Compensation architecture for the EC

The compensation awarded to EC members is primarily driven by the success of the company. In addition to a competitive fixed compensation, there is a performance-related component that rewards for performance and allows EC members to participate in the company’s long-term value creation. The overall compensation consists of the following elements:

• Annual base salary;
• Benefits (such as retirement benefits);
• Short-term incentive;
• Long-term incentive (share-based compensation).

To ensure consistency across the organization, roles within the organization have been evaluated using the job grading methodology of Korn Ferry Hay Group. The grading system is the basis for compensation activities such as benchmarking and determination of compensation structure and levels. For comparative purposes, dormakaba refers to external compensation studies that are conducted regularly by Korn Ferry Hay Group in most countries. Overall, these studies include the compensation data of 2,500 technology and industrial companies, including listed and privately held competitors in the security sector that are comparable with dormakaba in terms of annual revenues, number of employees, and complexity in the relevant national or regional markets. Consequently, there is no predefined peer group of companies that is used globally. Rather, the benchmark companies will vary from country to country based on the database of Korn Ferry Hay Group. For the CEO role, the following companies were included in the benchmark: Autoneum, Bucher Industries, EMS Chemie, Geberit, Georg Fischer, Landis+Gyr, Logitech, Lonza, OC Oerlikon, Sonova, and Sulzer (Swiss listed industrial companies of similar size in terms of market capitalization, revenue, and employees).

The compensation paid to the EC members must in principle be based on the market median in the relevant national or regional market and must be within a range of –20% to +35% of this figure. The variable component of compensation (= short- and long-term incentives) is targeted to make up for at least 50% of the overall compensation.

1. Annual base salary

EC members receive an annual base salary for fulfilling their role. It is based on the following factors:

• Content, responsibilities and complexity of the function;
• External market value of the respective role: amount paid for comparable positions in the industrial sector in the country where the member works;
• Individual profile in terms of skill set, experience, and seniority.

2. Benefits

As the EC is international in its nature, the members participate in the benefits plans available in their country of employment. Benefits consist mainly of retirement, insurance, and health care plans that are designed to provide a reasonable level of protection for the participants and their dependents in respect to the events of retirement, disability, death, and illness/accident. The EC members with a Swiss employment contract participate in the occupational pension plans offered to all employees in Switzerland, which consist of a basic pension fund and a supplementary plan for management positions. The pension fund of dormakaba in Switzerland is in line with benefits provided by other Swiss multinational industrial companies.

EC members under foreign employment contracts are insured commensurately with market conditions and with their position. Each plan varies in line with the local competitive and legal environment and is, as a minimum, in accordance with the legal requirements of the respective country.

Further, EC members are also provided with certain executive perquisites such as company car or car allowance, representation allowance, and other benefits in kind according to competitive market practice in their country of employment.

3. Variable compensation

The variable compensation consists of a short-term incentive (STI) and long-term incentive (LTI).

3.1 Short-term incentive

The short-term incentive is defined annually as a cash payment and aims to motivate the participants to meet and exceed the company’s financial objectives, which are defined in line with the Group’s strategy. Pursuant to the Article of Incorporation 24 the short-term incentive may not exceed 150% of the individual annual base salary for the EC members (cap).

Following the “We are ONE company” principle, the individual short-term incentive paid to the EC members is strictly based on Group and segment financial objectives and not on individual goals. For the CEO and other EC members (CFO, CTO [Chief Technology Officer], CMO [Chief Manufacturing Officer]), the incentive formula relates exclusively to Group results. For the Chief Operating Officers (COOs), it relates to segment results and Group results as follows:

The business results are compared to the previous year’s results to drive a continuous improvement of the business achievements, year after year.

The incentive formulas for all EC members are built around the following principle: the short-term incentive consists of a predefined share of profit, which is determined for each function individually, multiplied by a growth multiplier and, for COOs, by a net working capital (NWC) multiplier (see the following illustration).

The predefined share of profit is expressed as a percentage of Group net income or as a percentage of segment EBIT. The growth multiplier depends on the company’s or on the segment’s revenue growth compared to previous year and is capped at 1.6 in case of substantial growth; the net working capital (NWC) multiplier depends on the segment’s change of net working capital compared to previous year and is capped at 1.4 in case of substantial reduction of net working capital.

This formula is aligned to the business strategy of profitable growth because it rewards for bottom-line (Group net income or segment EBIT) and top-line results (sales growth).
Further, for the COOs responsible for a segment, the formula also includes an NWC multiplier, which reflects the focus on efficient management of the company’s financial resources.

The calculation of the short-term incentive is based – just as the audited financial statements of the Group – on the actual figures recorded in the financial reporting system. Special effects that have a material impact on the financial results, such as significant acquisitions and divestments or extraordinary results representing merger-related integration costs, are excluded so that the financial results are comparable to previous year. There was no such special effect in the reporting year.

3.2 Long-term incentive

The purpose of the long-term incentive is to give the EC an ownership interest in dormakaba and a participation in the long-term performance of the company and thus to align their interests to those of the shareholders.

At the beginning of the long-term incentive plan cycle (grant date), EC members are awarded restricted shares and performance share units of dormakaba on the basis of the following criteria:

• External benchmark: typical grant size of long-term incentive for a similar function in the relevant market and positioning of the individual’s total direct compensation compared to that benchmark. Total direct compensation includes fixed base salary plus short-term incentive plus allocation under the long-term incentive plan.
• Individual performance: measured against predefined priorities in the financial year prior to the grant, as documented within the performance management process. The long-term incentive is the only compensation program that takes into consideration the individual performance of the EC members. For each member, a list of individual strategic priorities is determined before the start of each financial year based on the mid-term plan of the Group, segment or function. At the end of each financial year, the individual performance of the member is evaluated against those strategic priorities and will be considered for the determination of the grant size of the long-term incentive in the following financial year.
• Strategic importance: impact of the EC member's projects on the long-term company's success.
• Retention: desire to retain the person to the company and to its overall long-term value creation by offering restricted shares and performance share units subject to a three-year vesting period.

Based on the above criteria, the CEO formulates a proposal for long-term incentive awards of the individual EC members and other members of Senior Management, which is subject to approval by the Compensation Committee. For the CEO, the Compensation Committee Chair formulates a proposal that is subject to the approval of the Compensation Committee. Starting with financial year 2018/19, the long-term incentive grant size is determined as a monetary amount (in previous years: number of shares). Pursuant to the Article of Incorporation 24 the fair value of the long-term incentive at grant may not exceed 150% of the individual annual base salary for the EC members (cap).

The long-term incentive award is split into two components: two-thirds are granted in form of restricted shares of dormakaba subject to a three-year blocking period. This component of the award is designed to provide participants an ownership interest in the long-term value creation of the company by making them shareholders. The remaining third of the award is granted in form of performance share units of dormakaba subject to a three-year performance-based vesting period. This component of the award is designed to reward participants for the future performance of the earnings per share (EPS) and the relative Total Shareholder Return (TSR) of the company over the three-year performance period. The vesting level may range from 0% to a maximum of 200% of the original number of units granted (maximum two shares for each performance share unit originally granted).

The TSR performance condition has been introduced in the long-term incentive plan starting with the grant in September 2018. TSR is measured relative to companies of the Swiss Market Index Mid (SMIM) and provides for a full vesting for median performance. The EPS growth target is fully aligned with dormakaba’s communicated strategy of organic sales growth, which is to outperform weighted GDP growth by 2% points. The vesting formula for both performance indicators is illustrated below, there is no vesting below the threshold levels of performance:

In summary, while the long-term incentive award is granted on the basis of factors related to the function (strategic importance) and the individual (positioning versus benchmark, performance, retention need), the vesting of the performance share units depends on future company performance (measured by EPS development and relative TSR).

Restricted shares and performance share units are usually awarded annually in September. In case of voluntary termination by the participant or termination for cause by the company, restricted shares remain blocked and the performance share units are forfeited without any compensation. In case of termination without cause or retirement, restricted shares remain blocked and the performance share units are subject to a pro rata vesting at the regular vesting date. In case of disability, death or change of control, the blocking period of the shares is lifted and performance share units are subject to an accelerated pro rata vesting based on a performance assessment by the BoD (see also Corporate Governance Report 'Changes of control and defense measures'). The conditions for the award of shares and performance share units are governed by the stock award plans of dormakaba.

Shares awarded in recent years have come from treasury shares and to a small extent from conditional capital.

Starting with the long-term incentive grant in September 2019, the mix between restricted shares and performance share units will be shifted towards more performance share units to further align to market practice: half of the grant will be awarded in form of performance share units and half of the grant will be awarded in form of restricted shares. Further, the long-term incentive awards will be subject to clawback and malus provisions. In certain circumstances, such as in case of financial restatement due to material non-compliance with financial reporting requirements or of fraudulent behavior or substantial willful misconduct, the BoD may decide to suspend the vesting or forfeit any granted long-term incentive award (malus provision) or to require the reimbursement of vested shares delivered under the long-term incentive (clawback provision).

4. Employment contracts

The EC members are employed under employment contracts of unlimited duration that are subject to a notice period of up to twelve months. EC members are not contractually entitled to termination payments or any change of control provisions other than the accelerated vesting and/or unblocking of share awards mentioned above. The employment contracts of the EC members may include non-competition clauses for a duration of up to a maximum of two years. In cases where the company decides to activate the non-competition provisions, the compensation paid in connection with such non-competition provisions may not exceed the monthly base salary, or half of the total compensation, for a period of twelve months.

5. Shareholding ownership guideline

The EC members are required to own a minimum multiple of their annual base salary in dormakaba shares within five years of hire or promotion to the EC, as set out in the following table.

To calculate whether the minimum holding requirement is met, all vested shares are considered regardless of whether they are restricted or not. However, unvested performance share units are excluded from the calculation. The Compensation Committee reviews compliance with the share ownership guideline on an annual basis. In the event of a substantial rise or drop in the share price, the BoD may, at its discretion, review the minimum ownership requirement.

6. Assessment of actual compensation paid to the EC in the 2018/19 financial year

In comparison to the previous year, total direct compensation (TDC) of the EC decreased by 12%. There are several factors that impacted the level of actual compensation paid to the EC in the 2018/19 financial year, which are summarized below.

• Change in EC composition: three former EC members are no longer reported in this financial year. All relevant compensation was reported in the Compensation Report for the financial year 2017/18. On the other side, one new EC member is reported on a full-year basis in this financial year versus pro rata in previous year.
• Changes in currency exchange rates: five members of the EC are paid in foreign currencies (three in Euros). Their compensation is converted into Swiss francs for the disclosure in this report. Due to the stronger Swiss franc against other major currencies compared to the previous year, especially with the Euro, the amounts disclosed in Swiss francs decreased even when the compensation amount in local currency has remained unchanged.
• Base salary increases: the base salary of one EC member was adjusted during the reporting year. The base salaries of the other EC members did not change compared to the previous financial year. The base salary increase amounts to 0.8% for the EC overall.
• STI payout: the STI payout formula is based on performance improvements versus previous year (and not on the achievement of budgeted targets). A payout of 111% of annual base salary (on average) for the EC members corresponds to the level of expected performance for the financial year 2018/19. The STI payout of the EC members reflects the underlying financial performance in the reporting year, especially the increase in Group net income which is the main driver of the STI payout for the CEO and EC members with global responsibility (CFO, CTO, CMO). All segment (COOs) contributed to the increased profitability compared to the previous year (increased EBITDA and EBIT as well as increased EBITDA margin and EBIT margin). All segments except AS AMER contributed to the organic sales growth of the Group. In the reporting year, the STI payout of EC members is 94% of annual base salary on average (previous year 84%). For the CEO, the STI payout is capped to 150% of annual base salary, as in previous year and as foreseen by the Article of Incorporation 24. Without applying the cap in both years, the STI amount in the reporting year would have been 8% higher than in the previous year.
• LTI grant in September 2018: the long-term incentive grant size was determined as monetary amount for the first time (previous year: number of shares). To determine the grant size following the change, the historical grant value as well allocation criteria that were in place for several years (described under section 3.2) such as individual performance in previous year, strategic importance of the projects under responsibility, position against benchmark and retention need were considered. Based on those factors and on the individual performance (achievement of strategic priorities in the year preceding the grant date), the LTI grant size of the CEO and one other EC member was increased compared to previous year, while it was decreased for two EC members. For the other EC members, the LTI grant size remained unchanged compared to previous year. The strategic priorities of the CEO for financial year 2017/18 (considered for determining the grant size in the reporting year) are detailed below and have been implemented successfully.

The performance share units granted under the long-term incentive in September 2015 vested in September 2018 based on the EPS growth over the three-year vesting period at a vesting level of 102.9%. The share price at vesting amounted to CHF 713.00 compared to CHF 653.00 at grant.

Variable compensation forms a major part of total direct compensation (TDC). The percentage of overall compensation paid to the EC as variable compensation in the reporting year was 67% (excluding benefits and social security contributions) and remained stable (previous year 64%). Variable compensation paid out in shares accounted to 32% of TDC (previous year 30%), which is in line with the compensation strategy (communicated in the previous Compensation Reports) to award 30% of total compensation in shares by applying compensation increases primarily on the long-term incentive component rather than on the other compensation elements.

At the AGM 2017, the shareholders approved a maximum aggregate amount of CHF 19,500,000 for the EC for the financial year 2018/19. The compensation effectively awarded of CHF 12,915,283 is within the limits approved by the shareholders.

As at 30 June 2019, in compliance with the Articles of Incorporation, there were no outstanding loans or credit facilities between dormakaba and current or former EC members, or parties closely related to them. Investments held by EC members or related persons (including conversion and option rights) – if any – are listed here.