ZIMMER HOLDINGS, INC.

345 East Main Street

Warsaw, Indiana 46580

 

March [  ], 2008

 

Dear Fellow Stockholder:

 

You are cordially invited to attend the 2008 Annual Meeting of Stockholders of Zimmer Holdings, Inc., which will be held at 9:00 a.m. on Monday, May 5, 2008, at [          ], New York, New York.

The notice of meeting and the proxy statement describe the business to be conducted at the meeting and provide other information that you should know when you vote your shares. Following the required business meeting we will report on the company’s operations.

Pursuant to the new rules recently adopted by the Securities and Exchange Commission, we are providing access to our proxy materials via the Internet. On or about March [  ], 2008, we will mail a Notice of Internet Availability of Proxy Materials (the “Notice”) to certain stockholders of record and beneficial holders, and on or about the same date we will mail a printed copy of the proxy statement and a proxy card to stockholders who have requested to receive them. On the mailing date of the Notice, all stockholders and beneficial holders will have the ability to access all of the proxy materials including the proxy statement.

It is important that your shares be represented whether or not you attend the meeting. Registered stockholders can vote their shares via the Internet or by using a toll-free telephone number. Instructions for using these convenient services appear on the Notice and the proxy card and in the proxy statement. If you received a printed copy of the proxy materials, you can also vote your shares by marking your votes on the proxy card, signing and dating it and mailing it promptly using the envelope provided.

We urge you to let us know your feelings about the company or to bring a particular matter to our attention. For those stockholders receiving a printed copy of the proxy materials, we have provided space on the proxy card for comments. If you received a Notice or hold your shares through an intermediary, please feel free to write directly to us.

 

 

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 [  ], 2008

 

TABLE OF CONTENTS

 

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

 

ZIMMER HOLDINGS, INC.

PROXY STATEMENT

 

Why did I receive a Notice of Internet Availability of Proxy Materials?

 

Instead of initially mailing a printed copy of the proxy materials to each stockholder, we may now furnish proxy materials to our stockholders via the Internet under the new e-proxy rules adopted by the Securities and Exchange Commission. On or about March [  ], 2008, we mailed a Notice of Internet Availability of Proxy Materials (the “Notice”) to certain stockholders of record and beneficial holders, and we mailed a printed copy of the proxy materials to stockholders who had so requested. If you received a Notice by mail, you will not receive a printed copy of the proxy materials unless you request such a copy in the manner described in the Notice. The Notice also instructs you as to how you may access and review this proxy statement and our 2007 Annual Report, and how you may 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 or about March [  ], 2008 at www.proxyvote.com. Our 2007 Annual Report, including financial statements, for the year ended December 31, 2007 is being made available at the same time and by the same method. The 2007 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 6, 2008 are entitled to vote at the meeting. As of that date, there were [     ] 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?

 

Five items:

 

 

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

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

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:

 

 

What is the difference between a “stockholder of record” and a “beneficial holder”?

 

These terms describe how your shares are held. If your shares are registered directly in your name with The Bank of New York, our transfer agent, you are a “stockholder of record”. If your shares are held in the name of a bank, broker, trust or other nominee as custodian, you are a “beneficial holder”.

 

What are my voting rights?

 

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

 

How do I vote by proxy?

 

If you are a stockholder of record, we encourage you to vote via the Internet or by telephone. Internet voting information is provided on the Notice and the proxy card. You may vote by touchtone telephone by calling 1 (800) 690-6903. You will need to have the Notice or, if you received a printed copy of the proxy materials, your proxy card or voting instruction card, available when voting via the Internet or by telephone. These methods are convenient and save us significant postage and processing expense. In addition, when you vote via the Internet or by telephone prior to the meeting date, your vote is recorded immediately and there is no risk that postal delays will cause your vote to arrive late and therefore not be counted.

If you are a stockholder of record and you received a printed copy of the proxy materials, you may vote by marking your proxy card, dating and signing it, and mailing it in the postage-paid envelope. The shares represented will be voted according to your directions. If your proxy card is signed and returned without specifying a vote or an abstention on any proposal, it will be voted according to the recommendation of the Board of Directors on that proposal.

If you are a beneficial holder, you must provide instructions on voting to your bank, broker, trust or other nominee holder.

 

How do I vote in person?

 

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 bank, broker, trust 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. However, we encourage you to vote by proxy card, by telephone, or via the Internet even if you plan to attend the meeting.

 

How do I vote my shares in the 401(k) plan?

 

If you participate in the Zimmer Holdings, Inc. Savings and Investment Program or the Zimmer Puerto Rico Savings and Investment Program, you may instruct the plan trustee on how to vote your shares by mail, by telephone or via the Internet as described above. Your plan trustee will vote the shares credited to your plan account in accordance with your voting instructions. The trustee votes the shares on your behalf because you are the beneficial holder, not the record holder, of the shares credited to your account. The trustee will vote the plan shares for which it does not receive voting instructions in the same proportion as the shares for which it received voting instructions.

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

 

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 bank, broker, trust 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?

 

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, provided that if the number of nominees exceeds the number of directors to be elected (a situation we do not anticipate), the directors will be elected by a plurality of the votes cast. Ratification of the selection of our independent registered public accounting firm, approval of the Amended Zimmer Holdings, Inc. Executive Performance Incentive Plan and approval of the stockholder proposal each requires the affirmative vote of the majority of the shares of common stock present or represented by proxy. Approval of the proposed amendments to our Restated Certificate of Incorporation requires the affirmative vote of 80% of the outstanding shares of common stock.

 

What effect do abstentions and broker non-votes have?

 

Shares not present at the meeting and shares voting “abstain” have no effect on the election of directors. For all other proposals, abstentions are treated as shares present or represented and voting, so abstaining has the same effect as a vote “against” the proposal. Broker non-votes on a proposal are not counted or deemed to be present or represented for the purpose of determining whether stockholders have approved that 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.

 

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 $6,000, 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.

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

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 6, 2008. Unless otherwise noted, shares are owned directly or indirectly with sole voting and investment power.

 

The following table sets forth, as of January 2, 2008, 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.

 

 *  Less than 1.0%

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

Under Section 16(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, our directors, executive officers and the beneficial holders of more than 10% of our common stock are required to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Based on our records and other information, we believe that during 2007 all applicable Section 16(a) filing requirements were met.

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.

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, as amended, 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, and will be provided in print without charge upon written request to our Corporate Secretary at the address shown on the cover page of this proxy statement. We intend to 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.

During 2007, the Board approved an amendment to our Restated Certificate of Incorporation to provide that, beginning with this annual meeting, the directors whose terms are expiring will be elected for one-year terms, with each director to hold office until such person’s successor is duly elected and qualified. In connection with Mr. Elliott’s resignation as Chairman of the Board effective November 30, 2007, the Board also approved an amendment to our Restated By-Laws to provide for a separate Chairman of the Board who does not also serve as our Chief Executive Officer. Mr. McGoldrick was appointed non-executive Chairman effective December 1, 2007.

As permitted by the rules of the New York Stock Exchange, the Board has adopted categorical standards to assist it in making determinations of director independence. These standards incorporate, and are consistent with, the definition of “independent” contained in the New York Stock Exchange listing standards. These standards are set forth in Appendix A to this proxy statement and are also included in the Board’s Corporate Governance Guidelines, which are available on our website as described above. The Board has determined that each of our non-employee directors, Stuart M. Essig, Larry C. Glasscock, Arthur J. Higgins, John L. McGoldrick 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. Essig, the Board considered his position as President and Chief Executive Officer of Integra LifeSciences Holdings Corporation, or Integra, a medical device company from which we purchase certain dental products. During 2007, the amount we paid Integra exceeded $1,000,000 but represented less than 2.00% of Integra’s gross revenues. After reviewing the terms of these transactions and the relationship that Mr. Essig has with Integra, the Board determined that he does not have a direct or indirect material interest in the transactions and that our business relationship with Integra does not diminish the ability of Mr. Essig to exercise his independent judgment on issues affecting our business.

In September 2006, the Board approved an amendment to our Restated By-Laws to 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

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

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 2008, both 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 director candidate at the annual meeting of stockholders, 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 “2009 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. During the past year, we paid a fee to a third-party search firm to assist the committee in identifying and evaluating potential director candidates. One of the candidates identified by the firm, Arthur J. Higgins, joined the Board of Directors effective February 12, 2007.

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 2007.

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.

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

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 Board meetings to report on and discuss their areas of responsibility. Directors are also expected to attend the annual meeting of stockholders. All of the directors then in office attended the 2007 annual meeting. In 2007, the Board of Directors held 14 meetings and committees of the Board held a total of 33 meetings. Each director attended more than 75% of the total meetings of the Board of Directors and each of the committees on which he served during 2007.

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. Prior to December 2007, the director who presided at these meetings rotated session-by-session among the non-management directors in alphabetical order of their last names. Beginning in December 2007, 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 Stuart M. Essig to receive such communications. Interested parties may contact Mr. Essig via e-mail at stuart.essig@zimmer.com.

Our Restated By-Laws provide that the Board may delegate responsibility to committees. During 2007, the Board had four standing committees: an Audit Committee established in accordance with Section 3(a)(58)(A) of 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 New York Stock Exchange listing standards. The membership of the Science and Technology Committee is composed of two 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 2007.

 

 

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

 

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

 

The Board of Directors has determined that both Larry C. Glasscock and Stuart M. Essig qualify as “audit committee financial experts” as defined by the rules of the Securities and Exchange Commission. 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 [     ].

 

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 2007 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 [     ].

 

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

 

 

 

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 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

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

generally accepted in the United States as well as rendering an opinion on management’s report on 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 13 meetings during 2007. 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. 2, An Audit of Internal Control over Financial Reporting Performed in Conjunction 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 thereon. 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 Statement on Auditing Standards No. 114, as amended (AICPA, Professional Standards, Vol. 1 AU Section 380, The Auditor’s Communication With Those Charged With Governance), 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 Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees), as adopted by the Public Company Accounting Oversight Board in Rule 3600 T, 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 provided to the company beyond those rendered in connection with its audit and related reviews of the consolidated financial statements and attestation on management’s report on 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, 2007 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

Larry C. Glasscock, Chair

Stuart M. Essig

Arthur J. Higgins

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

The Board of Directors has been divided into three classes whose terms expire at successive annual meetings. During 2007, our Restated Certificate of Incorporation was amended to provide that, beginning with this annual meeting, directors whose terms are expiring will be elected for one-year terms. As a result, two directors will be elected at the meeting to serve a term expiring in 2009. The nominees for director named below are currently our directors. Mr. Higgins was appointed a director by our full Board of Directors, effective February 12, 2007. Mr. Dvorak was appointed to serve on the Board of Directors, effective May 1, 2007, in connection with his appointment as our President and Chief Executive Officer. After the election of two directors at the meeting, we will have six directors, including the four directors whose present terms extend beyond the meeting, and there will be one vacancy on the Board of Directors. 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. Listed first below are the nominees for election, followed by the directors whose terms expire in 2009 and 2010, with information including their principal occupations and other business affiliations, the year each was first elected as a director, the Board committee memberships of each and each director’s age.

 

Nominees for Director: 2008 – 2009 Term

 

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

Two directors are to be elected at the meeting for one-year terms ending at the 2009 annual meeting. At the recommendation of the Corporate Governance Committee, the Board has nominated David C. Dvorak and Arthur J. Higgins for election at this annual meeting. Unless proxy cards are otherwise marked, the persons named as proxies will vote all proxies received for the election of each of the nominees.

If a nominee is unable or unwilling 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. Alternatively, the Board may reduce its size. The Board has no reason to believe that either of the nominees will be unwilling or unable to serve if elected as a director.

As previously reported, we and other major U.S. orthopaedic manufacturers settled an ongoing federal investigation into our financial relationships with consulting orthopaedic surgeons with the U.S. Attorney’s Office for the District of New Jersey in September 2007. Following the announcement of the settlement, two shareholder derivative actions were filed in Kosciusko Superior Court in Warsaw, Indiana in October 2007. The plaintiffs seek to maintain the actions against all of our current directors and two former directors. The plaintiffs claim, among other things, breaches of fiduciary duty by the individual defendants which allegedly allowed misconduct to occur, including illegal payments to doctors, and caused us financial harm, including the cost of our settlement with the federal government.

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

Our Restated Certificate of Incorporation obligates us to indemnify our officers and directors to the fullest extent permitted by Delaware law, provided that their conduct complied with certain requirements. We are obligated to advance defense costs to our directors, subject to the individual’s obligation to repay such amount if it is ultimately determined that the individual was not entitled to indemnification. In addition, our indemnity obligation can, under certain circumstances, include indemnifiable judgments, penalties, fines and amounts paid in settlement in connection with those actions. We did not advance any defense costs in 2007 to any of our current or former directors in connection with the derivative actions.

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

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

 

The Compensation and Management Development Committee of the Board of Directors consists of the five 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, 2007 and this proxy statement.

 

Compensation and Management Development Committee

 

Stuart M. Essig, Chairman
Larry C. Glasscock
Arthur J. Higgins
John L. McGoldrick
Augustus A. White, III, M.D., Ph.D.

 

Overview

 

This Compensation Discussion and Analysis supplements the more detailed information in the tables and narrative discussion that follows the tables. Our goal is to provide stockholders with a better understanding of our executive compensation practices and the decisions made concerning the compensation payable to our executive officers, including the persons named in the Summary Compensation Table, or the named executive officers, that appears on page [     ].

The Board of Directors has delegated to the Compensation and Management Development Committee, which we refer to as the committee in this section of the proxy statement, key aspects of the Board’s oversight responsibilities with respect to the design and administration of our executive compensation program. The committee also approves compensation paid to our executive officers, including the named executive officers. The report of the committee appears above.

While our executive compensation practices and related plans were originally patterned on those of our former parent, and we still follow some of these legacy practices, our practices and plans have evolved and will continue to change as circumstances warrant. Our executive compensation practices are affected by the highly competitive nature of the orthopaedics industry and the location of our executive offices in Warsaw, Indiana. A number of the leading orthopaedic manufacturers in the world have significant operations in and around Warsaw, Indiana, which means that there are opportunities for experienced orthopaedic executives in this community. On the other hand, the fact that Warsaw, Indiana, is a small community in a predominantly rural area presents challenges to attracting executive talent from other industries and parts of the country.

Several major events had significant effects on our executive compensation for 2007, including the appointment of a new Chief Executive Officer, or CEO, and a new Chief Financial Officer, or CFO, in May. We discuss the compensation-related aspects of those decisions in more detail below under “– Compensation for New CEO and CFO.” In addition, the $169.5 million civil settlement payment we made to the federal government in the third quarter affected the level of cash incentive payouts for 2007.

 

Major Elements of Compensation

 

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

Base Salaries.  We use base salary as a recruiting and retention tool and to recognize individual performance and responsibility through annual merit reviews and promotional increases.

Annual Cash Incentives.  We create opportunities each year for additional cash compensation that are tied to the achievement of annual performance objectives. We use our Executive Performance Incentive Plan, or EPIP, for this purpose. Each executive officer is eligible for an 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%),

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consolidated revenue (weighted at 25%) and consolidated free cash flow (weighted at 25%) – derived from the operating plan approved by the Board of Directors 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 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. The level of payouts for 2007 was affected by the impact of the third quarter civil settlement payment on earnings per share and consolidated cash flow. For additional information regarding the performance measure goals and the 2007 EPIP awards, see “Executive Officer Compensation Tables and Notes – Summary Compensation Table – Narrative Discussion – 2007 EPIP Target Award Opportunities.”

The Board of Directors has approved an amended EPIP which will be considered by stockholders at this meeting. See “Proposal 3. Approval of the Amended Zimmer Holdings, Inc. Executive Performance Incentive Plan” beginning on page [     ].

Equity-Based Incentives.  We make equity-based awards under stockholder-approved plans to provide incentives over periods longer than one year and to align the interests of our executives with those of our stockholders. These incentives take the form of stock options, restricted stock, restricted stock units, or RSUs, and performance shares. Performance shares are, and other types of awards in the discretion of the committee may be, conditioned upon achievement of performance goals.

The committee typically approves awards of stock options on an annual basis to management-level employees at its December meeting and sets a future date as the actual grant date at that time. For 2007, the grant dates followed the release of our fourth quarter and full-year 2006 earnings. The committee also made mid-year equity-based awards to our new CEO and CFO and two other executive officers in connection with their respective promotions. 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 favorable information or follow unfavorable disclosures.

Stock options generally become exercisable in four equal installments on the first through the fourth anniversaries of the grant date. Restricted stock and RSUs become non-forfeitable over a multi-year period. The committee typically provides a reward to retirement-eligible employees who have made contributions over a sustained period by accelerating the vesting of stock options granted under our management stock incentive plan held for at least one year from the grant date upon the employee’s retirement. The employee will continue to have the original option term to exercise such options. Our practice of accelerating the vesting of options upon an employee’s retirement is consistent with the practices of our peer group and allows us to use stock options as an effective long-term equity-based incentive for employees who, based on their age and years of service with us, are retirement eligible.

In addition, the vesting of stock options granted under our management stock incentive plan held for at least one year by an employee who has reached age 60 generally will accelerate. If the employee terminates employment under circumstances not meeting the definition of “retirement” under the plan, the employee will only have three months from the date of termination to exercise such options. This benefit, which is significantly less than the benefit afforded to retirement-eligible participants, enhances our ability to compete for, and provide meaningful equity-based incentives to, more experienced candidates who may be amenable to a late-stage career move but who are not eligible for retirement as defined in our stock incentive plans.

The terms and conditions of stock options granted to employees based outside the United States may vary to comply with local law or to obtain the full benefit of applicable tax laws in those jurisdictions.

Plan provisions allowing for accelerated vesting of stock options upon retirement or attainment of age 60 generally have not been considered when determining the type or number of awards granted to a particular executive in a given year.

The committee may delegate authority to our CEO to grant a limited number of equity-based awards for purposes of attracting new employees and rewarding employee performance. He cannot 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 may not exceed 150,000 per year. The CEO subsequently reports any such grants he makes to the committee.

The committee made grants of performance-based RSUs in mid-2007 to our CEO, CFO and two other executive officers in connection with their respective promotions. These performance-based RSUs are tied to our performance over an 18-month period. The committee also made grants of RSUs to a group of management-level employees, including our executive officers, in December 2007, which vest in two installments over the next two years. These grants were intended to provide an incentive to those management-level employees to remain employed through the critical implementation phase of the Deferred Prosecution Agreement and Corporate Integrity Agreement we entered into in September 2007. In addition to the awards made in 2007, performance shares that had been granted in 2006 were outstanding during 2007. These performance shares are tied to our performance over a three-year period ending December 31, 2008. Additional information on equity-based awards to the named executive officers, including the performance measures and goals set by the committee for the 2007 performance-based RSU grants and 2006 performance share grants, can be found in the tables and accompanying narrative discussion which follow this discussion and analysis.

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We require management-level employees 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.

 

Compensation Philosophy

 

We design our executive compensation program to attract, retain and motivate highly qualified executives and to align their interests with the interests of our stockholders. The ultimate goal of our program is to increase stockholder value by providing executives with appropriate incentives to achieve our business objectives. We seek to achieve this goal through a program that rewards executives for superior performance, as measured by both financial and non-financial factors. In the case of our executive officers, we intentionally make a greater proportion of their total compensation subject to the achievement of objective performance measures which we believe reflect increases in stockholder value. We also encourage executives to act as equity owners by requiring them to meet the stock ownership requirements discussed below under “– Stock Ownership Guidelines for Executive Officers.”

Management provides the committee with recommendations on the compensation of the executive officers other than the CEO. These recommendations include specific amounts for base salaries, target cash incentive opportunities and equity-based awards for the executive officers. These recommendations are developed initially by our human resources department with the assistance of management’s compensation consultant. We consider such factors as compensation history, tenure, 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 subjective assessment of the performance of each executive officer other than himself. The committee gives significant consideration to the recommendations of management, but also considers information and advice provided by the committee’s compensation consultant, Watson Wyatt & Company, or Watson Wyatt, whose activities are described in more detail below under “– Compensation Consultants.” The committee itself is responsible for reviewing the performance of the CEO, without the CEO’s participation, and determines his compensation. The committee considers our performance on an operational and financial basis and the committee’s assessment of the CEO’s contributions during the year and overall performance.

The compensation philosophy the committee employs is to set each major compensation element at levels which approximate a specific percentile of market, based on data obtained from published salary survey sources, as follows:

 

 

We have used above-median targets for annual cash incentives and equity-based incentives since we became an independent public company in 2001. As explained above, this approach makes a greater proportion of total compensation tied to the achievement of objective performance measures. The target percentiles shown above are derived from the survey data and not the peer group discussed below.

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 which includes the nature of the executive’s duties, number of direct reports and other factors. 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. Similarly, we believe that an effective CFO is vital to our success, as he not only supervises key business and financial operations, but has significant responsibilities in our ongoing disclosure obligations. 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 who has been the CFO. In 2007, the new CEO and CFO were promoted from other positions within the company. They did not have the same longevity as their predecessors and, as a result, the historic differences between the compensation of the CEO and CFO and the other executive officers have been significantly compressed.

Finally, as the importance of our international operations has increased, it is critical for us to attract and retain qualified executive talent outside of the United States. There is significant competition for experienced international executives. We must offer compensation that reflects competitive concerns, higher costs of living and local custom and practice to retain these individuals.

Our objective is to provide a total pay opportunity that is competitive with our closest competitors, but which also places a greater emphasis on equity-based compensation. When the actual pay of our executive officers is in alignment with our performance, this approach effectively aligns the interests of the executives with those of our stockholders.

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The committee assessed whether our 2007 compensation was consistent with the compensation philosophy explained above by asking Watson Wyatt to conduct a market review. The committee reviewed an analysis of 2007 compensation for each executive officer, including base salary, annual cash bonus, annual cash compensation (base salary plus annual cash bonus), long-term incentives and total direct compensation (annual cash compensation plus long-term incentives). This information was then compared to competitive pay level compensation collected from our peer group and from published compensation surveys. On an overall basis, the base salaries of our executive officers for 2007 were at the 25th percentile for the peer group and the 50th percentile for the survey data. Annual cash incentives at the target level were at the same percentiles. Long-term incentives were at the 50th percentile for the peer group and the 75th percentile for the survey data. This resulted in total direct compensation at the target level equal to the 50th percentile for the peer group and at or above the 75th percentile for the survey data.

 

Compensation Consultants

 

As it has for several years, Watson Wyatt acted as the committee’s consultant during 2007. Typically, the firm provides the committee with advice on compensation program design and best practices and produces the comparative information derived from the peer group and published survey data that the committee reviews. Major activities conducted during 2007 consisted of: (1) advising the committee on and helping to develop the compensation packages for our new CEO and CFO; (2) conducting a pay-for-performance analysis of our executive compensation over a three-year period; (3) preparing a market review of our 2007 executive compensation; and (4) preparing “tally sheets” for our executive officers that were considered when making compensation decisions for 2008. Watson Wyatt also reviewed and made recommendations for changes in our non-employee director compensation program. The firm’s activities are discussed at greater length in various parts of this discussion and analysis.

In May 2007, we engaged Steven Hall and Partners to serve as consultant to our human resources department and company management. Steven Hall and Partners compared our company compensation plans against our peer group companies for various forms of equity and long-term incentive plan designs, and provided recommendations, as well as advice on other compensation related matters. Steven Hall and Partners also assists the human resources department and management in providing the committee with recommendations for base salary, target bonus percents and long-term incentive awards for executive officers, except for the CEO. The specific recommendations are typically discussed with Watson Wyatt as the committee’s compensation consultant. The final recommendations are then reviewed by the committee which frequently makes adjustments to the final determinations. In addition, Steven Hall and Partners acts as a resource to the human resources department and management in analyzing the compensation information from and recommendations made by Watson Wyatt.

 

Benchmarking

 

It has been our practice for many years to compare our compensation practices with the practices of a group of other U.S. public companies, comprised of direct competitors and other bio-medical manufacturers of comparable size based on revenue and market capitalization. With Watson Wyatt’s assistance, the committee monitors the continuing relevancy of the companies in the peer group and makes changes as companies alter their focus, merge or are acquired, or as new competitors emerge.

The peer group for 2007 consisted of C.R. Bard, Inc.; Baxter International Inc.; Becton, Dickinson and Company; Biogen Idec Inc.; Biomet, Inc.; Boston Scientific Corporation; Covidien Ltd.; Genzyme Corporation; Medtronic, Inc.; St. Jude Medical, Inc.; Stryker Corporation; and Thermo Fisher Scientific Inc. Biomet, Inc. was removed effective January 1, 2008 due to its acquisition by private investors.

The committee uses information derived from the peer group to assess our compensation practices. It also considers more general market data obtained from published salary survey sources. The comparative data is for the previous year and therefore does not reflect compensation levels or trends on a real-time basis.

Management and its consultant also use data from other large healthcare companies to develop incentive plan design and other aspects of executive compensation other than pay levels.

 

Pay-for-Performance Analysis

 

The “pay-for-performance” analysis that the committee reviewed in 2007 compared the compensation of our five most senior executives, both in terms of realizable pay and realized pay, to comparable executives of the peer group for a three-year period from 2004 to 2006. The analysis also compared the three year compound average growth rates for three performance metrics – earnings per share, revenue and cash flow – as well as total stockholder return for the period. The analysis yielded a number of findings, including:

 

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The analysis demonstrated that, while we were a top performer in the period with respect to the three performance metrics used, we lagged the peer group in total stockholder return for the period, which directly impacted the realizable gain from stock option grants during the period. Our pay opportunity was above, while our realizable pay was below, the peer group median and our named executive officers realized approximately 30% of their target opportunity during the period.

The committee discussed the findings of the report and concluded that incremental adjustments in our compensation program may be warranted, but major changes in design were not needed, in order to improve the alignment of executive pay to our performance.

The committee also considered the market review of our 2007 executive compensation which is discussed above and in the narrative following the Summary Compensation Table on page [     ].

 

Other Compensation

 

Special Incentives.  On occasion, the committee has created opportunities for additional cash compensation based on the success of a specific project. An example of this is the special project incentive program we adopted to accomplish integration and expense savings and efficiencies or “synergies” following our 2003 acquisition of Centerpulse AG. There were no special compensation incentive arrangements during 2007 and none approved to date for 2008.

Perquisites.  We provide executive officers with a limited range of perquisites or other benefits not generally available to all salaried employees. We do not provide executives with company cars or car allowances unless they are living overseas and such practices are consistent with local custom. We maintain two club memberships in Northeastern Indiana for business use by sales and management personnel and pay the cost of a small number of club memberships internationally. Non-business use of our aircraft is limited and infrequent. The committee reviews our CEO’s non-business use of our aircraft on an annual basis. The CEO is taxed on the imputed income (computed using Standard Industry Fare Level rates) attributable to all such use and we do not provide any additional income to him to pay the taxes on the imputed income.

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.

Disability Compensation.  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.

Retirement and Other Post-Employment Benefits.  Executives based in the U.S. may be eligible to participate in our 401(k) savings and investment plan, or SIP, and the benefit equalization plan, or BEP/SIP, that supplements the SIP, our defined benefit pension plan, or RIP, the benefit equalization plan, or BEP/RIP, that supplements the RIP and our retiree medical plan. We originally established the RIP, the BEP/RIP and the BEP/SIP at the time of our separation from our former parent in 2001. Under the terms of an Employee Benefits Agreement between our former parent and us, we agreed to establish plans that were substantially identical in all material respects to corresponding plans offered by the former parent. Since 2001, we have continued to offer these plans and the SIP in an effort to remain market competitive, to retain talented employees, to assist employees in preparing for retirement, to provide income to employees following retirement and, in the case of the benefit equalization plans, to provide benefits to eligible executives that are comparable, as a percentage of compensation, to benefits provided to employees whose compensation is not limited by the annual compensation limit 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, the BEP/RIP and the retiree medical plan 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 post-employment 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 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 2007 Table on page [     ].

Employment and Similar Agreements.  We do not have employment agreements with any of our 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. See “Executive Officer

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Compensation Tables and Notes – Potential Payments Upon Termination of Employment – Change in Control Arrangements” on page [     ] for a more detailed description of the material terms of these agreements.

 

Compensation for New CEO and CFO

 

In 2006, J. Raymond Elliott, who had served as our CEO since 2001, announced his intention to retire as President and CEO during 2007. The Board of Directors conducted an extensive search for a successor CEO, considering both external and internal candidates. As part of the CEO succession process, the committee worked with Watson Wyatt and outside counsel to develop compensation arrangements for a new CEO.

Watson Wyatt provided the committee with data which compared the 2006 compensation for our CEO with our peer group and a larger group of Fortune 1000 companies that hired a new CEO from outside of the organization in 2005 or 2006. The data used included base salary, annual incentives, long-term incentives, inducement awards (sign-on or promotion related) and total direct compensation. The data demonstrated that external CEO hires typically received a median total direct compensation approximately 15% greater than the median total direct compensation of the predecessor CEO, while an internal candidate was more likely to receive total direct compensation approximately 25% less than the predecessor CEO (although the internal candidate’s compensation would significantly increase from the internal candidate’s compensation for the previous year). The committee used this data to develop possible compensation packages for both an external and an internal candidate consistent with our compensation philosophy.

In April 2007, following the Board of Directors’ approval of Mr. Dvorak as a possible successor CEO, the parties reached agreement on the following principal components:

 

The committee approved these compensation arrangements subject to Mr. Dvorak’s appointment as CEO by the full Board of Directors.

On April 25, 2007, Mr. Leno, who had served as our CFO since 2001, advised us of his intention to resign to pursue other business opportunities. The Board of Directors promoted Mr. Crines, who had previously served as our Senior Vice President, Finance, Operations, and Corporate Controller and Chief Accounting Officer, to the position of Executive Vice President, Finance and CFO. The committee increased Mr. Crines’ compensation at the time of his appointment, the principal components of which are:

 

In approving these compensation arrangements for the promoted officers, the committee recognized that they provided for compensation that was less than the amounts contemplated by the committee’s compensation philosophy. The primary reason for this difference was that the officers were new to their respective roles. The committee plans to consider future incremental increases in compensation, in addition to possible annual merit increases and market adjustments, to bring their compensation more in line with the compensation philosophy.

 

Stock Ownership Guidelines for Executive Officers

 

Our executive officers must meet stock ownership guidelines the Board of Directors has established in order to align their interests more closely with those of our stockholders. The committee oversees compliance with these guidelines and periodically reviews the guidelines. The guidelines require (1) our Chief Executive Officer to own shares with a value equal to at least five

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times his base salary; (2) other designated executive officers, including the other named executive officers, to own shares with a value equal to at least three times the executive’s base salary; and (3) other executive officers to own shares with a value equal to at least two times the executive’s base salary. All shares owned by an executive officer count toward these guidelines, including shares owned indirectly, shares held in our 401(k) savings plan or Employee Stock Purchase Plan, as well as restricted shares, RSUs and performance shares (at the target award level). In addition, one-half of the gain on vested stock options is counted toward these guidelines. All executive officers are currently in compliance with the guidelines or are pursuing approved 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 officer falls out of compliance with the stock ownership guidelines.

In addition, our policies prohibit our executives from engaging in any transaction in which they may profit from short-term speculative swings in the value of our stock. This includes “short sales” (selling borrowed securities which the seller hopes can be purchased at a lower price in the future) or “short sales against the box” (selling owned, but not delivered securities) and buying or selling “put” and “call” options (publicly available rights to sell or buy securities within a certain period of time at a specified price) or the like. Any other transactions involving our stock or derivative securities that could affect ownership by an executive, such as entering into “zero cost collars” or variable prepaid forward contracts and transfers to pooled investment vehicles, must be pre-cleared pursuant to our procedures.

 

Tax and Accounting Considerations

 

Section 162(m).  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 executives. 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 2007, the impact of the Section 162(m) limitation on our after-tax compensation expense was negligible.

The EPIP and our equity-based incentive plans contain performance-based conditions and have been approved by stockholders so that payments under those plans will not be limited by Section 162(m). We believe that the awards made under these plans 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. We are submitting an amended EPIP to the stockholders for consideration at this meeting so that compensation payable under the plan will continue to qualify as performance-based compensation. See “Proposal 3. Approval of the Amended Zimmer Holdings, Inc. Executive Performance Incentive Plan” beginning on page [     ].

Section 409A.  On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law, changing the tax rules applicable to nonqualified deferred compensation arrangements. As amended, Section 409A of the Code affects the payments of certain types of deferred compensation to key employees. The Internal Revenue Service finalized Section 409A regulations in 2007, and affected plans must now be amended before January 1, 2009 to conform with these new rules. We believe we are operating in good faith compliance with the statutory provisions which were effective January 1, 2005, and Internal Revenue Service guidance. We discuss our nonqualified deferred compensation arrangements on pages [     ].

Accounting for Stock-Based Compensation.  Beginning on January 1, 2006, we began accounting for stock-based payments in accordance with the requirements of Statement of Financial Accounting Standard No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), using the modified-prospective method. In accordance with this method, we did not adjust our financial statements for earlier periods to reflect the effect of SFAS 123(R).

Financial Statement Restatements.  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. We have not adopted a specific policy with respect to the recovery of compensation in the event of a financial statement restatement which is broader than the statutory requirements.

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Executive Officer Compensation Tables and Notes

 

The following tables set forth information regarding compensation paid to each of the persons who acted as our Chief Executive Officer or Chief Financial Officer during 2007 and our three other most highly compensated executive officers based on total compensation earned, excluding increases in pension value.

Mr. Leno forfeited unvested performance shares and shares of restricted stock when he resigned effective May 4, 2007. In accordance with SFAS 123(R), we reversed compensation expense relating to the forfeited shares that had been recognized for financial statement reporting purposes in 2006. As a result, the amount reported in this column for 2007 for Mr. Leno is negative.

 

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For a discussion of the assumptions made in the valuation, see Note 3 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

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For a discussion of the assumptions made in the valuation, see Note 3 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

 

 

 

 

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Narrative Discussion

 

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

2007 Base Salaries.  The 2007 base salaries for the named executive officers were as follows:

 

 

No change was made to Mr. Elliott’s base salary due to his announced retirement.

2007 EPIP Target Award Opportunities.  The 2007 target EPIP award opportunities for the named executive officers were 60% of base salary for Mr. Dvorak (increased to 100% in May 2007); 50% for Mr. Crines (increased to 60% in May 2007); 50% of base salary for Mr. Melzi; 60% of base salary for Ms. Conley; and 50% of base salary for Mr. Ooi. These percentages of base salary were the same as used for the same executive positions in the prior year. Mr. Leno forfeited his award opportunity, which had been set at 60% of base salary, upon his resignation. Had Mr. Leno remained an employee through the end of 2007, he would have received a payout of approximately $233,000. Mr. Elliott was not given a 2007 EPIP award opportunity because of his announced retirement.

The goals for the performance measures used in the EPIP for 2007 were originally set by the committee on the basis of the 2007 operating plan approved by the Board of Directors. The goals for adjusted earnings per share and consolidated revenue were set in December 2006 and the goals for consolidated free cash flow were set in February 2007. Actual payouts could range between 0% and 200% of the specified percentage of the executive’s base salary based upon actual 2007 performance.

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

 

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The sum of the weighted performance for each performance measure was to be 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 120% and 85%.

 

% of Performance Measure Goal		% of Award Target
120+			200
100			100
85			55
Less than 85			0

Adjusted earnings per share had to equal or exceed the target level ($3.91) in order for payments to exceed 100% of target. We calculate adjusted earnings per share for this purpose by excluding from earnings per share computed under generally accepted accounting principles any acquisition and integration expenses and purchase accounting adjustments.

In May 2007, the Board of Directors considered the impact of acquisitions we made in the first four months of 2007 on our operating plan. The Board concluded that these acquisitions would have a material impact on our 2007 operations and approved changes to the operating plan. Two of the performance measures used in the EPIP that were derived from the 2007 operating plan – consolidated revenue and consolidated free cash flow – were changed. The budgeted amount for consolidated revenue increased from $3.8 billion to $3.9 billion and the budgeted amount for consolidated free cash flow was reduced from $866 million to $785 million.

Since the 2007 EPIP goals had been derived from the operating plan, the committee considered whether adjustments should be made in the goals for the two performance measures to provide a more accurate assessment of our actual performance. The committee compared how the original goals would operate under the updated projections and the impact of changing the goals to track the changes made in the revised 2007 operating plan. The committee also reviewed the impact of a change in goals on the projected bonus payout for each executive officer and a number of other factors and concluded that the changes were appropriate.

Accordingly, the committee approved revising the goals for the consolidated revenue and consolidated free cash flow performance measures for 2007 under the EPIP as follows:

 

As explained above, in “Compensation Discussion and Analysis,” the level of payouts for 2007 was affected by the impact of the $169.5 million civil settlement payment we made to the federal government in the third quarter of 2007 to settle an ongoing investigation into financial relationships between orthopaedic manufacturers and consulting orthopaedic surgeons. Accordingly, payouts were made in an amount equal to 73.9% of the specified percentage of each executive’s base salary. See footnote 3 to the Summary Compensation Table for the awards paid to each of the named executive officers.

2007 Equity Awards.  For information on the equity awards made in 2007 to the named executive officers, see the narrative discussion following the Grants of Plan Based Awards in 2007 table on page [     ].

ZIMMER HOLDINGS, INC.                                                                                                                                                                             2008 PROXY STATEMENT

The following Grants of Plan Based Awards in 2007 table provides additional information about equity and non-equity incentive plan awards and stock and option awards granted to the named executive officers during the year ended December 31, 2007. The non-equity incentive plan awards were granted under the EPIP and all other awards were granted under the Zimmer Holdings, Inc. 2006 Stock Incentive Plan, or the 2006 Plan.