidates in our pharmaceutical pipeline, Bayer’s role in the bidding for the Boots OTC business, our assessment of the chemicals cycle and trends on the global agrochemicals market.


Bayer Annual Report 2005		Investor Information 71

We also organized two special conferences in 2005 to give analysts and investors even deeper insight into the Bayer Group’s business activities.

The first of these was held at the European headquarters of Bayer CropScience in Lyon, France, in September, and provided detailed information on all aspects of that subgroup’s business. Then in December, we invited investors to a research and development conference in London to explain the entire spectrum of research taking place in the Bayer Group. Both events were broadcast live on the Internet, and on-demand versions remain available on our website.

Moreover, we held a total of seven telephone conference calls, which were also streamed live over the Internet, to provide additional background to our quarterly results and key events at Bayer.

Buoyant demand for Bayer stock

Bayer shares are listed on all stock exchanges in Germany, on the New York Stock Exchange, and also in Spain, Japan, the U.K. and Switzerland. In the United States, Bayer stock is traded in the form of American Depositary Receipts (ADRs).

In early 2006 we delisted our stock in Italy, Luxembourg, the Netherlands, Belgium and France, largely because of low trading volumes in these markets.

The average daily trading volume in Bayer stock on the German stock exchanges was about 4.1 million shares (2004: 3.9 million). There were some 37.3 million ADRs outstanding at the end of December 2005, with each ADR representing one share.

WWW.INVESTOR.BAYER.COM


72 Corporate Governance*		Bayer Annual Report 2005

Bayer complies with the German Corporate Governance Code

Bayer has always placed great importance on responsible corporate governance and will continue to do so. Last year the company issued a declaration that it is in full compliance with the recommendations of the German Corporate Governance Code.

In 2005 the Board of Management and Supervisory Board again addressed the issue of code compliance, particularly in light of the new recommendations issued on June 2. The resulting Declaration of Conformity (see page 74) was published in December 2005 and posted on Bayer’s website along with previous declarations.

Compliance with the recommendations means, for example, that it will not be the rule for the former Chairman or other member of the Board of Management to become a member of the Supervisory Board (Article 5.4.4). Similarly, when elections to the Supervisory Board were held in April 2005, Bayer already complied with the recommendation that members be elected individually (Article 5.4.3.).

Supervisory Board: oversight and control functions

The role of the 20-member Supervisory Board is to oversee and advise the Board of Management. Under the German Codetermination Act, half the members of the Supervisory Board are elected by the stockholders, and half by the employees. The Supervisory Board is directly involved in decisions on matters of fundamental importance to the company and confers with the Board of Management on the company’s strategic alignment. It also holds regular discussions with the Board of Management on the company’s business strategy and status of its implementation.

The Chairman of the Supervisory Board coordinates its work and presides over the meetings. Through regular discussions with the Board of Management, the Supervisory Board is kept constantly informed of business policy, corporate planning and strategy. The annual budget and the consolidated financial statements of Bayer AG and the Bayer Group are submitted to the Supervisory Board to obtain its approval, which must also take the auditor’s report into account. Details are provided in the Report of the Supervisory Board on page 189 ff. of this Annual Report. The committees set up by the Supervisory Board operate in compliance with the German Stock Corporation Act, the German Corporate Governance Code, the U.S. Sarbanes-Oxley Act and the rules of the New York Stock Exchange. The committees of the Supervisory Board are as follows:

Presidial Committee: This comprises two stockholder representatives and two employee representatives. Its main task is to serve as the mediation committee pursuant to the German Codetermination Act. It submits proposals to the Supervisory Board on the appointment of members of the Board of Management if the necessary two-thirds majority is not achieved in the first vote at a plenary meeting.

Audit Committee: The Audit Committee, comprising three stockholder representatives and three employee representatives, meets four times a year. Its tasks include examining the company’s internal and external accounting and the quarterly and annual financial statements prepared by the Board of Management. On the basis of the auditor’s report on the annual financial statements, the Audit Committee submits proposals concerning their approval by the full Supervisory Board.

The Audit Committee also oversees the company’s internal control system along with the procedures used to identify, track and manage risks, and monitors compliance with laws and statutory regulations.

The company’s Corporate Auditing department reports regularly to the Audit Committee, which also is responsible for the company’s relationship with the external auditor. The Audit Committee prepares the awarding of the audit contract to the audit firm appointed by the Annual Stockholders’ Meeting, suggests areas of focus for the audit and determines the auditor’s remuneration. It also


*		report pursuant to Section 3.10 of the German Corporate Governance Code see note [29.1] to the financial statements on page 161 for information on Section 7.1.3 of the Code (stock option programs)

WWW.BAYER.COM > ABOUT BAYER > CORPORATE GOVERNANCE


Bayer Annual Report 2005		Corporate Governance 73

monitors the independence, qualifications, rotation and efficiency of the auditor.



	Basic		Variable
Remuneration of the Members of the Supervisory Board	Remuneration		Remuneration		Total
€
Dr. Paul Achleitner		70,041.67		21,012.50		91,054.17

Dr. Josef Ackermann		60,000.00		18,000.00		78,000.00

Andreas Becker		40,167.00		12,050.00		52,217.00

Karl-Josef Ellrich		75,000.00		22,500.00		97,500.00

Dr. Thomas Fischer		18,750.00		5,625.00		24,375.00

Erhard Gipperich		105,000.00		31,500.00		136,500.00

Thomas Hellmuth		60,000.00		18,000.00		78,000.00

Prof. Dr.-Ing. e. h. Hans-Olaf Henkel		75,000.00		22,500.00		97,500.00

Dr. rer. pol. Dipl.-Kfm. Klaus Kleinfeld		40,167.00		12,050.00		52,217.00

Dr. h. c. Martin Kohlhaussen		105,000.00		31,500.00		136,500.00

John Christian Kornblum		60,000.00		18,000.00		78,000.00

Petra Kronen		75,000.00		22,500.00		97,500.00

Dr. Heinrich von Pierer		24,791.33		7,437.50		32,228.83

Wolfgang Schenk		56,250.00		16,875.00		73,125.00

Hubertus Schmoldt		75,000.00		22,500.00		97,500.00

Dr. Manfred Schneider		180,000.00		54,000.00		234,000.00

Dieter Schulte		60,000.00		18,000.00		78,000.00

Dr.-Ing. Ekkehard D. Schulz		40,167.00		12,050.00		52,217.00

Dipl.-Ing. Dr. Ing. e. h. Jürgen Weber		60,000.00		18,000.00		78,000.00

Siegfried Wendlandt		75,000.00		22,500.00		97,500.00

Reinhard Wendt		19,833.00		5,950.00		25,783.00

Thomas de Win		75,000.00		22,500.00		97,500.00

Prof. Dr. Dr. h. c. Ernst-Ludwig Winnacker		60,000.00		18,000.00		78,000.00

Dr. Hermann Wunderlich		19,833.00		5,950.00		25,783.00

The Supervisory Board of Bayer AG has designated Dr. Manfred Schneider as an Audit Committee Financial Expert pursuant to the Sarbanes-Oxley Act.

Human Resources Committee: On this committee, too, there is parity of representation between stockholders and employees. It consists of the Chairman of the Supervisory Board, one other stockholder representative and two employee representatives. The Human Resources Committee prepares the personnel decisions to be made by the Supervisory Board. In particular, it concludes service contracts with the members of the Board of Management on behalf of the Supervisory Board. It also provides advice on long-term succession planning for the Board of Management.

Personal liability in place of a deductible

With regard to the recommendation in the German Corporate Governance Code that a deductible be agreed for any D&O (directors’ and officers’ liability) insurance, the company’s D&O insurance does not cover intentional breach of duty and thus there is no deductible.

Instead, personal declarations have been given by the members of the Board of Management and Supervisory Board that, should they cause damage to the company or third parties through gross negligence (by German standards) in the performance of their duties, they undertake to pay for such damage up to the equivalent of half their total annual compensation for the year in which such damage occurs. The members of the Supervisory Board undertake to pay for such damage, if caused by them, up to the equivalent of the variable portion of their respective annual compensation as Supervisory Board members for the relevant year.


74 Corporate Governance		Bayer Annual Report 2005

Disclosure of securities transactions by members of the Supervisory Board and Board of Management

To comply with Section 15 a of the German Securities Trading Act, members of the Board of Management and Supervisory Board and their close relatives are required to disclose all transactions involving the purchase or sale of Bayer stock where such transactions total €5,000 or more in a calendar year. Bayer publishes details of such transactions immediately on its website and also notifies the German Financial Supervisory Authority accordingly. No reportable securities transactions were made in fiscal 2005.

According to information filed with the company by members of the Board of Management and Supervisory Board, their total holdings of Bayer stock and related financial instruments amounted to less than 1 percent of the issued stock on the closing date for the financial statements.

Systematic monitoring of all business activities

Bayer has an internal control system in place to ensure early identification of any business or financial risks and enable it to manage such risks so as to minimize any impact on the achievement of its commercial objectives. The control system is designed to ensure timely and accurate accounting for all business processes and the constant availability of reliable data on the company’s financial position.

Where acquisitions are made during a fiscal year, we aim to bring the acquired units’ internal control systems into line with those of the Bayer Group as quickly as possible.

Declaration by the Board of Management and the Supervisory Board of Bayer AG

concerning the German Corporate Governance Code (June 2, 2005 version) pursuant to Article 161 of the German Stock Corporation Act*

Under article 161 of the German Stock Corporation Act, the Board of Management and the Supervisory Board of Bayer AG are required to issue an annual declaration that the company has been, and is, in compliance with the recommendations of the “Government Commission on the German Corporate Governance Code” as published by the Federal Ministry of Justice in the official section of the electronic Federal Gazette (Bundesanzeiger), or to advise of any recommendations that have not been, or are not being, applied. The declaration pursuant to article 161 of the Stock Corporation Act shall be available to shareholders at all times.

With respect to the past, the following declaration refers to the May 21, 2003 version of the Code. With respect to present and future corporate governance practices at Bayer AG, the following declaration refers to the recommendations in the June 2, 2005 version of the Code.

The Board of Management and the Supervisory Board of Bayer AG hereby declare that the company is in compliance with the recommendations of the “Government Commission on the German Corporate Governance Code” as published by the Federal Ministry of Justice in the official section of the electronic Federal Gazette and has been in compliance since issuance of the last declaration of conformity in December 2004.

Leverkusen, December 2005


For the Board of Management:		For the Supervisory Board:


Wenning	Kühn	Dr. Schneider


*		This is an English translation of a German document. The German document is the official and controlling version, and this English translation in no event modifies, interprets or limits the official German version.


Bayer Annual Report 2005		Corporate Governance 75

However, the control and risk management system cannot protect the company from all business risks. In particular, it cannot provide absolute protection against losses or fraudulent actions.

Corporate Compliance Program

Our corporate activity is governed by national and local laws and statutes that place a range of obligations on the Bayer Group and its employees throughout the world. Bayer manages it business responsibly in compliance with the statutory and regulatory requirements of the countries in which it operates.

The Board of Management has also issued guidelines to support legal compliance. These are summarized in the “Program for Legal Compliance and Corporate Responsibility at Bayer” (Corporate Compliance Program), which contains binding rules on complying with international trade law, adhering to the principle of fair competition and concluding contracts with business partners on fair terms.

To avoid conflicts of interest, every employee is required to separate corporate and private interests. The program also lays down clear rules for employee integrity toward the company and the responsible handling of insider information.

Compliance Committees have been established at Bayer AG and each of its subgroups and service companies: Bayer HealthCare, Bayer CropScience, Bayer MaterialScience, Bayer Business Services, Bayer Technology Services and Bayer Industry Services. Each Compliance Committee includes at least one legal counsel.

The role of these committees is to initiate and monitor systematic, business-specific training and other measures necessary to ensure implementation of the Corporate Compliance Program. They are also responsible for investigating any suspected violations of the Corporate Compliance Program and, if necessary, taking steps to rectify them. All Compliance Committees report at least once a year to a coordination committee chaired by the Chief Financial Officer on any violations notified to them, the investigations carried out and their outcomes, and any corrective or disciplinary action taken. They also report on the systematic training and implementation measures they have initiated to foster compliance.

All Bayer employees are required to immediately report any violations of the Compliance Program. In Germany, a telephone hotline to a law firm has been set up to allow this to be done anonymously.

Common values and leadership principles

The mission statement published in 2004 supplements the Corporate Compliance Program and sets out the principles underlying Bayer’s corporate strategy. It outlines the foundation of our corporate philosophy and activity to stockholders, customers, employees and the general public. Common values and leadership principles are considered essential for every employee’s daily work. The values include a will to succeed; a passion for our stakeholders; integrity, openness and honesty; respect for people and nature; and the sustainability of our actions. The assessment of managers’ performance on the basis of defined leadership principles (see graphic) helps to ensure adherence to these values throughout the enterprise.

Detailed reporting

To maximize transparency, we provide regular and timely information on the company’s position and significant changes in business activities for stockholders, financial analysts, stockholders’ associations, the media and the general public. Bayer complies with the recommendations of the Corporate Governance Code by publishing reports on business trends, earnings and the Group’s


76 Corporate Governance		Bayer Annual Report 2005

financial position four times a year. The annual consolidated financial statements of the Bayer Group are published within 90 days following the end of the fiscal year. In addition to the annual report, quarterly reports, news conferences and analysts’ meetings, Bayer publishes the reports on Form 20-F (annual report) and Form 6-K (e. g. quarterly report) as required by the U.S. Securities and Exchange Commission (SEC). Bayer also uses the Internet as a platform for timely disclosure of information, including details of the dates of major publications and events such as the annual and quarterly reports and the Annual Stockholders’ Meeting.

In line with the principle of fair disclosure, we provide the same information to all stockholders and all main target groups. All significant new facts are disclosed immediately. Stockholders also have timely access to the information that Bayer publishes in foreign countries in compliance with local stock market regulations.

In addition to our regular reporting, we issue ad-hoc statements on developments that might not otherwise become publicly known but have the potential to materially affect the price of Bayer stock.

Investor protection in compliance with the Sarbanes-Oxley Act

As an international company with subsidiaries in many countries, Bayer AG is listed on a number of stock exchanges around the world, including the New York Stock Exchange (NYSE). It therefore has to comply not only with the rules of the U.S. stock exchange regulator, the Securities and Exchange Commission (SEC), but also with U.S. laws such as the Sarbanes-Oxley Act adopted by the U.S. Congress in July 2002. This law is designed to provide greater protection for investors and has resulted in a variety of new corporate governance requirements in addition to the SEC rules.

The Bayer Group has brought its corporate governance into line with U.S. regulations in many respects, but further steps are necessary in some cases. For example, the Bayer Group is currently extending its system of internal controls over financial reporting to meet SEC demands, with the aim of ensuring compliance with Section 404 of the Sarbanes-Oxley Act as of fiscal 2006. This is taking place on the basis of the COSO model (Committee of Sponsoring Organizations of the Treadway Commission), which provides an internationally accepted standard for internal control systems.


Bayer Annual Report 2005		Consolidated Financial Statements of the Bayer Group 77

Table of Contents



	Consolidated Financial Statements of the Bayer Group

	Management’s Statement of Responsibility for Financial Reporting	78

	Independent Auditor’s Report	79

	Consolidated Statements of Income	80

	Consolidated Balance Sheets	81

	Consolidated Statements of Cash Flows	82

	Consolidated Statements of Recognized Income and Expense	83


	Notes to the Consolidated Financial Statements of the Bayer Group

1.	Key Data by Segment and Region	84

2.	General information	86

3.	Effects of new accounting pronouncements	87

4.	Basic principles of the consolidated financial statements	92

4.1	Consolidation methods	92

4.2	Foreign currency translation	93

4.3	Basic recognition and valuation principles	94

4.4	Cash flow statement	101

4.5	Procedure used in global impairment testing and its impact	102

5.	Critical accounting policies	103

6.	Segment reporting	110

7.	Changes in the Bayer Group	112

7.1	Scope of consolidation	112

7.2	Business combinations and other acquisitions; divestments; discontinued operations	115

	Notes to the Statements of Income

8.	Net sales	121

9.	Selling expenses	121

10.	Research and development expenses	121

11.	Other operating income	122

12.	Other operating expenses	122

13.	Costs by type	122

13.1	Costs of materials	122

13.2	Personnel expenses/employees	123

13.3	Other taxes	123

14.	Operating result (EBIT)	124

15.	Non-operating result	124

15.1	Loss from investments in affiliated companies – net	124

15.2	Interest expense – net	125

15.3	Other non-operating expense – net	125

16.	Income taxes	126

17.	Minority stockholders’ interest in income/losses	129

18.	Earnings per share (€) from continuing and discontinued operations	129

	Notes to the Balance Sheets

19.	Goodwill and other intangible assets	131

20.	Property, plant and equipment	134

21.	Investments in associates	136

22.	Other financial assets	137

23.	Other receivables	139

24.	Inventories	140

25.	Trade accounts receivable	140

26.	Liquid assets	141

27.	Changes in stockholders’ equity	141

28.	Provisions for pensions and other post-employment benefits	145

29.	Other provisions	160

29.1	Stock-based compensation	161

29.2	Environmental protection	165

29.3	Restructuring charges	166

30.	Financial liabilities	168

31.	Trade accounts payable	171

32.	Miscellaneous liabilities	172

33.	Financial instruments	173

33.1	Management of financial and commodity price risks	173

33.2	Primary financial instruments	174

33.3	Economic hedges and hedge accounting with derivative financial instruments	175

34.	Commitments and contingencies	177

35.	Legal risks	179

	Notes to the Statements of Cash Flows

36.	Net cash provided by operating activities	184

37.	Net cash used in investing activities	184

38.	Net cash used in financial activities	185

39.	Cash and cash equivalents at end of year	185

	Other information

40.	Audit fees	185

41.	Related parties	186

42.	Total remuneration of the Board of Management and the Supervisory Board, advances and loans	186


78 Consolidated Financial Statements of the Bayer Group		Bayer Annual Report 2005

Management’s Statement of Responsibility for Financial Reporting

The consolidated financial statements of the Bayer Group have been prepared by the management, which is responsible for the substance and objectivity of the information contained therein. The same applies to the management report, which is consistent with the financial statements.

Our financial reporting takes place according to the rules issued by the International Accounting Standards Board, London.

Effective internal monitoring procedures instituted by Group management at the consolidated companies along with appropriate staff training ensure the propriety of our reporting and its compliance with legal provisions. Integrity and social responsibility form the basis of our corporate principles and of their application in areas such as environmental protection, quality, product safety, plant safety and adherence to local laws and regulations. The worldwide implementation of these principles and the reliability and effectiveness of the monitoring procedures are continuously verified by our Corporate Auditing Department.

These measures in conjunction with a uniform reporting system throughout the Group ensure that Group companies present the management with an accurate view of their business operations, enabling us to discern risks to our assets or fluctuations in the economic performances of Group companies at an early stage and at the same time providing a reliable basis for the consolidated financial statements and management report.

The Board of Management conducts the business of the Group in the interests of the stockholders and in awareness of its responsibilities toward employees, communities and the environment in all the countries in which we operate. Our declared aim is to deploy the resources entrusted to us in order to increase the value of the Bayer Group as a whole.

In accordance with the resolution of the Annual Stockholders’ Meeting, the Supervisory Board appointed PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft as the independent auditor of the consolidated financial statements and of the statements’ compliance with the International Financial Reporting Standards. The scope of the auditor’s report, which appears on the following page, also includes Bayer’s risk management system, audited in light of the German Law on Corporate Supervision and Transparency. The consolidated financial statements, the management report and the auditor’s report were discussed in detail, in the presence of the auditor, by the Audit Committee of the Supervisory Board and at a plenary meeting of the Supervisory Board. The Report of the Supervisory Board appears on page 189 ff of this Annual Report.

The Board of Management


Bayer Annual Report 2005		Consolidated Financial Statements of the Bayer Group 79

Independent Auditor’s Report

We have audited the consolidated financial statements prepared by Bayer Aktiengesellschaft, Leverkusen, comprising the income statement, balance sheet, cash flow statement, statement of recognized income and expense and the notes to the consolidated financial statements, together with the group management report, for the business year from January 1, 2005 to December 31, 2005. The preparation of the consolidated financial statements and the group management report in accordance with the IFRS, as adopted by the E.U., and the additional requirements of German commercial law pursuant to § (Article) 315a Abs. (paragraph) 1 HGB (,,Handelsgesetzbuch”: German Commercial Code) are the responsibility of the parent Company’s Board of Management. Our responsibility is to express an opinion on the consolidated financial statements and on the group management report based on our audit.

We conducted our audit of the consolidated financial statements in accordance with § 317 HGB and German generally accepted standards for the audit of financial statements promulgated by the Institut der Wirtschaftsprüfer (Institute of Public Auditors in Germany) (IDW) and additionally observed the International Standards on Auditing (ISA). Those standards require that we plan and perform the audit such that misstatements materially affecting the presentation of the net assets, financial position and results of operations in the consolidated financial statements in accordance with the applicable financial reporting framework and in the group management report are detected with reasonable assurance. Knowledge of the business activities and the economic and legal environment of the Group and expectations as to possible misstatements are taken into account in the determination of audit procedures. The effectiveness of the accounting-related internal control system and the evidence supporting the disclosures in the consolidated financial statements and the group management report are examined primarily on a test basis within the framework of the audit. The audit includes assessing the annual financial statements of those entities included in consolidation, the determination of the entities to be included in consolidation, the accounting and consolidation principles used and significant estimates made by the Company’s Board of Management, as well as evaluating the overall presentation of the consolidated financial statements and the group management report. We believe that our audit provides a reasonable basis for our opinion.

Our audit has not led to any reservations.

In our opinion based on the findings of our audit the consolidated financial statements comply with the IFRS as adopted by the E.U., the additional requirements of German commercial law pursuant to § 315a Abs. 1 HGB and give a true and fair view of the net assets, financial position and results of operations of the Group in accordance with these requirements. The group management report is consistent with the consolidated financial statements and as a whole provides a suitable view of the Group’s position and suitably presents the opportunities and risks of future development.

Essen, March 1, 2006

PricewaterhouseCoopers
Aktiengesellschaft
Wirtschaftsprüfungsgesellschaft


P. Albrecht		V. Linke
Wirtschaftsprüfer		Wirtschaftsprüfer


80 Consolidated Financial Statements of the Bayer Group		Bayer Annual Report 2005

Bayer Group Consolidated Statements of Income


	Note			2004¹			2005
€ million
Net sales		[8	]		23,278			27,383

Cost of goods sold					(12,421	)		(15,027	)

Gross profit					10,857			12,356



Selling expenses		[9	]		(5,240	)		(5,713	)

Research and development expenses		[10	]		(1,927	)		(1,886	)

General administration expenses					(1,421	)		(1,444	)

Other operating income		[11	]		740			794

Other operating expenses		[12	]		(1,134	)		(1,295	)

Operating result [EBIT]		[14	]		1,875			2,812



Equity-method loss		[15.1	]		(139	)		(10	)

Non-operating income					483			634

Non-operating expenses					(997	)		(1,237	)



Non-operating result		[15	]		(653	)		(613	)



Income before income taxes					1,222			2,199



Income taxes		[16	]		(473	)		(641	)



Income from continuing operations after taxes					749			1,558



Income (loss) from discontinued operations after taxes		[7.2	]		(67	)		37



Income after taxes					682			1,595

of which attributable to minority interest		[17	]		(3	)		(2	)

of which attributable to Bayer AG stockholders (net income)					685			1,597



Earnings per share (€)					0.94			2.19

From continuing operations		[18	]		1.03			2.14

Basic					1.03			2.14

Diluted					1.03			2.14

From continuing and discontinued operations		[18	]		0.94			2.19

Basic					0.94			2.19

Diluted					0.94			2.19


1		2004 figures restated


Bayer Annual Report 2005		Consolidated Financial Statements of the Bayer Group 81

Bayer Group Consolidated Balance Sheets

Note

Dec. 31, 2004¹

Dec. 31, 2005

€ million

Noncurrent assets

Goodwill and other intangible assets

[19

]

5,952

7,688

Property, plant and equipment

[20

]

7,662

8,321

Investments in associates

[21

]

744

795

Other financial assets

[22

]

1,169

1,429

Other receivables

[23

]

113

199

Deferred taxes

[16

]

1,219

1,698

16,859

20,130

Current assets

Inventories

[24

]

4,738

5,504

Trade accounts receivable

[25

]

4,475

5,204

Other financial assets

[22

]

794

214

Other receivables

[23

]

1,543

1,421

Claims for tax refunds

[16

]

823

726

Liquid assets

[26

]

Marketable securities and other instruments

233

Cash and cash equivalents

3,570

3,290

15,972

16,592

Assets held for sale and discontinued operations

[7.2

]

4,757

—

Total current assets

20,729

16,592

Assets

37,588

36,722

Equity attributable to Bayer AG stockholders

Capital stock of Bayer AG

1,870

Capital reserves of Bayer AG

2,942

Other reserves

6,399

6,265

Accumulated other comprehensive income (loss) from discontinued operations

(379

)

—

10,832

11,077

Equity attributable to minority interest

111

Stockholders’ equity

[27

]

10,943

11,157

Noncurrent liabilities

Provisions for pensions and other post-employment benefits

[28

]

6,219

7,174

Other provisions

[29

]

1,204

1,340

Financial liabilities

[30

]

7,025

7,185

Miscellaneous liabilities

[32

]

203

516

Deferred taxes

[16

]

644

280

15,295

16,495

Current liabilities

Other provisions

[29

]

2,707

3,009

Financial liabilities

[30

]

2,166

1,767

Trade accounts payable

[31

]

1,759

1,974

Tax liabilities

[16

]

413

304

Miscellaneous liabilities

[32

]

1,918

2,016

8,963

9,070

Liabilities directly related to assets held for sale and discontinued operations

[7.2

]

2,387

—

Total current liabilities

11,350

9,070

Liabilities

26,645

25,565

Stockholders’ equity and liabilities

37,588

36,722


1		2004 figures restated


82 Consolidated Financial Statements of the Bayer Group		Bayer Annual Report 2005

Bayer Group Consolidated Statements of Cash Flows


	Note			2004¹			2005
€ million
Operating result [EBIT]					1,875			2,812

Income taxes					(490	)		(541	)

Depreciation and amortization					1,959			1,835

Change in pension provisions					(424	)		(586	)

(Gains) losses on retirements of noncurrent assets					(35	)		(43	)

Gross cash flow²					2,885			3,477



Decrease (increase) in inventories					(425	)		(181	)

Decrease (increase) in trade accounts receivable					(404	)		156

Decrease (increase) in trade accounts payable					(5	)		(115	)

Changes in other working capital, other non-cash items					211			205

Net cash provided by (used in) operating activities (net cash flow, continuing operations)		[36	]		2,262			3,542

Net cash provided by (used in) operating activities (net cash flow, discontinued operations)		[7.2	]		188			(40	)

Net cash provided by (used in) operating activities (net cash flow, total)					2,450			3,502



Cash outflows for additions to property, plant, equipment and intangible assets					(1,251	)		(1,389	)

Cash inflows from sales of property, plant, equipment and other assets					200			398

Cash inflows from sales of investments					90			1,189

Cash outflows for acquisitions less acquired cash					(358	)		(2,188	)

Interest and dividends received					400			451

Cash inflows from (outflows for) marketable securities					105			(202	)

Net cash provided by (used in) investing activities (total)		[37	]		(814	)		(1,741	)



Capital contributions					10			0

Bayer AG dividend and dividend payments to minority stockholders					(559	)		(440	)

Issuances of debt					1,393			2,005

Retirements of debt					(881	)		(2,659	)

Interest paid					(724	)		(787	)

Net cash provided by (used in) financing activities (total)		[38	]		(761	)		(1,881	)



Change in cash and cash equivalents due to business activities (total)					875			(120	)



Cash and cash equivalents at beginning of year					2,734			3,570



Change in cash and cash equivalents due to changes in scope of consolidation					6			(196	)

Change in cash and cash equivalents due to exchange rate movements					(45	)		36



Cash and cash equivalents at end of year		[39	]		3,570			3,290



Marketable securities and other instruments					29			233



Liquid assets as per balance sheets					3,599			3,523


1		2004 figures restated

2		For definition see Bayer Group Key Data on front flap


Bayer Annual Report 2005		Consolidated Financial Statements of the Bayer Group 83

Bayer Group Consolidated Statements of Recognized Income and Expense


	2004			2005
€ million
Changes in fair values of hedging instruments, recognized in stockholders’ equity		64			(15	)

Gains (losses) on hedging instruments, recognized in the income statement		4			3

Changes in fair values of available-for-sale securities, recognized in stockholders’ equity		12			9

Gains (losses) on available-for-sale securities, recognized in the income statement		(6	)		—

Revaluation surplus (IFRS 3)		66			—

Actuarial gains (losses) on defined benefit obligations for pensions and other post-employment benefits		(740	)		(1,207	)

Exchange differences on translation of operations outside the euro zone		(304	)		857

Deferred taxes on valuation adjustments, recognized directly in stockholders’ equity		251			470

Deferred taxes on valuation adjustments, removed from stockholders’ equity and recognized in the income statement		(2	)		—

Valuation adjustments recognized directly in stockholders’ equity		(655	)		117

Income after taxes		682			1,595

Total income and expense recognized in the financial statements		27			1,712

of which attributable to minority interest		(3	)		6

of which attributable to Bayer AG stockholders		30			1,706


84 Notes to the Consolidated Financial Statements of the Bayer Group		Bayer Annual Report 2005

Notes to the Consolidated Financial Statements of the Bayer Group

1. Key Data by Segment and Region

Segments


€ million	Health Care
	Pharmaceuticals,												Diabetes Care,
	Biological Products						Consumer Care						Diagnostics						Animal Health
	2004			2005			2004			2005			2004			2005			2004			2005

Net sales (external)		3,961			4,067			1,336			2,355			1,975			2,151			786			856

— Change in €		-9.4	%		2.7	%		-4.8	%		76.3	%		2.2	%		8.9	%		-0.5	%		8.9	%

— Change in local currencies		-5.9	%		1.7	%		1.4	%		75.2	%		6.9	%		8.1	%		4.5	%		7.1	%

Intersegment sales		38			58			16			14			1			1			4			8

Other operating income		128			49			20			38			6			67			12			5

Operating result [EBIT]		399			475			183			174			217			274			157			179

Return on sales		10.1	%		11.7	%		13.7	%		7.4	%		11.0	%		12.7	%		20.0	%		20.9	%

Gross cash flow*		386			449			161			223			287			320			109			146

Capital invested		2,305			2,501			792			2,860			1,817			1,978			392			408

CFROl*		16.8	%		18.7	%		20.1	%		7.6	%		14.7	%		16.9	%		27.2	%		36.5	%

Net cash flow*		261			481			279			323			388			373			125			174

Equity-method income (loss)		0			0			0			0			0			0			0			0

Equity-method investments		4			4			0			0			0			0			0			0

Total assets		4,052			3,489			1,287			3,621			1,809			1,955			554			642

Capital expenditures		115			142			40			59			121			108			25			21

Amortization and depreciation		174			188			69			120			170			178			23			24

Liabilities		2,138			2,086			505			816			687			748			202			341

Research and development expenses		740			680			45			57			144			148			67			69

Number of employees (as of Dec. 31)		18,400			16,900			3,800			6,800			7,000			7,100			2,900			3,000

Regions


€ million	Europe						North America
	2004			2005			2004			2005

Net sales (external) — by market		9,775			11,930			6,512			7,340

— Change in €		7.3	%		22.0	%		-6.7	%		12.7	%

— Change in local currencies		7.4	%		21.9	%		1.6	%		11.9	%

Net sales (external) — by point of origin		10,646			12,912			6,570			7,386

— Change in €		7.8	%		21.3	%		-6.5	%		12.4	%

— Change in local currencies		7.8	%		21.1	%		1.9	%		11.6	%

Interregional sales		3,512			3,933			1,690			1,913

Other operating income		492			348			130			295

Operating result [EBIT]		953			1,285			396			924

Return on sales		9.0	%		10.0	%		6.0	%		12.5	%

Gross cash flow*		1,503			1,733			770			1,126

Equity-method income (loss)		(39	)		6