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Independent Auditor's Report

To MERCK Kommanditgesellschaft auf Aktien, Darmstadt, Germany

Report on the Audit of the Consolidated Financial Statements and of the Combined Management Report

Opinions

We have audited the consolidated financial statements of MERCK Kommanditgesellschaft auf Aktien, Darmstadt, Germany, and its subsidiaries (the Group), which comprise the consolidated balance sheet as of December 31, 2019, the consolidated income statement, the consolidated statement of comprehensive income, consolidated statement of changes in net equity and consolidated cash flow statement for the financial year from January 1, 2019, to December 31, 2019, and notes to the consolidated financial statements, including a summary of significant accounting policies. In addition, we have audited the combined management report of MERCK Kommanditgesellschaft auf Aktien, Darmstadt, Germany, for the financial year from January 1, 2019, to December 31, 2019. In accordance with German legal requirements, we have not audited the components of the combined management report specified in the "Other Information" section of our auditor's report.

In our opinion, on the basis of the knowledge obtained in the audit,

  • the accompanying consolidated financial statements comply, in all material respects, with the IFRSs as adopted by the EU, and the additional requirements of German commercial law pursuant to Section 315e (1) HGB [Handelsgesetzbuch: German Commercial Code] and, in compliance with these requirements, give a true and fair view of the assets, liabilities, and financial position of the Group as of December 31, 2019, and of its financial performance for the financial year from January 1, 2019, to December 31, 2019, and
  • the accompanying combined management report as a whole provides an appropriate view of the Group's position. In all material respects, this combined management report is consistent with the consolidated financial statements, complies with German legal requirements and appropriately presents the opportunities and risks of future development. Our opinion on the combined management report does not cover the content of the components of the combined management report specified in the "Other Information" section of the auditor's report.

Pursuant to Section 322 (3) sentence 1 HGB, we declare that our audit has not led to any reservations relating to the legal compliance of the consolidated financial statements and of the combined management report.

Basis for the Opinions

We conducted our audit of the consolidated financial statements and of the combined management report in accordance with Section 317 HGB and EU Audit Regulation No 537/2014 (referred to subsequently as "EU Audit Regulation") and in compliance with German Generally Accepted Standards for Financial Statement Audits promulgated by the Institut der Wirtschaftsprüfer [Institute of Public Auditors in Germany] (IDW). Our responsibilities under those requirements and principles are further described in the "Auditor's Responsibilities for the Audit of the Consolidated Financial Statements and of the Combined Management Report" section of our auditor's report. We are independent of the group entities in accordance with the requirements of European law and German commercial and professional law, and we have fulfilled our other German professional responsibilities in accordance with these requirements. In addition, in accordance with Article 10 (2)(f) of the EU Audit Regulation, we declare that we have not provided non-audit services prohibited under Article 5 (1) of the EU Audit Regulation. We believe that the evidence we have obtained is sufficient and appropriate to provide a basis for our opinions on the consolidated financial statements and on the combined management report.

Key Audit Matters in the Audit of the Consolidated Financial Statements

Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements for the financial year from January 1, 2019, to December 31, 2019. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, we do not provide a separate opinion on these matters.

Acquisition of Versum Materials, Inc.

The accounting policies applied and disclosures on the acquisition are presented in the notes to the consolidated financial statements under note 5.

THE FINANCIAL STATEMENT RISK

On October 7, 2019, the Group acquired Versum Materials, Inc. The purchase price in accordance to IFRS 3 amounted to EUR 5,198 million. Taking into account the net assets acquired in the amount of EUR 2,054 million, this results in goodwill in the amount of EUR 3,144 million.

The identifiable assets acquired and liabilities assumed are generally recognized at fair value pursuant to IFRS 3 on the date of acquisition. The Group engaged an external expert to assist in the identification and measurement of the identifiable assets acquired and the liabilities assumed.

The identification and measurement of assets acquired and liabilities assumed are complex and based on assumptions of management that require judgment. The significant assumptions are related to the projections of the acquired business' sales and margins, customers churn rate, license fee rates as well as the cost of capital.

There is the risk for the consolidated financial statements that the assets acquired and liabilities assumed are improperly identified or inaccurately measured. There is also the risk that the disclosures in the notes to the consolidated financial statements are not complete and accurate.

OUR AUDIT APPROACH

With the involvement of our own valuation experts, we have assessed the appropriateness of key assumptions and parameters as well as the identification and calculation methods used, among other things. For this purpose, we initially obtained an understanding of the acquisition by interviewing employees in the Finance and M&A departments as well as by assessing the relevant contracts.

We reconciled the total purchase price to the relevant agreements and evidence of payment.

We have assessed the competency, skills and objectivity of the independent expert engaged by the Group. Furthermore, we have assessed the process of the identification of the assets acquired and liabilities assumed in terms of conformity with the requirements of IFRS 3 on the basis of our knowledge of the Group’s business model. We have evaluated the measurement methods used for their compliance with the accounting policies.

We have discussed projected revenue and margin development with those responsible for planning. Furthermore, we have reconciled these with the budgets prepared by management and have assessed the consistency of the assumptions with external industry-specific market assessments, including analyst expectations. We compared the license fee rates utilized to measure certain intangible assets with benchmarks from relevant databases. We compared the assumptions and parameters underlying the capital costs, in particular the risk-free rate, the market risk premium and the beta factor, with our own assumptions and publicly available data. We involved our valuation experts in the audit team to assist with this.

To assess the computational accuracy of the measurement of the identified assets and liabilities, we used a risk-based audit approach to recalculate the Company’s calculations on a sample basis.

In addition, we have assessed whether the disclosures in the notes regarding the acquisition are complete and appropriate.

OUR OBSERVATIONS

The approach used for identifying and measuring the assets acquired and liabilities assumed is appropriate and in line with the accounting policies to be applied. The key assumptions and parameters underlying the purchase price allocation are appropriate and the presentation of the acquisition in the notes to the consolidated financial statements is complete and appropriate.

Recognition and measurement of income tax liabilities and deferred tax liabilities

Explanatory notes on the recognition and measurement of income tax liabilities and deferred tax liabilities can be found in the notes to the consolidated financial statements under note 17.

THE FINANCIAL STATEMENT RISK

As of December 31, 2019, current income tax liabilities amount to EUR 1,402 million, and deferred tax liabilities amount to EUR 1,828 million.

The Group operates in different jurisdictions with different legal systems. The application of local regulations on income tax, tax incentives and transfer pricing rules is complex. The recognition and measurement of income tax liabilities require the Group to exercise judgment in assessing tax matters and to make estimates regarding uncertain tax positions.

The measurement of income tax liabilities and the assessment of unrecognized contingent tax liabilities are subject to judgment and estimation uncertainty. The Group routinely engages external experts to support its own risk assessment with expert opinions from tax specialists.

There is a risk for the financial statements that income tax liabilities and deferred tax liabilities are not fully recognized or not appropriately measured.

OUR AUDIT APPROACH

We involved our own specialists in international tax law into the audit team in order to evaluate the Group’s assessment of tax risks and the related opinions of external experts engaged by the Group.

We obtained an understanding of existing tax risks through inquiry of management of the affected group companies and employees of the tax department. We assessed the competence, capabilities and objectivity of the external experts and evaluated their expert opinions.

In addition, we analyzed correspondence with the relevant tax authorities and assessed the assumptions underlying the determination of income tax liabilities based on our knowledge and experience of how the relevant legal requirements are currently applied by the tax authorities and courts. We scrutinized the Group’s approach regarding the recognition and measurement of deferred tax liabilities, based on laws and regulations enacted as of the reporting date, and performed recalculations.

OUR OBSERVATIONS

The valuation model and assumptions underlying the recognition and measurement of income tax liabilities are reasonable. The approach regarding the recognition and measurement of deferred tax liabilities is adequate.

Impairment testing of goodwill

Explanatory notes on the impairment tests can be found in the notes to the consolidated financial statements under note 18.

THE FINANCIAL STATEMENT RISK

The goodwill in the consolidated financial statements as of December 31, 2019 amounts to EUR 17,141 million (39,1% of the Group's total assets), with EUR 11,135 million of this attributable to Life Science and with EUR 4,472 million to Performance Materials. The goodwill of Life Science results especially from the acquisition of the Sigma-Aldrich Corporation, USA, in November 2015. Due to the acquisition of Versum Materials, Inc., USA, in October 2019 the goodwill of Performance Materials has increased significantly.

Goodwill is to be tested for impairment once a year, and may need be tested ad hoc if necessary. In performing the goodwill impairment test, the Group primarily determines the recoverable amount by means of the discounted cash flow method. The valuation model used to determine the recoverable amount is complex and the result of this valuation are highly dependent on the projection of future net cash flows (taking into account future revenue growth, profit margins and long-term growth rates) and the discount factor used, and therefore is subject to significant estimation uncertainty.

There is a risk for the financial statements that an existing goodwill impairment loss was not recognized as of the reporting date. In addition, there is a risk that the related disclosures in the notes to the consolidated financial statements are not complete and appropriate.

OUR AUDIT APPROACH

Using our own sensitivity analyses, we assessed the extent to which the goodwill of the cash-generating unit would still be sufficiently covered by the respective recoverable amount if assumptions and parameters underlying the calculations were to change in a manner that is deemed possible. On the basis of these analyses, our audit particularly focused on the cash-generating units Life Science and Performance Materials.

We reconciled the expected net cash flows underlying the recoverable amount calculations with the current medium-term plan approved by management. To assess the assumptions used in preparing the medium-term plan, we obtained an understanding of the planning process through discussions with company representatives, including corporate management and representatives from the corporate divisions and the research and development department, we assessed the plausibility and consistency of the explanations received with the projections, and we compared the assumptions used with the expectations of external analysts and sources.

As part of our audit of the discount factor, we analyzed the peer group used. With regard to other assumptions and parameters (e.g. risk-free interest rate, beta factor, market risk premium), we compared those assumptions and parameters with our own assumptions and publicly available data to assess whether these were appropriate and whether they were within the range of external recommendations, to the extent available. In addition, we verified the calculation model used to determine the discount factor.

We assessed the appropriateness of the valuation model used. To verify arithmetical accuracy, we used a risk-based audit approach to recalculate the Company’s calculations based on samples contained in the valuation model.

In addition, we assessed whether the Company's disclosures regarding the goodwill impairment test in the notes to the consolidated financial statements are complete and appropriate.

OUR OBSERVATIONS

The calculation method used for the goodwill impairment test is appropriate and in line with the applicable valuation principles. Overall, the assumptions and parameters used by management are balanced. The disclosures in the notes to the consolidated financial statements are complete and properly depict the judgment associated with the subsequent measurement of goodwill.

Other Information

Management is responsible for the other information. The other information comprises information in the combined management report, not required by law or DRS 20, and marked as unaudited.

The other information furthermore comprises the remaining parts of the annual report.

The other information do not comprise the consolidated financial statements, the audited parts of the combined management report and our auditor's report.

Our opinions on the consolidated financial statements and on the combined management report do not cover the other information, and consequently we do not express an opinion or any other form of assurance conclusion thereon.

In connection with our audit, our responsibility is to read the other information and, in so doing, to consider whether the other information

  • is materially inconsistent with the consolidated financial statements, with the information in the combined management report audited for content or our knowledge obtained in the audit, or
  • otherwise appears to be materially misstated.

Responsibilities of Management and the Supervisory Board for the Consolidated Financial Statements and the Combined Management Report

Management is responsible for the preparation of the consolidated financial statements that comply, in all material respects, with IFRSs as adopted by the EU, and the additional requirements of German commercial law pursuant to Section 315e (1) HGB and that the consolidated financial statements, in compliance with these requirements, give a true and fair view of the assets, liabilities, financial position, and financial performance of the Group. In addition, management is responsible for such internal control as they have determined necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the consolidated financial statements, management is responsible for assessing the Group's ability to continue as a going concern. They also have the responsibility for disclosing, as applicable, matters related to going concern. In addition, they are responsible for financial reporting based on the going concern basis of accounting unless there is an intention to liquidate the Group or to cease operations, or there is no realistic alternative but to do so.

Furthermore, management is responsible for the preparation of the combined management report that, as a whole, provides an appropriate view of the Group's position and is, in all material respects, consistent with the consolidated financial statements, complies with German legal requirements, and appropriately presents the opportunities and risks of future development. In addition, management is responsible for such arrangements and measures (systems) as they have considered necessary to enable the preparation of a combined management report that is in accordance with the applicable German legal requirements, and to be able to provide sufficient appropriate evidence for the assertions in the combined management report.

The Supervisory Board is responsible for overseeing the Group's financial reporting process for the preparation of the consolidated financial statements and of the combined management report.

Auditor's Responsibilities for the Audit of the Consolidated Financial Statements and of the Combined Management Report

Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and whether the combined management report as a whole provides an appropriate view of the Group's position and, in all material respects, is consistent with the consolidated financial statements and the knowledge obtained in the audit, complies with the German legal requirements and appropriately presents the opportunities and risks of future development, as well as to issue an auditor's report that includes our opinions on the consolidated financial statements and on the combined management report.

Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Section 317 HGB and the EU Audit Regulation and in compliance with German Generally Accepted Standards for Financial Statement Audits promulgated by the Institut der Wirtschaftsprüfer (IDW) will always detect a material misstatement. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements and this combined management report.

We exercise professional judgment and maintain professional skepticism throughout the audit. We also:

  • Identify and assess the risks of material misstatement of the consolidated financial statements and of the combined management report, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinions. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal controls.
  • Obtain an understanding of internal control relevant to the audit of the consolidated financial statements and of arrangements and measures (systems) relevant to the audit of the combined management report in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of these systems.
  • Evaluate the appropriateness of accounting policies used by management and the reasonableness of estimates made by management and related disclosures.
  • Conclude on the appropriateness of management's use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Group's ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in the auditor's report to the related disclosures in the consolidated financial statements and in the combined management report or, if such disclosures are inadequate, to modify our respective opinions. Our conclusions are based on the audit evidence obtained up to the date of our auditor's report. However, future events or conditions may cause the Group to cease to be able to continue as a going concern.
  • Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements present the underlying transactions and events in a manner that the consolidated financial statements give a true and fair view of the assets, liabilities, financial position and financial performance of the Group in compliance with IFRSs as adopted by the EU and the additional requirements of German commercial law pursuant to Section 315e (1) HGB.
  • Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group to express opinions on the consolidated financial statements and on the combined management report. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our opinions.
  • Evaluate the consistency of the combined management report with the consolidated financial statements, its conformity with [German] law, and the view of the Group's position it provides.
  • Perform audit procedures on the prospective information presented by management in the combined management report. On the basis of sufficient appropriate audit evidence we evaluate, in particular, the significant assumptions used by management as a basis for the prospective information, and evaluate the proper derivation of the prospective information from these assumptions. We do not express a separate opinion on the prospective information and on the assumptions used as a basis. There is a substantial unavoidable risk that future events will differ materially from the prospective information.

We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

We also provide those charged with governance with a statement that we have complied with the relevant independence requirements, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, the related safeguards.

From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor's report unless law or regulation precludes public disclosure about the matter.

Further Information pursuant to Article 10 of the EU Audit Regulation

We were elected as group auditor at the annual general meeting on April 26, 2019. We were engaged by the Supervisory Board on June 28, 2019. We have been the group auditor of MERCK Kommanditgesellschaft auf Aktien, Darmstadt, Germany, without interruption since the financial year 1995.

We declare that the opinions expressed in this auditor's report are consistent with the additional report to the Supervisory Board pursuant to Article 11 of the EU Audit Regulation (long-form audit report).

Information on the Supplementary Audit

We issue this auditor’s report on the amended consolidated financial statements and amended combined management report on the basis of our statutory audit completed on February 17 2020 and our supplementary audit completed on May 13 2020, which concerned the amendment to disclosures in the notes to the consolidated financial statements and the combined management report due to the updated reporting on risks and opportunities and on expected developments. Please refer to the presentation of the amendments by the Executive Board in the amended notes to the consolidated financial statements, section “General Disclosures – Subsequent Events“ and in the amended combined management report, section „Report on Risks and Opportunities – Overall view of the risk and opportunity situation and management assessment“, section „Report on Expected Developments – Forecast for the Group“ and section „Additional Information on Merck KGaA, Darmstadt, Germany, in accordance with the German Commercial Code (HGB) – Forecast for Merck KGaA, Darmstadt, Germany“.

German Public Auditor Responsible for the Engagement

The German Public Auditor responsible for the engagement is Bodo Rackwitz.

Frankfurt am Main, 17 February 2020 / limited to the amendment referred to in the Information on the Supplementary Audit: 13 May 2020

KPMG AG
Wirtschaftsprüfungsgesellschaft
[Original German version signed by:]

[signature] Rackwitz
Wirtschaftsprüfer
[German Public Auditor]

[signature] Rienecker
Wirtschaftsprüferin
[German Public Auditor]