2014 PROXY STATEMENT HIGHLIGHTS			i
PROXY STATEMENT			1
GENERAL INFORMATION			1
CORPORATE GOVERNANCE			6
Proposal No. 1 – Election of Directors			6
Director Criteria, Qualifications and Experience			6
Directors and Nominees			7
Nominees for Director: 2014 – 2015 Term			7
Current Director Whose Term Expires at the Annual Meeting			11
Board Leadership Structure			12
Board Role in Risk Oversight			12
Policies on Corporate Governance			12
Director Independence			13
Majority Vote Standard for Election of Directors			13
Nominations for Directors			13
Communications with Directors			14
Certain Relationships and Related Person Transactions			14
Board Meetings, Attendance and Executive Sessions			14
Committees of the Board			14
Committee Assignments			15
Audit Committee			15
Compensation and Management Development Committee			15
Corporate Governance Committee			16
Security Ownership of Directors and Executive Officers			16
Security Ownership of Certain Beneficial Owners			17
Section 16(a) Beneficial Ownership Reporting Compliance			17
Compensation of Non-Employee Directors			18
2013 Director Compensation Table			18
Changes to Director Compensation in 2013			19
Retainers and Meeting Fees			19
Equity-Based Compensation and Mandatory Deferrals			20
Insurance, Expense Reimbursement and Director Education			20
EXECUTIVE COMPENSATION			21
Proposal No. 2 – Advisory Vote on Executive Compensation			21
Compensation Discussion and Analysis			22
Executive Summary			22
2013 Say on Pay Vote			22

2013 Business Highlights			22
2013 Performance and Payouts			23
Key Executive Compensation Program Practices			24
Components of Executive Compensation			25
Pay Mix			27
Market Review of 2013 Compensation			27
Three-Year Historical Pay-for-Performance Alignment			27
Base Salary			28
Annual Cash Incentives			28
Equity-Based Incentives			30
Other Compensation			31
The Committee’s Processes and Analyses			32
Governance Features of Our Executive Compensation Program			34
Compensation Committee Report			36
Compensation Risk Assessment			36
2013 Summary Compensation Table			37
Grants of Plan-Based Awards in 2013			39
Outstanding Equity Awards at 2013 Fiscal Year-End			40
Options Exercised and Stock Vested in 2013			43
Pension Benefits in 2013			43
Nonqualified Deferred Compensation in 2013			46
Potential Payments upon Termination of Employment			48
Change in Control Arrangements			51
Non-Compete Arrangements			52
Equity Compensation Plan Information			53
AUDIT			54
Proposal No. 3 – Ratification of Independent Registered Public Accounting Firm			54
Responsibilities of the Audit Committee			54
Activities of the Audit Committee in 2013			55
Audit Committee Pre-Approval of Services of Independent Registered Public Accounting Firm			55
Audit and Non-Audit Fees			56
Audit Committee Report			56
ADDITIONAL INFORMATION			57
Other Matters			57
Annual Report and Form 10-K			57
Incorporation by Reference			57

 

Corporate and Stockholder Information
Stock Symbol		ZMH
Exchanges		NYSE and SIX Swiss Exchange
Shares Outstanding		168,558,329
Headquarters		345 East Main Street, Warsaw, Indiana
Company Website		www.zimmer.com
Investor Relations Website		www.investor.zimmer.com
Public Company Since		2001
Transfer Agent and Dividend Reinvestment Plan Administrator		American Stock Transfer & Trust Co. www.amstock.com +1-888-552-8493 (domestic) +1-718-921-8124 (international)
Annual Meeting Information
Time and Date		9:00 a.m. (EDT) on Tuesday, May 6, 2014
Place		Conrad Indianapolis, 50 West Washington Street, Indianapolis, Indiana
Record Date		March 7, 2014
Voting				www.ProxyVote.com
				1-800-690-6903
				mail your proxy card / vote instruction form
				vote in person at the meeting

 

Matters for Stockholder Voting
Proposal		Board Recommendation		Page   Ref.
Election of Directors		FOR each nominee		6
Advisory Vote on Executive Compensation		FOR		21
Ratification of Appointment of PricewaterhouseCoopers LLP		FOR		54
Corporate Governance Highlights
Annual Election of All Directors				Yes
Director Election Standard				Majority
Independent Chairman of the Board				Yes
Independent Directors				All but one
Fully Independent Board Committees				Yes
Supermajority Voting Requirements				No
Shareholder Rights Plan				No
Director Stock Ownership Guidelines				Yes
Prohibition Against Pledging and Hedging				Yes
Regular Board Executive Sessions				Yes
All Directors Attended at Least 75% of 2013 Board and Committee Meetings				Yes

 

Executive Compensation Best Practices
Pay for Performance Philosophy				Yes
Prohibition on Hedging and Pledging				Yes
Stock Ownership Guidelines				Yes
Stock Retention Requirement				Yes
Dividend Equivalents on Restricted Stock Units				No
Executive Employment Agreements				No
Incentive Compensation Recoupment Policy				Yes
Limited Perquisites				Yes
“Double Trigger” Change in Control Arrangements				Yes
Commitment Not to Provide Excise Tax Gross-Up Payments in Future Severance Agreements				Yes

 

Based upon the recommendation of the Corporate Governance Committee, the Board has nominated nine directors for election at the annual meeting to hold office until the 2015 annual meeting and the election of their successors. All of the nominees currently are our directors. Paul M. Bisaro was appointed a director by our full Board effective December 12, 2013. Each nominee agreed to be named in this proxy statement and to serve if elected. All of the nominees are expected to attend the 2014 annual meeting.

In accordance with the Board’s mandatory retirement policy set forth in our Corporate Governance Guidelines, the Board did not nominate John L. McGoldrick for re-election to the Board. Mr. McGoldrick will retire from the Board effective as of the annual meeting after serving as our director since 2001, including service as non-executive Chairman of the Board from 2007 to 2013. The Board is deeply grateful to Mr. McGoldrick for his many years of leadership. Effective upon Mr. McGoldrick’s retirement, the Board intends to reduce its size to nine members.

 

We are a global leader in musculoskeletal care. We design, develop, manufacture and market orthopaedic reconstructive, spinal and trauma devices, biologics, dental implants and other surgical products. We have operations in more than 25 countries around the world and sell products in more than 100 countries. We operate in markets characterized by rapidly evolving technologies, complex regulatory requirements and significant competition. The Corporate

Governance Committee is responsible for reviewing and assessing with the Board, on an annual basis, the experience, qualifications, attributes and skills sought of Board members in the context of our business and the then-current membership on the Board. The committee looks for current and potential directors collectively to have a mix of experience, skills and qualifications, some of which are described below:

 

In evaluating director candidates and considering incumbent directors for nomination to the Board, the committee considers a variety of factors. These include each candidate’s character and integrity, reputation for working constructively in a collegial environment and availability to devote sufficient time to Board matters. Diversity of background and diversity of gender, race, ethnicity, national origin and age are also relevant factors in the selection process. The committee also considers whether a candidate can meet the independence standards for directors and members of key committees under applicable stock exchange and SEC rules. With respect to incumbent directors, the committee considers the director’s past performance on the Board and contributions to the committees on which he or she serves.

While the Board has not formally adopted a policy regarding director diversity, the committee actively considers diversity in director recruitment and nomination and believes the nominees for election at the annual meeting reflect these efforts: two director nominees (22%) are female; one director nominee (11%) is African-American; and one director nominee (11%) was born and has lived and worked outside the United States.

Following each nominee’s biography, we have included an assessment of the qualifications, skills and experience of such nominee.

 

One of the key responsibilities of the Board is to have a leadership structure that allows it to provide effective oversight of management and maximize the contributions of its members. Currently, the Board is led by a non-executive Chairman of the Board selected from among the independent directors. The non-executive Chairman is responsible for Board activities, while the Chief Executive Officer leads the management, operations and employees of the company. The Board adopted this leadership structure in 2007. 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 is not opposed in concept to combining these roles. Prior to 2007, the positions of Chairman and Chief Executive Officer had been held by the same person. The Board believes it should maintain the flexibility to change its leadership structure as circumstances warrant.

Larry C. Glasscock, who has served as one of our independent directors since 2001, has served as non-executive Chairman since

2013. The non-executive Chairman of the Board has the following duties and responsibilities:

 

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presiding at meetings of the Board and stockholders;

 

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approving the agendas for meetings of the full Board, as prepared by the Chief Executive Officer;

 

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presiding at executive sessions of the independent directors;

 

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coordinating the activities of the independent directors; and

 

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serving as the liaison between the Chief Executive Officer and the rest of the Board.

If the Board decides in the future to combine the positions of Chairman and Chief Executive Officer, the independent directors will designate one of themselves as “Lead Independent Director.” The Lead Independent Director would have the duties and responsibilities of the current non-executive Chairman, except for the duty to preside at meetings of the Board and stockholders.

 

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 Board’s role in risk oversight has not affected its leadership structure.

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 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 “finance code of ethics”), a code of ethics that applies to our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Corporate Controller, and other finance organization employees. 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 finance code of ethics, the Board’s Corporate Governance Guidelines and the charters for each of the Audit Committee, Compensation and Management Development Committee, Corporate Governance Committee, and Research, Innovation 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. If we make any substantive amendments to the finance code of ethics or grant any waiver, including any implicit waiver, from a provision of the code to our Chief Executive Officer, Chief Financial Officer, or Chief Accounting Officer and Corporate Controller, we will disclose the nature of that amendment or waiver in the Investor Relations section of our website. 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 New York Stock Exchange 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, Christopher B. Begley, Betsy J. Bernard, Paul M. Bisaro, Gail K. Boudreaux, Larry C. Glasscock, Robert A. Hagemann, Arthur J. Higgins, John L. McGoldrick and Cecil B. Pickett, Ph.D., meets these standards and is independent. The remaining director, David C. Dvorak, who is an employee, is not independent.

 

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 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.” All nominees for election as directors at the 2014 annual meeting are currently serving on the Board.

 

The Corporate Governance Committee screens candidates and recommends candidates for nomination to the full Board. In seeking and evaluating director candidates, the committee considers individuals in accordance with the criteria described above under “CORPORATE GOVERNANCE – Proposal No. 1-Election of Directors – Director Criteria, Qualifications and Experience.” Director candidates may be recommended by Board members, a third-party search firm or stockholders. Mr. Bisaro, who was appointed to the Board in December 2013, was recommended as a director candidate by a third-party search firm.

The committee considers candidates proposed by stockholders and evaluates them using the same criteria as for other candidates. A stockholder who wishes to recommend a director candidate for consideration by the 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 committee as a nominee, must comply with the advance notice requirements set forth in our Restated By-Laws. (See “What is the deadline to propose actions for consideration or to nominate individuals to serve as directors at the 2015 annual meeting of stockholders?” on page 5 for more information on these procedures.)

 

Stockholders or other interested parties may contact our directors by writing to them either individually or as a group or partial group (such as all independent directors), c/o Corporate Secretary, Zimmer Holdings, Inc., 345 East Main Street, Warsaw, Indiana 46580. If you wish your communication to be treated confidentially, please write the word “CONFIDENTIAL” prominently on the envelope and address it to

the director by name so that it can be forwarded without being opened. Communications addressed to multiple recipients, such as to “Board of Directors,” “Audit Committee,” “Independent Directors,” etc. will necessarily have to be opened and copied by the Office of the Corporate Secretary in order to forward them, and hence cannot be treated confidentially.

 

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.

Under our Code of Business Conduct, which is available on our website at www.zimmer.com, our Legal Department or Compliance Office 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 Board meetings, meetings of committees on which they serve and stockholder meetings. Directors are expected to spend the time needed and meet as frequently as necessary to properly discharge their responsibilities. During 2013, the Board held six meetings and committees of the Board held a total of 24 meetings. All directors attended 75% or more of the meetings of the Board and committees on which they served.

All current directors then in office attended the 2013 annual meeting of stockholders.

Each regularly scheduled Board meeting normally begins with a session between the Chief Executive Officer and the independent directors. This provides a platform for discussions outside the presence of the non-Board management attendees, as well as an opportunity for the independent directors to go into executive session (without the Chief Executive Officer) if requested by any director. The independent directors may meet in executive session, without the Chief Executive Officer, at any time, and are scheduled for such independent executive sessions at each regularly scheduled Board meeting. Mr. Glasscock, in his capacity as non-executive Chairman, presides at these executive sessions.

 

Our Restated By-Laws provide that the Board may delegate certain of its responsibilities to committees. During 2013, the Board had four standing committees: an Audit Committee, a Compensation and Management Development Committee, a Corporate Governance Committee and a Research, Innovation and Technology Committee. Each of the committees is composed entirely of independent

directors. In addition, the members of the Audit Committee and the Compensation and Management Development Committee meet the heightened standards of independence required by SEC rules and New York Stock Exchange listing standards.

The table below shows the current membership of each Board committee and the number of meetings held during 2013.

 

The principal functions of the Audit Committee include:

 

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appointing, evaluating and, where appropriate, replacing our independent registered public accounting firm;

 

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pre-approving all auditing services and permissible non-audit services provided to us by our independent registered public accounting firm;

 

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reviewing with our independent registered public accounting firm and with management the proposed scope of the annual audit, past audit experience, our program for the internal examination and verification of our accounting records and the results of recently completed internal examinations;

 

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resolving disagreements between management and our independent registered public accounting firm regarding financial reporting;

 

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reviewing major issues as to the adequacy of our internal controls; and

 

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overseeing our compliance with legal and regulatory matters and aspects of our risk management processes.

The Board of Directors has determined that Christopher B. Begley, Larry C. Glasscock, Robert A. Hagemann and John L. McGoldrick qualify as “audit committee financial experts” as defined by SEC rules. See pages 7-11 for a description of their respective business experience. Stockholders should understand that this designation is an SEC 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 SEC requirement does not affect the duties, obligations or liability of any other member of the Audit Committee or the Board.

See also the “Audit” section of this proxy statement for additional information about the Audit Committee’s responsibilities and actions and the Audit Committee Report.

 

The duties of the Compensation and Management Development Committee include:

 

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administering our annual and long-term incentive plans;

 

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reviewing and making recommendations to the Board with respect to incentive compensation and equity-based plans;

 

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approving compensation of executive officers;

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discussing with management the Compensation Discussion and Analysis required by SEC regulations and, if appropriate, recommending its inclusion in our Annual Report on Form 10-K and proxy statement; and

 

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reviewing the results of Say on Pay votes and determining whether changes should be made to our executive compensation policies and programs to address stockholder concerns.

 

None of the members of the Compensation and Management Development Committee during 2013 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 36.

 

The duties of the Corporate Governance Committee include:

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developing and recommending to the Board criteria for selection of non-management directors;

 

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recommending director candidates to the Board;

 

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overseeing the annual self-evaluation process for the Board and its committees;

 

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periodically reviewing the Board’s leadership structure and recommending any proposed changes to the Board for approval;

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periodically reassessing the Board’s Corporate Governance Guidelines and recommending any proposed changes to the Board for approval; and

 

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periodically reviewing, in cooperation with the Compensation and Management Development Committee, the form and amount of non-employee director compensation and recommending any proposed changes to the Board for approval.

 

Section 16(a) of the Exchange Act requires our directors, executive officers and persons who own more than 10% of our common stock to file reports of ownership and changes in ownership with the SEC.

Based on our records, we believe that during 2013 all applicable Section 16(a) filing requirements were met.

 

At the joint request of the Corporate Governance Committee and the Compensation and Management Development Committee, in May 2013 Towers Watson & Co. (“Towers Watson”) reviewed our non-employee director compensation program relative to market practices and proposed recommendations for adjustments. In formulating its recommendations, Towers Watson reviewed the most recent proxy statements of the companies in our peer group, multiple surveys on director compensation and third party sources regarding current and emerging best practices in this area. Towers Watson also researched the practices of Fortune 500 companies in regard to compensation paid for the non-executive chair position.

Towers Watson’s review indicated that the retainer paid to the non-executive chair under our program was positioned below the 25^th percentile of the peer group and published market data, and that the total direct compensation we paid to non-employee directors in 2012 was positioned at the 39^th percentile of the peer group. Towers Watson also reported that the practice of paying board and committee meeting fees was continuing to decline in prevalence, with only about one-third of the companies in our peer group and one-third of Fortune

500 companies paying meeting fees. Finally, Towers Watson found that the pay mix of our non-employee director compensation program was consistent with our peer group and general market practices, with 34% of total compensation paid in cash and 66% of total compensation paid in the form of equity.

Based on its review, Towers Watson recommended a number of changes to our non-employee director compensation program. The Compensation and Management Development Committee reviewed and discussed Towers Watson’s recommendations and, together with the Corporate Governance Committee, recommended to the Board of Directors that the following changes be made in the program to better align it with market practices:

 

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increase the additional annual retainer paid to the non-executive chair from $60,000 to $150,000;

 

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increase the annual retainer paid to non-employee directors for board service from $50,000 to $95,000; and

 

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eliminate all board and committee meeting fees.

The Board of Directors approved these changes effective as of July 1, 2013.

 

We pay non-employee directors quarterly, on the last day of March, June, September and December. As described above, the Board approved changes to our non-employee director compensation

program effective as of July 1, 2013. Accordingly, we paid the following amounts during 2013:

 

Directors who commence service on the Board, or who commence service as a committee chair or as non-executive chair, are paid applicable quarterly fees beginning with the quarter during which they commence such service. Similarly, directors who terminate service on

the Board or terminate service as a committee chair or as non-executive chair are paid applicable quarterly fees through the quarter during which such service terminated.

 

We awarded each non-employee director who was elected or re-elected at the 2013 annual meeting of stockholders 500 DSUs as of the date of the annual meeting with an initial value based on the price of our common stock on that date. We require that these annual DSU awards be credited to a deferred compensation account under the provisions of the Director Deferred Compensation Plan. DSUs represent an unfunded, unsecured right to receive shares of our common stock or the equivalent value in cash, and the value of DSUs varies directly with the price of our common stock. We also require that 50% of a director’s annual retainer be deferred and credited to his or her deferred compensation account in the form of DSUs with an initial value equal to the amount of fees deferred until the director holds a total of at least 5,000 DSUs.

Non-employee directors may elect to defer receipt of compensation in excess of their mandatory deferral and annual DSU award. Elective deferrals are credited to the director’s deferred compensation account in the form of either treasury units, dollar units or DSUs with an initial value equal to the amount of fees deferred. The value of treasury units and dollar units does not change after the date of deferral. Amounts deferred as treasury units are credited with interest at a rate based on the six-month U.S. Treasury bill discount rate for the preceding year. Amounts deferred as dollar units are credited with interest at a rate based on the rate of return of our invested cash during the preceding year. When we pay cash dividends on our common stock, amounts deferred as DSUs are credited with additional DSUs equal to the number of shares of our common stock

that could have been purchased if we paid cash dividends on the DSUs held in directors’ deferred compensation accounts and such cash was reinvested in our common stock. These additional DSUs are subject to mandatory deferral.

All treasury units, dollar units and DSUs are immediately vested and payable following termination of the non-employee director’s service on the Board. We settle annual DSU awards and mandatory deferral DSUs in shares of our common stock. We pay the value of treasury units, dollar units and elective deferral DSUs in cash. Non-employee directors may elect to receive the cash payment in a lump sum or in not more than ten annual installments. Non-employee directors may also elect to convert all or a portion of their annual retainer not subject to mandatory deferral into stock options using a ratio of an option to purchase three shares of common stock for each DSU the director would have received if he or she had elected to defer such compensation. These stock options become fully exercisable on the last day of the calendar year in which the options are granted if the director continues as a non-employee director throughout that year.

During 2013, we also awarded each continuing non-employee director RSUs as of the date of the annual meeting of stockholders with an initial value of $120,000 based on the price of our common stock on that date. These awards were made under the Stock Plan for Non-Employee Directors. The RSUs vested immediately and are subject to mandatory deferral until May 7, 2016, or, if later, the director’s retirement or other termination of service from the Board. We will settle the RSUs in shares of our common stock.

 

We provide non-employee directors with travel accident insurance and reimburse reasonable expenses they incur for transportation, meals and lodging when on Zimmer business. We also reimburse

non-employee directors for reasonable out-of-pocket expenses, including tuition costs incurred in attending director education programs.

 

The Board of Directors is committed to excellence in corporate governance and recognizes the interest our stockholders have expressed with respect to our executive compensation program. As a part of that commitment, and in accordance with Section 14A of the Exchange Act, our stockholders are being asked to approve, on an advisory basis, the compensation of our named executive officers as reported in this proxy statement. This proposal, commonly known as a “Say on Pay” proposal, gives stockholders the opportunity to endorse or not endorse our executive compensation program for the named executive officers for 2013.

Last year, stockholders showed strong support for our executive compensation program; more than 95% of the stockholders who voted on our Say on Pay proposal voted in favor of the proposal.

As described in detail in the Compensation Discussion and Analysis section of this proxy statement (“CD&A”), our executive compensation program is designed to attract, motivate and retain highly qualified and effective senior leaders who drive our success. In designing our program, the Compensation and Management Development Committee of our Board works to foster an environment in which executives are motivated to achieve financial performance goals and individual objectives that will drive the success of our business and, in turn, increase stockholder value on a long-term, sustainable basis. Taking into consideration feedback received from stockholders, the committee has improved our executive compensation program and practices over the past few years to strengthen the alignment of executives’ interests with those of our stockholders. Our compensation program:

 

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links a significant portion of total compensation to the achievement of performance goals that we believe will create long-term stockholder value;

 

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consists primarily of equity-based compensation, which encourages executives to think and act like owners of the company;

 

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subjects a significant percentage of total compensation to multi-year performance goals and/or vesting requirements,

which gives executives a long-term view and enhances retention;

 

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differentiates annual incentive compensation based on executives’ contributions and the performance of their specific business unit and/or geographic area of responsibility; and

 

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provides a competitive total pay opportunity.

We have adopted policies, including our stock ownership guidelines, executive compensation recoupment policy and prohibitions against hedging and pledging company securities, to ensure long-term focus and appropriate levels of risk-taking by our executive officers. Each of these policies is described in more detail in the CD&A.

The Board of Directors believes that our executive compensation program is designed to meet the objectives discussed in the CD&A. Accordingly, the Board recommends that stockholders vote in favor of the following resolution:

“RESOLVED, that the stockholders of Zimmer Holdings, Inc. approve, on an advisory basis, the compensation of the company’s named executive officers, as disclosed in this proxy statement pursuant to the SEC’s executive compensation disclosure rules, including the CD&A, the compensation tables and narrative disclosures.”

As an advisory vote, this proposal is not binding on the company, the Board or the Compensation and Management Development Committee, and will not be construed as overruling a decision by the company, the Board or the committee or creating or implying any additional fiduciary duty for the company, the Board or the committee. However, the committee and the Board value the opinions expressed by stockholders in their vote on this proposal and will consider the outcome of the “Say on Pay” vote when making future executive compensation decisions.

The Board has adopted a policy providing for annual Say on Pay advisory votes. Accordingly, the next Say on Pay vote will occur in 2015.

 

Our executive compensation programs are designed to achieve the following fundamental objectives:

 

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focus executives’ attention on specific financial, operational and strategic objectives;

 

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align executives’ interests with the long-term interests of our stockholders;

 

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recognize company and individual performance;

 

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reflect the value of each executive’s position in the market and within the company; and

 

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attract, retain and motivate a highly qualified and effective senior leadership team.

To accomplish these objectives, the Compensation and Management Development Committee of our Board (the “committee”) annually reviews and approves our executive compensation program components and target compensation levels, as well as specific performance metrics and targets, payout ranges and actual payouts. We emphasize performance-based compensation that appropriately rewards executives for delivering results that meet or exceed multiple pre-established goals over one- and three-year periods, with metrics and targets selected because they are directly linked to our strategic goals. In addition, our long-term incentive (“LTI”) program rewards both absolute stock price growth and relative total shareholder return (“TSR”).

 

At our 2013 annual meeting, stockholders showed strong support for our executive compensation program, with more than 95% of votes cast approving our advisory Say on Pay resolution. Following the 2013 Say on Pay vote, the committee considered the overwhelmingly favorable results of the vote and input from some of our major stockholders.

Based on the strong level of stockholder support, and in light of significant changes to our executive compensation program implemented over the past few years in response to feedback provided, the committee made no material changes in our executive compensation programs as a result of the 2013 Say on Pay vote.

 

In 2013, Zimmer delivered solid financial results and executed on key commercial, operational and strategic priorities amid the uncertainty of the global economic environment and healthcare reform measures in the U.S. and abroad. Our performance throughout the year was a validation of our philosophy of growth through innovation and further bolstered our position as a global leader in healthcare, exclusively focused and fully diversified within musculoskeletal care. Highlights include the following:

 

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We drove sales growth in 2013 fueled by the successful commercialization of innovative new solutions across our portfolio, from our flagship Knee offering, Persona® The Personalized Knee System, to our differentiated Transposal® Fluid Waste Management System, which enhances our presence in the OR suite.

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We outgrew the market in a number of geographies and product categories, maintaining and expanding our #1 global market share position in Knees and taking share from our competitors in our Extremities and Surgical categories.

 

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We reported 2013 net sales of $4.62 billion, an increase of 3.4% reported and 4.9% on a constant currency basis over 2012.

 

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Diluted earnings per share (“EPS”) for the year were $4.43 reported and $5.75 adjusted, an increase of 8.5% adjusted over 2012.

 

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Our stock price increased 39.8%, from $66.66 at the end of 2012 to $93.19 at the end of 2013.

 

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We achieved a TSR of 41.2% as of December 31, 2013, outperforming our peer group.

 

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In line with our commitment to return value to our stockholders, we paid out more than $850 million in the form of cash dividends and share repurchases in 2013.

 

 

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We focused significant resources on our operational excellence initiatives, investments intended to improve future operating results, and we continued to make progress toward achievement of excellence in our global quality infrastructure.

 

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We also demonstrated our commitment to pursue strategic growth opportunities through our acquisitions of Knee Creations, LLC and Germany-based NORMED Medizin-Technik GmbH. The Knee Creations asset acquisition enhances our portfolio of Knee treatments through the addition of the Subchondroplasty® procedure, an innovative, proprietary joint-preservation treatment that has been shown to deliver sustained relief to patients with knee pain. The NORMED acquisition strengthens our Extremities and Trauma product portfolios and new product development capabilities in the fast growing foot and ankle and hand and wrist categories.

2013 Performance and Payouts

Zimmer’s performance in 2013 had the following direct impact on executive compensation:

 

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Our NEOs as a group earned an average of 89.1% of their annual cash incentive opportunities. Actual payouts for the NEOs ranged from 76.5% to 110.1% of target opportunity.

 

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None of the long-term incentives awarded to our NEOs in 2013 have fully vested. Performance-based restricted stock units (“PRSUs”) awarded in 2013 are subject to achievement of TSR-related performance goals through 2015, as described more fully below, and stock options awarded in 2013 will vest over four years.

 

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For his service as our CEO, Mr. Dvorak earned total compensation of $7,689,748 in 2013, a decrease of $949,588, or 11.0%, from 2012. Mr. Dvorak’s 2013 compensation included the grant date fair value of PRSUs that will vest, if at all, in 2016 and stock options that are subject to continued vesting requirements through 2017.

 

ü		Pay for performance.  A significant percentage of executives’ target total direct compensation, 88% for our CEO, is at-risk and variable with performance, including stock price performance.
ü		Linkage between performance measures and strategic objectives.  Performance measures for incentive compensation are linked to both strategic and near-term operating objectives designed to create long-term stockholder value.
ü		Performance metric for the LTI program aligns with longer time horizon and minimizes duplication with annual cash incentive plan.  We use internal total shareholder return (“iTSR”) over a three-year period as the performance metric for the PRSU component of the LTI program. iTSR is derived from operating profit growth and free cash flow yield.
ü		Vesting of PRSUs tied to performance relative to peers.  Vesting of PRSUs is tied to meeting target iTSR, subject to a relative TSR modifier based on the S&P 500 Healthcare Index, which requires us to perform well relative to peers.
ü		Moderate target market positioning for LTI awards.  Although the committee generally targets LTI awards between the 50th and 75th percentiles of market, grants to the CEO were below the 50th percentile of market in each of 2011, 2012 and 2013.
ü		Challenging threshold performance goals under the annual cash incentive plan.  The revenue target must be achieved at 95% for a 50% payout; other metrics must be achieved at 90% for a 50% payout. Achievement below these thresholds results in zero payout.
ü		Increased emphasis on performance of executives’ specific business unit or geographic area of responsibility in annual cash incentive plan.  We tie annual incentive plan performance goals for NEOs with specific business unit and/or geographic responsibility to the results of that business unit or geography, rather than the company’s consolidated results.
ü		Use of peer group.  We use a peer group of other U.S. headquartered publicly traded companies selected on the basis of business focus, market capitalization, revenues and other factors to assess compensation levels, equity usage and incentive plan design and for performance comparisons.
ü		Moderate change-in-control benefits.  Change-in-control severance benefits are limited to two times target cash compensation.

ü		Double trigger in the event of a change-in-control.  Change-in-control severance benefits and long-term equity incentive awards have a double trigger; that is, they will not vest or be paid in the event of a change-in-control unless also accompanied by a qualifying termination of employment.
ü		No excise tax gross-ups in new agreements.  We eliminated gross-up provisions from change-in-control severance agreements with newly hired or promoted executives after July 2009.
ü		No employment contracts.  Our executives are “at will” employees with no employment agreements.
ü		Robust stock ownership guidelines.  Executives are required to hold equity with a value equal to a multiple of five times salary for our CEO and three times salary for each other NEO. 100% of net after-tax shares received upon vesting or exercise of awards must be retained until an executive meets the guideline ownership level.
ü		Policy prohibiting hedging and pledging of company securities.
ü		No dividends or dividend equivalents accrued or paid on unearned performance-based equity awards.
ü		Maximum payout caps for annual cash incentive compensation and performance-based equity awards.
ü		Clawback of incentive compensation in the event of restatement.  Awards to executive officers under short- and long-term incentive compensation plans are subject to clawback in the event of certain financial restatements. The clawbacks are designed to discourage imprudent risk taking.
ü		Non-competition agreement required for equity award eligibility.  All employees must sign a non-competition agreement as a condition of receiving an equity award. The award is subject to clawback if the agreement is breached.
ü		No repricing or exchange of underwater stock options.  Our equity incentive plans do not permit repricing or exchange of underwater stock options without stockholder approval.
ü		No inclusion of equity awards in pension calculations.
ü		Limited executive perquisites.

 

The following table describes the elements of target direct compensation for 2013. Our executive compensation program uses a mix of fixed and variable compensation elements and provides alignment with both short- and long-term business goals through annual and long-term incentive opportunities. In addition, we offer retirement plans and welfare benefits that are generally available to all employees and we provide a very limited range of perquisites or

other benefits to our executive officers. The intention of the committee is to provide a total pay opportunity that is comparable to our closest peer group and industry competitors, but which also places a greater emphasis on at-risk equity-based compensation. As executives assume positions of greater responsibility, a larger portion of their total compensation is tied to achieving objective performance measures.

 

Target compensation for individual executives may vary from the percentiles noted above based on a variety of factors, such as experience and time in the position, the nature of the executive’s responsibilities, criticality of the role and difficulty of replacement,

internal equity, retention concerns, individual performance and expected future contributions, readiness for promotion to a higher level, and, in the case of externally recruited executives, compensation earned at a prior employer.

 

To assess whether our 2013 compensation was consistent with the target levels described above, in December 2013 the committee reviewed an analysis of the NEOs’ 2013 compensation conducted by the committee’s consultant, Towers Watson & Co. (“Towers Watson”), including:

 

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base salary;

 

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target total cash compensation (base salary + target annual cash incentive);

 

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target LTI; and

 

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target total direct compensation (base salary + target annual cash incentive + target LTI).

This information was then compared to competitive pay level compensation information collected from our peer group. The table below summarizes the actual market positioning of target compensation for the NEOs, in the aggregate, compared to the latest data available for the peer group. As the table shows, this review indicated that all elements of compensation for 2013 were positioned below the stated target positioning for those elements.

 

In addition to the market review of 2013 compensation, Towers Watson assessed, at the committee’s request, the pay-for-performance alignment of our executive compensation programs over the three-year period ended December 31, 2012. This assessment was intended to assist the committee in reinforcing its pay-for-performance commitment by evaluating the degree to which NEOs’ realizable pay is aligned with corporate performance. Specifically, Towers Watson examined the extent to which the value delivered (or deliverable) to the NEOs under our executive compensation program was aligned with our financial performance over the three-year period, relative to the twelve companies in our peer group discussed below. With respect to Zimmer and each peer company, Towers Watson reviewed the following:

 

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historical performance in terms of TSR and multiple financial performance measures, including revenue growth, earnings per share growth, free cash flow yield, operating income margin and return on invested capital;

 

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executives’ pay opportunity (i.e., target value of compensation), made up of base salary and the target value of annual cash incentives and long-term equity-based incentives;

 

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executives’ realizable pay (i.e., actual value of compensation earned), made up of base salary and annual cash incentives earned, the market value of time-based equity awards granted during the period, the market value of performance-based equity awards settled during the period, and the target value of outstanding performance-based equity awards; and

 

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the ratio of realizable pay to pay opportunity, using a ratio of 100% to indicate that actual compensation earned was equal to the target value of compensation at the date of grant.

The analysis revealed that our NEOs’ realizable pay was aligned with our TSR and our financial performance for the three-year period relative to the companies in our peer group. Specifically, our TSR ranked at the 45^th percentile of the peer group over the three-year

period, our performance in terms of eight different financial measures ranked from the 98^th percentile to the 25^th percentile of the peer group, with the average at the 54^th percentile and the median at the 61^st percentile, and our NEOs’ realizable pay ranked at the 55^th percentile of the peer group. The committee believes this analysis provides evidence that our executive compensation program is designed in a manner that aligns pay and performance.

 

Annual base salary increases for our global employee population, including NEOs, are generally effective in April of each year. In setting NEOs’ base salaries for 2013, the committee considered our 2013 employee merit increase guidelines, market data based on peer group benchmarking, changes in job responsibilities and internal equity. After considering these factors, the committee approved a base salary increase of 2.5% for each U.S.-based NEO and 4.5% for

Mr. Ooi, consistent with the merit increase guidelines for employees based in the U.S. and Singapore, respectively. For Dr. Mazur-Hofsaess, who was promoted to the position of President, EMEA effective April 1, 2013, the committee approved a base salary increase of 3.0%, higher than the merit increase guideline for employees based in Switzerland, to reflect her increased job responsibilities.

 

Annual cash incentives for executives are determined under the Executive Performance Incentive Plan (“EPIP”). When establishing 2013 target EPIP awards, the committee considered the following:

Target EPIP award percentages. In determining target EPIP award percentages, the committee reviewed NEOs’ job responsibilities, market data based on peer group benchmarking, and internal equity. After considering these factors, the committee decided to maintain the 2012 target percentages in 2013 for each NEO, other than Dr. Mazur-Hofsaess. Dr. Mazur-Hofsaess’ target bonus percentage was increased in recognition of the greater responsibilities she assumed when promoted to the position of President, EMEA. The 2013 target EPIP awards as a percentage of base salary are as follows: Mr. Dvorak – 125%, Mr. Crines – 80%, Dr. Mazur-Hofsaess – 75%, Mr. Ooi – 75% and Mr. McCaulley – 80%.

Financial performance measures. The committee selected four financial measures by which to assess our 2013 performance for purposes of the EPIP. The below table shows the performance

measures, their respective weightings and the rationale for their selection. With respect to Messrs. Dvorak and Crines, the committee set performance metrics based on the company’s consolidated

results. With respect to Dr. Mazur-Hofsaess and Messrs. Ooi and McCaulley, executives with top-line responsibility for specific business units and/or geographic segments, the committee generally set performance metrics based on the executives’ respective areas of responsibility, rather than on consolidated results. The committee believes this approach more closely aligns those executives’ pay with the performance of the business units or geographic areas for which they are primarily responsible. The committee established specific goals for each of the measures in early 2013 based on the annual operating plan approved by the Board. Because the operating plan forms the basis for both the company’s annual sales and earnings guidance communicated to investors and the EPIP financial targets, the interests of the NEOs are aligned with those of stockholders.