SEATTLE FILMWORKS INC, 10-K/A, 1996-05-31

SEATTLE FILMWORKS INC
10-K/A, 1996-05-31
PHOTOFINISHING LABORATORIES

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K/A
(AMENDMENT NO. 1)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended SEPTEMBER 30, 1995

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-15338

SEATTLE FILMWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

WASHINGTON 91-0964899
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

1260 16TH AVENUE WEST
SEATTLE, WASHINGTON 98119
(206) 281-1390
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE OF PRINCIPAL EXECUTIVE OFFICES)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE

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 X No
----- -----

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]

As of November 30, 1995, there were issued and outstanding 7,153,978 shares
of Common Stock, par value $.01 per share. As of November 30, 1995, the
aggregate market value of the Registrant's Common Stock held by nonaffiliates of
the Registrant was $101,024,175 based on the last sale price of the Registrant's
Common Stock as reported on the Nasdaq National Market.

Page 1 of 20 Pages

No Exhibits

<PAGE>

PART I

ITEM 1 - BUSINESS

DESCRIPTION OF BUSINESS

The principal business of Seattle FilmWorks, Inc. (the "Company") is the
marketing of 35mm film, photofinishing services and related products on a
direct-to-consumer primarily on a mail order basis under the brand name
Seattle FilmWork-Registered Trademark-. The Company offers its customers the
options of having their photographs delivered as slides or prints or as digital
images delivered either over the Internet using the Company's PhotoMail-TM-
software, or on floppy diskettes under the Pictures On Disk-TM- brand name. To
permit viewing of digital images on personal computers, the Company provides
various versions of software under the titles PhotoWorks-TM- and PhotoWorks-TM-
Plus. To a lesser extent, the Company also provides photofinishing services,
products, and supplies on a wholesale basis. The Company also provides a
variety of reprint and enlargement services to its mail order and wholesale
photofinishing customers.

The Company was incorporated in Washington State in June 1976. The
executive offices of the Company are located at 1260 Sixteenth Avenue West,
Seattle, Washington 98119, and the Company's telephone number is (206) 281-1390.

FORWARD-LOOKING INFORMATION

This Report contains certain forward-looking statements which involve known
and unknown risks, uncertainties and other factors which may cause actual
results, performance or achievements of the Company or industry trends to differ
materially from those expressed or implied by such forward-looking statements.
Such factors include, among others, those discussed in Item 1 of Part I under
the heading "Risk Factors" and elsewhere in this Report and those identified by
the Company from time to time in other filings with the Securities and Exchange
Commission, press releases and other communications.

PHOTOFINISHING INDUSTRY AND DIRECT-MARKETING OVERVIEW

According to information published by the Photo Marketing Association
International ("PMAI"), domestic amateur photofinishing sales totalled
approximately $5.5 billion in 1994, having exhibited little or no growth since
1990. In 1994, the dominant method of distributing photofinishing services and
products was through retail stores, including discount and mass merchants,
drugstores, supermarkets and camera/specialty stores. Management believes the
vast majority of rolls of film are sent to wholesale photofinishing laboratories
for processing, although a growing percentage are processed in-store using
on-site equipment. The following table sets forth U.S. amateur photofinishing
industry market shares in terms of rolls processed and total sales for the years
1990 through 1994, based on information provided by PMAI:

U.S. AMATEUR PHOTOFINISHING INDUSTRY MARKET SHARES

Rolls Processed (in millions) Dollar Sales (in billions)
----------------------------- --------------------------
1990 1994 1990 1994
---- ---- ---- ----
Rolls % Rolls % $ % $ %
----- --- ----- --- --- --- --- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Discount and mass merchants,
drugstores, supermarkets and
camera/specialty stores. . . . . . . . 468 67.1% 540 75.4% $3.46 62.9% $3.72 67.7%
Standalone minilabs. . . . . . . . . . . 127 18.2 99 13.8 1.48 26.9 1.29 23.4
Mail order . . . . . . . . . . . . . . . 65 9.3 55 7.7 .30 5.4 .31 5.6
Other. . . . . . . . . . . . . . . . . . 38 5.4 22 3.1 .26 4.8 .18 3.3
---- ----- --- ----- ----- ----- ----- -----
Total. . . . . . . . . . . . . . . . . 698 100.0% 716 100.0% $5.50 100.0% $5.50 100.0%
---- ----- --- ----- ----- ----- ----- -----
---- ----- --- ----- ----- ----- ----- -----
</TABLE>

Outside the photofinishing industry, direct-to-consumer marketing, with
distribution through the mail, has grown significantly in recent years. Leading
users of direct marketing include mail-order houses and catalog mailers,
magazine publishers, insurance companies, book and record clubs, financial
institutions and credit card companies. Management believes growth in the use of
direct-marketing is generally attributable to social, economic and technological
changes and to the relative cost-effectiveness of direct-marketing techniques.
Management also believes several factors have enhanced consumer responsiveness
to direct marketing as a purchasing medium, including growth in the number of
people in the most active segment of the purchasing population, growth in the
number of two-career families that have more disposable income with less time to
shop and increased availability and use of credit cards.

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In the future, on-line services and increased use of personal computers may
provide additional channels for direct-to-consumer marketing. See "Risk Factors-
- -Dependence on Direct-Marketing Programs; Accounting for Customer Acquisition"
and "--Dependence on the Internet and Potential Liability for Content."

MARKETING AND CUSTOMER ACQUISITION

One of the key elements of the Company's operating strategy is to generate
demand by utilizing its proprietary direct-marketing techniques and extensive
database to efficiently target existing and prospective customers. The Company
has used mail, print media, television, radio, telephone and, more recently, the
Internet and on-line services to target groups of consumers and businesses,
bypassing the traditional distribution channel of retail outlets.

The Company makes extensive use of marketing tests in order to evaluate
which of a variety of marketing programs offers the best probable return on
investment. The Company's direct-marketing programs use coded advertisements to
monitor consumer response and to provide measurable results for a specific
marketing program. Measuring the effectiveness of marketing tests takes into
account both the response rate to advertised offers and estimates of customer
lifetime value to the Company, measured in terms of profit generated from the
estimated future stream of orders, thereby allowing for the targeting of a
marketing effort to specific market segments through selected media. The Company
uses computers to maintain and analyze extensive data and segment markets using
geographic, demographic and psychographic information about potential customers.

Since the early 1980s, the primary method the Company has utilized to
acquire new film processing customers has been its introductory offer of two
rolls of film for $2.00 or less (the "Introductory Offer"). The Company
regularly refines the Introductory Offer to improve its effectiveness, but the
basic concept of sending two rolls of branded film to targeted potential
customers has remained fairly constant. The Introductory Offer has been
nationally advertised through direct-response media, including package inserts,
newspaper supplements and magazines. The Company also has a customer referral
program in which existing customers suggest family and friends to whom the
Company mails an introductory package. Beginning in early 1995, the Company
further refined its Introductory Offer program by targeting the growing
population of personal computer users. Favorable rates of return from this group
led to an expansion in the Company's customer acquisition investment.

SERVICES AND PRODUCTS

Seattle FilmWorks is a leader in the development and introduction of
innovative photofinishing services and products. Beginning in 1978 with the
introduction of its privately branded film and continuing with the option of
receiving both photographic prints and individually color-corrected slides from
the same roll of film, the Company established an early tradition of service and
product differentiation. The following table illustrates the Company's service
and product introductions during the past five years:

SERVICE OR PRODUCT YEAR OF INTRODUCTION

PhotoMail-TM- . . . . . . . . . . . . . . . . . . 1995
PhotoWorks-TM- for Macintosh. . . . . . . . . . . 1995
PhotoWorks-TM- Plus for Windows . . . . . . . . . 1994
PhotoWorks-TM- for Windows. . . . . . . . . . . . 1994
PhotoWorks-TM- for MS-DOS . . . . . . . . . . . . 1994

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Pictures On Disk-TM-. . . . . . . . . . . . . . . 1994
Pictures Plus-TM- Index . . . . . . . . . . . . . 1993
Professor FilmWorks-TM- . . . . . . . . . . . . . 1992
Backprinting & Referenced Negatives . . . . . . . 1992
Easy-Order System . . . . . . . . . . . . . . . . 1991
Express-Mail Delivery . . . . . . . . . . . . . . 1991

In 1991, the Company began to offer mail-order photofinishing customers the
options of express-mail pickup and delivery service and the Easy-Order System,
whereby a customer sets up a standing order, thus avoiding the need to fill out
an order form with each order. This pattern of service and product innovation
continued with the introduction in early 1992 of the Company's system for
printing the date, roll identification and print number on the back of each
print and the corresponding information on each strip of negatives (known as
backprinting) and free telephone pre-recorded mini-lessons on photography from
Professor FilmWorks-TM-. Additionally, in 1993, the Company introduced the
Pictures Plus-TM- Index, which offers thumbnail-size copies of images from a
roll of film on a single 4" by 6" print as a handy reference for the customer.

In early 1994, the Company introduced Pictures On Disk-TM-, which delivers
on a single floppy disk a digital version of each photograph on a roll of film.
This product was coupled with the introduction of the Company's internally
developed PhotoWorks-TM- software, which enables users to create digital albums
of their photographs and to incorporate the digital images into text, slide
shows and screen savers. PhotoWorks-TM- software is available in Microsoft
Windows, MS-DOS and Apple Macintosh versions and is provided at no charge with a
customer's first order of Pictures On Disk-TM-. PhotoWorks-TM- is also available
for free download over the Internet from the Company's Web site. A more fully
featured version, PhotoWorks-TM- Plus, is sold directly to customers as an
upgrade and is available through selected retail software stores.

In October 1995, the Company introduced the private delivery of digital
photographs from its laboratory directly to customers over the Internet through
its PhotoMail-TM- delivery service. Customers requesting PhotoMail-TM- delivery
are sent an e-mail notifying them that their photographs are ready for
downloading at the Company's Web site (www.filmworks.com). Such customers can
then share their photographs with friends, family and business associates who
may download the photographs using a download password. Management believes
that communication with digital versions of personal photographs is a natural
extension of the rapid proliferation of e-mail and other forms of Internet
communication.

Although mail-order photofinishing is viewed as a convenience by many
consumers, mail-order turnaround time (generally seven to ten days) is longer
than many alternative sources for photofinishing services (in some cases within
one hour). The Company has addressed this issue by offering the option of
express-mail pickup and delivery service by means of the U.S. Postal Service for
an extra charge and, more recently, with an immediate delivery-after-processing
option through its PhotoMail-TM- Internet delivery service. However, turnaround
time remains a competitive disadvantage for the Company.

Management believes that the prices for its services and products are
competitive. The Company, however, has chosen not to compete primarily on the
basis of price, but rather by offering a variety of value-added, innovative and
high-quality services and products, thereby seeking to differentiate itself from
other photofinishers.

The Company also provides a variety of reprint and enlargement services for
its mail-order customers, as well as selling 35mm rolled film, single-use
cameras and photofinishing supplies on a wholesale basis to photofinishing
minilabs, retail stores and commercial users of photographic film. These
products are packaged by the Company and marketed under the brand OptiColor-TM-
Film & Photo. Rolled film and single-use cameras are also marketed on a private
label basis with the customer specifying its own brand name. Although it
represents a small percentage of revenues, the Company also provides
photofinishing services on private label, retail and wholesale bases.

<PAGE>

RESEARCH AND DEVELOPMENT

Through internal and external research and development efforts, the Company
has established the capability to develop innovative digital media and
photofinishing services and products. The Company seeks to identify customer
needs and shifts in consumer preferences in order to design or refine the
Company's services and products. In fiscal 1995, fiscal 1994 and fiscal 1993,
the Company incurred research and development expenses of $458,000, $459,000 and
$285,000, respectively, primarily in connection with development and enhancement
of its PhotoMail-TM-, PhotoWorks-TM- and Pictures On Disk-TM- services and
products. See Item 7 of Part II--"Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Operations."

CUSTOMER SERVICE AND SUPPORT

Management believes that customer satisfaction is critical to the Company's
ongoing success. The Company has a 100% money-back satisfaction-guarantee
policy under which it will provide a full refund if a customer's complaint
cannot otherwise be resolved.

The direct-to-consumer photofinishing business involves contacts with a
large number of customers. For customer convenience, the Company provides
toll-free telephone access at 1-800-FILMWORKS. The Company's customer service
staff is equipped with direct access to the Company's extensive proprietary
database and is trained to promote certain of the Company's services and
products, as well as to answer questions regarding order status, basic
photography and photofinishing and use of PhotoWorks-TM- software. On average,
in a week the Company's customer support personnel respond to approximately
22,000 telephone calls from customers, 2,000 written inquiries and 2,000 e-mail
messages. The majority of these inquiries are general information requests and
order status inquiries. In addition, the Company offers free pre-recorded
mini-lessons on photography over the telephone from Professor FilmWorks-TM-.

The Company also maintains a Web site on the Internet (www.filmworks.com).
While on-line, customers may download versions of Company software, access
answers to frequently asked questions and send electronic messages to customer
service. In the future, the Company expects to offer its customers the ability
to determine the status of their orders by direct access through the Company's
Web site.

OPERATIONS

The Company operates a laboratory in a single facility in Seattle,
Washington, which is designed to produce consistent, high-quality
photofinishing. The system is designed for 24-hour in-house turnaround
processing of photofinishing orders. The process for producing prints begins
with the entry of each order into the Company's customer database, primarily
using information provided by the customer on the order form. Each roll received
for processing is barcoded with an identification number, which enables the
tracking of each order throughout the production process. Following order
entry, individual rolls of film are spliced together into a reel of film which
is then developed as a batch. Once the film is developed, each negative is
computer analyzed, and the color-corrected image is printed on photographic
paper using state-of-the-art equipment. Order information is then printed on
the back of each print and the corresponding information is printed on a paper
tab which is attached to each sleeved negative. After a visual quality
inspection, the orders are packaged for delivery to the customer. If a customer
requests, photographs are digitized and delivered through the mail on 3 1/2"
diskettes or via download over the Internet. Although much of the
photofinishing and order handling process has been automated, trained personnel
operate machinery and regularly monitor product quality with the assistance of
computerized control and measurement systems.

The Company has the ability to process various types of 35mm color film,
including those manufactured by Eastman Kodak Company, Fuji Photo Film U.S.A.,
Inc., affiliates of Konica Corporation, 3M, Inc., Agfa and other major
producers of conventional 35mm color negative film. The Company also has the
ability to process 35mm color negative film manufactured by Eastman Kodak
Company for professional motion picture studios which has been packaged by
the Company or others for use in 35mm still cameras.

<PAGE>

Currently, the Company estimates that it is capable of processing up to
approximately 120,000 rolls of film per week with its existing facilities and
equipment. The Company has initiated steps to expand its processing capacity.

SUPPLIERS

The Company obtains its conventional 35mm film from a few large
manufacturers of photographic film, including Agfa Corporation and 3M, Inc., its
supply of Eastman motion picture film as surplus from motion picture studios and
television production companies and its photographic paper and chemicals from a
single supplier, Agfa. In addition, the individual cassettes into which the
Company spools 35mm film for still cameras are manufactured for the Company by
foreign sources, principally in China and South Korea. Currently, substantially
all of the Company's purchases from foreign suppliers are paid for in U.S.
dollars. The Company's mail-order services and products are handled largely
through the U.S. Postal Service. See "Risk Factors--Reliance on Key Vendor and
Supplier Relationships; Foreign Sourcing."

MANAGEMENT INFORMATION SYSTEMS

Management information systems ("MIS") are an essential component of the
Company's strategy to provide superior service to its customers, as well as to
effectively support internal operations. The systems support all major aspects
of the Company's business, including mail-order operations, order entry,
production, warehousing, distribution, purchasing, inventory control and
customer service, as well as various financial systems and electronic
communication systems. All shared data, including the Company's customer
database files, are backed up on a regular basis, with tapes stored in an
off-site secure facility. The Company uses MIS to automate much of its
photofinishing operations.

It is not uncommon for system defects, shutdowns, slowdowns or other
problems to occur in connection with conversion to new data-processing
equipment. While the Company has taken a number of precautions against certain
events that could disrupt the operation of its MIS, there can be no assurance
that the Company will not experience systems failures or interruptions, which
could have a material adverse effect on its business, financial condition and
operating results. See "Risk Factors--Dependence on Production Capabilities,
Statistical Models and Management Information Systems."

COMPETITION

Management believes that the principal competitive factors in the consumer
photofinishing industry are price, convenience, range of available services,
quality of processing, speed of service and product differentiation. There are
no significant proprietary or other barriers to entry into the photofinishing
industry. The Company has sought to differentiate its photofinishing services by
offering a number of value-added services and products and emphasizing quality
and convenience rather than seeking to be a low-price or rapid turnaround
provider. Although management believes the Company is a leader in developing
and marketing innovative photo-related services and products, competitors can
and do provide similar services and products. Some of these competitors have
introduced products which compete with the Company's Pictures On Disk-TM- and
PhotoWorks-TM- products. Also, sales of consumer photofinishing services have
experienced little or no growth since 1990. See "Business--Photofinishing

<PAGE>

Industry and Direct-Marketing Overview." Accordingly, the Company's growth has
been the result of market share gain.

In addition, the wholesale distribution market for rolled film and
photofinishing supplies is highly competitive and is dominated by suppliers
which manufacture what they sell and may, therefore, potentially have lower
costs of goods for these items than the Company. Relatively few firms, however,
have the capability to produce small-production quantities of private label
rolled film. Management believes the principal competitive factors in this
segment of the wholesale distribution market are price, ability to provide
private label products and capability to deliver small-production quantities on
short notice.

The photography industry is characterized by evolving technology and
changing services and products. The introduction of photographic services and
products embodying new technologies could render existing services and products
obsolete. The Company's future success will depend on its ability to adapt to
new technologies and develop new or modify existing services and products to
satisfy evolving consumer needs. For example, the commercialization of filmless
digital imaging technologies may have a negative impact on the photofinishing
industry generally. Moreover, Advanced Photo System ("APS"), which includes a
new film format, has been introduced, the processing of which requires special
equipment the Company does not presently possess. Management believes that APS
currently constitutes an insignificant percentage of the film the Company is
asked to process, and the Company has therefore decided not to establish this
capability. However, there can be no assurance that the development of these or
other new technologies or any failure by the Company to anticipate or
successfully respond to such developments will not have a material adverse
effect on the Company's business, financial condition and operating results.
See "Risk Factors--Competition" and "--Rapid Technological Change."

PROPRIETARY TECHNOLOGY

The Company markets its services and products under registered and
common-law trademarks and service marks, including Seattle FilmWorks-Registered
Trademark-, OptiColor-TM- Film & Photo, Pictures On Disk-TM-, PhotoMail-TM-,
PhotoWorks-TM-, Pictures Plus-TM- Index and Professor FilmWorks-TM-. On
December 17, 1993 and on July 28, 1994 the Company filed applications for
registration of the mark "PhotoWorks" with the United States Patent and
Trademark Office. The latter application was refused due to the prior (1990)
registration of the mark Photo Works Visual Marketing-Registered Trademark-.
The Company subsequently purchased the rights to the mark "Photo Works Visual
Marketing-Registered Trademark-" and associated good will from the owner of that
mark. Recently the Company learned of the use of the mark "PhotoWorks" in
connection with a product similar to the Company's PhotoWorks-TM- product by
another party which had filed for registration of that mark in the United States
on July 22, 1994. The Company believes that it has priority over the other user
of PhotoWorks based, in part, upon its purchase of the rights to Photo Works
Visual Marketing-Registered Trademark- as well as the time, scope and extent of
the Company's use of PhotoWorks-TM- as compared to that of the other company;
but there can be no assurance that the Company would prevail if this other user
of the mark were to claim that it has superior rights to PhotoWorks.See "Risk
Factors--Intellectual Property."

The Company considers a large portion of its PhotoWorks-TM- software, its
process for production of Pictures On Disk-TM- and certain other processes to be
proprietary. The Company has not filed any patents or patent applications, in
part to avoid disclosure of its competitive strengths. The Company, however,
does attempt to protect its proprietary rights to software through a combination
of copyright, trademark and trade secret laws and employee and third-party
nondisclosure agreements, by restricting access to certain portions of its
premises and by including contractual restrictions on use and disclosure in its
end-user licenses. Moreover, the Company's PhotoWorks-TM- Plus product is
shipped in sealed packages on which notices are prominently displayed informing
the end-user that, by breaking the package seal, the end-user agrees to be bound
by the license agreement contained in the package. The legal and practical
enforceability and extent of liability for violations of license agreements that
purport to become effective upon opening a sealed package are unclear.

This Report contains trademarks other than those of the Company.

<PAGE>

GOVERNMENTAL REGULATION

The Company's direct-mail operations, including its transmission of digital
images over the Internet, are subject to regulation by the U.S. Postal Service,
the Federal Trade Commission and various state, local and private consumer
protection and other regulatory authorities. In general, these regulations
govern the manner in which orders may be solicited, the form and content of
advertisements, information which must be provided to prospective customers, the
time within which orders must be filled, obligations to customers if orders are
not shipped within a specified period of time and the time within which refunds
must be paid if the ordered merchandise is unavailable or returned. The law
relating to the liability of on-line services companies, Internet access and/or
content providers, Web hosts and electronic publishers for information carried
on or disseminated through their systems for, among other things, infringement
of copyrighted material or trademarks, violations of personal rights of privacy
and publicity and dissemination of material legally judged to be obscene,
indecent or defamatory, is currently unclear. Such claims have been brought,
and sometimes successfully asserted, against on-line services. In addition, the
recently passed Telecommunications Act of 1996 imposes, in some circumstances,
liability for or prohibits the transmission over the Internet of certain types
of information and content. This or other legislation could result in
significant potential liability to the Company, as well as additional costs and
technological challenges in complying with mandatory requirements. See "Risk
Factors--Dependence on the Internet and Potential Liability for Content" and "--
Governmental Regulation."

ENVIRONMENTAL COMPLIANCE

The Company's photofinishing operations involve the use of several
chemicals which are subject to federal, state and local governmental regulations
relating to the storage, use, handling and disposal of such chemicals. The
Company actively monitors its compliance with applicable regulations and works
with regulatory authorities to ensure compliance. To the best of management's
knowledge, the Company has never received a significant citation or fine for
failure to comply with applicable environmental requirements. However, there
can be no assurance that changes in environmental regulations or in the kinds of
chemicals used by the Company will not impose the need for additional capital
equipment or other requirements. See "Risk Factors--Potential Adverse Impact of
Environmental Regulations."

EMPLOYEES

At November 30, 1995, the Company had 478 full-time employees, of whom
approximately 407 were engaged in production operations and 71 in marketing,
general and administrative functions. The Company's employees are not covered
by a collective bargaining agreement, and the Company believes its relations
with its employees are good.

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers and directors of the Company, as of November 30, 1995
were:

Name Age Position
- --------------------------------------------------------------------------------
Gary R. Christophersen 49 President, CEO and Director
Sam Rubinstein 78 Director
Douglas A. Swerland 50 Director
Craig E. Tall 49 Director
Peter H. van Oppen 43 Director
Michael F. Lass 41 Vice President-Operations
Case H. Kuehn 43 Vice President-Finance, CFO and Treasurer
Bruce A. Ericson 46 Vice President-Marketing

All directors are elected annually and hold office until the next annual
meeting of the shareholders of the Company and until their successors are
elected and qualified. Officers serve at the discretion of the Board of
Directors.

<PAGE>

Mr. Gary R. Christophersen, the Company's President and Chief Executive
Officer, joined the Company in January 1982 as Vice President-Operations and has
served as a Director of the Company since 1982. In May 1983, Mr. Christophersen
became a Senior Vice President of the Company and General Manager of Seattle
FilmWorks. In August 1988, Mr. Christophersen became the President and Chief
Executive Officer of the Company.

Mr. Sam Rubinstein became a Director of the Company in March 1986. From
June 1985 until May 1988 he was the Chairman of the Board and Chief Executive
Officer of Farwest Fisheries, Inc., a seafood processing and marketing firm.
From 1974 until December 1987, Mr. Rubinstein was the Chairman of the Board and
Chief Executive Officer of Bonanza Stores, Inc., an operator of variety and drug
stores. From February 1984 to January 1986 Mr. Rubinstein was the Chairman of
the Board and Chief Executive Officer of Whitney-Fidalgo Seafoods, Inc., another
seafood processor.

Mr. Douglas A. Swerland became a Director of the Company in October 1988.
Since December 1993, Mr. Swerland has been founder and President of Swerland
Apparel Ventures, Inc., a clothing superstore retailer specializing in designer
clothing. From 1978 to November 1993, Mr. Swerland was the President and a
Director of Jay Jacobs, Inc., which operates a chain of specialty retail apparel
stores in the West with its headquarters located in Seattle, Washington. Mr.
Swerland had been employed with Jay Jacobs, Inc., in various capacities since
1969. Jay Jacobs, Inc. filed a voluntary petition for Chapter 11 bankruptcy
protection in May 1994 and emerged successfully therefrom in November 1995.

Mr. Craig E. Tall became a Director of the Company in October 1988. Since
September, 1990, Mr. Tall has served as an Executive Vice President of
Washington Mutual, Inc. In addition, from April 1987 through the present, Mr.
Tall has served as an Executive Vice President of Washington Mutual Bank.

Mr. Peter H. van Oppen became a Director of the Company in October 1988.
Since February 1995, Mr. van Oppen has been Chairman, President and Chief
Executive Officer of Interpoint Corporation, a publicly held manufacturer of
proprietary and custom electronic components and data storage libraries,
located in Redmond, Washington. Mr. van Oppen became Chief Executive Officer
in September 1989 and was President and Chief Operating Officer of Interpoint
Corporation, from March 1987 until September 1989. From 1985 until March
1987, Mr. van Oppen served as Executive Vice President for Finance and
Operations of Interpoint Corporation. Mr. van Oppen has been a Director of
Interpoint Corporation since 1984.

Mr. Michael F. Lass has been Vice President-Operations since September
1988. Mr. Lass joined the Company in 1984 as Manager of Operations. From 1982
to 1984, Mr. Lass was Vice President and General Manager of Breezin Sportswear.
From 1980 to 1982, Mr. Lass was General Manager and a Director of Mountain
Safety Research, Inc., a manufacturer of outdoor recreational products.

Mr. Case H. Kuehn, Vice President-Finance and Treasurer, joined the Company
in February 1995. From April 1994 to February 1995, Mr. Kuehn was Chief
Financial Officer of Shoe Inn, Inc., doing business as Shoe Pavilion. From
January 1992 to March 1994, Mr. Kuehn was General Manager of Pro Mark
Technologies, Inc., a manufacturer of computer/video-based inspection equipment.
From March 1990 to January 1992, Mr. Kuehn was Vice President, commercial
lending, at First National Bank of Chicago. From November 1985 to February
1990, Mr. Kuehn performed business valuation consulting with Price Waterhouse.

Mr. Bruce A. Ericson has been Vice President-Marketing since November 1989.
Mr. Ericson joined the Company in May 1984 as Director of Publishing. From
January 1988 until October 1989, Mr. Ericson served the Company as Director of
Marketing.

<PAGE>

RISK FACTORS

IN ADDITION TO THE OTHER INFORMATION IN THIS REPORT, THE FOLLOWING RISK
FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE COMPANY AND ITS
BUSINESS.

ABILITY TO SUSTAIN AND MANAGE GROWTH

The Company has experienced significant growth in revenues and
profitability in recent periods. This growth has occurred despite little or no
growth in the U.S. photofinishing industry in the 1990s and an actual decline in
the number of rolls processed by the mail-order film processing portion of the
domestic photofinishing market during the same period. See "Business--
Photofinishing Industry and Direct-Marketing Overview." The continued growth of
the Company's revenues and profitability is dependent in large part on its
ability to acquire new customers at a reasonable cost. There can be no
assurance that the Company will continue to grow or to effectively manage its
growth. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business." The Company may, when and if the
opportunity arises, acquire other businesses involved in activities or having
service and product lines that are compatible with the Company's business, but
the Company has no current understanding, agreement or arrangement to make any
acquisitions. Acquisitions involve numerous risks, which could have a material
adverse effect on the Company's business, financial condition and operating
results.

DEPENDENCE ON DIRECT-MARKETING PROGRAMS; ACCOUNTING FOR CUSTOMER ACQUISITION

Management believes that a large part of the Company's growth in
photofinishing revenues is attributable to its direct-marketing programs, which
are primarily based on its customer acquisition technique of offering two rolls
of film for $2.00 or less. The Company devotes substantial resources to and
regularly tests new and modified direct-marketing programs in an effort to
improve the efficiency of its customer acquisition and retention efforts. There
can be no assurance that the Company's customer acquisition and retention
efforts will continue to be effective. A decline in the effectiveness of these
efforts or a failure to compete effectively against new or existing competitors
which use direct-marketing techniques could have a material adverse effect on
the Company's business, financial condition and operating results. See
"Business--Marketing and Customer Acquisition" and "--Competition."

The direct costs of customer acquisition programs, primarily the cost of
film, postage and printed materials for the Company's free or low-cost film
offers sent to prospective and existing customers, but excluding advertising
costs, are deferred and amortized over a period of up to three years as part
of customer acquisition costs. The Company establishes amortization rates
for these capitalized assets based on estimates of the timing of future roll
processing volumes per customer. Rates of amortization are compared from
time to time with the actual timing of processing volumes in order to assess
whether the amortization rates appropriately match the direct costs of
customer acquisition with the related revenues. Moreover, if the Company
were to experience a material change in the timing of roll processing
volumes, it could be required to accelerate the rate of amortization of
capitalized customer acquisition expenditures, which could have a material
adverse effect on the Company's business, financial condition and operating
results. If the Company were to experience a significant decline in the
amount of revenues from its customers without an offsetting decrease in
direct customer acquisition costs, it is possible that the Company may not be
allowed to capitalize customer acquisition costs under generally accepted
accounting principles. See Item 7 of Part II--"Management's Discussion and
Analysis of Financial Condition and Results of Operations."

RAPID TECHNOLOGICAL CHANGE

The photography industry is characterized by evolving technology and
changing services and products. The introduction of photographic services and
products embodying new technologies could render existing services and products
obsolete. The Company's future success will depend in part on its ability to
adapt to new technologies and develop new or modify existing services and
products to satisfy evolving consumer needs. For example, the commercialization
of filmless digital imaging technologies, including mass-market filmless digital
cameras, may have a negative impact on companies such as Seattle FilmWorks,
which process traditional film-based images and slides. The development of these
or other new technologies, or any failure by the Company to anticipate or
successfully respond to such developments, could have a material adverse effect
on the Company's business, financial condition and operating results. See
"Business--Competition."

<PAGE>

FLUCTUATIONS IN QUARTERLY RESULTS AND SEASONALITY

The Company's quarterly operating results have fluctuated in the past and
are expected to fluctuate in the future as a result of a variety of factors,
including changes in the mix of sales, intensity of promotional activities,
price increases by suppliers, introductions of new products, research and
development requirements, actions by competitors, foreign currency exchange
rates, conditions in the direct-to-consumer market and the photofinishing
industry in general, national and global economic conditions and other factors.
Moreover, demand for the Company's photo-related services and products is highly
seasonal, with the highest volume of photofinishing activity occurring during
the summer months. As a result, the Company's operating results for any period
are not necessarily indicative of results for any future period. Due to the
foregoing factors, the Company's operating results in a future period may be
below the expectations of public market analysts and investors. In such event,
the price of the Common Stock may be materially adversely affected. See Item 7
of Part II--"Management's Discussion and Analysis of Financial Condition and
Results of Operations."

COMPETITION

The market for consumer photofinishing services is characterized by intense
competition among a number of firms competing in a segment in which average
revenue per roll processed declined during the 1990s, according to
photofinishing industry data. Many of the Company's competitors have
substantially greater financial, technical and other resources than the Company.
The Company faces competition in the consumer photofinishing market from other
direct marketers and from competitors in other distribution channels, including
much larger companies which provide photofinishing services on a wholesale basis
to independent retail outlets and, in some cases, through multiple retail
outlets owned by the photofinisher, many of which provide photofinishing service
within hours. There are no significant proprietary or other barriers to entry
into the photofinishing industry. The Company has sought to differentiate its
photofinishing services by offering a number of value-added services and
products and emphasizing quality and convenience rather than seeking to be a
low-price or rapid turnaround provider. Although management believes the
Company is a leader in developing and marketing innovative photo-related
services and products, competitors can and do provide similar services and
products. There can be no assurance the Company will continue to compete
effectively through development of innovative services and products or to
respond appropriately to industry trends or to activities of competitors. In
addition, the wholesale distribution market for rolled film and photofinishing
supplies is highly competitive and is dominated by suppliers which manufacture
what they sell and may, therefore, potentially have lower costs of goods for
these items than the Company. There can be no assurance that the Company will
be able to compete effectively with current or future competitors or that the
competitive pressures faced by the Company will not have a material adverse
effect on the Company's business, financial condition and operating results.
See "Business--Competition."

DEPENDENCE ON KEY PERSONNEL

The Company's success depends in large part on the abilities and continued
service of its executive officers and other key employees, in particular Gary R.
Christophersen, the Company's President and Chief Executive Officer. These
individuals, including Mr. Christophersen, are not subject to employment
agreements that would prevent them from leaving the Company. There can be no
assurance that the Company will be able to retain the services of such executive
officers and other key employees. The loss of key personnel could have a
material adverse effect on the Company's business, financial condition and
operating results.

DEPENDENCE ON THE INTERNET AND POTENTIAL LIABILITY FOR CONTENT

In October 1995, the Company introduced the private delivery of digital
photographs from its laboratory directly to customers over the Internet through
its PhotoMail-Registered Trademark- delivery service. Although the Company
provides its services and products through multiple distribution channels, the
Company's success may depend in part on the continued expansion of the Internet
and its network infrastructure. Rapid growth in interest in and use of the
Internet is a recent phenomenon, and there can be no assurance that the
Company's Internet-related services will prove to be a competitive advantage.
Moreover, critical issues concerning the commercial use of the Internet
(including security, reliability, cost, ease of use and access and quality of
service) remain unresolved and may affect both the growth of Internet use and
the Company's financial results. The law relating to the liability of on-line
services

<PAGE>

companies, Internet access and/or content providers, Web hosts and electronic
publishers for information carried on or disseminated through their systems for,
among other things, infringement of copyrighted material or trademarks,
violations of personal rights of privacy and publicity and dissemination of
material legally judged to be obscene, indecent or defamatory, is currently
unclear. Such claims have been brought, and sometimes successfully asserted,
against on-line services. In addition, the recently passed Telecommunications
Act of 1996 imposes, in some circumstances, liability for or prohibits the
transmission over the Internet of certain types of information and content.
This or other legislation could result in significant potential liability to the
Company, as well as additional costs and technological challenges in complying
with mandatory requirements. From time to time, the Company has assisted
authorities in the discovery and prosecution of child pornography. However, the
Company does not assume responsibility to edit the content of its customers'
photographs, slides, digital images or personal home pages unless responding to
a specific complaint. The potential liability for content made available over
the Internet through its Web site could require the Company to implement
additional measures to reduce its exposure to such liability, which may require
it to incur significant expense or to discontinue certain service or product
offerings. While the Company carries general liability insurance, such insurance
may not cover potential claims of this type or may not be adequate to compensate
the Company for any liability that may be imposed for information carried on or
disseminated through its systems. Any costs not covered by insurance incurred
as a result of such liability or asserted liability could have a material
adverse effect on the Company's business, financial condition and operating
results. See "Business--Governmental Regulation."

RELIANCE ON KEY VENDOR AND SUPPLIER RELATIONSHIPS; FOREIGN SOURCING

The Company obtains its conventional 35mm film from a few large
manufacturers of photographic film, including Agfa Corporation ("Agfa") and
3M, Inc., its supply of Eastman motion picture film as surplus from motion
picture studios and television production companies and its photographic paper
and chemicals from a single supplier, Agfa. In addition, the individual
cassettes into which the Company spools 35mm film for still cameras are
manufactured for the Company by foreign sources, principally in China and South
Korea. As there are relatively few suppliers of film, photographic paper and
chemicals, the elimination of any one supplier could cause a material disruption
within the industry and could have a material adverse effect on the Company's
business, financial condition and operating results. Other than an agreement
with Agfa which is subject to possible termination beginning in September 1996,
the Company has no long-term purchase contracts or other contractual assurance
of continued supply, pricing or access to film, paper, chemicals or cassettes.
Although the Company has experienced limited delays in the delivery of certain
supplies in the past, such delays have not had a significant impact on the
Company's operations. While management believes that alternate sources of film,
paper, chemicals and cassettes are available, there can be no assurance that the
Company will be able to continue to acquire its requirements for these supplies
in sufficient quantities or on terms as favorable to the Company as those
currently available to it. Also, conversion to an alternate supplier may cause
delays, reduced quality or other problems. The Company's operations may be
adversely affected by political instability resulting in the disruption of trade
with foreign countries in which the Company's contractors and suppliers are
located and existing or potential duties, tariffs or quotas that may limit the
quantity of certain types of goods that may be imported into the United States.
Moreover, sales of the Company's services and products on a direct-to-consumer
mail-order basis are largely dependent on the U.S. Postal Service for receipt of
orders and delivery of processed film or other products. Any significant
changes in the operations of or prices charged by the U.S. Postal Service or
extended interruptions in postal deliveries could have a material adverse effect
on the Company's business, financial condition and operating results. See
"Business--Operations" and "--Suppliers."

DEPENDENCE ON PRODUCTION CAPABILITIES, STATISTICAL MODELS AND MANAGEMENT
INFORMATION SYSTEMS

The Company depends on its management information systems to process
orders, provide rapid response to customer inquiries, manage inventory and
accounts receivable collections, purchase, sell and ship products efficiently
and on a timely basis and maintain cost-efficient operations. It is not
uncommon for system defects, shutdowns, slowdowns or other problems to occur in
connection with conversion to new data-processing equipment. While the Company
has taken a number of precautions against certain events that could disrupt the
operation of its management information systems, there can be no assurance that
the Company will not experience systems failures or interruptions, which could
have a material adverse effect on its business, financial condition and
operating results. See "Business--Management Information Systems." The Company
also depends on statistical models developed to

<PAGE>

measure the effectiveness of its marketing programs and on its employees who are
knowledgeable about such models. In addition, the Company continually faces
risks regarding the availability and cost of labor, the potential need for
additional capital equipment, plant and equipment obsolescence, quality control,
excess or insufficient capacity and disruption in the Company's operations. The
loss of employees knowledgeable about the Company's statistical models or a
disruption in the Company's photofinishing or direct-marketing operations could
have a material adverse effect on the Company's business, financial condition
and operating results. See "Business--Operations" and "--Suppliers."

GOVERNMENTAL REGULATION

The Company's direct-mail operations are subject to regulation by the U.S.
Postal Service, the Federal Trade Commission and various state, local and
private consumer protection and other regulatory authorities. In general, these
regulations govern the manner in which orders may be solicited, the form and
content of advertisements, information which must be provided to prospective
customers, the time within which orders must be filled, obligations to customers
if orders are not shipped within a specified period of time and the time within
which refunds must be paid if the ordered merchandise is unavailable or
returned. From time to time the Company has modified its methods of doing
business and its marketing operations in response to inquiries and requests from
regulatory authorities. To date, such changes have not had an adverse effect on
the Company's business. There can be no assurance, however, that future
regulatory requirements or actions will not have a material adverse effect on
the Company's business, financial condition and operating results. See
"Business--Governmental Regulation."

POTENTIAL ADVERSE IMPACT OF ENVIRONMENTAL REGULATIONS

The Company's photofinishing operations involve the use of several
chemicals which are subject to federal, state and local governmental regulations
relating to the storage, use, handling and disposal of such chemicals. The
Company actively monitors its compliance with applicable regulations and works
with regulatory authorities to ensure compliance. However, there can be no
assurance that changes in environmental regulations or in the kinds of chemicals
used by the Company will not impose the need for additional capital equipment or
other requirements. Any failure by the Company to control the use of, or
adequately restrict the discharge of, hazardous substances under present or
future regulations could subject it to substantial liability or could cause its
operations to be suspended. Such liability or suspension of operations could
have a material adverse effect on the Company's business, financial condition
and operating results. See "Business--Environmental Compliance."

STATE SALES TAX

Many states impose taxes on the sale or use of products and the sale of
certain services within the taxing state's borders. To the extent a seller of
taxable products or services is subject to the jurisdiction of a taxing state,
the state may impose a sales tax directly on the seller or may impose a duty on
the seller to collect a sales or use tax from the seller's customers. A seller
is generally considered subject to the jurisdiction of a taxing state for sales
or use tax purposes when the seller has an in-state presence that is beyond de
minimis. An in-state presence can include solicitation of orders for sales in
the taxing state either in-person or through an employee or other agent. The
Company currently collects and pays sales tax only with respect to shipments to
the state of Washington. The Company has structured its operations in a manner
designed to minimize the likelihood that it has more than a de minimis physical
presence in any state other than Washington. However, if a state taxing
authority determines that the Company has established more than a de minimis
physical presence in that particular state, the Company could be obligated to
collect a sales or use tax (or pay a sales tax in states that impose a tax on
the seller) on some sales of its services and products. Should the Company be
found liable by a state taxing authority for unpaid historic sales and use
taxes, such liabilities could have a material adverse effect on the Company's
business, financial condition and operating results. From time to time,
legislation has been introduced in the U.S. Congress that, if enacted into law,
would impose a state sales or use tax collection obligation on out-of-state
mail-order companies such as the Company. Enactment of any such legislation
could have a material adverse effect on the Company's business, financial
condition and operating results.

<PAGE>

INTELLECTUAL PROPERTY

The Company considers a large portion of its PhotoWorks-TM- software, its
process for production of Pictures On Disk-TM- and certain other processes to be
proprietary. The Company has not filed any patents or patent applications, in
part to avoid disclosure of its competitive strengths. Moreover, the Company's
PhotoWorks-TM- Plus product is shipped in sealed packages on which notices are
prominently displayed informing the end-user that, by breaking the package seal,
the end-user agrees to be bound by the license agreement contained in the
package. The legal and practical enforceability and extent of liability for
violations of license agreements that purport to become effective upon opening a
sealed package are unclear. See "Business--Proprietary Technology."

POSSIBLE VOLATILITY OF STOCK PRICE

The market price of the Common Stock has been, and is likely to continue to
be, volatile. There can be no assurance that the market price of the Common
Stock will not fluctuate significantly from its current level. The market price
of the Common Stock could be subject to significant fluctuations in response to
a number of factors, such as actual or anticipated variations in the Company's
quarterly operating results, the introduction of new services or products by the
Company or its competitors, changes in other conditions or trends in the
Company's industry, changes in governmental regulations, changes in securities
analysts' estimates of the Company's, or its competitors' or industry's, future
performance or general market conditions. See Item 7 of Part II--"Management's
Discussion and Analysis of Financial Condition and Results of Operations." In
addition, stock markets have experienced extreme price and volume volatility in
recent years, and this volatility has had a substantial effect on the market
prices of securities of many smaller public companies for reasons frequently
unrelated to the operating performance of such companies. These broad market
fluctuations may adversely affect the market price of the Common Stock. See
"Price Range of Common Stock."

ANTITAKEOVER CONSIDERATIONS

The Company's Board of Directors has the authority, without shareholder
approval, to issue up to 2,000,000 shares of Preferred Stock and to fix the
rights and preferences thereof. This authority, together with certain
provisions of the Company's Amended and Restated Articles of Incorporation and
the Washington Business Corporation Act, may discourage takeover attempts or
tender offers that could result in shareholders receiving a premium over the
market price for the Common Stock or that shareholders may otherwise consider to
be in their best interests.

<PAGE>

PART II

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

Seattle FilmWorks, Inc. is a leading direct-to-consumer marketer and
provider of high-quality amateur photofinishing services and products. The
Company offers an array of complementary services and products primarily on a
mail-order basis under the brand name Seattle FilmWorks-Registered Trademark-.
The Company has experienced an increase in net revenues in each year since 1990.
Management believes this growth is attributable principally to its
direct-marketing programs, including the customer acquisition technique of
offering two rolls of film for $2.00 or less (the "Introductory Offer"). The
Introductory Offer has been nationally advertised in package inserts, newspaper
supplements and magazines and through various other direct-response media.

Beginning in fiscal 1995, the Company shifted the focus of, and
substantially expanded, its customer acquisition programs. Management believes
that these steps are the primary reasons for the acceleration in growth of net
revenues and net income during fiscal 1995. In addition, management believes its
core photofinishing business has benefitted from the introduction of new
products, such as Pictures On Disk-TM- and PhotoWorks-TM-, in January 1994.

Customer acquisition costs are comprised of the costs of generating a lead
and the amortization of direct costs associated with the Company's promotional
offers sent to prospective and existing customers. The costs of generating a
lead include all direct-response media, advertising and other costs associated
with developing target customer lists. These costs per lead have declined during
each of the last three fiscal years. The direct costs of customer acquisition
include film, postage and printed material costs associated with mailings to
prospective and existing customers. These direct costs per recipient of the
Introductory Offer have also declined during each of the last three fiscal
years.

The direct costs of customer acquisition programs are capitalized as an
asset on the Company's balance sheet under "capitalized customer acquisition
expenditures." Capitalized customer acquisition expenditures relating to
prospective customers are amortized over three years, and capitalized customer
acquisition expenditures relating to certain marketing activities to groups of
existing customers are amortized over six months. These amortization rates are
based on estimates of the timing of future roll processing volumes per customer.
The proportion of capitalized customer acquisition expenditures to be amortized
over three years relative to those to be amortized over six months will vary
from period to period based on the timing and mix of promotional activities.
Rates of amortization are compared from time to time with the actual timing of
roll processing volumes in order to assess whether the amortization rates
appropriately match the direct costs of customer acquisition with the related
revenues. If the Company were to experience a material change in the timing of
roll processing volumes, it could be required to accelerate the rate of
amortization of capitalized customer acquisition expenditures, which could have
a material adverse effect on the Company's business, financial condition and
operating results.

Customer acquisition costs as a percentage of net revenues increased to
13.8% in fiscal 1995 as compared to 13.1% in fiscal 1994. However, customer
acquisition costs as a percentage of net revenues has declined significantly
from 19.8% in fiscal 1991 to 18.1% in fiscal 1992 and 16.6% in fiscal 1993.
Management believes this trend toward decreasing customer acquisition costs as a
percentage of net revenues is due primarily to more efficient customer
acquisition programs. Future periods may reflect increased customer acquisition
costs due to timing of the amortization of capitalized expenditures or the
development and initiation of additional marketing programs. For

<PAGE>

tax purposes, customer acquisition expenditures are expensed as incurred,
thereby reducing current federal income tax liabilities and increasing deferred
federal income tax liabilities. See Note F of Notes to Financial Statements.

Net income as a percentage of net revenues has improved from 6.5% in fiscal
1991 to 9.1% in fiscal 1995 primarily due to the relationship between changes in
costs of goods sold and customer acquisition costs which in turn are primarily
driven by changes in sales mix and the Company's customer acquisition strategy.
Operating results will fluctuate in the future due to changes in the mix of
sales, intensity of promotional activities, price increases by suppliers,
introductions of new products, research and development requirements, actions by
competitors, foreign currency exchange rates, conditions in the
direct-to-consumer market and the photofinishing industry in general, national
and global economic conditions and other factors.

Cost of goods and services consist of labor, postage and supplies related
to the Company's services and products. Other selling expenses include
marketing costs associated with building brand awareness, testing new marketing
strategies and marketing to existing customers, as well as certain costs
associated with acquiring new customers. Research and development expenses
consist primarily of costs incurred in researching new computerized digital
imaging concepts, developing computer software products and creating equipment
necessary to provide customers with new computer-related photographic services
and products. General and administrative expenses consist of costs related to
computer operations, human resource functions, finance, accounting, investor
relations and general corporate activities.

Demand for the Company's photo-related services and products is highly
seasonal, with the highest volume of photofinishing activity occurring during
the summer months. This seasonality, when combined with the general growth of
the Company's photofinishing business, has produced greater photofinishing net
revenues during the last half of the Company's fiscal year (April through
September), with a peak occurring in the fourth fiscal quarter. Net income is
affected by the seasonality of the Company's net revenues due to the fixed
nature of a large portion of the Company's operating expenses, seasonal
variation in sales mix and the Company's practice of relatively higher marketing
program expenditures prior to the summer months.

RESULTS OF OPERATIONS

The following table presents information from the Company's statements of
income, expressed as a percentage of net revenues for the periods indicated.

Fiscal Years Ended
September 30, September 24, September 25,
1995 1994 1993
------------- ------------- -------------
<S> <C> <C> <C>
Net revenues . . . . . . . . . . . . . . 100.0% 100.0% 100.0%

Cost of goods and services . . . . . . . 61.3 62.0 59.6
-------- -------- --------

GROSS PROFIT . . . . . . . . . . . . . . 38.7 38.0 40.4

Operating expenses:
Customer acquisition costs . . . . . . . 13.8 13.1 16.6
Other selling expenses . . . . . . . . . 6.5 6.9 6.7
Research and development . . . . . . . . 0.7 0.9 0.7
General and administrative . . . . . . . 4.3 4.6 4.7
-------- -------- --------

Total operating expenses . . . . . . . . 25.3 25.5 28.7
-------- -------- --------

INCOME FROM OPERATIONS . . . . . . . . . 13.4 12.5 11.7

Total other income . . . . . . . . . . . 0.4 0.3 0.7
-------- -------- --------

INCOME BEFORE INCOME TAXES . . . . . . . 13.8 12.8 12.4

<PAGE>

Provision for income taxes (Note F). . . 4.7 3.9 4.0
-------- -------- --------

NET INCOME . . . . . . . . . . . . . . . 9.1% 8.9% 8.4%
-------- -------- --------
-------- -------- --------
</TABLE>

Net revenues increased 25.0% to $62,185,000 in fiscal 1995 from $49,753,000
in fiscal 1994. Net revenues in fiscal 1994 increased 16.4% to $49,753,000 from
$42,728,000 in fiscal 1993. The increases were primarily due to expanded
investment in customer acquisition and other selling activities during fiscal
1995, fiscal 1994 and fiscal 1993, which increased the number of new customers
and photofinishing orders processed in fiscal 1995 and fiscal 1994. In addition,
increased distribution of rolled film and photo-related products on a wholesale
basis during fiscal 1995 and fiscal 1994, including sales generated as a result
of the acquisition of selected assets of a wholesale film business in 1994,
favorably affected net revenues. Management also believes that its core
photofinishing business benefitted from the Company's entry into the personal
computer market with its PhotoWorks-TM- and Pictures On Disk-TM- products, which
were introduced in January 1994. The increased revenues in fiscal 1995 were
also favorably affected by an additional one-week reporting period in fiscal
1995 as compared to fiscal 1994 and fiscal 1993.

Gross profit as a percentage of net revenues for fiscal 1995, fiscal 1994
and fiscal 1993 was 38.7%, 38.0% and 40.4%, respectively. The increase in gross
profit percentage in fiscal 1995 as compared to fiscal 1994 was primarily due to
a sales mix containing a higher proportion of photofinishing services, which
have a higher gross profit margin than the Company's wholesale film and
photo-related supplies business. Gross profit as a percentage of net revenues
in fiscal 1994 was lower than fiscal 1993, resulting from changes in customer
acquisition promotional activities, including free film offers, which resulted
in a decrease in revenues received in connection with certain promotional
offers. Also, fiscal 1994 net revenues included a higher proportion of sales of
lower-margin wholesale film and photo-related supplies as compared to fiscal
1993.

Total operating expenses as a percentage of net revenues for fiscal 1995,
fiscal 1994 and fiscal 1993 were 25.3%, 25.5% and 28.7%, respectively. Although
total operating expenses increased in actual dollars in both fiscal 1995 and
fiscal 1994 as compared to the prior fiscal year, total operating expenses as a
percentage of net revenues were substantially unchanged in fiscal 1995 as
compared to fiscal 1994, but decreased in fiscal 1994 as compared to fiscal 1993
primarily due to a decrease in customer acquisition costs as a percentage of net
revenues and an increase in net revenues in each of those years that was greater
than the increases in operating expenses. The decrease as a percentage of net
revenues in fiscal 1995 and fiscal 1994 as compared to fiscal 1993 is also
attributable to more cost-effective advertising programs.

Customer acquisition costs as a percentage of net revenues were 13.8% in
fiscal 1995, up from 13.1% in fiscal 1994 and down from 16.6% in fiscal 1993.
The increase in fiscal 1995 was primarily due to increased expenditures related
to the Company's customer acquisition programs targeted at personal computer
users. The decrease in fiscal 1994 from fiscal 1993 was primarily due to changes
in customer acquisition promotional activities, which allowed the Company to
maintain the response rate to the Introductory Offer while reducing advertising
expenses associated with attracting new customers.

Other selling expenses increased to $4,035,000 in fiscal 1995 as compared
to $3,458,000 in fiscal 1994 and $2,868,000 in fiscal 1993. The increases in
fiscal 1995 and fiscal 1994 were primarily due to increased expenditures for
selling activities promoting the sale of rolled film and other photo-related
products and increased marketing to existing customers. Other selling expenses
in fiscal 1995 and fiscal 1994 also included amortization of a noncompete
agreement associated with the January 1994 acquisition of certain assets of a
wholesale film business. See Note B of Notes to Financial Statements.
Expressed as a percentage of net revenues, other selling expenses decreased to
6.5% in fiscal 1995 as compared to 6.9% in fiscal 1994 and 6.7% in fiscal 1993.

General and administrative expenses increased to $2,657,000 in fiscal 1995
as compared to $2,276,000 in fiscal 1994. The increase in fiscal 1995 was
primarily due to increased expenditures relating to recruitment, consulting and
additional labor costs due to increased volumes. Expressed as a percentage of
net revenues, general and administrative expenses declined to 4.3% in fiscal
1995 as compared to 4.6% in fiscal 1994 and 4.7% in fiscal 1993.

<PAGE>

Research and development expenses during fiscal 1995, fiscal 1994 and
fiscal 1993 were $458,000, $459,000 and $285,000, respectively, increasing from
fiscal 1993 primarily in connection with the development of the Company's
PhotoWorks-TM- and Pictures On Disk-TM- products. Prior to fiscal 1993, research
and development expenses, which primarily related to photofinishing and
film-spooling equipment, were not material and, accordingly, were included in
general and administrative expenses or cost of goods sold.

Total other income in fiscal 1995 was $252,000 as compared to $187,000 in
fiscal 1994 and $290,000 in fiscal 1993. The increase in total other income in
fiscal 1995 as compared to fiscal 1994 was primarily due to interest income from
short-term investments due to the availability of cash reserves generated from
operations during fiscal 1995. The decrease in total other income in fiscal 1994
as compared to fiscal 1993 resulted primarily from the receipt of sales tax
refunds in fiscal 1993 and no comparable refunds in fiscal 1994, as well as
slightly higher interest expense in fiscal 1994.

Net income increased to $0.73 per share in fiscal 1995 as compared to
$0.54 per share in fiscal 1994 and $0.43 per share in fiscal 1993. The
increases resulted primarily from higher net revenues and increased income from
operations. Earnings per share for both fiscal 1995 and fiscal 1994 were also
favorably affected by the repurchase of 750,000 shares of Common Stock by the
Company during the fourth quarter of fiscal 1994.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities was $6,908,000, $4,330,000 and
$4,329,000 in fiscal 1995, fiscal 1994 and fiscal 1993, respectively. The
increase in cash provided by operating activities in fiscal 1995 as compared to
fiscal 1994 was primarily due to an increase in net income, deferred taxes and
accounts payable. These increases were partially offset by the increase in net
customer acquisition expenditures. Net cash provided by operating activities
for fiscal 1994 as compared to fiscal 1993 was relatively unchanged as the
increase in net income, income taxes payable and accrued expenses was offset in
part by a decrease in accounts payable and increases in accounts receivable and
inventories.

Net cash used in investing activities was $1,629,000, $809,000 and
$4,641,000 in fiscal 1995, fiscal 1994 and fiscal 1993, respectively. Net cash
used in investing activities during fiscal 1995 increased primarily due to a net
decrease in sales of securities. The decrease in net cash used in investing
activities in fiscal 1994 as compared to fiscal 1993 was primarily due to a
decrease in the purchases of securities available for sale and an increase in
sales of securities. The sales of securities in fiscal 1994 were partially
offset by $1,637,000 paid in connection with the acquisition of assets of a
wholesale film business.

Net cash provided by financing activities was $570,000 in fiscal 1995 as
compared to net cash used in financing activities of $6,517,000 and $318,000 in
fiscal 1994 and fiscal 1993, respectively. The increase in net cash provided by
financing activities in fiscal 1995 as compared to fiscal 1994 is primarily
attributable to the Company's repurchase of 750,000 shares of Common Stock
during fiscal 1994. The repurchase of Common Stock in fiscal 1994 is the
primary reason for the increase in net cash used in financing activities as
compared to fiscal 1993.

As of November 30, 1995, the Company's principal sources of liquidity
included $8,969,000 in cash and short term investments together with an unused
operating line of credit of $5,000,000. The ratio of current assets to current
liabilities for the Company was 2.0 to 1 at the end of fiscal 1995, which
reflects an increase from the current ratio of 1.6 to 1 at the end of fiscal
1994 (after reclassifications relating to customer acquisition costs and
deferred income taxes). The increase in the current ratio at the end of fiscal
1995 compared to fiscal 1994 was primarily due to increased cash and short term
investments generated by operations. The lower cash balance at the end of
fiscal 1994 was due in part to expenditures related to the July 1994 repurchase
of 750,000 shares of Common Stock and the January 1994 acquisition of certain
assets of a wholesale film business. The Company has financed its business
principally through cash generated by operations and borrowings.

Capital expenditures during fiscal 1995 totaled $1,633,000 including
equipment for new photofinishing services and for expanding capacity of existing
photofinishing operations. In fiscal 1994, the Company made capital
expenditures of $1,414,000 relating to photofinishing equipment and leasehold
improvements. The Company has committed to purchase equipment related to its
Pictures On Disk-TM- product in the amount of $470,000 by January 1,

<PAGE>

1997. In addition, the Company has plans to expend approximately $3,500,000 in
fiscal 1996, principally for additional photofinishing and data processing
equipment, and for leasehold improvements, although at this time it has no
binding commitments to do so.

The Company currently anticipates that existing funds together with
anticipated cash flow from operations and the Company's available line of credit
of $5,000,000 will be sufficient to finance its operations, including planned
capital expenditures, and to service its indebtedness for the foreseeable
future. However, if the Company does not generate sufficient cash from
operations to satisfy its ongoing expenses, the Company will be required to seek
external sources of financing or refinance its obligations. Possible sources of
financing include the sale of equity securities or additional bank borrowings.
There can be no assurance that the Company will be able to obtain adequate
financing in the future. See Item 1 of Part I--"Risk Factors."

INFLATION

The results of the Company's operations have not been significantly
affected by inflation during any of the last three fiscal years. Although the
Company has incurred moderately increased costs for labor, materials, postage
and overhead, it has been able to offset the impact of such increases through
enhanced operating efficiencies.

ADOPTION OF ACCOUNTING STANDARDS

In October 1995, the Financial Accounting Standards Board issued Statement
No. 123, "Accounting for Stock-Based Compensation." This pronouncement
establishes accounting and reporting standards for stock-based employee
compensation plans, including stock purchase plans, stock options and stock
appreciation rights. This standard defines a fair value-based method of
accounting for these equity instruments, which method measures compensation cost
based on the value of the award and recognizes that cost over the service
period. Companies may elect to adopt this standard or to continue accounting
for these types of equity instruments under current guidance, Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." The Company has elected to follow APB Opinion No. 25 and related
interpretations in accounting for its employee stock options.

SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this amended report to be signed on
its behalf by the undersigned, thereunto duly authorized.

SEATTLE FILMWORKS, INC.
(REGISTRANT)

DATED: May 31, 1996 By: //s// Case H. Kuehn
----------------------------------
Case H. Kuehn
Vice President-Finance
Chief Financial Officer
(Principal Financial and
Accounting Officer)