ZIMMER HOLDINGS, INC.
345 East Main Street
Warsaw, Indiana 46580

 

March 19, 2010

 

Dear Stockholder:

We look forward to your attendance either in person or by proxy at the 2010 Annual Meeting of Stockholders of Zimmer Holdings, Inc. We will hold the meeting at 9:00 a.m. Eastern Time on Monday, May 3, 2010 at the Conrad Indianapolis, 50 West Washington Street, Indianapolis, Indiana.

You will find information regarding the matters to be voted on in the attached Notice of Annual Meeting of Stockholders and Proxy Statement. We are sending many of our stockholders a notice regarding the availability of this proxy statement, our 2009 Annual Report on Form 10-K and other proxy materials via the Internet. This electronic process gives you fast, convenient access to the materials, reduces the impact on the environment and reduces our printing and mailing costs. A paper copy of these materials can be requested using one of the methods described in the materials.

Your vote is important. Whether or not you plan to attend the meeting in person, it is important that your shares be represented. Please vote as soon as possible.

 

 

David C. Dvorak

President and

Chief Executive Officer

 

Zimmer Holdings, Inc.
345 East Main Street
Warsaw, Indiana 46580

 

 

 

 

 

By Order of the Board of Directors

 

 

Chad F. Phipps

Senior Vice President, General Counsel and Secretary

 

March 19, 2010

 

TABLE OF CONTENTS

 

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

 

ZIMMER HOLDINGS, INC.

PROXY STATEMENT

 

 

This proxy statement and accompanying proxy are being provided to stockholders on or about March 19, 2010 in connection with the solicitation by the Board of Directors of Zimmer Holdings, Inc. (“Zimmer,” “we,” “us,” “our” or the “company”) of proxies to be voted at the 2010 annual meeting on May 3, 2010.

 

Why did I receive these materials or a Notice regarding the Internet availability of proxy materials?

 

On or about March 19, 2010, we mailed a Notice of Internet Availability of Proxy Materials (“Notice”) to most of our stockholders and a printed copy of the proxy materials to those stockholders who had previously requested a printed copy. The Notice instructs stockholders as to how to access and review this proxy statement and our 2009 Annual Report over the Internet, and how to submit your proxy to vote at the annual meeting.

This proxy statement, the form of proxy and voting instructions are being made available to our stockholders on March 19, 2010 at www.proxyvote.com. Our 2009 Annual Report, including financial statements for the year ended December 31, 2009, is being made available at the same time and by the same method. The 2009 Annual Report is not to be considered as part of the proxy solicitation materials or as having been incorporated by reference.

 

Who is entitled to vote at the annual meeting?

 

Holders of record of our $0.01 par value common stock at the close of business on March 4, 2010 are entitled to vote at the meeting. As of that date, there were 202,767,904 shares of common stock outstanding and entitled to vote. We are soliciting proxies on behalf of the Board of Directors to give all stockholders who are entitled to vote on the matters that come before the meeting the opportunity to do so whether or not they attend the meeting in person.

 

What will stockholders vote on at the meeting?

 

 

 

Will there be any other items of business on the agenda?

 

We do not expect any other items of business because the deadline for stockholder proposals and nominations has already passed. Nonetheless, in case there is an unforeseen need, the accompanying proxy gives discretionary authority to the persons named on the proxy with respect to any other matters that might be brought before the meeting. Those persons intend to vote that proxy in accordance with their best judgment.

 

What are the recommendations of the Board of Directors on how I should vote my shares?

 

The Board of Directors recommends that you vote your shares as follows:

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

 

What are my voting rights?

 

Holders of our common stock are entitled to one vote per share.

 

How can I vote my shares without attending the meeting?

 

Whether you hold shares directly as a registered stockholder of record or beneficially in street name, you may vote without attending the meeting. You may vote by granting a proxy or, for shares held beneficially in street name, by submitting voting instructions to your broker, trustee or nominee. In most cases, you will be able to do this by using the Internet or telephone or by mail if you received a printed set of the proxy materials.

By Internet – If you have Internet access, you may submit your proxy via the Internet by following the instructions provided in the Notice, or if you received a printed version of the proxy materials by mail, by following the instructions provided with your proxy materials and on your proxy card or voting instruction card.

By Telephone or Mail – If you received printed proxy materials, you may submit your proxy by telephone by following the instructions provided on your proxy card or voting instruction card. If you received a Notice, you may submit your proxy by telephone after accessing the proxy materials via the Internet. You may also submit your proxy by mail by signing your proxy card if your shares are registered or, for shares held beneficially in street name, by following the voting instructions included by your broker, trustee or nominee, and mailing it in the envelope provided. If you provide specific voting instructions, your shares will be voted as you have instructed.

 

How do I vote my shares in person at the meeting?

 

Either an admission ticket or proof of ownership of our common stock, as well as a form of personal identification, must be presented in order to be admitted to the meeting. If you are a stockholder of record and received a Notice, your Notice is your admission ticket. If you are a stockholder of record and received a printed copy of the proxy materials, you must bring the admission ticket portion of your proxy card to be admitted to the meeting. If you are a beneficial holder and wish to vote in person at the meeting, you must obtain from your broker, trustee or other nominee holder a legal proxy issued in your name and present it to the inspectors of election with your ballot to be able to vote at the meeting. We encourage you to vote via the Internet, by telephone or by mail even if you plan to attend the meeting.

 

What can I do if I change my mind after I vote my shares?

 

If you are a stockholder of record, you may revoke your proxy at any time before it is voted at the meeting by: (1) giving timely written notice of the revocation to our Corporate Secretary, or (2) submitting a later-dated vote in person at the meeting, via the Internet, by telephone or by mail. If you are a beneficial holder, you may submit new voting instructions by contacting your broker, trustee or other nominee holder. You may also vote in person at the annual meeting if you obtain a legal proxy as described above.

 

What vote is required to approve each proposal?

 

Proposal 1 – Directors receiving the majority of votes cast (where the number of shares voted “for” a director exceeds the number of shares voted “against” the director) will be elected. If you hold your shares in street name, please note that the New York Stock Exchange, or NYSE, rules that guide how brokers vote your stock have changed. Your brokerage firm or other nominee may no longer vote your shares with respect to the election of directors without specific instructions from you as to how to vote. Abstentions and broker non-votes will not be taken into account in determining the outcome of the election of directors. We urge you to provide instructions to your broker so that your votes may be counted on this important matter.

Proposal 2 – Ratification of the selection of PwC as our independent registered public accounting firm requires the affirmative vote of the majority of the shares of common stock present or represented by proxy. This proposal is considered a “routine” matter under NYSE rules, and, therefore, brokerage firms and nominees have the authority under those rules to vote your shares on this proposal if you have not furnished voting instructions at least 10 days before the meeting. Abstentions are treated as shares present or represented and voting, so abstaining has the same effect as a vote “against” this proposal.

 

May I give my proxy to someone other than the individuals listed on the proxy card?

 

If you are a registered stockholder and wish to give your proxy to someone other than the individuals named on the proxy card, you may do so by crossing out the names appearing on the proxy card and inserting the name of another person. The person you have designated on the proxy card must present the signed card at the meeting.

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

 

Who tabulates the votes?

 

Representatives of Broadridge Financial Solutions, Inc. will tabulate the votes and act as independent inspectors of election.

 

Who pays the cost of this proxy solicitation?

 

We will pay the costs of this solicitation. Our employees may solicit proxies on behalf of the Board of Directors by mail, telephone, facsimile, electronic transmission and personal solicitation. In addition, we have retained The Altman Group, Inc. to assist in soliciting proxies for a fee of $7,000, plus out-of-pocket expenses. We will, upon request, reimburse brokerage firms and others for their reasonable expenses incurred for forwarding solicitation material to beneficial holders of stock. Questions concerning proxy voting or process should be directed to The Altman Group, Inc. via telephone at 1 (800) 499-8419 (this call is toll-free in the United States).

 

Is there a list of stockholders entitled to vote at the annual meeting?

 

A list of stockholders entitled to vote at the meeting will be available at the meeting and for ten days prior to the meeting, between the hours of 8:00 a.m. and 5:00 p.m. Eastern Time, at our offices at 345 East Main Street, Warsaw, Indiana. If you would like to view the stockholder list, please contact our Corporate Secretary to schedule an appointment.

The following table sets forth certain information concerning each person (including any group) known to us to beneficially own more than five percent (5%) of our common stock as of March 4, 2010. Unless otherwise noted, shares are owned directly or indirectly with sole voting and investment power.

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

The following table sets forth, as of January 4, 2010, beneficial ownership of shares of our common stock by each current director, each of the executives named in the Summary Compensation Table and all current directors and executive officers as a group. Unless otherwise noted, such shares are owned directly or indirectly with sole voting and dispositive power. None of the shares owned by our directors and executive officers have been pledged as security.

 

 *  Less than 1.0%

Our business is managed under the direction of the Board of Directors. The Board has responsibility for establishing broad corporate policies and for our overall performance.

Our Board is led by a non-executive Chairman of the Board selected from among the independent directors. Until 2007, the positions of chairman of the board and chief executive officer of our company were held by the same person. The Board separated this combined role into two roles — a Chairman who would be responsible for board leadership and a chief executive officer who is responsible for leading the management, operations and employees of our company — when it promoted David C. Dvorak to his current positions as our President and Chief Executive Officer in 2007. Later that year, the Board appointed John L. McGoldrick as non-executive Chairman. Mr. McGoldrick continues to hold this position. The Board believes that this leadership structure allows the Board to function efficiently and effectively and that it continues to be appropriate. However, the Board evaluates its leadership structure on an ongoing basis and may change it as circumstances warrant.

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

The Board of Directors oversees the risk management processes that have been designed and are implemented by our executives to determine whether those processes are functioning as intended and are consistent with our business and strategy. The Board executes its oversight responsibility for risk management directly and through its committees.

The Audit Committee is specifically tasked with overseeing our compliance with legal and regulatory requirements, discussing our risk assessment and risk management processes with management and receiving information on material legal and regulatory affairs, including litigation. Our Vice President, Global Internal and Compliance Audit, who reports directly to the committee, coordinates our global enterprise risk assessment process. We use this process to identify, assess and prioritize internal and external risks, to develop processes for responding to, mitigating and monitoring risks and to inform the development of our internal audit plan, our annual operating plan and our long-term strategic plan. The committee receives detailed reports regarding our enterprise risk assessment process and the committee’s meeting agendas include discussions of individual risk areas throughout the year. Members of our management who have responsibility for designing and implementing our risk management processes regularly meet with the committee. The committee discusses our major financial risk exposures with our Chief Financial Officer and Chief Accounting Officer. The committee also receives reports from our General Counsel, Chief Information Officer, Chief Compliance Officer and other persons who are involved in our risk management processes.

The Board’s other committees oversee risks associated with their respective areas of responsibility. For example, the Compensation and Management Development Committee assesses risks relating to our compensation policies and practices.

The full Board considers specific risk topics, including risk-related issues pertaining to laws and regulations enforced by the U.S. Food and Drug Administration and foreign government regulators and risks associated with our strategic plan and our capital structure. In addition, the Board receives detailed regular reports from members of our executive operating committee and other personnel that include discussions of the risks and exposures involved with their respective areas of responsibility. Further, the Board is routinely informed of developments that could affect our risk profile or other aspects of our business.

We are committed to maintaining the highest standards of business conduct and corporate governance, which we believe are essential to running our business efficiently, serving stockholders well and maintaining our integrity in the marketplace. We have adopted a Code of Business Conduct that applies to all directors, officers and employees and a Code of Ethics for Chief Executive Officer and Senior Financial Officers. The Board of Directors has adopted Corporate Governance Guidelines, which, in conjunction with our Restated Certificate of Incorporation, Restated By-Laws, Board committee charters and key Board policies, form the framework for our governance. The current version of the Code of Business Conduct, the Code of Ethics for Chief Executive Officer and Senior Financial Officers, the Board’s Corporate Governance Guidelines and the charters for each of the Audit Committee, Compensation and Management Development Committee, Corporate Governance Committee and Science and Technology Committee, as well as the Board’s policies on auditor ratification and stockholder rights plans, are available in the Investor Relations/Corporate Governance section of our website, www.zimmer.com. We will post on our website any substantive amendment to, or waiver from, the Code of Ethics for Chief Executive Officer and Senior Financial Officers or a provision of the Code of Business Conduct that applies to any of our directors or executive officers. The Board regularly reviews corporate governance developments and modifies its Corporate Governance Guidelines, committee charters and key practices as warranted.

The Board’s Corporate Governance Guidelines, which are available on our website as described above, include criteria adopted by the Board to assist it in making determinations regarding the independence of its members. The criteria are consistent with the NYSE listing standards regarding director independence. To be considered independent, the Board must determine that a director has no material relationship, directly or indirectly, with us. In assessing independence, the Board considers all relevant facts and circumstances. The Board has determined that each of our non-employee directors, Betsy J. Bernard, Marc N. Casper, Larry C. Glasscock, Robert A. Hagemann, Arthur J. Higgins, John L. McGoldrick, Cecil B. Pickett, Ph.D. and Augustus A. White, III, M.D., Ph.D., meets these standards and is independent. The Board has determined that David C. Dvorak, who is an employee, is not independent.

In making its determination with respect to Mr. Casper, the Board considered his position as President and Chief Executive Officer of Thermo Fisher Scientific Inc., or Thermo Fisher, a leading provider of analytical instruments, equipment, software and services for research, manufacturing, analysis and diagnostics from which we purchase certain products. During 2009, the amount we paid Thermo Fisher exceeded $1,000,000 but represented less than one percent of Thermo Fisher’s gross revenues. After reviewing the terms of these transactions, the Board determined that Mr. Casper does not have a direct or indirect material interest in the transactions and that our business relationship with Thermo Fisher does not diminish the ability of Mr. Casper to exercise his independent judgment on issues affecting our business.

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

The Corporate Governance Committee, in recommending the nominees for election as directors, considered the knowledge, experience, integrity and judgment of each candidate; the potential contribution of each candidate to the diversity of backgrounds, experience and competencies which the Board desires to have represented; and each candidate’s ability to devote sufficient time and commitment to his or her duties as a director. The Corporate Governance Committee also took into account the specific core competencies or technical expertise necessary to staff Board committees. Since each nominee for director is currently on our Board of Directors, the Corporate Governance Committee also considered the significant contributions that each such individual has made to our Board of Directors and its committees during his or her tenure as a Director. The Corporate Governance Committee believes that each of the nominees possesses the judgment and integrity necessary to make independent decisions and a willingness to devote adequate time to Board duties. In addition, the Corporate Governance Committee believes that each of the nominees brings his or her own particular experiences and set of skills, giving the Board, as a whole, competence and experience in a wide variety of areas. Additional biographic and other information concerning the directors can be found on pages 12 to 14. Set forth below is a summary description of the experiences, qualifications, attributes and skills that led the Corporate Governance Committee to the conclusion that each such person is qualified to serve as a director:

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

 

Our Restated By-Laws require directors to be elected by the majority of the votes cast with respect to that director in uncontested elections (the number of shares voted “for” a director must exceed the number of votes cast “against” that director). In a contested election (a situation in which the number of nominees exceeds the number of directors to be elected), the standard for election of directors will be a plurality of the shares represented in person or by proxy at any such meeting and entitled to vote on the election of directors. If a nominee who is serving as a director is not elected at the annual meeting, under Delaware law the director would continue to serve on the Board as a “holdover director.” However, under our Restated By-Laws, any director who fails to be elected must offer to tender his or her resignation to the Board. The Corporate Governance Committee would then make a recommendation to the Board whether to accept or reject the resignation, or whether other action should be taken. The Board will act on the Corporate Governance Committee’s recommendation and publicly disclose its decision and the rationale behind it within 90 days from the date the election results are certified. The director who tenders his or her resignation will not participate in the Board’s decision. If a nominee who was not already serving as a director is not elected at the annual meeting, under Delaware law that nominee would not become a director and would not serve on the Board as a “holdover director.” In 2010, all nominees for election as directors are currently serving on the Board.

The Corporate Governance Committee will consider director nominees recommended by stockholders. A stockholder who wishes to recommend a director candidate for consideration by the Corporate Governance Committee should send such recommendation to our Corporate Secretary at the address shown on the cover page of this proxy statement, who will then forward it to the committee. Any such recommendation should include a description of the candidate’s qualifications for board service, the candidate’s written consent to be considered for nomination and to serve if nominated and elected, and addresses and telephone numbers for contacting the stockholder and the candidate for more information. A stockholder who wishes to nominate an individual as a candidate for election, rather than recommend the individual to the Corporate Governance Committee as a nominee, must comply with the advance notice requirements set forth in our Restated By-Laws (see “2011 Proxy Proposals” for more information on these procedures).

In considering candidates for the Board, the Corporate Governance Committee considers the entirety of each candidate’s credentials and does not have any specific minimum qualifications that must be met by a committee-recommended nominee. The committee is guided by the following basic selection criteria for all nominees: independence; highest character and integrity; experience and understanding of strategy and policy-setting; reputation for working constructively with others; and sufficient time to devote to Board matters. The committee also gives consideration to diversity, age, international background and experience and specialized expertise in the context of the needs of the Board as a whole. When the Board has a vacancy or is otherwise looking to add one or more members, the committee typically engages a third-party search firm to assist the committee

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

in identifying and evaluating potential director candidates. If the committee is seeking director candidates with particular experience, qualifications, attributes or skills, it will so instruct the search firm. In the past, the committee has, for example, instructed the search firm to identify candidates who could bring diversity of race, gender and/or international experience to the Board.

The Board has implemented a process whereby our stockholders may send communications to the Board’s attention. Any stockholder desiring to communicate with the Board, or one or more specified members thereof, should communicate in a writing addressed to Zimmer Holdings, Inc., Board of Directors, c/o Corporate Secretary, at the address shown on the cover page of this proxy statement. The Board has instructed our Corporate Secretary to promptly forward all such communications to the specified addressees thereof.

On an annual basis, each director and executive officer is obligated to complete a director and officer questionnaire which requires disclosure of any transactions with us in which the director or executive officer, or any member of his or her immediate family, has an interest. Under our Audit Committee’s charter, which is available on our website at www.zimmer.com, our Audit Committee must review and approve all related person transactions in which any executive officer, director, director nominee or more than 5% stockholder of the company, or any of their immediate family members, has a direct or indirect material interest. The Audit Committee may not approve a related person transaction unless (1) it is in or not inconsistent with our best interests and (2) where applicable, the terms of such transaction are at least as favorable to us as could be obtained from an unrelated third party. No related person transaction in an amount exceeding $120,000 occurred during 2009.

Under our Code of Business Conduct, which is available on our website at www.zimmer.com, our Compliance Officer or an attorney in our Legal Department is charged with reviewing any conflict of interest involving any other employee.

The Board meets on a regularly scheduled basis during the year to review significant developments affecting us and to act on matters requiring Board approval. It also holds special meetings when an important matter requires Board action between scheduled meetings. Members of senior management regularly attend meetings of the Board and its committees to report on and discuss their areas of responsibility. Directors are expected to attend the annual meeting of stockholders. All directors attended the 2009 annual meeting. In 2009, the Board of Directors held 8 meetings and committees of the Board held a total of 27 meetings. Each director attended more than 75% of the total meetings of the Board of Directors and each of the committees on which he or she served during 2009.

Non-management directors meet in executive sessions without management present upon the adjournment of every regularly scheduled meeting of the Board and at other times they determine. Mr. McGoldrick, in his capacity as non-executive Chairman, presides at these meetings of non-management directors.

The Board has adopted a method for communicating directly with the non-management directors and has designated Mr. McGoldrick to receive such communications. Interested parties may contact Mr. McGoldrick via e-mail at john.mcgoldrick@zimmer.com.

Our Restated By-Laws provide that the Board may delegate certain of its responsibilities to committees. During 2009, the Board had four standing committees: an Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, a Compensation and Management Development Committee, a Corporate Governance Committee and a Science and Technology Committee. The membership of each of the Audit Committee, the Compensation and Management Development Committee and the Corporate Governance Committee is composed entirely of independent directors. In addition, the members of the Audit Committee meet the heightened standards of independence for audit committee members required by Securities and Exchange Commission rules and NYSE listing standards. The membership

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

of the Science and Technology Committee is composed of three independent directors and one employee representative, and the committee works together with an Advisory Board of Science and Technology.

The table below shows the current membership of each Board committee and the number of meetings held during 2009.

 

 

Audit Committee.  The principal functions of the Audit Committee include:

 

The Board of Directors has determined that Larry C. Glasscock, Robert A. Hagemann, Arthur J. Higgins and John L. McGoldrick qualify as “audit committee financial experts” as defined by the rules of the Securities and Exchange Commission. See pages 12-13 for a description of their respective business experience. Stockholders should understand that this designation is a Securities and Exchange Commission disclosure requirement related to these directors’ experience and understanding with respect to certain accounting and auditing matters. The designation does not impose upon these directors any duties, obligations or liabilities that are greater than are generally imposed on them as members of the Audit Committee and the Board, and their designation as audit committee financial experts pursuant to this Securities and Exchange Commission requirement does not affect the duties, obligations or liability of any other member of the Audit Committee or the Board.

The report of the Audit Committee appears on pages 10-11.

 

Compensation and Management Development Committee.  The duties of the Compensation and Management Development Committee include:

 

None of the members of the Compensation and Management Development Committee during 2009 or as of the date of this proxy statement is or has been our officer or employee or had any relationship requiring disclosure under Item 404 of Regulation S-K of the Exchange Act. None of our executive officers served on the compensation committee or board of any company that employed any member of the Compensation and Management Development Committee or the Board or otherwise under circumstances requiring disclosure under Item 404 of Regulation S-K.

The report of the Compensation and Management Development Committee appears on page 16.

 

Corporate Governance Committee.  The duties of the Corporate Governance Committee include:

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

 

 

Science and Technology Committee.  The duties of the Science and Technology Committee include:

 

The Audit Committee is responsible for monitoring the integrity of the company’s financial statements, the qualifications, performance and independence of the independent registered public accounting firm, the performance of the company’s internal audit function and compliance with certain legal and regulatory requirements. The committee is directly responsible for the appointment, compensation, retention and oversight of the work of the independent registered public accounting firm.

Management is responsible for the financial reporting process, including the system of internal control, for the preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States and for management’s report on internal control over financial reporting. The independent registered public accounting firm is responsible for auditing the consolidated financial statements and expressing an opinion as to their conformity with accounting principles generally accepted in the United States as well as rendering an opinion on the company’s internal control over financial reporting. The committee’s responsibility is to oversee and review the financial reporting process and to review and discuss management’s report on internal control over financial reporting. Committee members are not, however, professionally engaged in the practice of accounting or auditing and do not provide any expert or other special assurance as to such financial statements concerning compliance with laws, regulations or accounting principles generally accepted in the United States or as to the independence of the independent registered public accounting firm. The committee relies, without independent verification, on the information provided to it and on the representations made by management and the independent registered public accounting firm.

The committee held 11 meetings during 2009. The meetings were designed, among other things, to facilitate and encourage communication among the committee, management, the internal auditor and the independent registered public accounting firm, PricewaterhouseCoopers LLP, or PwC.

The committee discussed with the internal auditor and PwC the overall scope and plans for their respective audits. The committee met with the internal auditor and PwC, with and without management present, to discuss the results of their examinations and their evaluations of the company’s internal control over financial reporting. The committee reviewed and discussed compliance with Section 404 of the Sarbanes-Oxley Act of 2002, including consideration of the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 5, An Audit of Internal Control over Financial Reporting That is Integrated With an Audit of Financial Statements.

The committee discussed major financial risk exposures with management and the steps management has taken to monitor and control such exposures, including risk assessment and risk management policies.

Management has represented to the committee that the consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States, and the committee has reviewed and discussed the consolidated financial statements with management and PwC. The committee reviewed and discussed with management, the internal auditor and PwC management’s report on internal control over financial reporting and PwC’s report on internal control over financial reporting. The committee also discussed with management and the internal auditor the process used to support certifications by the Chief Executive Officer and Chief Financial Officer that are required by the Securities and Exchange Commission and the Sarbanes-Oxley Act of 2002 to accompany periodic filings with the Securities and Exchange Commission and the processes used to support management’s report on internal control over financial reporting.

The committee also discussed with PwC all matters required to be discussed by that firm’s professional standards, including, among other things, matters related to the conduct of the audit of the consolidated financial statements and the matters required to be discussed by AU Section 380, Communication With Audit Committees, as adopted by the Public Company Accounting Oversight Board in Rule 3200 T.

PwC provided to the committee the written disclosures and the letter required by applicable Public Company Accounting Oversight Board requirements and represented that PwC is independent from the company. The committee also discussed with PwC its independence from the company. When considering PwC’s independence, the committee considered if services PwC

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

provided to the company beyond those rendered in connection with its audit and related reviews of the consolidated financial statements and the company’s internal control over financial reporting, were compatible with maintaining its independence. The committee concluded that the provision of such services by PwC has not jeopardized PwC’s independence.

Based on the reviews and discussions described above, and subject to the limitations on the committee’s role and responsibilities referred to above and in the charter of the Audit Committee, the committee recommended to the Board of Directors, and the Board approved, that the audited consolidated financial statements for the year ended December 31, 2009 be included in the Annual Report on Form 10-K for filing with the Securities and Exchange Commission.

The committee has also confirmed there have been no new circumstances or developments since their respective appointments to the Audit Committee that would impair any member’s ability to act independently.

 

Audit Committee

Robert A. Hagemann, Chairman

Larry C. Glasscock

Arthur J. Higgins

John L. McGoldrick

Augustus A. White, III, M.D., Ph.D.

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

 

Eight members of our Board are standing for re-election, to hold office until the 2011 annual meeting of stockholders. Augustus A. White, III, M.D., Ph.D., whose term expires at the meeting, is not seeking re-election. After the election of eight directors at the meeting, there will be one vacancy on the Board. The Board plans to fill the vacancy in due course following the selection of a suitable candidate, in accordance with our Restated Certificate of Incorporation. Certain information about the nominees and Dr. White is set forth below. For more information concerning the qualifications of the directors, see the discussion under “Qualifications of Directors” that begins on page 6.

 

Nominees for Director: 2010 — 2011 Term

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

Nominees for Director: 2010 – 2011 Term (continued)

 

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

 

Current Director Whose Term Expires at the Annual Meeting

Eight directors are to be elected at the meeting for one-year terms ending at the 2011 annual meeting. At the recommendation of the Corporate Governance Committee, the Board has nominated Betsy J. Bernard, Marc N. Casper, David C. Dvorak, Larry C. Glasscock, Robert A. Hagemann, Arthur J. Higgins, John L. McGoldrick and Cecil B. Pickett, Ph.D. for election at this annual meeting. Unless otherwise instructed, the persons named as proxies will vote all proxies received for the election of each of the nominees.

If a nominee is unable or declines to serve as a nominee at the time of the annual meeting, the persons named as proxies may vote for a substitute nominee designated by the Board to fill the vacancy or for the balance of the nominees, leaving a vacancy, or, the Board may reduce its size. The Board has no reason to believe that any of the nominees will be unable or decline to serve if elected.

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT YOU VOTE “FOR” EACH OF THE EIGHT NOMINEES FOR DIRECTOR. 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2010 PROXY STATEMENT

The Audit Committee has appointed PwC as our independent registered public accounting firm for 2010. PwC has served as our independent registered public accounting firm since 2001. Representatives of PwC attended all meetings of the Audit Committee in 2009. We expect that representatives of PwC will be present at the annual meeting and will be available to respond to appropriate questions. They will also have an opportunity to make a statement if they desire to do so.

The Audit Committee’s appointment of PwC is being submitted to the stockholders for ratification. If a majority of stockholders voting on the matter do not ratify the selection, the Audit Committee will reconsider its choice taking into consideration the views of the stockholders and may, but will not be required to, appoint a different independent registered public accounting firm.

The following table shows the fees that we paid or accrued for audit and other services provided by PwC for the years 2009 and 2008. All of the services described in the following fee table were approved in conformity with the Audit Committee’s pre-approval process, described below.

 

 

 

The Audit Committee pre-approves all audit and permissible non-audit services to be provided to us by our independent registered public accounting firm prior to commencement of services. Mr. Hagemann, Audit Committee Chairman, has the delegated authority to pre-approve such services up to a specified aggregate fee amount. These pre-approval decisions are presented to the full Audit Committee at its next scheduled meeting.

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT YOU VOTE “FOR” RATIFICATION OF THE APPOINTMENT OF PWC AS OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR 2010. 

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The Compensation and Management Development Committee of the Board of Directors consists of the six directors named below, each of whom meets the independence standards of the Board’s Corporate Governance Guidelines, the New York Stock Exchange listing standards and applicable securities laws.

We reviewed and discussed with management the Compensation Discussion and Analysis that follows this report. Based on our review and discussions with management, we recommended to the Board of Directors that the Compensation Discussion and Analysis be included in Zimmer’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009 and this proxy statement.

Compensation and Management Development Committee

 

Arthur J. Higgins, Chairman
Betsy J. Bernard
Marc N. Casper
Larry C. Glasscock
John L. McGoldrick
Cecil B. Pickett, Ph.D.

 

Overview

 

This Compensation Discussion and Analysis, or CD&A, provides information about our executive compensation program and explains how and why we arrived at the levels and forms of compensation for 2009 for our President and Chief Executive Officer, or CEO, and the other executive officers named in the Summary Compensation Table on page 26. For purposes of this proxy statement, we refer to these officers as our “named executive officers.” This CD&A should be read in conjunction with the Summary Compensation Table and the other compensation tables and narratives included in this proxy statement.

This CD&A explains the philosophy of our executive compensation program, the decision-making process that the Compensation and Management Development Committee of our Board of Directors, which we refer to as the “committee” in the CD&A, follows to set compensation for the named executive officers, and the major elements of compensation that we employ, including the performance measures used to determine incentive compensation. This CD&A also explains the assessments the committee conducted in 2009 to determine whether our executive compensation program was aligned with our pay-for-performance philosophy and consistent with the management of risk within the company.

 

Our Executive Compensation Program Philosophy

 

We believe that our employees are critical to the success of our business strategy, and we seek to compensate them in a manner that will drive the success of our business, and, in turn, increase stockholder value on a long-term, sustainable basis. Consistent with this philosophy, we design our executive compensation program to accomplish the following:

 

Overview of How Compensation Decisions are Made

 

 

Role of Compensation and Management Development Committee and Input from Management

 

The committee is comprised entirely of independent directors as required by New York Stock Exchange listing standards and consistent with Securities and Exchange Commission Rule 16b-3. The committee is responsible for determining our executive

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compensation strategies, structure, policies and programs and must specifically approve compensation actions relating to our named executive officers.

When setting compensation for our executive officers, the committee receives input from management and from its compensation consultant, Towers Watson & Co., or Towers Watson. (During 2009, the committee’s consultant was Watson Wyatt Worldwide, which merged with another firm to form Towers Watson & Co. in January 2010.) The committee considers data obtained from general market compensation surveys and from our compensation peer group, discussed below. The committee also reviews tally sheets for our named executive officers and considers other factors, including internal equity.

The committee gives significant consideration to the recommendations of management when setting compensation for our named executive officers other than our CEO. Management’s recommendations include specific amounts for base salaries, target cash incentive opportunities and equity-based awards. These recommendations are developed initially by our human resources personnel with the assistance of Towers Watson. We consider such factors as compensation history, tenure, internal equity, responsibilities and retention concerns to maintain consistency among our executives. These recommendations are then reviewed, and may be changed, by our CEO who also considers his own assessment of the performance of each executive officer other than himself. Our CEO, our Senior Vice President, Global Human Resources and our Vice President, Global Compensation, Benefits and HRIS participate in committee meetings, at the request of the committee, to provide background information and explanations supporting compensation recommendations.

The committee itself is responsible for reviewing the performance of our CEO, without his participation, and determining his compensation. The committee considers the organization’s performance on an operational and financial basis and the committee’s assessment of the CEO’s contributions during the year and overall performance. The committee receives input and recommendations with respect to CEO compensation from Towers Watson.

The committee also reviews and approves actions related to other aspects of compensation that affect employees below the senior executive level, including annual incentive plan performance goals, equity award design, equity value ranges and share pools.

 

Role of Compensation Consultant

 

In making its decisions, the committee receives input from Towers Watson. The committee has instructed Towers Watson to provide advice and guidance to the committee on compensation proposals, including changes to compensation levels, the design of incentive plans, the setting of performance goals, and the design of other forms of compensation and benefits programs, as well as relevant information about market practices and trends. Typically, Towers Watson attends committee meetings, reviews existing compensation programs to ensure consistency with our compensation philosophy and current market practices and produces the comparative information derived from peer group and published survey data that the committee reviews when setting compensation. With respect to 2009, Towers Watson’s major activities included:

On occasion, management engages the committee’s consultant to perform services outside of executive or director compensation. The following table shows the fees that we paid or accrued for consulting services related to executive or director compensation and all other services provided by Watson Wyatt Worldwide in 2009. All of the services described in the following fee table were approved or ratified by the committee.

 

 

 

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The committee believes that Towers Watson’s advice is not influenced by any other economic relationship that the firm might have with us. In making this assessment, the committee considered the following:

Pursuant to the committee’s policy, the Towers Watson fee budget for all services to be provided during the fiscal year is presented to the committee for review and approval, generally at the committee’s February meeting. To the extent that a service can be forecasted in advance, approval may be given by the committee as part of the fee budget presented to the committee. With respect to a service that is identified after the budget is approved, the scope and cost of the service are to be provided to the Vice President, Global Compensation, Benefits and HRIS, who will arrange to obtain approval. The committee has delegated to its Chairman the authority to preapprove services to be provided by the committee’s consultant, provided that such services do not exceed an aggregate of $100,000 annually. Any approvals given by the Chairman using this delegation of authority are to be reported to the full committee at its next meeting. Annually, the committee is to receive a report of the total fees we paid to the consultant and its affiliates for executive or director compensation services and all other services.

 

Use of Compensation Survey Data

 

In setting named executive officer compensation, the committee considers market data obtained from published compensation survey sources and from our peer group as explained below. In general, the committee targets each major compensation element at levels which approximate a specific percentile of market, based on this data, as follows:

Using above-median targets for annual cash incentives and equity-based incentives ties a greater proportion of total compensation to the achievement of objective performance measures. The committee’s intention is to provide a total pay opportunity that is comparable to our closest competitors, but which also places a greater emphasis on equity-based compensation. The committee believes that when the actual pay of the named executive officers is dependent upon our financial performance, the interests of the executives are better aligned with those of our stockholders.

Target compensation for individual executive officers may vary from the percentiles shown above based on a variety of factors, such as experience and time in the position, criticality of the role and difficulty of replacement, retention concerns, individual performance and expected future contributions, readiness for promotion to a higher level and, in the case of externally recruited named executive officers, compensation earned at a prior employer. Actual incentive plan payouts and, in turn, total realized compensation, may vary above or below the targeted level based on our performance relative to our corporate financial and strategic goals as well as our stock price performance.

The committee assessed whether our 2009 compensation was consistent with the compensation philosophy explained above by asking Towers Watson to conduct a market review. The committee reviewed an analysis of 2009 compensation for each executive officer, including base salary, annual cash incentive, annual cash compensation (base salary plus annual cash incentive) and long-term incentive compensation. This information was then compared to competitive pay level compensation collected from our peer group, discussed below, and from published compensation surveys. The market review revealed that the base salaries of our executive officers for 2009 were generally consistent with the published survey medians, while the base salaries of our CEO and our Chief Financial Officer, or CFO, continued to be below the peer group median. The market review also found that the target total cash compensation of our executive officers for 2009 was generally consistent with the 65th percentile of the published survey data, while the target total cash compensation of our CEO, our CFO and our Senior Vice President and Chief Scientific Officer were below the 65th percentile of the peer group. Finally, the market review showed that the target long-term incentive grants to each of our named executive officers, based on grant date fair value, was above the 75th percentile of the published survey data, below the 75th percentile of the peer group and, in the case of our CEO and our Chairman, Europe, Middle East and Africa, below the median of the peer group.

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Use of Peer Group Data

 

The committee utilizes compensation data for a peer group of eleven companies to assess named executive officer compensation levels, equity usage and incentive plan design and for performance comparisons. The peer group data is used as one of several inputs the committee considers when making compensation determinations. The committee selected this peer group with the assistance of Towers Watson. The peer group consists of U.S. headquartered publicly traded companies, including companies with whom we compete for business and for executive talent and other large bio-medical manufacturers.

The committee routinely reviews the continuing relevancy of the companies in the peer group and makes changes as circumstances warrant. At the time the committee made compensation decisions for 2009, the peer group consisted of the following companies:

 

In May 2009, the committee reviewed the existing peer group with the assistance of Towers Watson, taking into consideration business focus, market capitalization, revenues, net income and the public availability of compensation and financial performance information. The committee revised the composition of the peer group by removing Baxter International Inc., Biogen Idec Inc. and Genzyme Corporation and adding Beckman Coulter, Inc., Hospira, Inc. and Quest Diagnostics Incorporated. Accordingly, the peer group currently consists of the following companies:

 

 

Internal Equity Considerations

 

The committee reviews the relative pay differences for different executive officers considering not only the market targets described above, but also the responsibilities of the executive, including the nature of the executive’s duties, number of direct reports and other factors, as well as the executive’s tenure and experience in his or her current position, expected future contributions, retention concerns, local market practice for executives outside the United States and compensation earned at prior employers for external recruits. The committee believes that the position of CEO has the greatest opportunity to impact our performance and to ensure that our most senior executives exhibit the behavior necessary to meet our business and compliance objectives. Accordingly, the committee has historically set total target cash compensation (base salary plus target bonus opportunity) for the CEO at a multiple of the total compensation of the next most highly compensated executive officer. Since 2007, the next most highly compensated executive officer after the CEO in terms of total target cash compensation has been the Chairman, Europe, Middle East and Africa. Based in Italy, he is responsible for the sales, marketing and distribution of our products in the European, Middle Eastern and African regions. He has served in his current position since 2003 and has served in senior executive roles with us for 20 years.

In 2007, our new CEO was promoted from another position within the company. He had not been one of our executive officers for as long as his predecessor and, as a result, the historic difference between the compensation of the CEO and that of the other executive officers has been significantly compressed. As part of the market review described above, the committee requested Towers Watson to compare our CEO’s target cash and direct compensation with the average target cash and direct compensation of our other named executive officers. We refer to this relationship as the CEO pay multiple. The committee asked Towers Watson to compare our CEO pay multiple to the CEO pay multiple of each of the companies in our peer group. This comparison revealed that our CEO pay multiple using target total cash compensation (base salary plus target bonus opportunity) was below the 25th percentile of the peer group. The comparison also showed that our CEO pay multiple using target direct compensation (target total cash compensation plus target long-term incentive grant value) was below the 50th percentile of the peer group.

 

Use of Tally Sheets

 

The committee annually reviews tally sheets prepared by its consultant for each of our named executive officers. These tally sheets detail the value of each element of the executive’s compensation for the current and four previous years. The tally sheets

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serve as a concise historical summary of total compensation and benefits. They also reflect the current realizable value of vested equity awards as well as the value of unvested equity awards. The tally sheets assist the committee in understanding the levels of executive compensation that have been, and are being, received by our named executive officers. They also assist the committee in analyzing the potential wealth creation of long-term incentive awards and the retentive value of unvested equity awards.

 

Major Elements of Compensation

 

There are three major elements of our executive compensation program: base salary, annual cash incentives and long-term equity-based incentives. Our retirement plans and welfare benefits are generally available to all employees, including our named executive officers, and we also provide a limited range of perquisites or other benefits.

 

Base Salary

 

We use base salary to provide a fixed component of compensation to our named executive officers, as a recruiting and retention tool and to recognize individual performance and responsibility through annual merit reviews and promotional increases. As explained above, an executive’s base salary may vary from the 50th percentile of market due to the nature of his or her responsibilities, individual performance, tenure, internal equity, retention concerns and other factors. The salaries earned by our named executive officers appear in the Summary Compensation Table under the “Salary” column. The narrative discussion following the Summary Compensation Table provides further information regarding 2009 base salary increases for each named executive officer.

 

Annual Cash Incentives

 

We provide annual incentive compensation in the form of a market-competitive, performance-based cash bonus to focus our executives on pre-set objectives each year and drive specific behaviors that foster short-term and long-term growth and profitability. We use our Executive Performance Incentive Plan, or EPIP, for this purpose. Each executive officer is eligible for an annual award opportunity in an amount based upon a percentage of his or her base salary. The executive officers believed to have the greatest responsibility for our overall performance in the coming year are assigned the highest percentages so that more of their total compensation is tied to achievement of objective performance measures.

The performance objectives used in the EPIP are established by the committee at the beginning of each year. In recent years, the committee has set specific goals for three performance measures — adjusted earnings per share (weighted at 50%), consolidated revenue (weighted at 25%) and consolidated free cash flow (weighted at 25%) — derived from the operating plan approved by the Board for that year. This allocation is consistent with the committee’s belief that earnings per share is the performance measure that correlates most directly with stockholder value.

Actual payouts under the EPIP depend upon the extent to which we achieve the performance measure goals. Payouts generally range from 0% of a specified percentage of base salary if we fail to achieve at least 85% of the goal, to a maximum of 200% of the specified percentage if we achieve 120% or more of the goal. Payouts cannot exceed two times the specified percentage of base salary. For 2009, in light of the continuing deterioration in the global economy and in an effort to drive a focus on improved financial performance, the committee reduced the payout percentages associated with below-target performance. Our actual performance against the targets set by the committee was as follows:

 

 

 

As a result, the EPIP payout percentage applicable to our named executive officers for 2009 was 91.9% of their target awards. The dollar amount of the EPIP payout to each of our named executive officers for 2009 appears in the Summary Compensation Table under the “Non-Equity Incentive Plan Compensation” column. Additional information about the EPIP appears in the narrative discussion that follows the Summary Compensation Table. In addition, the annual EPIP opportunity for each named executive officer appears in the Grants of Plan Based Awards in 2009 table under the heading “Estimated Possible Payouts Under Non-Equity Incentive Plan Awards.”

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Equity-Based Incentives

 

Historically, the committee has made annual awards of long-term incentive compensation opportunities to management-level employees, including our named executive officers. These awards have included stock options, restricted stock, performance shares and performance-based RSUs. We believe the ownership stake provided by these equity-based incentives when combined with the multiple-year vesting or performance periods aligns our executives’ interests with the interests of our stockholders and promotes executive retention. The awards are made under our stockholder-approved equity-based incentive plans.

The committee routinely reconsiders the design of our long-term incentive compensation program with Towers Watson’s assistance and considers emerging market trends, the incentive compensation practices of our peer companies and the impact of outstanding equity awards. For 2009, the committee decided to change the mix of equity-based awards granted to the named executive officers from stock options only to a mix of stock options and performance-based RSUs that combined achievement of objective performance goals with multi-year vesting requirements.

In 2009, the committee changed from a fixed-share to a value-based approach in determining equity-based awards to the named executive officers. The committee believed that the change would reduce unintended variability in the value of awards resulting from fluctuations in our stock price. Based on competitive compensation data and the market targets described above, the committee first determined the value of the awards to be granted. Then, using valuation methods determined by the committee in consultation with Towers Watson, the award was allocated into stock options and performance-based RSUs.

The committee determined that, subject to the limit on full value awards under our 2006 Stock Incentive Plan, the named executive officers should receive approximately fifty percent of the value of their total annual equity-based award in stock options that vest ratably over a four-year period, and approximately fifty percent in performance-based RSUs that are also subject to time-based vesting requirements. Due to the limit on full value awards under the plan, the named executive officers received approximately sixty percent of the value of their total equity-based award in stock options and approximately forty percent in performance-based RSUs.

Stock Options.  We believe stock options are an effective means to align the interests of executives with those of our stockholders because stock options only have value if our stock price increases after the stock options are granted. Our stock options vest at the rate of one-fourth per year over four years, beginning one year from the grant date, and expire ten years from the grant date. The exercise price for the stock options is based on the average of the high and low sales prices of our stock on the grant date. The grant date fair value of the stock options awarded to our named executive officers appears in the Summary Compensation Table under the “Option Awards” column.

Performance-based RSUs.  The performance-based RSUs granted to the named executive officers in 2009 could have been earned based upon the extent to which we achieved the performance measure set by the committee. The committee chose adjusted earnings per share as the sole performance measure for this component of the 2009 equity-based award because it believed this performance measure would correlate most closely with the creation of stockholder value. Before selecting this performance measure, the committee considered the fact that adjusted earnings per share is also one of the three performance measures used in the EPIP and discussed the potential impact of utilizing the same performance measure under both plans. The committee ultimately decided that it was appropriate to tie the performance-based RSU component of the equity-based award to the achievement of this measure. The target approved by the committee and our actual 2009 performance are set forth above under “Annual Cash Incentives.” As a result of our actual 2009 performance, approximately 84.66% of the target number of each named executive officer’s 2009 performance-based RSUs were earned. One-third of these earned RSUs will vest in each of 2011, 2012 and 2013, contingent on the executive’s continued employment through the applicable vesting date. The grant date fair value of the performance-based RSUs awarded to our named executive officers appears in the Summary Compensation Table under the “Stock Awards” column.

Grant Practices.  The committee has traditionally approved equity-based awards to named executive officers at approximately the same time each year. For 2009, the committee approved awards in January 2009 with a grant date in February 2009 following the release of our fourth quarter and full-year 2008 earnings.

The committee typically delegates authority to our CEO to grant a limited number of equity-based awards for purposes of attracting new employees, rewarding superior employee performance and recognizing exceptional effort and commitment as he deems appropriate from time to time. He is not authorized to grant awards to executive-level employees or new hires for executive-level positions. The aggregate number of shares underlying all such grants by the CEO during 2009 was limited to 175,000. The CEO subsequently reports any such grants he makes to the committee.

We do not backdate stock options or issue stock options with exercise prices below the fair market value of our common stock on the grant date. We do not purposely schedule grant dates to precede the release of favorable information or follow unfavorable disclosures.

Under the terms of our management stock incentive plan and corresponding award agreements, the vesting of stock options held for at least one year accelerates upon the employee’s retirement or reaching age 60. In the case of retired employees, the options remain exercisable for the original option term. For employees 60 or older, if the employee’s employment ends for a reason other than retirement as defined in the plan, the employee will have three months from the date of termination to

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exercise. We believe these practices enhance the effectiveness of stock options granted to more experienced employees. The committee does not consider these accelerated vesting practices when it determines the type or number of awards granted to a particular employee in any given year.

We require management-level employees, including all of the named executive officers, to sign a non-competition agreement as a condition of receiving an equity award. In addition, the award agreement provides that, if the employee breaches the non-competition agreement, the committee may require the employee to forfeit his or her award, even if vested. To the extent an award has previously been exercised or becomes non-forfeitable, the committee may require the employee to return any shares of common stock he or she received upon the exercise or cash proceeds received upon sale.

 

Other Compensation

 

Retirement and Other Post-Employment Benefits.  Named executive officers based in the U.S. may be eligible to participate in our 401(k) savings and investment plan, or SIP, the benefit equalization plan, or BEP/SIP, that supplements the SIP, our defined benefit pension plan, or RIP, and the benefit equalization plan, or BEP/RIP, that supplements the RIP. We originally established these plans in 2001 to maintain levels of benefits consistent with those of our former parent. We have continued to offer these plans in an effort to remain competitive with market practices, retain talented employees, assist employees in preparing for retirement, provide income to employees following retirement and, in the case of the benefit equalization plans, provide benefits to eligible executives that are comparable, as a percentage of compensation, to benefits provided to employees whose compensation is not subject to limits under U.S. law. We believe that the total retirement benefits we provide are comparable to the retirement benefits provided by other companies within the medical device and biotech industries. The RIP and the BEP/RIP are only available to executives hired before September 2, 2002. This was taken into account when we determined to provide enhanced benefits to affected employees under our SIP. Additionally, the cost of providing retirement benefits generally affects decisions regarding the types and amounts of other compensation and benefits that we may offer our employee population as a whole, but the provision of, or a named executive officer’s accumulated benefit under, our retirement plans generally does not affect decisions regarding the types or amounts of other compensation paid to that named executive officer in a given year. These plans are discussed in greater detail in the narrative following the Pension Benefits in 2009 table.

Employment and Change in Control Severance Agreements.  We do not have employment agreements with any of our named executive officers. However, we have entered into change in control severance agreements with each of them. These agreements are intended to maintain continuity of management, particularly in the context of a transaction in which we undergo a change in control. These agreements are “double triggered,” which means that an executive is only entitled to severance payments if (1) we experience a change in control as defined in the agreement and (2) the executive’s employment with us is terminated. The committee believes that it is appropriate to provide the named executive officers with the specified severance in the event that their employment is terminated in connection with a change in control or their position is modified in such a way as to diminish their compensation, authority or responsibilities. See “Change in Control Arrangements” in the narrative discussion following the Potential Payments upon Termination of Employment table for a more detailed description of the material terms of these agreements.

In the summer of 2009, at the committee’s request, Towers Watson reviewed our change in control severance agreements in light of current market practices and emerging trends. This review revealed that our agreements were generally consistent with both current practices and emerging trends. The committee directed Towers Watson specifically to analyze the market prevalence of tax “gross-up” provisions, both within S&P 500 companies and within our compensation peer group. The committee considered the rationales for and against tax gross-up provisions, the increasing trend toward the reduction or elimination of tax gross-up protections and data demonstrating the continued prevalence of tax gross-up provisions among companies in our peer group and the S&P 500. Following this review, the committee decided that any change in control severance agreement that we enter into with newly hired or promoted executive officers after July 2009 will not contain any tax gross-up provisions. However, the committee did not make any changes in our existing change in control severance agreements at this time.

Severance Benefits (Unrelated to a Change in Control).  We maintain a severance plan applicable to all U.S.-based salaried employees. The plan provides compensation to employees in the event of an involuntary termination without cause, based primarily on the employee’s years of service with the company. At the time of Mr. Throdahl’s termination of employment, the committee reviewed the benefits that would be payable to him under the severance plan. The committee also reviewed information regarding general market and peer group practices with respect to severance benefits paid to executive-level employees. Following this review and after consultation with Towers Watson, the committee determined that it was appropriate to provide an enhanced severance benefit to Mr. Throdahl. The severance benefit provided to Mr. Throdahl, which appears in the “All Other Compensation” column of the Summary Compensation Table for Mr. Throdahl’s 2009 compensation, was equal to approximately one-half of his annual base salary. Based on the market and peer group data reviewed by the committee, this amount correlates to the bottom of the range of severance benefits typically provided to executive-level employees in the event of involuntary termination without cause. Mr. Throdahl was required to sign a general release of claims as a condition to receipt of this benefit and he continues to be bound by the terms of his non-competition agreement with the company.

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Disability Compensation.  Named executive officers based in the U.S. may participate in the Restated Zimmer, Inc. Long-Term Disability Income Plan for Highly Compensated Employees. This plan is funded from our general assets and individual disability insurance policies we pay for. The plan provides disability benefits, as a percentage of total compensation, that are comparable to benefits provided to employees whose compensation is not limited for purposes of determining benefits payable under our base long-term disability insurance plan.

Perquisites.  We provide executive officers with a limited range of perquisites or other benefits not generally available to all salaried employees. These include the BEP/SIP, the BEP/RIP and the long-term disability income plan discussed above. We do not provide executives with company cars or car allowances unless they are living overseas and such practices are consistent with local market practice. Non-business use of our aircraft is limited and infrequent. No named executive officer used our aircraft for non-business purposes during 2009.

In the summer of 2009, at the committee’s request, Towers Watson reviewed our existing perquisite program in light of current market practices and emerging trends. This review revealed that, compared to our compensation peer group and general market practice, our perquisites were minimal and consistent with current market trends of decreased perquisite offerings. The committee believes that our executive compensation program’s emphasis on performance-based compensation, rather than on entitlements such as perquisites, is consistent with our compensation philosophy.

We provide all management-level employees who relocate their principal residence at our request with benefits provided under our relocation assistance program, including, for example, reimbursement of temporary housing and moving expenses. We provided relocation assistance to Mr. McCaulley in connection with his relocation from Pennsylvania to Indiana when we hired him as President, Zimmer Reconstructive. Significant declines in home values had occurred since the time Mr. McCaulley purchased his Pennsylvania residence. Under these circumstances and, to facilitate his hiring, the committee approved a special loss-on-sale benefit not to exceed $250,000 to compensate Mr. McCaulley for a portion of the loss he incurred on the sale of his Pennsylvania residence. This amount was approved by the committee after consultation with Towers Watson and as part of the negotiation of Mr. McCaulley’s pay package. This amount is reflected in the “All Other Compensation” column of the Summary Compensation Table for Mr. McCaulley’s compensation. Mr. McCaulley did not receive tax gross-up assistance related to this payment and is responsible for all applicable taxes. Mr. McCaulley must repay this loss-on-sale benefit to the company in the event he voluntarily resigns or is terminated for cause within two years of receipt of the benefit.

 

Three-Year Pay-for-Performance Alignment

 

At the committee’s request, in the fall of 2009 Towers Watson examined the pay-for-performance alignment of our executive compensation programs. Specifically, Towers Watson assessed the extent to which the value delivered to the named executive officers under our executive compensation programs was aligned with our financial performance over the three-year period ended December 31, 2008. With respect to that three-year period, Towers Watson reviewed:

The analysis revealed that the executives’ realizable pay was strongly aligned with both our total stockholder return and our financial performance. Specifically, for the three-year period ended December 31, 2008, we performed at the 10th percentile of the peer group for total stockholder return, at the 41st percentile for earnings per share growth, and in the bottom quartile of the peer group for revenue and free cash flow growth. On a composite basis, we performed at the 10th percentile of the peer group, while the realizable pay of our named executive officers over the three-year period was at the 17th percentile of our peer group.

Further, the relationship between realizable pay and pay opportunity, as well as the value sharing ratios, each supported the conclusion that our incentive programs were operating as intended and were aligned with our performance. While our target pay opportunity was at the 75th percentile of the peer group over the three-year period, the realizable pay (amounts actually earned) was approximately 30% of pay opportunity, the lowest in our peer group, predominantly due to the effect of underwater stock option awards, unearned performance-contingent equity awards and below-target bonus plan achievement. In addition, the ratio of realizable pay to revenue/earnings/market capitalization was in the bottom quartile of our peer group, which was consistent with our performance during that period.

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Executive Compensation Risk Assessment

 

At the committee’s request, in the fall of 2009 Towers Watson assessed our executive compensation program and its relationship to organizational risk from two perspectives — a qualitative view focused on various design features/characteristics of our executive compensation program, and a quantitative view using the results of the firm’s research and its PayRiskScore measurement tool to identify certain elements of CEO compensation design that strengthen or weaken the alignment between realizable pay levels and organizational risk. The firm’s assessment was intended to serve as a diagnostic tool for assessing executive compensation risk; it focused on our senior executive compensation practices and did not examine compensation at other levels or divisions of the organization. However, the components of our senior executive compensation program are part of our global compensation structure, and the majority of the compensation policies or practices that apply to other levels of our employees or to any of our subsidiaries or divisions are included in our senior executive compensation program.

The qualitative analysis revealed that our executive compensation practices did not have any design features that would promote excessive or undue risk-taking on the part of our executives. Further, the quantitative assessment indicated that our executive compensation program has very limited risk aggravators and numerous risk mitigators and that our PayRiskScore was within an acceptable range and well above general industry and healthcare industry averages.

 

Executive Stock Ownership Guidelines

 

The named executive officers must meet stock ownership guidelines set by the Board. The committee oversees compliance with these guidelines and periodically reviews the guidelines. The guidelines require our CEO to own shares with a value equal to at least five times his base salary and the other named executive officers to own shares with a value equal to at least three times their base salary. All shares owned by the officer count toward these guidelines, including shares owned indirectly, shares held in our employee stock purchase plan, as well as restricted shares, RSUs and performance-based RSUs (at the target award level). In addition, one-half of the unrealized gain on vested stock options is counted toward these guidelines. All named executive officers are currently in compliance with the guidelines or are pursuing plans that will enable them to achieve compliance within the five-year time frame prescribed in the guidelines. We have approved procedures by which every executive officer must obtain clearance prior to selling any shares of our common stock, in part to ensure no executive falls out of compliance with the stock ownership guidelines.

In addition, we have policies in place to prevent executive officers from hedging the economic risk of ownership of our common stock.

 

Other Compensation Practices

 

 

Tax Deductibility of Compensation

 

Section 162(m) of the Internal Revenue Code, or the Code, limits the deductibility of compensation paid to the most highly-compensated executive officers of U.S. public companies to $1,000,000 per year unless the compensation qualifies as performance-based. The committee’s policy is to take into account Section 162(m) in establishing compensation of our named executive officers. However, the deductibility of some types of compensation payments can depend upon the timing of the vesting or an executive’s exercise of previously granted awards. Interpretations of and changes in applicable tax laws and regulations as well as other factors beyond our control also can affect deductibility of compensation. For these and other reasons, the committee has determined that it will not necessarily seek to limit executive compensation to that sum which is deductible under Section 162(m) of the Code. In 2009, the impact of the Section 162(m) limitation on our after-tax compensation expense was not material.

The EPIP and our equity-based incentive plans contain performance-based conditions and have been approved by stockholders so that payments under those plans can qualify as performance-based compensation. We will continue to monitor developments and assess alternatives for preserving the deductibility of compensation payments and benefits to the extent reasonably practicable, consistent with our compensation policies and what we believe is in the best interests of our stockholders.

 

Financial Statement Restatements and Potential Impact on Compensation of Executive Misconduct

 

Section 302 of the Sarbanes-Oxley Act of 2002 provides that, in the event that a U.S. public company is required to prepare an accounting restatement due to the material noncompliance of the company, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer must reimburse the company for (1) any bonus or other incentive-based or equity-based compensation received by that person from the company during the 12-month period following the first public issuance or filing with the Securities and Exchange Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and (2) any profits realized from the sale of securities of the company during that 12-month period.

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We have not adopted a formal policy with respect to the recovery of compensation in the event of a financial statement restatement, as a result of misconduct, that is broader than the statutory requirements. However, if the Board determines that a named executive officer has engaged in fraudulent or intentional misconduct, the Board may take a range of actions to remedy the misconduct, prevent its recurrence, and impose such discipline on the wrongdoers as would be appropriate. Discipline would vary depending on the facts and circumstances, and may include (1) termination of employment; (2) initiation of a lawsuit to recover damages resulting from the misconduct; and (3) if the misconduct resulted in a significant restatement of our financial results, seeking reimbursement of any portion of performance-based or incentive compensation paid or awarded to the executive that is greater than would have been paid or awarded if calculated based on the restated financial results. These remedies would be in addition to, and not in lieu of, any actions imposed by law enforcement agencies, regulators or other authorities.

The committee, with the assistance of Towers Watson, is monitoring legislative and regulatory developments and market trends with respect to compensation recovery policies and is expected to evaluate whether adoption of such a policy that is broader than the statutory requirements is in the best interests of the company and our stockholders.

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Executive Officer Compensation Tables and Notes

The following tables set forth information regarding compensation paid to our CEO, our CFO and each of our three other most highly compensated executive officers based on total compensation earned, excluding increases in pension value, for 2009. The tables also provide compensation information with respect to a former executive officer who would have been among the three other most highly compensated executive officers if he had been serving as an executive officer as of December 31, 2009.

 

 

 

 

 

 

 

Option awards granted to the named executive officers in 2008 and 2007 had no intrinsic value as of December 31, 2009. The closing price of our common stock on December 31, 2009 as reported by the New York Stock Exchange was $59.11. The exercise prices of option awards in 2008 and 2007 range from $76.33 to $88.76. These option awards will have no intrinsic value until our stock price increases above these levels.

 

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Narrative Discussion

 

The following narrative provides additional information with respect to the compensation reported in the Summary Compensation Table.

2009 Base Salaries.  The 2009 base salaries for the named executive officers were as follows:

 

 

 

2009 EPIP Target Award Opportunities.  The 2009 target EPIP award opportunities for the named executive officers were 115% of base salary for Mr. Dvorak; 75% of base salary for Mr. Crines; 70% of base salary for Mr. McCaulley and 65% of base salary for each of Dr. Blanchard and Mr. Melzi. Mr. Throdahl forfeited his award opportunity, which had been set at 70% of base salary, upon termination of his employment.

The goals for the performance measures used in the EPIP for 2009 were set by the committee in February 2009 on the basis of the 2009 operating plan approved by the Board of Directors. Actual payouts could range between 0% and 200% of the specified percentage of the executive’s base salary based upon actual 2009 performance.

The following are the performance measures and goals for each of the performance measures set by the committee:

 

The sum of the weighted performance for each performance measure was applied to the following payout schedule to determine the award. Each performance measure was capped at 120% of target and had a threshold of 85% of target with linear interpolation between the specified percentages.

 

% of Performance Measure Goal		% of Award Target
120+			200
100			100
95			50
85			25
Less than 85			0

Adjusted earnings per share had to equal or exceed the target level ($4.13) in order for payments to exceed 100% of target. We calculate adjusted earnings per share for this purpose by excluding the effects of the following from earnings per share computed under generally accepted accounting principles: inventory step-up, acquisition, integration, realignment and other expenses, the provision for certain Durom^® Acetabular Component product claims in the U.S., goodwill impairment, net curtailment and settlement and the tax benefit related to the 2007 civil settlement with the U.S. government. Based on our 2009 financial results, payouts were made in an amount equal to 91.9% of the specified percentage of each executive’s base salary. See

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the “Non-Equity Incentive Plan Compensation” column of the Summary Compensation Table for the awards paid to each of the named executive officers under the EPIP for 2009.

2009 Equity Awards.  For information on the equity awards made in 2009 to the named executive officers, see the narrative discussion following the Grants of Plan Based Awards in 2009 table.

Severance Benefits.  Mr. Throdahl received severance benefits equal to 26 weeks’ salary upon termination of his employment effective June 12, 2009. We provide more information regarding these severance benefits above under “Compensation Discussion and Analysis — Major Elements of Compensation — Other Compensation — Severance Benefits (Unrelated to a Change in Control).”

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The following table provides additional information about the non-equity incentive plan awards, performance-based RSU awards and option awards granted to the named executive officers during 2009. The non-equity incentive plan awards were granted under the EPIP and the performance-based RSU awards and option awards were granted under the Zimmer Holdings, Inc. 2006 Stock Incentive Plan, or the 2006 Plan.

 

 

 

 

Narrative Discussion

 

Non-Equity Incentive Plan Awards.  The non-equity incentive plan awards reflected in columns (c) through (e) of the Grants of Plan-Based Awards in 2009 table represent the executives’ EPIP incentive opportunity for 2009. Amounts actually earned for 2009 performance are shown in the Summary Compensation Table in the column titled “Non-Equity Incentive Plan Compensation.” Material terms of the EPIP awards are described above under “Compensation Discussion and Analysis — Major Elements of Compensation — Annual Cash Incentives” and in the narrative discussion following the Summary Compensation Table.

Equity Incentive Plan Awards.  The equity incentive plan awards reflected in columns (f) through (h) of the Grants of Plan-Based Awards in 2009 table represent performance-based RSU awards. The grant date fair value of these RSU awards is $39.94 per unit. Material terms of the performance-based RSU awards, including a discussion of the applicable performance measure and target and actual performance for 2009, are described above under “Compensation Discussion and Analysis — Major Elements of Compensation — Equity-Based Incentives — Performance-based RSUs.” Based on our actual 2009 performance, the named executive officers earned the RSUs shown in the table below, which represent approximately 84.66% of each executive’s target award. One-third of these earned RSUs will vest and be paid out in the form of shares in each of 2011, 2012 and 2013, contingent on the executive’s continued employment through the applicable vesting date (unless termination of the executive’s

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employment occurs following the first anniversary of the grant date as a result of death, disability or retirement, as defined in the 2006 Plan).

 

Name		RSUs
David C. Dvorak			41,905
James T. Crines			14,646
Bruno A. Melzi			12,571
Jeffery A. McCaulley			12,571
Cheryl R. Blanchard, Ph.D.			8,381
Mark C. Throdahl			—

Option Awards.  The option awards reflected in column (j) of the Grants of Plan-Based Awards in 2009 table represent nonqualified stock options. The grant date fair value of these awards is $16.01 per option, as determined using a Black-Scholes option pricing model. The stock options generally become exercisable in four equal installments on the first through fourth anniversaries of the grant date, contingent on the executive’s continued employment through the applicable vesting date (unless termination of the executive’s employment occurs following the first anniversary of the grant date as a result of death, disability or retirement, as defined in the 2006 Plan). Other material terms of our option awards are described above under “Compensation Discussion and Analysis — Major Elements of Compensation — Equity-Based Incentives — Stock Options” and “— Grant Practices.”

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