Management Report

Liquidity and Capital Resources

Operating cash flow

Gross cash flow in the second quarter of 2008 rose by 11.4 percent, from €1,187 million in the prior-year period to €1,322 million, as a result of the strong business performance. Net cash flow improved by €73 million to €889 million (Q2 2007: €816 million) despite a seasonal increase in cash tied up in working capital.

Gross cash flow in the first half of 2008 advanced to €2,973 (H1 2007: €2,598 million). Net cash flow rose by 19.0 percent to €1,417 million (H1 2007: €1,191 million).

Bayer Group Summary Cash Flow Statements	2nd Quarter 2007	2nd Quarter 2008	1st Half 2007	1st Half 2008
€ million
Gross cash flow*	1,187	1,322	2,598	2,973
Changes in working capital/other non-cash items	(371)	(433)	(1,407)	(1,556)
Net cash provided by (used in) operating activities (net cash flow), continuing operations	816	889	1,191	1,417
Net cash provided by (used in) operating activities (net cash flow), discontinued operations	(36)	0	2	0
Net cash provided by (used in) operating activities (net cash flow) (total)	780	889	1,193	1,417
Net cash provided by (used in) investing activities (total)	(53)	(321)	4,536	(785)
Net cash provided by (used in) financing activities (total)	(3,889)	(1,227)	(5,653)	(1,096)
Change in cash and cash equivalents due to business activities (total)	(3,162)	(659)	76	(464)
Cash and cash equivalents at beginning of period	6,143	2,717	2,915	2,531
Change due to exchange rate movements and to changes in scope of consolidation	(1)	0	(11)	(9)
Cash and cash equivalents at end of period	2,980	2,058	2,980	2,058

* for definition see Bayer Group Key Data.

Investing cash flow

In the second quarter of 2008, there was a net cash outflow of €321 million for investing activities (Q2 2007: €53 million). This amount mainly comprised €265 million in disbursements relating to the purchase of the eastern European OTC business of Sagmel, Inc. Cash outflows for property, plant and equipment in the second quarter totaled €347 million (Q2 2007: €440 million). This figure included the expenditures for the expansion of our polymers production facilities in Caojing, near Shanghai, China. Inflows consisted primarily of €224 million in interest and dividend payments, as well as €91 million in proceeds from the divestiture of property, plant, equipment and other assets.

The net cash outflow for investing activities in the first six months of 2008 amounted to €785 million. This amount mainly comprised €227 million in payments concerning the acquisition of U.S.-based Possis Medical, Inc. and €265 million relating to the purchase of the OTC business of Sagmel, Inc. In the prior-year period, there was a cash inflow of €4,536 million, comprising mainly the net proceeds from the divestitures of the diagnostics business, H.C. Starck and Wolff Walsrode. Cash outflows for property, plant and equipment and intangible assets in the first half came to €635 million (H1 2007: €641 million). The principal cash inflows were €298 million in interest and dividend payments and €107 million in proceeds from the divestiture of property, plant, equipment and other assets.

Financing cash flow

The net cash outflow for financing activities in the first half of 2008 amounted to €1,096 million. The outflow in the prior-year period came to €5,653 million. This included €3.9 billion for net loan repayments, the greater part of this amount (€2.1 billion) being for the scheduled redemption of our 2002/2007 Eurobond in April 2007. The Bayer AG dividend and dividend payments to minority stockholders of consolidated companies amounted to €1,040 million in the first half of 2008 (H1 2007: €775 million).

Liquid assets and net debt

As of June 30, 2008 the Bayer Group held cash and cash equivalents of €2,058 million, including €747 million deposited in escrow accounts. This amount is earmarked for payments to be made in connection with the squeeze-out of the remaining minority stockholders of Bayer Schering Pharma AG and civil law settlements of antitrust proceedings. Pursuant to a resolution of the Extraordinary Stockholders’ Meeting of Bayer Schering Pharma AG on January 17, 2007, the shares of that company that are still held by minority stockholders will be transferred to the main stockholder, Bayer Schering GmbH, a wholly owned subsidiary of Bayer AG, in return for cash compensation of €98.98 per share. Dissenting stockholders are seeking to have the stockholder resolution set aside or to have it declared null and void. As of June 30, 2008, we held a 96.3 percent interest in Bayer Schering Pharma AG. In view of the restriction on its use, the liquidity held in escrow accounts was not deducted when calculating net debt.

Net Debt	Dec. 31, 2007	March 31, 2008	June 30, 2008
€ million
Noncurrent financial liabilities as per balance sheets (including derivatives)	12,911	12,648	8,925
of which hybrid bond	1,237	1,237	1,221
Current financial liabilities as per balance sheets (including derivatives)	1,287	1,757	6,010
Derivative receivables	(230)	(301)	(314)
Financial liabilities	13,968	14,104	14,621
Cash and cash equivalents*	(1,776)	(1,967)	(1,311)
Current financial assets	(8)	(35)	(6)
Net debt from continuing operations	12,184	12,102	13,304
Net debt from discontinued operations	-	-	-
Net debt (total)	12,184	12,102	13,304

* In view of the restriction on its use, the €747 million liquidity in escrow accounts in the second quarter of 2008 (March 31, 2008: €750 million; Dec. 31, 2007: €755 million) was not deducted when calculating net debt. June 30, 2008: €1,311 million = €2,058 million - €747 million.

In the second quarter net debt (total) rose by €1.2 billion to €13.3 billion. This was mainly due to our dividend payout of €1.0 billion and to payments of €0.5 billion for annual payments of variable compensation to our employees. In addition, the interest payment dates for our bonds occur mainly in the second quarter, resulting in expectedly high disbursements. As of June 30, 2008 we had financial liabilities of €14.6 billion, including the €1.2 billion subordinated hybrid bond issued in July 2005 and the €2.3 billion mandatory convertible bond issued in April 2006. Net debt should be viewed against the fact that Moody’s and Standard & Poor’s treat 75 percent and 50 percent, respectively, of the hybrid bond as equity. Both rating agencies consider the mandatory convertible bond wholly as equity. Unlike conventional borrowings, the hybrid bond thus only has a limited effect on the Group’s rating-specific indicators, while the mandatory convertible bond has no effect. In light of their maturity dates, the mandatory convertible bond issued in 2006 and the floating rate note of Bayer AG, also issued in 2006, were reclassified from noncurrent to current financial liabilities. Our noncurrent financial liabilities amounted to €8.9 billion as of June 30, 2008.

In the second quarter of 2008, Standard & Poor’s raised Bayer’s long-term issuer rating to A– with stable outlook. Moody’s has changed the outlook for our long-term issuer rating of A3 from “negative” to “stable.” The short-term ratings are A-2 (Standard & Poor’s) and P-2 (Moody’s). These investment-grade ratings document good creditworthiness.

Net pension liability

Capital market interest rates continued to rise in the second quarter of 2008. The net pension liability fell once again, to €3.9 billion. Provisions for pensions and other post-employment benefits declined from €5.0 billion to €4.7 billion. At the same time prepaid benefit assets, reflected in the balance sheet under “Other receivables,” declined by €0.1 billion to €0.8 billion.

Net pension liability	Dec. 31, 2007	March 31, 2008	June 30, 2008
€ million
Provisions for pensions and other post-employment benefits	5,501	4,970	4,696
Prepaid benefit assets	(533)	(882)	(760)
Net pension liability	4,968	4,088	3,936