Performance Report

Economics

Through our alignment to our Mission Statement “Bayer: Science For A Better Life” and ongoing optimization of our portfolio we are concentrating our activities on the high-growth, innovation-driven areas of health care, nutrition and high-tech materials. Our strategic alignment to attractive markets and our concentration on our core competencies are confirmed by our financial performance: 2007 was Bayer’s most successful year yet

Dynamic sales and earnings performance

In 2007 we lifted sales 11.8 percent to €32.4 billion. After adjustment for currency and portfolio effects, the Bayer Group grew sales by 6.1 percent. Sales advanced 7.3 percent at Bayer HealthCare, 5.6 percent at Bayer CropScience and 6.2 percent at Bayer MaterialScience.

This dynamic performance is also reflected in Group earnings: Income before income taxes increased from €2.0 billion in 2006 to €2.2 billion in 2007 while income after taxes climbed from €1.7 billion to €4.7 billion. These figures include the proceeds from the divestment of the Diagnostics division, H.C. Starck and Wolff Walsrode, which had an impact in the first half of 2007. Income from the continuing operations after taxes increased from €1.5 billion to €2.3 billion. Further key figures can be found inside the front cover and in the Annual Report 2007.

Core earnings per share from continuing operations therefore improved from €2.99 to €3.80. To allow stockholders to benefit appropriately from the company’s success in 2007, the dividend was raised from €1.00 to €1.35.

Key financial data for the Bayer Group* (in € million)

	2003	2004	2005	2006	2007
Net sales	28.567	23.278	24.701	28.956	32.385
Sales outside Germany	85,8%	86,9%	84,4%	84,4%	85,1%
Income (loss) before income taxes	-1.994	1.222	1.912	1.980	2.234
Income (loss) from continuing operations after taxes	-131	749	1.374	1.526	2.306
Income (loss) from discontinued operations after taxes	-1.218	-67	221	169	2.410
Income (loss) after taxes	-1.349	682	1.595	1.695	4.716
Return on stockholders’ equity	-9,7%	6,1%	14,4%	14,1%	31,8%
Net debt (total)	5.952	5.422	5.494	17.539	12.184
Income taxes			-538	-454	72

See also key data for the Bayer Group inside the front cover.
* figures for 2006 restated, figures for 2003 to 2005 as reported

Innovative research and development

As an inventor company, we aim to set trends in research-intensive areas. We invest in research and development (R&D) to generate opportunities for our business and safeguard the success of the company. Our R&D is closely aligned to the needs of our markets and embedded in an excellent international network of leading universities, public research institutions and partners in the corporate sector. We have an especial focus on developing new products to strengthen our core businesses. This is accompanied by steady endeavors to optimize our product portfolio and production processes.

We increased our R&D spending by around 12 percent to €2.6 billion in 2007. Around 66 percent of this was allocated to Bayer HealthCare to pave the way for further innovative health care products. Bayer CropScience invested €637 million in innovations in the Crop Protection and BioScience areas. That corresponded to around 25 percent of Bayer’s total R&D expenses. The Bayer MaterialScience subgroup spent €209 million on R&D into high-performance, custom-tailored materials and systems solutions in 2007 (excluding development projects undertaken with its customers).

Research and development expenses (in € million)

	2003	2004	2005	2006	2007
Total	2.404	1.927	1.729	2.297	2.578
of which Bayer HealthCare	1.245	996	834	1.426	1.700
of which Bayer CropScience	725	679	664	614	637
of which Bayer MaterialScience*	249	236	214	227	209
of which LANXESS (discontinued operations)	168
of which reconciliation**	17	16	17	30	32

* excluding R&D undertaken jointly with customers
** not directly allocable to the subgroups, e.g. expenditures of the service companies

We need to protect our intellectual property in order to maintain our intensive research in the long term. We are convinced that effective patent protection and compliance with the provisions of the World Trade Organization’s (WTO) TRIPS treaty (Trade-Related Aspects of Intellectual Property Rights) are essential to drive the necessary innovation.

Market success through sustainable innovations

Innovation is the basis for growth and progress. Innovations are essential to address current challenges such as climate change, global population growth and diseases for which there is still no effective cure. For us, innovation does not simply mean the commercialization of new products and processes. It also means optimizing established products and processes.

A glance at the product ranges currently offered by our subgroups and service companies demonstrates that in 2007 we once again managed to launch a large number of innovations that bring us closer to our goal of sustainable development.

The Bayer-wide “Triple-i” initiative also exemplifies our inventor spirit: Since the launch of this initiative in 2006 our employees have submitted more than 3,000 innovative ideas, including many ideas for new products which our subgroups are now working on.

Examples of sustainable innovations by Bayer’s subgroups and service companies

Innovation	Explanation
Bayer HealthCare
The oral cancer drug Nexavar® has received marketing authorization for the treatment of patients with liver cancer in the United States and the European Union.	Nexavar® is the first systemic therapy for liver cancer and the only medication that is proven to significantly increase the overall life expectancy of patients with this disease. Developed jointly by Bayer HealthCare AG and Onyx Pharmaceuticals, Inc., Nexavar® is already registered for the treatment of advanced kidney cancer in more than 60 countries.
The European Commission has extended marketing authorization for Zevalin® in Europe. Zevalin® may now be used as consolidation therapy in previously untreated patients with follicular lymphoma who have responded to induction therapy. The benefit of Zevalin® following rituximab in combination with chemotherapy has not been established.	An international Phase iii trial on Zevalin® as a treatment for follicular lymphoma has shown that use as a first-line consolidation therapy in patients with advanced follicular lymphoma prolongs the progression-free period of this disease by two years. The results of the study, which was published in December, also show that this medication has good tolerability and did not cause any health-related deterioration in the quality of life.
An application for marketing authorization for rivaroxaban (proposed tradename Xarelto®) in the prevention and therapy of thrombosis has been submitted to the European Agency for the Evaluation of Medicinal Products (EMEA).	The results of Phase iii trials show that oral administration of the anticoagulant rivaroxaban (Xarelto®) prevents venous thromboembolism (VTE) in the lower limbs of patients after orthopedic surgery more effectively than the current standard therapy.
The European Commission has granted marketing authorization for MabCampath® (active ingredient: alemtuzumab) for the treatment of patients with b-cell chronic lymphocytic leukemia (B-CLL) for whom combination therapy with fludarabin is not suitable.	B-CLL is the most common type of leukemia in adults in western countries. MabCampath® works entirely differently from chemotherapy and is the first and only monoclonal antibody approved for the treatment of B-CLL in Europe. The FDA (Food and Drug Administration) has also granted approval to extend the use of Campath® as a single-agent therapy for first-line treatment of B-CLL patients in the United States. MabCampath® is marketed as Campath® in the United States. Campath®/MabCampath® was developed jointly by Bayer Schering Pharma and the biotech company Genzyme.
Bayer CropScience
A new applicator has been developed for safer application of crop protection products.	The new appliance allows safer and more effective application of crop protection products, for example, on banana crops, thus reducing the quantity required.
Active ingredient formulations for healthy plants ensure more efficient use of water by plants.	Active ingredient formulations marketed under the label “Confidor® Stress Shield Inside” protect plants from biotic and abiotic stress factors. This reduces water consumption and increases harvest yields.
Bayer MaterialScience
Bayer MaterialScience is building a major hydrochloric acid recycling plant in Shanghai, China.	This is the first time that this innovative oxygen depolarized cathode technology has been used for hydrochloric acid electrolysis in a major industrial facility. The process breaks down hydrochloric acid into chlorine and water. The new facility will have capacity to handle 215,000 metric tons chlorine per year and is scheduled to come on stream in 2008.
A new Desmodur® polyisocyanate facilitates the production of durable coatings with extremely low emissions.	Wood and furniture coatings containing this new polyisocyanate have far lower emissions of volatile organic compounds (VOCS) than conventional coatings and also have superior scratch resistance and solvent stability.
New Bayhydrol® UV binders are used to formulate environment-friendly UV-curing waterborne coatings that cure rapidly when exposed to UV radiation.	A new polyurethane dispersion permits the formulation of UV-curing soft-touch coatings for plastics. These high-quality, user-friendly coatings minimize emissions of volatile organic compounds (VOCS).
Bayer Business Services
Bayer Business Services provides IT-based health, safety and environment (HSE) services.	This new service offering encompasses the design, generation and management of safety-relevant documents and special advice on national and international HSE-relevant chemical product safety directives. This service facilitates the handling of chemical substances.
Bayer Technology Services
The Bayer Climate Check provides an ecological basis for decisions on potential climate-friendly and energy-efficient production processes and for capital expenditure and technology projects.	The Bayer Climate Check developed by Bayer Technology Services is a tool to compile detailed information on all emissions generated in a production process, including on the raw materials required for the process, their manufacture and transportation. This tool has been certified by the German technical authorities (TÜV Süd).
Bayer Technology Services is building the largest wastewater treatment plant to date based on Bayer’s proprietary LOPROX® process in Israel. The client is Makhteshim Chemical Works Ltd., one of the country’s leading producers and exporters of crop protection products.	The LOPROX® (Low Pressure Oxidation) process developed by Bayer prepares highly contaminated effluent for processing in biological wastewater treatment plants. The technology is installed upstream of biological wastewater treatment plants. Wastewater treated in the new plant will be well within the Israeli government’s more stringent regulations on wastewater quality, which come into force in 2010.
CURRENTA
The thermal waste air incinerator in Dormagen has been modernized and CO₂ emissions have been cut by 18,000 metric tons p.a.	A regenerative thermoreactor and high-performance cooler allow recycling of thermal energy from the incineration process.

Our contribution to regional economic development

Our partners and production sites also benefit from our value creation. Last year, we worked with more than 40,000 suppliers around the world and purchased products and services worth more than €15 billion. Our procurement volume is therefore a key factor in the development of the local economy in many regions. To enable small and mid-sized suppliers to benefit, we help make them fit for the global market and enable them to meet Bayer’s social, ecological and quality standards. For example, Bayer CropScience and the German cooperation agency GTZ introduced the “Green World” food chain partnership project in Kenya in 2006. This provides advice and support for smallholders on sustainable farming methods through trading centers in their villages. In this way Bayer supports the production of healthy food and improved marketing in compliance with international quality standards. By the end of 2007 more than 4,000 smallholders had been included in this project. In 2007 Bayer CropScience launched another food chain partnership project, the “Flavour Guarantee Project,” in Brazil in collaboration with the non-governmental organization HortiBrasil and some 500 small farmers. This collaboration has resulted in certified, hence competitive, products for Brazilian supermarkets which undergo strict quality control procedures. Bayer CropScience and HortiBrasil have also developed a teaching program for schools as part of the Flavour Guarantee Project, to teach children the principles of a healthy and balanced diet.

Our sites are also important economic factors in their role as employers. Through the wages and salaries paid to our employees, including social security and pension contributions (in total more than €1.6 billion in 2007) and pension obligations of more than €15 billion in 2007, we make a substantial contribution to the purchasing power and social welfare of the areas around our sites. We also actively support economic development to enhance the areas where we operate. One example is the “CHEMPARK Start-Up Initiative.” This project developed by CURRENTA– as Bayer Industry Services has been called since 2008 – helps innovative new companies in the early stages of development by providing facilities and assistance to integrate them into CHEMPARK. CHEMPARK – formerly the Bayer Chemical Park network – is one of the largest and most competitive chemical parks in Europe with sites in Leverkusen, Dormagen and Krefeld-Uerdingen in Germany. Its attractiveness to innovative companies is demonstrated by the decision of high-tech company NTK-cables Gmbh in January 2008 to set up operations at the Leverkusen CHEMPARK.

Open dialogue with our neighbors plays a central role in our CHEMPARK concept. As the manager and operator of CHEMPARK, CURRENTA is responsible for site communications for companies based there as well as for coordinating all communication with the local community, media and politicians.

That is particularly important in the case of controversial issues such as the co pipeline which is being built between our German sites in Dormagen and Krefeld-Uerdingen. This is another project which has shown us the importance of networking with local residents and critics. We will be continuing this open and constructive dialogue because we are convinced that the pipeline will be safe and will have a positive effect on the competitiveness of the local chemical and plastics industry.

Bayer utilizes public funding where this is deemed appropriate. Such funds often enable us to undertake activities which would not be possible on purely commercial grounds. We regard public-sector subsidies as part of our sustainable partnership with governments and states for the benefit of both sides. Such funding is normally applied for locally by the units operating in the relevant countries. We do not have a central system to monitor such applications.

No state authorities have a stake of more than three percent in Bayer.

As a result of the corporate tax reform in Germany, Bayer benefited from a non-cash deferred tax credit of €912 million in 2007. That resulted in tax income of €72 million in 2007. (For further information on the social commitment see

)

Personnel expenses and pension obligations (in € million)

	2003	2004	2005	2006	2007
Personnel expenses*	7.906	6.026	5.318	6.630	7.571
of which social expenses and expenses for pensions and other benefits	1.829	1.204	1.009	1.414	1.611
Pension obligations**	14.192	13.581	15.561	16.708	15.022

* The slight increase in personnel expenses compared with the previous year is principally due to the complete integration of the former Schering Group into the data for 2007; in the data for 2006 Schering is only included from June 23. Figures for 2003-2005 as reported. Figures for 2006 restated.
** present value of defined-benefit obligations for pensions and other post-employment benefits

Responsible competitive conduct

Our economic and social responsibility includes making sure that our strict corporate compliance code is observed throughout the Bayer Group. Our “Program for Legal Compliance and Corporate Responsibility at Bayer” bans corruption and anti-competitive conduct. It also prescribes compliance with anti-discrimination regulations and the protection of intellectual property and sets out rules on product safety, occupational safety and environmental protection. To ensure that the program is applied consistently, an efficient compliance structure has been put in place worldwide in recent years. We use suitable means to communicate our policy of “zero tolerance” of non-compliance to our employees and provide additional information on specific issues. During 2007, which we declared “Anti-Corruption Year,” we initiated a global communication campaign on corporate compliance with a clear focus on avoiding corruption (see Focus Issue Corporate Compliance

Our political activities

Bayer also sets out clear guidelines for political activities. We do not make donations to politicians, political parties or related institutions on principle. As in the past, German employees who are elected to the European Parliament, German parliament, a regional parliament or local council are covered by the “Officeholders Directive” introduced in 2005 (see Sustainable Development Report 2005, page 31) to ensure we systematically avoid potential conflicts of interest. Bayer also sets out clear guidelines for political activities. We do not make donations to politicians, political parties or related institutions on principle. As in the past, German employees who are elected to the European Parliament, German parliament, a regional parliament or local council are covered by the “Officeholders Directive” introduced in 2005 (see Sustainable Development Report 2005

) to ensure we systematically avoid potential conflicts of interest.

Bayer works closely with major national and international business associations to make sure that our expertise plays a part in a constructive and consensus-oriented political dialogue. Examples are our membership of “econsense – Forum for Sustainable Development of German Business,” a central platform established to promote networking between representatives of German industry on sustainability issues.

Uniform communication with political decision-makers is coordinated by our Community Council Politics, which meets once a month to define and prioritize our contribution to the political debate. Issues are systematically analyzed and evaluated by this body before being passed on to the responsible staff at our subgroups.

This structure ensures that our position is communicated clearly and uniformly by the entire Group and is aligned to our corporate governance rules.

Responsible handling of risks

Sustainability management has a firm place in risk and reputation management at Bayer. In keeping with the German legislation on corporate control and transparency (KonTraG), we ensure that risks are identified and communicated as early as possible and that timely and effective counter-action is taken. Based on our Risk Management Policy, we therefore keep a close eye on the challenges facing our global business and report fully on them in our Annual Report.

One challenge that we are addressing in detail is climate change. Initial estimates of the economic implications suggest that timely climate protection makes better economic sense than dealing with the potentially serious effects. This is the key message of the Stern Review on the Economics of Climate Change.

Climate protection also offers economic opportunities by opening up new markets for efficient technologies and climate-friendly products. Climate protection will therefore alter business conditions. Alongside an increase in energy prices as a result of energy and climate policy, new commercial opportunities are arising (see Focus Issue Climate Change

The threat from extreme weather conditions such as storms, floods and drought is also increasing in many areas. We have therefore reviewed and, where necessary, adapted our safety precautions at sites that are potentially at risk. Since global supply of food, water and medicines is becoming an increasingly pressing issue, we are also paying special attention to climate change in the alignment of our product portfolio and business activities.

Bayer respects all national and international external trade regulations. As an exporter, we are aware of the responsibility involved in exporting our products to other countries. We support the efforts of the international community to prevent the manufacture and spread of chemical, biological and atomic weapons and of the relevant carrier systems and to combat international terrorism. We play an active part in international campaigns to fight the illegal manufacture of narcotics by monitoring corresponding intermediates.

We have taken organizational precautions to ensure compliance with the large number of national and international control regulations for many years and in 2007 adopted a corresponding Group-wide directive. In Germany, all companies that produce goods requiring export licenses are obliged to name export officers who are registered with the German Federal Office of Economics and Export Control (BAFA). These officers must belong to the management body of the company and carry legal responsibility for compliance with foreign trade regulations. Export officers in the German and foreign subsidiaries have been appointed to ensure the creation of the necessary organizations. In addition, Bayer Business Services has set up an export control office to support the subgroups in this area. This also provides information, advice and training on monitoring basic materials and compliance with the chemical weapons agreement.

Sustainability indices and sustainability funds

Sustainable development in the corporate sector is becoming an increasingly important criterion for investors all over the world. Bayer is represented in several sustainability indices and sustainability funds. This is a clear acknowledgement of our business strategy and our commitment to sustainable development.

We have been included continuously in the Dow Jones Sustainability Index (DJSI) World and the European djsi stoxx since their establishment in 1999 and 2001 respectively. The indicators for environmental and climate protection were extended in the 2007 ranking. Bayer’s outstanding performance on these criteria in 2007 led to a further honor: The Group was the only European company in its sector to be included again in the Climate Disclosure Leadership Index, the first worldwide climate index.

Since 2001 we have also been included continuously in the European and global sustainability indices of FTSE, an independent company established by the Financial Times and London Stock Exchange (FTSE4Good Europe Index and FTSE4Good Global Index). This was confirmed again by the six-monthly review in March 2008. Since May 2007 we have also been included in the FTSE4Good Environmental Leaders Europe 40 Index, which singles out European companies with an exemplary environmental performance. We have also maintained our position on the Eurozone Index issued by France’s Advanced Sustainable Performance Indices (ASPI).

The analysts of the Storebrand Principle Funds once again rated Bayer among the top companies in its sector in its most recent evaluation, awarding it the accolade “Best in Class - Environmental and Social Performance.”