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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Commission File Number: 000-50661

POLAROID HOLDING COMPANY
(Exact name of Registrant as specified in its charter)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes o    No ý

        As of November 5, 2004, the number of outstanding shares of the Registrant's Common Stock, $.001 par value, was 34,956,069.

POLAROID HOLDING COMPANY
FORM 10-Q
For the Three and Nine Month Periods Ended September 26, 2004
INDEX

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Statement of Earnings

Polaroid Holding Company and Subsidiary Companies
Three and nine month periods ended September 26, 2004 and September 28, 2003
(in millions, except per share and share amounts)
(unaudited)

See accompanying notes to consolidated financial statements and accompanying review report of KPMG LLP.

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Consolidated Balance Sheet

Polaroid Holding Company and Subsidiary Companies
(in millions, except per share amount)
(unaudited)

See accompanying notes to consolidated financial statements and accompanying review report of KPMG LLP.

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Consolidated Statement of Cash Flows

Polaroid Holding Company and Subsidiary Companies
Nine month periods ended September 26, 2004 and September 28, 2003
(in millions)
(unaudited)

See accompanying notes to consolidated financial statements and accompanying review report of KPMG LLP.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.     Accounting Information

Basis of Presentation

        The accompanying consolidated financial statements include the accounts of Polaroid Holding Company and its domestic and foreign subsidiaries, all of which are either wholly owned or majority owned (collectively, the "Company"). Intercompany transactions have been eliminated. The information furnished in this interim unaudited report reflects all normal adjustments that, in the opinion of management, are necessary for a fair presentation of the results of the interim periods.

        The Company's results of operations for the three and nine month periods ended September 26, 2004 are not necessarily indicative of the results to be expected for the full year. The information included in this quarterly report on Form 10-Q should be read in conjunction with the information in "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Quantitative and Qualitative Disclosures About Market Risk" and the consolidated financial statements and notes thereto included in Items 7, 7A and 8, respectively, in the Company's Form 10-K for the fiscal year ended December 31, 2003. As noted therein, the Company's Form 10-K for the fiscal year ended December 31, 2003 does not contain all of the financial information that is required by the rules and regulations applicable to such report, and the absence of such information could be material to investors.

Use of Estimates

        The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires the Company's management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Cash Payments for Interest and Income Taxes

        The Company's cash payments for interest and income taxes for the three and nine month periods ended September 26, 2004 and September 28, 2003 were as follows (in millions):

Termination Costs:

        In the second quarter of 2004, the Company made a decision to terminate the test marketing and development of its instant digital printing kiosk and does not plan to commercialize this product in the future. As a result, the Company recorded a charge of $2.8 million in cost of sales in the second quarter of 2004, related to certain media and hardware vendor termination costs as well as for fixed asset write-offs. These non-standard costs were reported in the Global Manufacturing business segment.

Asset Sales:

        In the second quarter of 2004, the Company sold certain held for sale property located in Germany for net cash proceeds of $4.0 million and reported a gain of $1.0 million on this sale in general and

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administrative expenses. In addition, the Company sold certain excess real estate located in the United Kingdom for $0.5 million and recognized this amount as a gain in general and administrative expenses.

        Also in the second quarter of 2004, the Company received a cash distribution of $1.2 million related to the sale of the Company's equity interest in a private company. The gain of $1.2 million from the sale of the Company's investment in this company was recorded in other income. In connection with this sale, the Company negotiated a settlement of a license agreement with the private company and, as a result, received a cash payment $0.4 million in the second quarter of 2004. This settlement amount was also recorded in other income.

Other Non-cash Items:

        In the first nine months of 2004 and 2003, the Company recorded other non-cash items of $6.4 million and $5.9 million, respectively, in its cash flows from operating activities. These non-cash items primarily related to foreign exchange adjustments.

Stock-Based Compensation:

        The Company accounts for its stock-based compensation under the intrinsic value method of accounting as defined by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations and provides disclosure related to its stock-based compensation under the provisions of SFAS 123, Accounting for Stock-Based Compensation ("SFAS 123"), as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure.

        If compensation cost for the Company's stock option awards (see Note 3) had been determined based on the fair value at grant date for awards under the plans consistent with SFAS 123, the Company's net earnings and basic and diluted earnings per common share, based on net earnings available to common

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stockholders, would have been changed to the pro forma amounts as follows (in millions except per share data):

        The fair value of the Company's stock option grants during the first six months of 2004 was estimated on the grant date using the Minimum Value Method with the following weighted average assumptions:

        The fair value of the Company's stock option grants during the third quarter of 2004 was estimated on the grant date using the Black Scholes Method with the following weighted average assumptions:

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2.     Earnings per Share

        The numerators and denominators of the basic and diluted earnings per common share computations for the Company's reported net earnings available to common stockholders were as follows (in millions except share and per share amounts):

        The calculation of diluted earnings per common share for the three and nine month periods ended September 26, 2004 does not include the effects of 158,625 outstanding options to purchase shares of the Company's common stock because the effects were anti-dilutive. The Company's basic earnings per share calculations for the three and nine month periods ended September 28, 2003 contain an immaterial revision to include the vested portion of the outstanding restricted shares of Common Stock that have been included in the diluted earnings per share calculations.

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3.     Stock-based Compensation

        In the first and second quarters of 2003, the Company sold 2,855,390 and 1,169,350 restricted shares of its Common Stock, respectively, for a nominal amount to certain executives and directors. These sales were exempt from registration under the Securities Act of 1933, as amended (the "Securities Act"), pursuant to Section 4(2) thereof or pursuant to Rule 701 promulgated thereunder. These shares are subject to restrictions, including those on voting rights, transfers, sales and other matters, and are subject to repurchase by the Company under certain circumstances. A total of 25% of the restricted shares of Common Stock vests one year after the date specified in the grant letter for the award and an additional 12.5% vest every six months thereafter over the following three year period. The intrinsic value, based on the estimated fair value, of these restricted shares at the time of sale of $0.4 million was recorded by the Company as deferred compensation in common stockholders' equity and is being recognized in general and administrative expense on a straight line basis over the four year vesting period for these shares.

        In the third quarter of 2003, the Company sold 42,440 restricted shares of its Common Stock for a nominal amount to a director with terms similar to those applicable to the sales of restricted shares of Common Stock in the first and second quarters of 2003.

        In the first quarter of 2004, the Company sold 843,900 restricted shares of its Common Stock for a nominal amount to certain executives and a director of the Company. These sales were exempt from registration under the Securities Act, pursuant to Section 4(2) thereof or pursuant to Rule 701 promulgated thereunder. These shares are subject to the same terms as described above for the restricted shares of Common Stock granted in the third quarter of 2003. The intrinsic value, based on the estimated fair value, of these restricted shares at the time of sale of $4.7 million was recorded by the Company as deferred compensation in common stockholders' equity and is being recognized in general and administrative expense on a straight line basis over the four year vesting period for these shares.

        Concurrent with the sale of the restricted shares of Common Stock in the first quarter of 2004, the Company purchased 170,901 shares of the newly issued restricted shares of Common Stock for approximately $0.9 million. The Company did not pay the purchase price to the sellers but instead used the purchase price of these shares to pay a portion of each such seller's income tax liability related to the original purchase of restricted shares of Common Stock. In addition, the Company awarded a bonus of $1.1 million in the first quarter of 2004 to the purchasers of the restricted shares of Common Stock that was used to pay most of the purchasers' remaining income tax liability associated with the original purchase of restricted stock. The bonus was recorded in general and administrative expenses in the first quarter of 2004. The deferred compensation of approximately $0.9 million related to the shares repurchased was recognized as a non-cash expense in general and administrative expenses in the first quarter of 2004. The Company also recognized a non-cash expense in general and administrative expenses of approximately $0.3 million and $0.9 million in the third quarter and first nine months of 2004, respectively, based on a straight line amortization of the deferred compensation related to the grant of restricted shares of Common Stock in the first quarter of 2004.

        The Company has the right to purchase the non-vested restricted shares of Common Stock held by executives or directors who leave the Company or the Board of Directors, respectively, for a nominal amount. These repurchased shares are recorded as treasury stock and are available to be reissued. As of September 26, 2004, the Company has repurchased a total of 553,340 shares of non-vested restricted shares of Common Stock from executives who left the Company, of which 80,312 shares were repurchased in the third quarter of 2004.

        In the first quarter of 2004, the Company adopted the 2004 Stock Option Plan under which directors, executives and certain employees may be granted options to purchase restricted shares of the Company's Common Stock (the "2004 Stock Option Plan"). Any shares of Common Stock issued upon exercise of

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options will be subject to restrictions, including restrictions on voting rights, transfers, sales and other matters, and will be subject to repurchase by the Company under certain circumstances.

        In the first quarter of 2004, the Company granted a total of 452,901 options to certain executives and a director pursuant to the 2004 Stock Option Plan. The options issued in the first quarter of 2004 have a term of ten years from the date of grant and 25% of the options vest one year after the date specified in the grant letters for the award (which in some cases is prior to the grant date) and an additional 12.5% vest every six months thereafter over the following three year period.

        In the second quarter of 2004, the Company granted a total of 123,375 options to certain executives pursuant to the 2004 Stock Option Plan. These options have a term of ten years from the date of grant and 25% of the options vest one year after the date of the grant and an additional 12.5% vest every six months thereafter over the following three year period.

        In the third quarter of 2004, the Company granted a total of 158,625 options to certain executives pursuant to the 2004 Stock Option Plan. These options have a term of ten years from the date of grant and 25% of the options vest one year after the date of the grant and an additional 12.5% vest every six months thereafter over the following three year period.

        As of September 26, 2004, the Company has recorded the intrinsic value of its stock-based compensation grants as deferred compensation in common stockholders' equity. This deferred compensation is being amortized to general and administrative expenses over the respective vesting periods of these grants. As of September 26, 2004, 915,735 options were authorized under the 2004 Stock Option Plan, 717,671 options had been granted and remained outstanding under the 2004 Stock Option Plan, and 198,064 options were available for future grant under the 2004 Stock Option Plan.

        A summary of the Company's stock option awards as of September 26, 2004, and the changes for the period from January 1 to September 26, 2004, is presented below:

        Of the Company's stock option awards outstanding at September 26, 2004, 4,875 were exercisable.

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4.     Comprehensive Income

        The Company's total comprehensive income for the three and nine month periods ended September 26, 2004 and September 28, 2003 were as follows (in millions):

        Accumulated other comprehensive income as of September 26, 2004, consisted of foreign currency translation adjustments of $16.1 million offset by an unrealized loss on available for sale securities of $0.1 million. Accumulated other comprehensive income as of December 31, 2003, consisted of unrealized foreign currency translation adjustments of $17.0 million. There were no tax effects associated with the foreign currency translation adjustments recorded in accumulated other comprehensive income at September 26, 2004 or December 31, 2003.

5.     Business Segments

        The Company's reportable business segments are: the Americas Region; the International Region; Global Manufacturing; and Research and Development ("R&D"). The Company also has an All Other segment that includes: the eyewear business; the commercial secure identification systems business; brand and technology licensing operations; and contract manufacturing. The Americas Region consists of sales, marketing and distribution operations in the United States of America and other countries in North America and South America. The International Region consists of sales, marketing and distribution operations outside the Americas Region. Global Manufacturing consists of worldwide activities associated with manufacturing, procurement, developing manufacturing processes for new products, and inventory management. R&D consists of research and development activities. The Company's business segments are managed by senior executives who are directly responsible for all activities in the segment and report to the Company's chief operating decision-maker.

        The Company evaluates the performance of its business segments based on each segment's impact on profit from operations and its asset management. In the regional sales and marketing segments, profit from operations is based on standard product costs excluding intercompany margins and therefore reflects contribution to worldwide Company profits from third party sales. Non-standard manufacturing costs along with the costs of procurement, inventory management and developing manufacturing processes for new products are reported as costs in profit from operations in the Global Manufacturing segment. For the R&D segment, research and development costs are expensed as incurred in profit from operations. The financial results of each business segment are reviewed by the Company's chief operating decision-maker.

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        The Company has one category called Corporate which is not classified as a business segment. This category includes: central marketing; centralized information systems; general and administrative functions; worldwide finished goods planning activities; and certain other corporate functions. The non-segment Corporate category also includes costs related to restructuring activities, certain incentive compensation costs and certain other non-operating items.

        The following is a summary of information related to the Company's business segments and the non-segment Corporate category (in millions):

6.     Restructuring Charges

        The Company recorded restructuring charges of $6.7 million in the third quarter of 2004, and $8.9 million in the first nine months of 2004. These charges were recorded in the non-segment Corporate category and primarily represented charges for involuntary severance programs intended to downsize and consolidate certain sales and marketing operations, primarily in the International Region, certain operations in Global Manufacturing and certain non-segment Corporate operations. These reductions were intended to further reduce the Company's cost of manufacturing and its overhead costs. The charges in the third quarter of 2004 and the first nine months of 2004 also included approximately $0.1 million and $0.4 million, respectively, of exit costs related to the liquidation of certain non-U.S. marketing subsidiaries.

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        The following table summarizes the Company's reserves established for restructuring programs at December 31, 2003 and the related cash charges for the three and nine month periods ended September 26, 2004 (in millions):

        Approximately $3.0 million of the severance charges in the first nine months of 2004 represent pension enhancement costs under a non-U.S. pension plan. In the first nine months of 2004, approximately $0.8 million of cash payments had been made to the local pension trust related to these charges. These cash payments are included in the Company's pension plan cash contributions in the first nine months of 2004 (see Note 7).

        The Company recorded restructuring charges of $0.1 million in the third quarter of 2003 and $1.7 million in the first nine months of 2003. These charges were recorded in the non-segment Corporate category and represented charges for involuntary severance programs intended to downsize and consolidate certain operations in Global Manufacturing, certain sales and marketing operations, and certain non-segment Corporate operations. These reductions were intended to further reduce the Company's cost of manufacturing and its overhead costs.

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        The following table summarizes the Company's reserves established for restructuring programs at December 31, 2002 and the related cash and non-cash charges for the three and nine month period ended September 28, 2003 (in millions):

7.     Pension Plans

        The components of the Company's net periodic pension expense for its manufacturing subsidiaries in the United Kingdom and the Netherlands with trusteed, contributory defined benefit pension plans for the three and nine month periods ended September 26, 2004 and September 28, 2003 were as follows (in millions):

        The Company expects to contribute a total of approximately $8.7 million to these pension plans in fiscal 2004. As of September 26, 2004, approximately $5.8 million of cash contributions have been made to these pension plans. Therefore, the Company expects to make $2.9 million of additional cash contributions to fund these pension plans during the remainder of fiscal 2004.

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8.     Short-term Debt

        In September 2004, the Company entered into an amendment to its $100 million credit facility (the "Credit Agreement"). The amendment provides for a reduction in the minimum earnings before interest, taxes, depreciation and amortization ("EBITDA") covenant levels (calculated as of the end of each fiscal quarter on a rolling four quarter basis) for the third and fourth fiscal quarters of 2004 and the first fiscal quarter of 2005 to $38.0 million, $12.5 million and $2.5 million, respectively. The EBITDA covenant level for the second fiscal quarter 2005, which is the final period tested, was unchanged by this amendment and remained at $53.0 million. In addition, the amendment removed the ability of the Company to redeem shares of its outstanding Preferred Stock and to pay dividends or make other distributions to any of its shareholders without approval of the lenders under the Credit Agreement. In connection with this amendment, the Company paid the lenders under the Credit Agreement a fee of $0.2 million. The Company did not borrow under the revolving credit line in the Credit Agreement in the first nine months of 2004 or 2003.

9.     Common Stockholder's Equity

        As of September 26, 2004, the Company had authorized 50,000,000 shares of Common Stock with a par value of $0.001 per share (the "Common Stock"), of which 34,956,069 shares were issued and outstanding. In the first quarter of 2004, the Company repurchased 170,901 shares of its restricted Common Stock (see Note 3) for approximately $0.9 million and recorded this repurchase as treasury stock. In addition, as of September 26, 2004, the Company has repurchased a total of 553,340 shares of non-vested restricted stock for a nominal amount from executives who left the Company (refer to Note 3) and recorded these repurchases as treasury stock.

10.   Preferred Stock

        As of December 31, 2003, the Company had issued and outstanding 446,150 shares of Series A 8% Cumulative Compounding Preferred Stock (the "Preferred Stock"). In April 2004, the Company paid a dividend of $1.4 million on the Preferred Stock (representing all accrued and unpaid dividends on the Preferred Stock as of that date) and redeemed 50% of the then outstanding Preferred Stock for $22.3 million. As of September 26, 2004, 223,190 shares of the Company's Preferred Stock were outstanding.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
Polaroid Holding Company and Subsidiary Companies

        We have reviewed the accompanying consolidated balance sheet of Polaroid Holding Company and Subsidiary Companies as of September 26, 2004 and the related consolidated statements of earnings for the three and nine month periods ended September 26, 2004 and September 28, 2003 and consolidated statements of cash flows for the nine month periods ended September 26, 2004 and September 28, 2003. These consolidated financial statements are the responsibility of the Company's management.

        We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

        Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with United States generally accepted accounting principles.

        We have previously audited, in accordance with auditing standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Polaroid Holding Company and Subsidiary Companies as of December 31, 2003, and the related consolidated statements of earnings, stockholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated February 4, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2003, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

KPMG LLP
Boston, Massachusetts
October 25, 2004

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

        Some statements in this report may be forward looking in nature, or "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of forward-looking words or phrases such as "believe", "expect", "anticipate", "should", "plan", "seek", "goal", "outlook", "target", "intend", "will", "estimate" and "potential" among others. Actual results may differ materially from those projected in or implied by any forward-looking statement as a result of a wide variety of factors, which include, but are not limited to those set forth in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Annual Report for the fiscal year ended December 31, 2003 filed with the United States Securities and Exchange Commission ("SEC") on Form 10-K on April 14, 2004 (the "Form 10-K"). The Registrant assumes no obligation to update forward-looking statements whether as a result of new information, future events or otherwise.

Background

        The following information should be read in conjunction with the information regarding the Company in Part I Item 1. Financial Statements and in conjunction with the Form 10-K for the fiscal year ended December 31, 2003 and the quarterly reports filed on Form 10-Q for the subsequent fiscal quarters. As noted therein, the Company's Form 10-K for the fiscal year ended December 31, 2003 does not contain all of the financial information that is required by the rules and regulations applicable to such report, and the absence of such information could be material to investors. The information on the Company's results of operations for any interim period, including the information presented below, is not necessarily indicative of the results of the Company's operations for the entire year.

Business

        The Company designs, develops, manufactures and markets instant and digital imaging products and related products. The Company's principal products are instant cameras and instant film, which are marketed worldwide. In addition to its principal products, the Company designs, develops, manufactures and/or markets photographic hardware accessories for the instant photography market. The Company's other products and services consist of eyewear, principally sunglasses, and secure identification systems for commercial applications. The Company also performs contract manufacturing for and licenses its brand and technology to third parties.

        As previously disclosed, the Company made a decision in the second quarter of 2004 to terminate the test marketing and development of its instant digital printing kiosk and does not plan to commercialize this product in the future. The Company continues its efforts to design and develop other digital printing applications that will enable digital images to be printed quickly, conveniently and affordably. The Company has made and continues to make a significant investment in instant digital printing which continues to have an adverse effect on profit from operations. There can be no assurance that any of these digital printing applications will be commercialized.

Overview of Third Quarter and First Nine Months of 2004 Results

        The Company's net sales in the third quarter of 2004 were $153 million, which includes a favorable impact from foreign exchange of approximately $3 million. The Company's variances from standard manufacturing costs and its sales and marketing expenses in the third quarter of 2004 include a total of approximately $2 million from the unfavorable impact of foreign exchange. In the third quarter of 2004, the Company recorded approximately $7 million of restructuring expenses. Also in the third quarter of 2004, the Company determined that it was not probable that it would meet the criteria for its 2004 employee cash incentive compensation program and, as a result, reversed the year to date provision for this program resulting in a reduction of overhead expenses of $4 million. The Company may, in its discretion,

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consider an alternative 2004 employee incentive compensation program which could result in a charge for employee incentive compensation in the fourth quarter of 2004. In the third quarter of 2004, the Company revised its estimate of its effective tax rate for 2004 to negative 20% from negative 2% used in the second quarter of 2004, primarily due to lower than expected earnings and a foreign tax credit carryback. As a result, the Company recorded a tax benefit of $8 million in the third quarter of 2004. The Company's effective tax rate of negative 20% for 2004, which was estimated in the third quarter of 2004, is not necessarily indicative of the Company's effective tax rate for future periods. In the third quarter of 2004, the Company's profit from operations was $12 million and its net earnings were $19 million, or $0.54 per common share on a diluted basis based on net earnings available to common stockholders.

        The Company's net sales in the first nine months of 2004 were $496 million, which includes a favorable impact from foreign exchange of approximately $15 million, and a favorable impact of approximately $3 million related to the resolution of a post audit claim by a major customer. The Company's variances from standard manufacturing costs and its sales and marketing expenses in the first nine months of 2004 include a total of approximately $14 million from the unfavorable impact of foreign exchange. In the first nine months of 2004, the Company recorded approximately $9 million of restructuring expenses and $3 million of costs related to its decision to terminate the development and test marketing of the instant digital printing kiosk. In the third quarter of 2004, the Company reversed its year to date provision for its employee cash incentive compensation program resulting in a reduction of overhead expenses of $4 million. The Company may, in its discretion, consider an alternative 2004 employee incentive compensation program which could result in a charge for employee cash incentive compensation in the fourth quarter of 2004. The Company's estimate of its effective tax rate for 2004 that is used for the first nine months of 2004 is negative 20%, primarily due to the use of foreign tax credits in the U.S., including a projected foreign tax credit carryback, generated as a result of dividends paid or expected to be paid from certain of the Company's foreign subsidiaries. As a result, the Company recorded an income tax benefit of $9 million in the first nine months of 2004. The Company's effective tax rate of negative 20% for 2004, which was estimated in the third quarter of 2004, is not necessarily indicative of the Company's effective tax rate for future periods. The Company's profit from operations in the first nine months of 2004 was $45 million and its net earnings were $54 million, or $1.50 per common share on a diluted basis based on net earnings available to common stockholders.

        The market for instant photography has been experiencing a significant and steady decline in demand due to competition from digital camera products and media formats. The Company's net sales of instant camera and film products, excluding the favorable impact of foreign exchange, declined by approximately 22% in the third quarter of 2004 compared to the third quarter of 2003. Excluding the portions of the favorable impact of foreign exchange, the second quarter resolution of a post audit claim by a major customer and lower net costs for marketing programs that related to instant cameras and film, the Company's net sales of instant camera and film products declined approximately 19% for the first nine months of 2004 compared to the same period in 2003. Declining demand is expected to continue and to continue to have a negative impact on the Company's net sales of instant camera and film products. The rate of decline of the Company's net sales of instant cameras and film may increase or decrease in the future. Although the Company has been attempting to reduce its costs in line with the decline in its instant camera and film sales, the Company's gross margin has declined by approximately 3 percentage points in the first nine months of 2004 compared to the same period in 2003. The Company has been and continues to be challenged to reduce its fixed as well as variable costs in the future. If the Company is not successful in reducing these costs in line with the reductions in its net sales, the Company's profit from operations and net earnings would be negatively impacted.

        At September 26, 2004, the Company had cash and cash equivalents of $101 million and no outstanding debt, compared to cash and cash equivalents of approximately $167 million and no outstanding debt at December 31, 2003. During the first nine months of 2004, the Company's net cash used by operating activities was $33 million. Cash flow from investing activities during the first nine months of 2004 was $8 million, which related to capital spending of $19 million, offset, in part, by $4 million of

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proceeds from the sale of held for sale assets and $7 million from the use of deposits from the sale of held for sale assets in 2003. Cash used by financing activities during this period was $25 million, which related to the payment of dividends on the Company's Preferred Stock and the redemption of fifty percent of the outstanding shares of the Company's Preferred Stock.

General

        The Company's reportable business segments are: the Americas Region; the International Region; Global Manufacturing; and R&D. The Company also has an All Other segment that includes: the eyewear business; the commercial secure identification systems business; brand and technology licensing operations; and contract manufacturing. The Americas Region consists of sales, marketing and distribution operations in the United States of America and other countries in North America and South America. The International Region consists of sales, marketing and distribution operations outside the Americas Region. Global Manufacturing consists of worldwide activities associated with manufacturing, procurement, developing manufacturing processes for new products, and inventory management. R&D consists of the Company's research and development activities. The Company's business segments are managed by senior executives who are directly responsible for all activities in the segment and report to the Company's chief operating decision-maker.

        The Company has one category called Corporate which is not classified as a business segment. This category includes: central marketing; centralized information systems; general and administrative functions; worldwide finished goods planning activities; and certain other corporate functions. The Corporate category also includes costs related to restructuring activities, certain incentive compensation costs and certain other non-operating items.

        The Company evaluates the performance of its business segments based on each segment's impact on profit from operations and its asset management. In the regional sales and marketing segments, profit from operations is based on standard product costs excluding intercompany margins and therefore reflects contribution to worldwide Company profits from third-party sales. Non-standard manufacturing costs along with the costs of procurement, inventory management and developing manufacturing processes for new products are reported as costs in profit from operations in the Global Manufacturing segment. For the R&D segment, research and development costs are expensed as incurred in profit from operations. The financial results of each business segment are reviewed by the Company's chief operating decision-maker.

        The Americas and International Regions are responsible for managing accounts receivable and for charges associated with reserves for slow moving and obsolete finished goods inventory. The Company manages and reports worldwide inventories, excluding the slow moving and obsolete finished goods inventories, centrally in Global Manufacturing.

Critical Accounting Estimates

        The methods, estimates and judgments the Company uses in applying its accounting policies have a significant impact on the results it reports in its financial statements. Some of the Company's accounting policies require it to make subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. The Company's most critical accounting estimates include: revenue recognition, which impacts gross margin; allowance for doubtful accounts, which impacts profit from operations; valuation of inventory, which impacts gross margin; and recognition and measurement of current and deferred income tax assets and liabilities, which impacts the Company's income tax provision. Below, the Company discusses these policies further, as well as the estimates and judgments involved.

Revenue Recognition:

        The Company recognizes net sales when all of the following criteria have been met: evidence exists that the customer is bound to the transaction; the product has been shipped and title has passed to the customer; the sales price to the customer has been fixed or is determinable; and collectability of the sales

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price is reasonably assured. Provisions for estimated sales returns and allowances are made at the time the products are sold. To arrive at net sales, the Company records reductions to net sales for the cost of programs offered to customers that include cash and volume discounts and cooperative and other advertising allowances. The Company recognizes the liability for these programs at the time the related sales are recorded. The Company determines the cost of these programs based on the terms of the programs, estimates using its historical experience and internal and customer data. The Company adjusts net sales for the cost of price protection programs associated with customer inventories, as well as for the cost of promotional allowances and other fees and coupons, at the time it can reasonably estimate this cost. To the extent actual experience differs from the estimates, adjustments to net sales could be recognized, which could have an impact on the Company's net sales and net earnings.

Allowance for Doubtful Accounts:

        The Company's allowance for doubtful accounts is reviewed on a regular basis and is based on a variety of factors including: individual account risk profiles, which consider customer credit ratings and financial condition reviews; a review of individual accounts receivable aging; and new information that becomes available on specific customers, economic trends and changes in customer payment terms. If circumstances related to specific customers were to change, the Company's estimates of the collectability of its accounts receivable could be adjusted, which would have an impact on the Company's net earnings.

Inventory:

        The Company's policy for valuation of inventory, including the determination of obsolete or excess inventory and lower of cost or market reserves, requires it to estimate the future demand for its products within specific time horizons, generally one year or less. The estimates of future demand, that the Company uses in the valuation of inventory, are the basis for the Company's short-term manufacturing and procurement plans. If the demand forecast for specific products is greater than actual demand and the Company fails to reduce its manufacturing output and procurement accordingly, the Company could be required to record additional inventory reserves, which would have a negative impact on the Company's net earnings.

Income Taxes:

        In determining its provision for income taxes for financial statement purposes, the Company must make certain estimates and judgments. These estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of its revenue and expense.

        The Company must assess the likelihood that it will be able to recover its deferred tax assets. Unless the recovery is more likely than not, the Company must increase its provision for taxes by recording a reserve, in the form of a valuation allowance, for the deferred tax assets that it estimates may not ultimately be recoverable. Should there be a change in the Company's ability to recover the remainder of its deferred tax assets, its tax provision would decrease or increase in the period of the change, which would have a positive or negative impact on the Company's net earnings.

        In addition, the calculation of the Company's income tax liabilities involves dealing with uncertainties in the application of complex tax regulations. The Company recognizes potential liabilities for anticipated tax audit issues in the United States of America ("U.S.") and other tax jurisdictions based on the Company's estimate of the amount of these additional taxes and when they will be due. If the payment of these amounts ultimately proves to be unnecessary, the reversal of these liabilities would result in tax benefits being recognized in the period when the Company determined the liabilities are no longer necessary. If the Company's estimate of these tax liabilities proves to be less than the ultimate assessment,

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a further charge to tax expense would result, which would have a negative impact on the Company's net earnings.

Stock-Based Compensation:

        The Company has sold shares of restricted Common Stock and granted options to purchase shares of the Company's restricted Common Stock to certain of its directors and executives. The purchase price of the restricted Common Stock sold was nominal and the exercise price of the options granted was equal to the estimated fair value of the underlying restricted shares of Common Stock on the date of grant. To record and disclose the cost of these sales and grants for financial reporting, the Company must make estimates and judgments to arrive at the estimated fair value of its restricted Common Stock, including consideration of the trading price of the Company's Common Stock and the impact that transfer restrictions have on fair value. Estimates of fair value are inherently subjective. If the Company were to make a different determination of the fair value of its restricted Common Stock, the amount of its deferred compensation and its stock-based compensation expense would be different which could have a positive or negative impact on the Company's net earnings.

Pension Benefits:

        The calculation of the Company's defined pension benefit costs and obligations are dependent on the assumptions used by its actuaries. These assumptions, which are reviewed by the Company annually, include discount rates, salary growth rates, expected long-term return on plan assets, and other factors. The significant factors utilized by the Company's actuaries are discussed in further detail in Note 13 of the Notes to Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. To the extent actual experience differs from the Company's assumptions, the differences are recorded as unrecognized gains and losses, which are amortized to net earnings over the estimated future service period of plan participants, if the cumulative amount of the unamortized gains or losses exceeds 10% of the greater of the plan's projected benefit obligation or market-related value of plan assets. Significant differences in actual experience to assumptions or significant changes in future assumptions would affect the Company's pension benefit obligations and costs, which could have a positive or negative impact on the Company's net earnings.

Restructuring Charges:

        The Company has implemented a number of restructuring programs in an effort to reduce its costs in line with the continuing decline in its instant camera and film business. These programs consist of involuntary severance programs and certain exit costs primarily related to the liquidation of certain non-U.S. marketing subsidiaries. The Company records severance-related expenses in accordance with the provisions of Financial Accounting Standards Board ("FASB") Statement No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Costs" or Statement No. 112, "Employer's Accounting for Post-Employment Benefits." Non-employee-related exit and disposal costs, primarily costs to consolidate or close facilities, are accounted for under the provisions of FASB Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". The Company estimates its liabilities for these programs, which are approved by the Company's management, by obtaining detailed estimates of costs for these programs, including the estimated costs of employee severance and related benefits, contract termination payments for leases, distributor arrangements and other contractual obligations, and any other qualifying exit costs related to the exit plan. These estimated costs are grouped by specific programs and are monitored on a monthly basis. These costs represent the Company's best estimate, but require assumptions about the programs that could change over time. Estimates are evaluated periodically to determine if a change is required. There were no material changes in estimates recorded by the Company during the first nine months of 2004 and 2003 related to its restructuring programs. However, if the Company were to change its estimates for these charges, the change could have a positive or negative impact on the Company's profit from operations and net earnings.

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Consolidated Worldwide Results for Third Quarter of 2004 Compared to Third Quarter of 2003

        The following table presents selected financial information regarding the Company's results of operations for the three month periods ended September 26, 2004 and September 28, 2003. This table is presented for use in the discussion of operating results for the third quarter of 2004 compared to the third quarter of 2003 below. The results for these periods are as follows (in millions, except for percentages):

        The Company's consolidated net sales and gross margin for the third quarter of 2004 compared to the third quarter of 2003 were as follows (dollars in millions):

        The Company's consolidated net sales in the third quarter of 2004 decreased by $32 million, or approximately 17%, compared to the same period of 2003, primarily as a result of lower net sales of instant film and, to a lesser degree, instant cameras. Net sales in the third quarter of 2004 include approximately $3 million from the favorable impact of foreign exchange. Excluding the favorable impact of foreign exchange, the Company's net sales of instant cameras and film declined by approximately 22% in the third quarter of 2004 compared to the same period of 2003. The net sales of instant cameras and film in the third quarter of 2004 were negatively impacted by competition from digital camera products and media formats.

        The Company had a gross margin of $69 million or 45% in the third quarter of 2004 compared to a gross margin of $94 million or 51% in the third quarter of 2003. The decrease in gross margin of 6 percentage points was mainly due to the impact of lower net sales, primarily of instant film, which decreased gross margin by approximately 6 percentage points. The decrease in net sales resulted in lower production volumes. This in turn resulted in an increase in manufacturing unit costs due to certain costs

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which were not reduced in line with the lower production volumes. The decrease in gross margin also included the impact of higher promotion costs in the third quarter of 2004 compared to the same period in 2003 which decreased gross margin by approximately 1 percentage point. The decreases in gross margin were offset, in part, by the favorable impact of foreign exchange on net sales in the third quarter of 2004, which increased gross margin by approximately 1 percentage point.

        The Company's selling, general and administrative ("SG&A") expenses were $39 million and $56 million, for the third quarter of 2004 and 2003, respectively. The Company's SG&A expenses are its reported marketing, research, engineering and administrative expenses, excluding the R&D segment expenses. The decrease of $17 million in SG&A expenses in the third quarter of 2004 compared to the same period in 2003 reflects a reduction of approximately $8 million in regional sales and marketing expenses to approximately $25 million in the third quarter of 2004 from approximately $33 million in the same period in 2003. This decrease was primarily due to lower advertising expenses and the favorable impact of restructuring programs. The decrease in SG&A expenses, in the third quarter of 2004 compared to the same period in 2003, also reflects approximately $8 million of lower costs in the non-segment Corporate category for employee cash incentive compensation. This decrease included approximately $4 million related to the reversal of the Company's year to date provision for employee cash incentive compensation. In the third quarter of 2004, the Company determined that it was not probable that it would meet the criteria for its 2004 employee cash incentive compensation program and, as a result, reversed its year to date provision for employee cash incentive compensation. The Company may, in its discretion, consider an alternative 2004 employee cash incentive compensation program which could result in a charge for employee cash incentive compensation in the fourth quarter of 2004.

        SG&A expenses in the third quarter of 2004 compared to the same period in 2003 also included an increase of approximately $2 million in certain infrastructure costs in the non-segment Corporate category, including an increase in the cost of corporate governance, and approximately $1 million from the unfavorable impact of foreign exchange on regional sales and marketing expenses. These increases were offset by reductions of approximately $4 million mainly in the other non-segment Corporate category costs, including savings from restructuring. The majority of the Company's SG&A expenses were recorded in the Americas and International Region segments with the remainder recorded primarily in the non-segment Corporate category.

        In the third quarter of 2004, the Company recorded restructuring charges of approximately $7 million compared to restructuring charges of less than $1 million in the same period in 2003. The increase in these charges in the third quarter of 2004 related to involuntary severance programs intended to downsize and consolidate the Company's non-U.S. manufacturing operations and, to a lesser degree, certain of the Company's sales and marketing, and non-segment Corporate category administrative operations. The Company expects to make most of the cash payments related to the third quarter 2004 restructuring charges by the end of the fourth quarter of 2004. Refer to Note 6 of the consolidated financial statements contained in Part I Item 1. Financial Statements for more information on the Company's restructuring programs.

        The gross margin and expenses discussed above resulted in profit from operations of $12 million in the third quarter of 2004 compared to a profit from operations of $28 million in the third quarter of 2003. The net of other income and expense in the third quarter of 2004 was income of less than $1 million, primarily related to interest income, compared to income of $9 million in the third quarter of 2003. Other income in the third quarter of 2003 primarily related to foreign exchange gains, including a net foreign currency translation gain of approximately $7 million, previously recorded as a cumulative translation adjustment within stockholders' equity that resulted from the liquidation of certain non-U.S. subsidiaries, and foreign currency transaction gains of approximately $2 million.

        In the third quarter of 2004, the Company revised its estimate of its effective tax rate for 2004 to negative 20% from negative 2% used in the second quarter of 2004 primarily due to lower than expected earnings in 2004 and a foreign tax credit carryback. As a result, the Company recorded an income tax

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benefit of $8 million, or an effective tax rate of negative 75%, on reported earnings before income taxes of $11 million in the third quarter of 2004 compared to an income tax expense of $5 million, or an effective tax rate of 12%, on reported earnings before income taxes of $36 million in the third quarter of 2003. The decrease in the Company's effective tax rate for 2004 was primarily related to the use of foreign tax credits in the U.S., including a projected foreign tax credit carryback, generated as a result of dividends paid or expected to be paid from certain of the Company's foreign subsidiaries. The Company's effective tax rate of negative 20% for 2004, which was estimated in the third quarter of 2004, is not necessarily indicative of the Company's effective tax rate for future periods.

        In the third quarter of 2004 the Company's net earnings were $19 million compared to net earnings of $34 million in the third quarter of 2003. Basic and diluted earnings per common share based on earnings available to common stockholders were $0.58 and $0.54, respectively, in the third quarter of 2004, compared to $1.02 and $1.00, respectively, for basic and diluted earnings per common share based on earnings available to common stockholders in the third quarter of 2003. Net earnings in the third quarter of 2003 included an extraordinary gain of $3 million which related to adjustments required under purchase accounting for the fair values of certain liabilities assumed by the Company in its asset purchase from Primary PDC, Inc. on July 31, 2002.

        The following is a summary of the Company's net sales and profit from operations by business segment, and for the non-segment Corporate category, for the periods indicated (in millions):

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Americas Region

        Net sales and profit from operations for the Americas Region for the third quarter of 2004 and 2003, were as follows (in millions):

        Net sales in the Americas Region decreased by $23 million, or approximately 22%, in the third quarter of 2004 compared to the same period in 2003, primarily related to lower net sales of instant film and, to a lesser degree, instant cameras. Competition from digital camera products and media formats negatively impacted the Company's net sales in the Americas Region in the third quarter of 2004.

        Profit from operations in the Americas Region for the third quarter of 2004 was $26 million compared to profit from operations of $41 million in the same period of 2003. The decline in profit from operations in the Americas Region of $15 million was primarily due to the impact of lower net sales. This decrease was offset, in part, by lower selling and administrative expenses, primarily related to lower advertising costs and, to a lesser degree, savings from restructuring in the third quarter of 2004.

International Region

        Net sales and profit from operations for the International Region for the third quarter of 2004 and 2003 were as follows (in millions):