Internal management system of the Merck Group
As a global company with a diverse portfolio of products and services, Merck uses a comprehensive framework of indicators to manage performance. The most important KPI (key performance indicator) to measure performance is EBITDA pre one-time items.
The Value Creation and Financial KPI Pyramid, which summarizes the important financial performance measures of the Merck Group, reflects the comprehensive framework of financial KPIs to steer the businesses and prioritize the allocation of cash resources. It consists of three managerial dimensions, which require the use of different indicators: Merck Group, Business and Projects.
Abbreviations
EBITDA pre = Earnings before interest, income tax, depreciation and amortization pre one-time items
EPS = Earnings per share
MEVA = Merck value added
BFCF = Business free cash flow
ROCE = Return on capital employed
NPV = Net present value
IRR = Internal rate of return
eNPV = expected Net present value
PoS = Probability of success
Key performance indicators of the Merck Group and its businesses
The three key performance indicators sales, EBITDA pre one-time items1, and business free cash flow1 are the most important factors for assessing operational performance. Reference to these KPIs can therefore be found in the Report on Economic Position, the Report on Risks and Opportunities, and in the Report on Expected Developments. As the most important indicators of Merck’s financial business performance, the KPIs are key elements of Merck’s performance management system.
Sales
Sales are defined as the revenues from the sale of goods and services rendered to external customers net of value added tax and after sales deductions such as rebates or discounts. Sales are the main indicator of business growth in the Merck Group and therefore an important parameter of external as well as internal performance measurement.
Merck Group → Sales
Show table| € million / change in % | 2014 | 2013 | Change |
|---|---|---|---|
| Sales | 11,291.5 | 10,700.1 | 5.5 |
EBITDA pre one-time items
EBITDA pre one-time items is the main performance indicator measuring ongoing operational profitability and is used internally and externally. To allow for a better understanding of the underlying operational performance, it excludes from the operating result depreciation and amortization as well as one-time items. One-time items are restricted to the following categories: impairments, integration costs / IT costs, restructuring costs, gains / losses on the divestment of businesses, acquisition costs, and other one-time items. The classification of specific income and expenses as one-time items follows clear definitions and underlies strict governance at Group level. Within the scope of internal performance management, EBITDA pre allows for the necessary changes or restructuring without penalizing the performance of the operating business.
Merck Group → Reconciliation EBIT to EBITDA pre one-time items
Show table| € million / change in % | 2014 | 2013 | Change |
|---|---|---|---|
| Operating result (EBIT) | 1,762.0 | 1,610.8 | 9.4 |
| Depreciation and amortization | 1,261.6 | 1,237.9 | 1.9 |
| Impairment losses / Reversals of impairment losses | 99.3 | 220.5 | – 55.0 |
| EBITDA | 3,122.9 | 3,069.2 | 1.7 |
| Restructuring costs | 83.9 | 130.5 | – 35.7 |
| Integration costs / IT costs | 87.2 | 49.0 | 78.0 |
| Gains / losses on the divesment of businesses | – 1.9 | 2.3 | – 182.6 |
| Acquisition-related one-time items | 85.0 | 0.0 | – |
| Other one-time items | 10.6 | 2.3 | 365.2 |
| EBITDA pre one-time items | 3,387.7 | 3,253.3 | 4.1 |
Business free cash flow (BFCF)
Business free cash flow comprises the major cash-relevant items that the individual businesses can influence and are under their full control. It sums up EBITDA pre one-time items less investments in property, plant and equipment, software, advance payments for intangible assets, as well as changes in inventories and trade accounts receivable. To manage working capital on a regional and local level, the businesses use the two indicators days sales outstanding and days in inventory.
Merck Group → Business Free Cash Flow
Show table| € million / change in % | 2014 | 2013 | Change |
|---|---|---|---|
| EBITDA pre one-time items | 3,387.7 | 3,253.3 | 4.1 |
| Investments in property plant and equipment and software as well as advance payments for intangible assets | – 527.5 | – 446.2 | 18.2 |
| Changes in inventories as reported in the balance sheet | – 185.5 | 59.7 | – |
| Changes in trade accounts receivable as reported in the balance sheet |
– 214.2 | 93.2 | – |
| Adjustment first-time consolidation of AZ Electronic Materials S.A. |
144.6 | – | – |
| Business free cash flow | 2,605.1 | 2,960.0 | – 12.0 |
Investments and value management
Sustainable value creation is essential to secure the long-term success of Merck. To optimize the allocation of financial resources, Merck uses a defined set of parameters as criteria for the prioritization of investment opportunities and portfolio decisions.
Net present value
The main criterion for the prioritization of investment opportunities is net present value. It is based on the discounted cash flow method and is calculated as the sum of the discounted free cash flows over the projection period of a project. Consistent with the definition of free cash flow, the weighted average cost of capital (WACC), representing the weighted average of the cost of equity and cost of debt, is used as the discount rate. Depending on the type and location of a project different mark-ups are applied to the WACC.
Internal rate of return (IRR)
The internal rate of return is a further important criterion for the assessment of acquisition projects and investments in property, plant and equipment. It is the discount rate that makes the present value of all future free cash flows equal to the initial investment or the purchase price of an acquisition. A project adds value if the internal rate of return is higher than the weighted cost of capital including mark-ups.
Return on capital employed (ROCE)
In addition to NPV and IRR, ROCE is an important metric for the assessment of investment projects. It is calculated as the operating result (EBIT) pre one-time items divided by the sum of property, plant and equipment, intangible assets, trade accounts receivable and trade accounts payable, as well as inventories.
Payback period
An additional parameter to prioritize investments into property, plant and equipment is the payback period, which indicates the time in years after which an investment will generate positive net cash flow.
Merck value added (MEVA)
MEVA gives information about the financial value created in a period. Value is created when the return on capital employed (ROCE) of the company or the business is higher than the weighted average cost of capital (WACC). MEVA metrics provide Merck with a powerful tool to weigh investment and spending decisions against capital requirements and investors’ expectations.
Capital Market-Related Parameters
Net income and earnings per share (EPS)
Earnings per share are calculated by dividing profit after tax attributable to the shareholders of Merck KGaA (net income) by the weighted average number of theoretical shares outstanding. The use of a theoretical number of shares takes into account the fact that the general partner’s capital is not represented by shares. To provide a more comparable view, Merck also publishes EPS pre, which excludes one-time items and amortization of intangible assets and is based on the company’s underlying tax ratio.
Credit rating
The rating of Merck’s credit worthiness by external agencies is an important indicator with respect to the company’s ability to raise debt capital at attractive market conditions. The capital market makes use of the assessments published by independent rating agencies in order to assist debt providers in estimating the risks associated with a financial instrument. Merck is currently assessed by Moody’s and Standard & Poor’s (S&P). The most important factor for the credit rating is the ability to repay debt, which is determined in particular by the ratio of operating cash flow to (net) financial debt.
Dividend ratio
With the aim of ensuring an attractive return to shareholders, Merck pursues a reliable dividend policy with a target payout ratio based on EPS pre one-time items (see definition above).
Other Relevant / Non-Financial Performance Measures
Apart from the indicators of the financial performance of the businesses, non-financial measures also play an important role in furthering the success of the company. From a Group perspective, specifically innovations in the businesses as well as the attraction and retention of highly qualified employees are of central importance.
Innovation
Innovation is the foundation of the business and will also be the prerequisite for future success in changing markets. Merck is continuously working to develop new products and service innovations for patients and customers. Indicators for the degree of innovation are defined individually depending on the specifics of the respective businesses.
Talent retention
Employing a highly qualified and motivated workforce is the basis for achieving Merck’s ambitious business goals. Therefore, Merck puts a strong focus on establishing the processes and the environment needed to attract and retain the right talent with the right capabilities at the right time. To measure the success of the related measures, Merck has implemented talent retention as an important non-financial indicator.
1 Financial indicators not defined by International Financial Reporting Standards.