Annual Report 1996

As of December 31, 1996, the Company had fixed stock-based compensation plans as described below. Effective January 1, 1996 the Company adopted FAS 123. Under FAS 123, the Company has elected not to adopt the new accounting method and will continue to account for its stock-based compensation under the existing provisions of APB 25 and related interpretations. Accordingly, no compensation expense has been recognized.

In 1990, the Company adopted the Polaroid Stock Incentive Plan (the 1990 Plan) under which officers and other key employees may be granted stock options, stock appreciation rights and restricted stock as incentives to increase revenues and profits. Stock options granted may be either non-qualified or incentive stock options. Up to 3,000,000 shares of the Company's common stock have been authorized for use under the 1990 Plan.

In May 1993, the Company adopted the 1993 Polaroid Stock Incentive Plan (the 1993 Plan) under which officers and other key employees may be granted awards in the form of stock options, stock appreciation rights, restricted stock, and any other form determined by the Board of Directors to be consistent with the 1993 Plan, as incentives to increase revenues and profits. Stock options granted may be either non-qualified or incentive stock options. A maximum of 4,000,000 shares of the Company's common stock have been authorized for use under the 1993 Plan, plus the unissued shares from the 1990 Plan. The number of common shares reserved for granting of future options under the 1990 and 1993 Plans was 1,522,966, 2,152,591 and 3,138,074 at December 31, 1996, 1995 and 1994, respectively.

The Company normally issues stock options at the fair market value of the Company's common stock on the grant date, however, on June 15, 1993, the non-employee members of the Board approved the issuance of 848,122 options at an option price of $32.25 per share. This reflected the fair market value of the Company's common stock on April 26, 1993 which was the fifth business day after the first quarter earnings release. That date corresponds to the date on which options have been granted historically. Since the fair market value on June 15, 1993 was $37.00 per share, $4.1 million was recorded as deferred compensation and is being amortized to compensation expense over the options' four year vesting period. During 1996, 1995 and 1994, compensation expense related to this stock option grant was $1.0 million per year.

The options awarded under the 1990 Plan and the 1993 Plan vest ratably each year over approximately a four year period and are exercisable for approximately a ten year period from the date of grant, if the holder remains in the employ of the Company. If the option holder's employment terminates for reasons other than change of control or retirement, no further vesting can occur. When an option holder's employment terminates for any reason other than retirement, death or disability, all vested options must be exercised within three months from the termination date or approximately ten years from the date of the grant, whichever is earlier.

In 1990, the Company adopted the Polaroid Board of Directors' Stock Option Plan (the Directors' Plan), which granted each non-employee director an option to purchase 3,000 shares of the Company's common stock. For a new non-employee director, the date of the grant is the date the director joins the Board. In 1996, the shareholders approved an amendment to the Directors' Plan to award each non-employee director as of July 25, 1995 a one-time grant of an option to purchase 2,000 shares of the Company's common stock at $42.63 per share. Vesting of this option grant will conform with the terms outlined in the Directors' Plan.

Under the Directors' Plan, options vest ratably each year over a four year period from the date the director joins the Board and are exercisable for a ten year period from the date of grant. Vesting ceases when an individual terminates as a director, and a former director must exercise his or her vested options within three years from the date of termination or ten years from the date of grant, whichever is earlier. Up to 100,000 shares of the Company's authorized common stock may be issued under the Directors' Plan. As of December 31, 1996, a cumulative total of 75,000 options have been granted at prices ranging from $33.13 to $45.38 under the Directors' Plan.

A committee of non-employee members of the Board of Directors is the administrator for the 1990 Plan and the 1993 Plan and, as such, can at the time of the grant determine the vesting period, the period the option shall remain exercisable (or a stock shall remain restricted), and may designate if a dividend equivalent payment (or a dividend for restricted stock) will be paid on the grant equal to the dividend payment made on a share of the Company's common stock. The administrator for the 1990 Plan and the 1993 Plan may waive or amend conditions of the option grant, such as accelerating vesting terms during an early retirement and severance program.

A summary of the Company's fixed stock option plans as of December 31, 1996, 1995, and 1994 and changes during the years ending on those dates is presented below:

If compensation cost for the Company's fixed stock option plans had been determined based on fair value at grant date for awards under the plans consistent with FAS 123, the Company's net earnings and earnings per share would have been reduced to the pro-forma amounts as follows:

Fully diluted earnings per share are not stated because they are greater than primary earnings per share.

The effect of applying FAS 123 as shown in the above pro-forma disclosures is not representative of the pro-forma effect on net earnings in future years because it does not take into consideration pro-forma compensation expense related to grants made prior to 1995.

The fair value of each option grant was estimated on the grant date using the Black-Scholes Option-Pricing Model with the following weighted average assumptions:

Dividend equivalent payments on outstanding stock options of $2.1 million, $2.1 million and $1.9 million were made in 1996, 1995 and 1994, respectively. Approximately 81% and 76% of the options granted in 1996 and 1995, respectively, were issued with dividend equivalents.

Under the 1993 Plan, the Company awarded 15,000 shares of restricted stock at $45.88 per share in 1996 and 25,000 shares of restricted stock at $46.50 per share in 1995. The 1996 restricted shares vest at the end of a five-year period if the Company achieves certain financial objectives. The 1995 restricted shares vest ratably each year over a five year period. The value of the restricted stock issued was recorded as deferred compensation and is being amortized to compensation expense ratably over a five year period from the award date.

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