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So Everyone is Using Market Conditions: Great! What Does that Mean? SPEAKERS Kevin McDonald, Director, Executive Compensation, Covidien (US) Dr. Thomas Schmalberger, Head of Reward & Organizational Effectiveness, OC Oerlikon, (CH) David Tuch, Partner, New Bridge Street, an Aon Hewitt Company (UK) MODERATOR Jon Burg, Associate Partner, Radford, an Aon Hewitt Company (US) “Market Condition” – an accounting term • Market condition – vesting of share award is related to share price e.g.: • Absolute Share price target • Absolute TSR target • Relative TSR target – Company’s TSR vs. comparator group or vs. index • Non-market condition – vesting related to condition not related to share price e.g.: • Growth in EPS • Return on equity Brief history • Initially companies used non market based performance conditions such as growth in EPS over 3 year period but: • Increasingly difficult to set robust targets • Company’s don’t always like setting/disclosing targets • Shareholders expect targets to get harder if strong past performance/prospects look easier but not weaker if poor past performance/prospects look tougher • Use of relative TSR targets deals with many of these issues (note shareholders don’t like absolute share price or TSR targets) About OC Oerlikon OC Oerlikon provides innovative industrial solutions for the efficient and clean production of Food, Clothing, Transportation Systems, Infrastructure, Energy and Electronics. Headquartered and publicly traded (OERL) in Switzerland, we are present in 34 countries world wide with about 160 sites and nearly 13 000 employees. Three years ago we sharpened our mission … •Strive to be your most reliable business partner, worldwide. •Increase value through high-quality innovative industrial solutions, continuously. •Engage highly qualified professionals. •Our commitment is your success! … and re-launched our core values … Integrity, Team Spirit, Excellence and Innovation … preparing the ground for a philosophy of «Best-in-Class». «Best-in-Class» designates the position in a peer group relating to operational and market performance and applies equally to financial results, processes and culture. Topics range from operational excellence and procurement efficiency to health, safety and environmental standards and employee engagement levels. All functions are encouraged to compare against peers to learn and improve. The success is reflected in business results. 2012 Revenue (in MCHF) 2’906 EBIT (in MCHF) 421 Net Income (in MCHF) 385 Diluted EPS 1.16 P/E Ratio 8.77 2011 2’731 318 224 0.68 7.40 ( 6.4%) (31.4%) (71.9%) (70.5%) (15.6%) 2010* 4’182 51 5 0.01 490.0 ( 16%) (>100%) (>100%) (>100%) * Incl discontinued business Starting in 2011, we adapted our compensation strategy to the best-in-class philosophy and plan to have it implemented globally by the end of 2013. • Spun from Tyco International in 2007 • Is a global medical device and pharmaceutical manufacturing company with nearly $12 Billion in annual revenue 2012 Sales by Segment Medical Supplies $1.8B 2012 Sales by Geography Other Americas $0.7B Asia-Pacific $1.9B Pharmaceuticals Medical Devices $2.0B $8.1B United States $6.6B Europe $2.7B Medical device products in the endomechancial, soft tissue repair, energy, airway & ventilation, oximetry & monitoring and vascular markets Generic and branded pharmaceuticals, active pharmaceutical ingredients, contrast agents and delivery systems, radiopharmaceuticals Medical supplies including wound care, incontinence, needles and syringes, enteral feeding, operating room kits and accessories Our Mission Create and deliver innovative healthcare solutions, developed in ethical collaboration with medical professionals, which enhance the quality of life for patients and improve outcomes for our customers and our shareholders. Our Vision Deliver unmatched value to our customers by providing solutions that improve patient outcomes and healthcare delivery through clinically relevant and economically valuable innovation. So how does a relative TSR target work? % vesting • Most common – Company vs. Peer Group • Companies in an index (e.g. FTSE 100) • Bespoke group of companies • Less common – Company vs. Index – • Often used when small number of comparators available • Recognised index (e.g. FTSE 100) • Index of bespoke group of companies 10 0 % 80% 60% 40% 20% 0% Median Upper quartile Co TSR performance vs. peers % vesting 10 0 % 80% 60% 40% 20% 0% Index Index + X% p.a. Co TSR performance vs. Index Compensation Strategy Attract the finest talent and to motivate and reward best-in-class performance through Base salary aligned to market level STI aimed above the market level and at all managers and professionals LTI aligned to market level and for Global Leaders LTI Pay Level LTI STI Base Previous STI Base Current Pay-for-(Long-Term) Performance • The Long-Term Incentive (LTI) is a three-year equity program aimed at motivating Global Leaders to plan and act with a long-term view. • Eligibility in the LTI program was enlarged from some 30 to some 130 Global Leaders. • The LTI is specifically designed for rewarding the relative increase in total shareholder return compared to the total shareholder return of relevant peers. • Peers are the 27 companies we compare ourselves to in terms of operational performance as well as shareholder return. Company Sector Company Sector Jingwei Textile Bodycote Coating Lakshmi Textile Kennametal Coating Rieter Textile Textile Praxair Coating Schweiter Textile Sandvik tooling Coating Am Axle Drive Systems General Electric Industry Group Brembo Drive Systems Siemens Industry Group Carraro Drive Systems GEA Industry Group Dana Drive Systems Sumitomo Industry Group Bharat Gears Drive Systems Thyssen Krupp Industry Group BorgWarner Drive Systems ABB Swiss Industry Group Atlas Vacuum Sulzer Swiss Industry Group Gardner Vacuum Georg Fischer Swiss Industry Group Inficon Vacuum OC Oerlikon Swiss Industry Group Ingersoll Rand Vacuum Pfeiffer Vacuum Upper Quartile Market Median LTI Plan Design – Performance Share Awards (PSA) LTI 2012 2012 LTI 2013 2013 2014 2013 2014 2015 2014 2015 LTI 2014 Starting Value: VWAP over first 30 days of Year 1 Ending Value: VWAP over last 30 days of Year 3 Performance Condition – Total Shareholder Return (TSR) Relative TSR Rank 3 of peer group or above Rank 10 of peer group Rank 15 of peer group Rank 20 of peer group or below Payout Factor 200% (Max.) 100% 80% 0% Vesting Period 2016 Performance Period Pay-for-(Long-Term) Performance Target PSA X Payout Factor = Effective Shares Example Rank 3 CHF 10’000 / VWAP°10.00 = PSA 1’000 10 PSA 1’000 * Factor 1.5 = PSA 1’500 OERL 1’500 * SP 11.00 = CHF 16’500 15 20 °VWAP over the first ten trading days after publication of the previous year’s financial results. Payout Factor Covidien’s Executive Long-term Incentive Structure Performance Share Payout Curve and Healthcare Industry Index Capped at 2.0x RSUs 20% Stock Options 40% Performance Shares 40% Stock options and RSUs have four year prorated vesting Performance shares have a three year cliff vest based on total shareholder return against an industry index Employee equity mix is 50% stock options and 50% RSUs No payout below 30th percentile 3-year total percentile performance vs. healthcare industry index (below) Abbott CareFusion Stryker Corp. Baxter Int’l Hospira Teleflex Becton, Dickinson Johnson & Johnson Thermo Fisher Boston Scientific Medtronic Zimmer Holdings C.R. Bard Owens & Minor Cardinal Health St. Jude Medical Selecting a bespoke peer group low Volatility vs. Correlation for each potential peer company 70% high likelihood of achieving both maximum and zero payouts; average result fairly high high TSR VOLATILITY (RELATIVE TO PEER GROUP) payouts vary significantly but on average fairly high; outcomes have little perceived link to company performance TSR volatility 60% 50% 40% 30% moderate variance of outcome about median, leading to partial payout in some years company generally close to median, leading to low average payout low high Example of how to interpret volatility and correlation analysis 20% 10% 0% 0% low high 10% 20% low TSR CORRELATION WITH PEER GROUP Ideal position The low correlations of these companies suggests they might not be appropriate peers 30% 40% 50% high 60% TSR correlation The high correlations of the larger companies suggest they would still be appropriate peers Why do shareholders like relative TSR? • Alignment of interests • Removes scope for management gaming the setting of target range • Should take out impact of external factors that impact on performance i.e. should be a robust measure irrespective of general economic conditions/position within a cycle • Should show how management have performed vs. their competitors • In theory, TSR should take account of all performance indicators and market’s view of future performance Challenges with TSR Performance Share Plan • Initially, performance shares were granted to all employees • Until first payout, plan was not widely understood or valued • Changes in index due to corporate transactions • Continued pressure to align plan with market • Communication was a challenge; solved by PeerTracker Overall plan has been a success with positive feedback from executives, the Compensation Committee and shareholders Three Challenges Introducing equity-settled compensation requires some learning in terms of: • Investors, in addition to customers, suppliers and staff • Insider trading regulations Replacing an accounting-based with a market-based LTI plan requires a change in mindset from: • My division to my corporation • My business presentation to our equity story • My business performance to our stock performance In addition, building an LTI plan on a «Best-in-Class» philosophy requires a change in mindset from: • My comfort zone (good and better) to the edge (best) More issues to consider with relative TSR? • Can be seen by management as a lottery • Can be difficult to select an appropriate comparator (group of companies or index) • Lack of clear line of sight between actions taken by management and results • Potentially difficult for management to see how they are doing unless TSR vs. published index LTI Communication Webinar Series Twice a year we offer webinars to new and existing LTI Participants to present the LTI plan in the context of the compensation strategy, explain the plan design and demo the Administration and Communication Platform. Administration and Communication Platform We offer LTI participants an administration and communication platform from a third party to support the election of annual allocations, monitor the performance and value of their unvested and vested grants and transfer or sell their vested shares. Performance and Payout Tracker Within the administration and communication platform we provide participants with daily updates of the total shareholder return of Oerlikon and its peers as well as the associated payout factor of their grant. Performance Payout Factor Administration & Communication Platform Questions? Thank You! Jon Burg, FSA Radford, an Aon Hewitt Company [email protected] Kevin McDonald Covidien [email protected] David Tuch New Bridge Street, an Aon Hewitt Company [email protected] Dr. Thomas Schmalberger OC Oerlikon [email protected]