<PAGE>   1
================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    Form 10-Q

                            -------------------------

(Mark One)

 [X]   Quarterly report pursuant to Section 13 or 15(d) of the Securities 
       Exchange Act of 1934

For the quarterly period ended September 30, 1998 or

 [ ]   Transition report pursuant to Section 13 or 15(d) of the Securities 
       Exchange Act of 1934

For the transition period from_________ to __________

Commission file number 0-15939

                           SHOWSCAN ENTERTAINMENT INC.
             (Exact name of registrant as specified in its charter)

                  DELAWARE                                       95-3940004
      (State or other jurisdiction of                         (I.R.S. Employer
       incorporation or organization)                        Identification No.)

            3939 LANDMARK STREET
          CULVER CITY, CALIFORNIA                                   90232
  (Address of principal executive offices)                        (Zip Code)

Registrant's telephone number, including area code: (310) 558-0150

            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   [ ]

  As of November 6, 1998, the Registrant had 5,642,058 shares of Common Stock,
$.001 par value, issued and outstanding.

================================================================================

              This report contains 25 consecutively numbered pages.

<PAGE>   2

                           SHOWSCAN ENTERTAINMENT INC.

                                      INDEX


<TABLE>
<CAPTION>
                                                                                          Page
                                                                                          ----
<S>                                                                                       <C>
PART I - FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets as of September 30, 1998
and March 31, 1998                                                                           3

Condensed Consolidated Statements of Operations for the Three
Months and Six Months Ended September 30, 1998 and 1997                                      5

Condensed Consolidated Statements of Cash Flows for the Six
Months Ended September 30, 1998 and 1997                                                     6

Notes to the Condensed Consolidated Financial Statements                                     8


ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
          FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                     11
 
PART II - OTHER INFORMATION


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                    23

Signatures                                                                                  24
</TABLE>



                                        2

<PAGE>   3

PART I. - FINANCIAL INFORMATION

ITEM 1. - FINANCIAL STATEMENTS

                           SHOWSCAN ENTERTAINMENT INC.
                      Condensed Consolidated Balance Sheets
                 (Dollars in Thousands Except Share Information)

<TABLE>
<CAPTION>
                                                                SEPTEMBER 30,     MARCH 31,
                                                                    1998            1998
                                                                -------------     ---------
                                                                 (unaudited)       (Note)
<S>                                                             <C>               <C>    
               ASSETS                                     
Current assets:
  Cash and cash equivalents                                        $ 1,599         $ 2,492
  Accounts receivable (net of allowances)                            2,870           2,161
  Unbilled receivables on uncompleted
   film and equipment contracts                                      1,598             708
  Due from affiliated entities, net of allowances (Note 6)             174             794
  Equipment sales inventory                                          1,467           1,186
  Prepaid expenses and other current assets                             31             193
                                                                   -------         -------
Total current assets                                                 7,739           7,534

Film library (net of amortization)                                   3,325           3,765

Investment in and advances to O&O theatres (Note 2)                    353             440

Patents and other intellectual properties (net of amortization)        684             900

Other assets, including equipment and leasehold
   improvements, net of accumulated depreciation and
   amortization                                                      1,021           1,072
                                                                   -------         -------

Total assets                                                       $13,122         $13,711
                                                                   =======         =======
</TABLE>

Note: The balance sheet at March 31, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.


See accompanying notes to unaudited condensed consolidated financial statements.



                                   (Continued)



                                        3
<PAGE>   4

                           SHOWSCAN ENTERTAINMENT INC.
                Condensed Consolidated Balance Sheets (continued)
                 (Dollars in Thousands Except Share Information)


<TABLE>
<CAPTION>
                                                               SEPTEMBER 30,       MARCH 31,
                                                                   1998              1998
                                                               -------------       ---------
                                                                (unaudited)         (Note)
<S>                                                            <C>                 <C>     
    LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable                                               $    254          $    752
  Customer advances on uncompleted film and
   equipment contracts                                              3,278             2,317
  Accrued expenses and other current liabilities                    2,726             2,241
  11% note payable (Note 3)                                         1,000             1,000
  8% convertible notes, due September 1, 1999 (Note 4)              5,690                --
                                                                 --------          --------
Total current liabilities                                          12,948             6,310
                                                                 --------          --------
8% convertible notes (Note 4)                                          --             5,690

Stockholders' equity:
  Series A Convertible Preferred Stock, $.001 par value;
   150,000 shares authorized, no shares issued and
   outstanding                                                         --                --
  Series C Convertible Preferred Stock, $.001 par value;
   100,000 shares authorized; 49,000 shares issued and
   outstanding                                                         --                --
  Common stock, $.001 par value; 20,000,000 shares
   authorized; 5,642,058 shares issued and outstanding                  6                 6
  Additional paid-in capital                                       42,567            42,567
  Accumulated deficit                                             (42,399)          (40,862)
                                                                 --------          --------
Total stockholders' equity                                            174             1,711
                                                                 --------          --------
Total liabilities and stockholders' equity                       $ 13,122          $ 13,711
                                                                 ========          ========
</TABLE>


Note: The balance sheet at March 31, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.



See accompanying notes to unaudited condensed consolidated financial statements.



                                        4
<PAGE>   5

                           SHOWSCAN ENTERTAINMENT INC.
                 Condensed Consolidated Statements of Operations
               (Dollars in Thousands Except Per Share Information)


<TABLE>
<CAPTION>
                                                 THREE MONTHS ENDED         SIX MONTHS ENDED
                                                    SEPTEMBER 30,             SEPTEMBER 30,
                                                 1998         1997         1998         1997 
                                                --------------------      --------------------
                                                     (Unaudited)              (Unaudited)
<S>                                             <C>          <C>          <C>          <C>    

Revenues:
  Film licensing and production services        $   924      $ 1,192      $ 1,550      $ 2,131
  Equipment sales and related services            1,744        1,280        2,880        1,580
                                                -------      -------      -------      -------
                                                  2,668        2,472        4,430        3,711

Costs of revenues                                 1,330        1,382        2,610        2,117
                                                -------      -------      -------      -------
Gross profit                                      1,338        1,090        1,820        1,594

Costs and expenses:
  General and administrative expenses             1,314        1,576        2,585        3,166
  Depreciation and amortization                     118          190          288          389
                                                -------      -------      -------      -------
                                                  1,432        1,766        2,873        3,555
                                                -------      -------      -------      -------
Operating loss                                      (94)        (676)      (1,053)      (1,961)


Other income (expense):
  Equity in net operations of O&O Theatres          (55)        (202)        (113)        (364)
  Other income, including interest                   39           23           58           41
  Interest and other expenses                      (215)        (137)        (429)        (327)
                                                -------      -------      -------      -------
                                                   (231)        (316)        (484)        (650)
                                                -------      -------      -------      -------


Net loss                                        $  (325)     $  (992)     $(1,537)     $(2,611)
                                                =======      =======      =======      =======

Basic and diluted net loss per common
   share (Note 5)                               $  (.06)     $  (.18)     $  (.27)     $  (.46)
                                                =======      =======      =======      =======
</TABLE>



See accompanying notes to unaudited condensed consolidated financial statements.



                                        5
<PAGE>   6

                           SHOWSCAN ENTERTAINMENT INC.
                 Condensed Consolidated Statements of Cash Flows
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                                SIX MONTHS ENDED
                                                                  SEPTEMBER 30,
                                                             1998              1997
                                                            ------------------------
                                                                  (Unaudited)
<S>                                                         <C>              <C>     
Cash flows from operating activities:
  Net loss                                                  $(1,537)         $(2,611)
  Adjustments to reconcile net loss
   to net cash provided by (used in) operating
   activities:
    Depreciation and amortization                               288              389
    Amortization of film library                                509              423
    Equity in net operations of O & O theatres                  113              364
    Accrued interest on debt                                    229              232
    Provision for doubtful accounts                              60               60
    Changes in operating assets and liabilities:
      Accounts receivable                                      (149)             (46)
      Equipment sales inventory                                (281)             195
      Unbilled receivables on uncompleted film and
       equipment contracts                                     (890)            (978)
      Prepaid expenses                                          162              706
      Investment in and advances to O&O theatres                (26)             278
      Accounts payable, accrued expenses and other
       current liabilities                                     (242)          (1,097)
      Customer advances on uncompleted equipment
       contracts                                                961            2,485
                                                            -------          -------

  Net cash (used in) provided by operating activities       $  (803)         $   400
                                                            -------          -------

Cash flows from investing activities:
  Redemptions of short term investments                          --               --
  Purchases of equipment and leasehold
   improvements                                                  (7)             (15)
  Additions to film library                                     (69)            (763)
  Other assets                                                  (14)             557
                                                            -------          -------

    Net cash used in investing activities                   $   (90)         $  (221)
                                                            -------          -------
</TABLE>



                                   (Continued)



                                        6
<PAGE>   7

                           SHOWSCAN ENTERTAINMENT INC.
           Condensed Consolidated Statements of Cash Flows (Continued)
                             (Dollars in Thousands)


<TABLE>
<CAPTION>
                                                                    SIX MONTHS ENDED
                                                                      SEPTEMBER 30,
                                                                 1998              1997
                                                                ------------------------
                                                                       (Unaudited)
<S>                                                             <C>              <C>    
  Balance forwarded                                             $  (893)         $   179
                                                                -------          -------


  Net increase/(decrease) in cash and cash equivalents             (893)             179

Cash and cash equivalents, beginning of period                    2,492            2,562
                                                                -------          -------

Cash and cash equivalents, end of period                        $ 1,599          $ 2,741
                                                                =======          =======


Supplemental disclosures of cash flow information:
   Interest paid                                                $   228          $   232
                                                                =======          =======


   Income taxes paid                                            $    --          $    --
                                                                =======          =======
</TABLE>



See accompanying notes to unaudited condensed consolidated financial statements.



                                        7
<PAGE>   8

                           SHOWSCAN ENTERTAINMENT INC.
            Notes to the Condensed Consolidated Financial Statements
                                   (Unaudited)


Note 1--Introduction:

        The accompanying unaudited condensed consolidated financial statements
of Showscan Entertainment Inc. (the "Company") have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three-month period and the six-month period ended
September 30, 1998 are not necessarily indicative of the results that may be
expected either for any other quarter in the fiscal year ending March 31, 1999
or for the entire fiscal year ending March 31, 1999. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's Annual Report on Form 10-K for the year ended March 31, 1998.

Note 2--Owned and Operated Theatres ("O&O Theatres"):

        The Company has significantly revised its O&O Theatres policies and has
during the past 18 months, closed five (5) of its theatres, including
Framingham, Massachusetts (2), San Antonio, Texas (1), and London, England (2).
Accordingly, the Company currently operates and/or has an ownership interest in
two (2) Showscan Attractions located at Universal CityWalk in Universal City,
California and Osaka, Japan. Generally, in each of these arrangements, the
Company receives reimbursement for direct expenses, a percentage of each
theatre's cash flow (equal to its ownership percentage), and receives separately
annual film licensing revenues and management fees (if applicable). The Company
accounts for its investment in the O&O Theatres under the equity method of
accounting.

Note 3--11% Promissory Note:

        On November 1, 1997, the Company completed a placement of a $1,000,000
promissory note through an unaffiliated third party. The note bears interest at
a rate of 11 percent per annum. Principal and interest amounts are payable in
full on November 15, 1998. The note is secured by accounts receivable from the
distribution of the Company's film library and the proceeds thereof. In
connection with the placement, $130,000 of debt issue costs were incurred and
have been amortized over the original term of the note. On November 13, 1998,
the Company and the lender reached an agreement to modify the note so that the
principal will be repaid in the following installments:



                                        8

<PAGE>   9

<TABLE>
<S>                                                       <C>     
           November 15, 1998                              $290,000
           
           December 31, 1998                              $150,000
           
           January 31, 1999                               $150,000
           
           February 28, 1999                              $150,000
           
           March 31, 1999                                 $260,000
</TABLE>

        All accrued but unpaid interest on the note as of November 15, 1998
($110,000) shall be paid together with the principal payment on such date. All
interest that accrues after such date shall be due and payable on March 31,
1999.

Note 4--8% Convertible Notes:

        On September 1, 1995, the Company completed a private placement of
$7,000,000 in secured convertible notes ("8% Convertible Notes") with a European
bank. The 8% Convertible Notes mature on September 1, 1999 and bear interest at
8% per annum which is payable semi-annually and are convertible at the option of
the holder into shares of the Company's common stock ("Common Stock") at a
conversion price of $5.75 per share. Through September 30, 1998, $1,310,000 of
such notes had been converted into 227,819 shares of Common Stock leaving an
outstanding balance of $5,690,000. The notes are secured by substantially all of
the assets of the Company, although the security excludes the Company's film
library and the capital stock of its subsidiaries, which includes its O&O
Theatres. In connection with the placement, $619,000 of debt issue costs were
incurred and are being amortized over the life of the notes. The Company is in
discussions with its European bank regarding an extension of the maturity date
of this debt and additional financing in excess of the amounts currently
outstanding. There can be no assurance that the Company will be successful in
the extension of the maturity date or such additional financing.

Note 5--Loss per common share:

        The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" (SFAS No. 128), effective with its March 31, 1998 fiscal
year end. SFAS No. 128 establishes standards for computing and presenting
earnings per share (EPS) and supersedes APB Opinion No. 15, "Earnings Per Share"
(APB No. 15). SFAS No. 128 replaces the presentation of primary EPS with a
presentation of basic EPS. Basic EPS excludes the dilutive effects, if any, of
common stock equivalents, and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted EPS is computed similarly to fully diluted EPS pursuant to
APB No. 15, with certain modifications. SFAS No. 128 also required dual
presentation of basic EPS and diluted EPS on the face of the income statement
for all periods presented. All earnings per share amounts for all periods have
been presented, and where appropriate, restated to conform to the SFAS No. 128
requirements.

        Per share information has been determined by using 5,642,058 weighted
average shares outstanding for the six-months and the three-months ended
September 30, 1998 and 1997.



                                        9

<PAGE>   10

Note 6--Receivables from affiliated entities:

        At June 30, 1998, the Company was due $712,000 from United Artists
Theatre Circuit, Inc. ("UA"). The payment terms for this receivable provided for
(a) interest on the unpaid principal balance to be charged at 7.5% and (b)
principal and interest to be paid in full on or before December 31, 1996
(Maturity Date); since the UA Venture had not accepted one of the theatre sites
it had been offered by UA prior to the Maturity Date, the Maturity Date was to
be extended 30 days after the date that the UA Venture did accept, but in no
event would that Maturity Date have been extended later than August 19, 1999. In
July 1998, the Company and UA reached an agreement to settle the amount owed by
means of a $318,000 payment, the purchase by the Company of certain new
simulation equipment and other assets owned by UA, the offset of certain amounts
and the payment of the remaining amounts over approximately one year. As part of
this agreement, the Company also agreed to expand the ability of UA to "source"
projection and other theatre equipment, in addition to simulation equipment,
through the Company. Fifty percent (50%) of any such "sourced" equipment will
count toward UA's achievement of the $13,950,000 aggregate equipment purchase
requirement. Any such "sourcing" of projection and other theatre equipment must
result in at least an aggregate benefit (as defined) to the Company of
$3,200,000. If UA shall fail to achieve this requirement and/or shall fail to
order and install 16 additional Simulation Attractions by August 1999, then UA
shall owe the Company liquidated damages as set forth in the Theater Rights
Agreement, which at present aggregates $5,280,000. It is the Company's belief
that UA will not order or install any additional Simulation Attractions but that
it may source projection equipment through the Company. The Company has removed
the UATC systems from its contract backlog.

        At September 30, 1998, affiliates of certain directors owed the Company
a combined balance of $336,000 related to advances made by the Company on their
behalf to several O&O Theatres to satisfy capital calls to cover operating
expenses at such theatres and certain other administrative costs. On July 8,
1998, the affiliates of the certain directors indicated to the Company that they
dispute their obligation to pay these sums. Accordingly, the Company has fully
reserved for such amounts in its accompanying consolidated balance sheets.



                                       10

<PAGE>   11

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Overview:

        Showscan Entertainment Inc. (the "Company") is a leading provider of
movie-based motion simulation theatre attractions ("Showscan Attractions") to
the expanding out-of-home entertainment market. The Company's business includes:
(i) licensing and distributing the films in its library to all operators of
simulation attractions (including those installed by the Company and those
previously installed by competitors of the Company); (ii) licensing the
proprietary technologies necessary to produce and exhibit Showscan films; (iii)
selling and installing Showscan Attractions and specialty theatres including the
equipment necessary for each (including motion bases, projectors, screens, sound
systems, synchronization and show control, and theatre design packages); (iv)
producing films using the Showscan process; and (v) to a limited extent,
establishing Showscan Attractions in which the Company has an economic interest
("O&O Theatres"). The Company is also committed to the continued recognition of
the Showscan(R) brand name worldwide.

        The principal sources of the Company's revenues are the licensing of the
Showscan film library and technologies, the sale and installation of projectors,
screens, sound systems and other equipment used to exhibit Showscan films, and
the sale of motion bases and other equipment used in most Showscan Attractions.
The Company currently derives most of its revenues from export sales (60-85% for
each of the three years ended March 31, 1998 and the six-month period ended
September 30, 1998). The Company does not believe that inflation has had a
material impact on the Company's net revenues or on its results of operations
for the three most recent fiscal years and the six-month period ended 
September 30, 1998.

Comparison of the six months ended September 30, 1998 and 1997:

        Revenues for the six-month period ended September 30, 1998 (the "Six
Month Period") increased by $719,000 or 19% from revenues for the six-month
period ended September 30, 1997 due to an increase in revenues recognized from
equipment sales and related services.

        Film licensing and production service revenues in the Six Month Period
decreased by $581,000 or 27% to $1,550,000 from $2,131,000 in the six-month
period ended September 30, 1997. The decrease was primarily due to (i) the
renegotiation of certain film licensing contracts in Asia due to adverse
economic conditions in that region, and (ii) the reduction in film revenues
collected from O & O Theatres due to the closure of five such theatres since the
prior year period.

        Revenues from equipment sales and related services for the Six Month
Period increased $1,300,000 or 82% to $2,880,000 from $1,580,000 in the
six-month period ended September 30, 1997. The increase is due to the increase
in the number of Showscan Attractions shipped during the Six Month Period as
compared to the corresponding prior year six-month period and to certain
modifications of two equipment sales contracts which resulted in additional
non-refundable payments (aggregating $519,000) to the Company under such
contracts. Three Showscan



                                       11
<PAGE>   12

Attractions were shipped in the Six Month Period as compared to two units
shipped in the six-month period ended September 30, 1997.

        The Company recognizes equipment sales under the
percentage-of-completion method of accounting, generally measured by the
percentage that the labor hours incurred to date bears to the estimated total
labor hours of each contract. This results in a disparity in the comparison of
equipment sales revenues over different time periods, as the Company records
revenues under this method rather than on the date that the sales agreement is
signed. The actual signing of a Showscan Attraction sale precedes its delivery
and installation by an average of five to six months. Accordingly, the
recognition of revenue for equipment sales during the current and future
quarters is affected by (i) the timing of such sales; (ii) the schedule of the
build-out of the Showscan Attractions; and (iii) the shipment, delivery and
installation of the equipment and related services.

        Costs of revenues were 59% of revenues in the Six Month Period as
compared to 57% in the six-month period ended September 30, 1997. Equipment cost
of sales to total equipment sales decreased to 63% in the Six Month Period from
72% in the six-month period ended September 30, 1997, primarily as a result of
the modifications to two equipment sales contracts. Film licensing cost of sales
to total film licensing sales was 51% in the Six Month Period as compared to 46%
in the six-month period ended September 30, 1997. The increase in film licensing
cost of sales in the Six Month Period from the six-month period ended September
30, 1997 is due to the increase in film distribution expenses for three films
that were acquired during the fiscal year ended March 31, 1998 and were released
in the Six Month Period.

        Amortization of the film library for the Six Month Period and the
six-month period ended September 30, 1997 was $509,000 and $423,000,
respectively. The increase in film amortization is due to the additional
amortization of three films in the Six Month Period that were added to the
Company's film library in the past fiscal year (and are now in release) and were
not amortized in the six-month period ended September 30, 1997. The Company
reviews film library estimated revenues on a quarterly basis (based on the then
current market conditions) and, where applicable, unamortized film costs are
written down to estimated net realizable value.

        General and Administrative expenses decreased $581,000 or 18% in the Six
Month Period from the six-month period ended September 30, 1997. The decrease
can be primarily attributed to (i) the significant reduction in the number of
employees, and (ii) a reduction in legal and marketing expenses from the
six-month period ended September 30, 1997.

        The loss on investment in O&O Theatres decreased to $113,000 in the Six
Month Period from $364,000 in the six-month period ended September 30, 1997, as
a result of the Company's closing of five of its O&O Theatres. The loss for the
Six Month Period is primarily the result of the following factors: (i) operating
losses at the Universal CityWalk theatre, (ii) operating losses at the two (2)
London/Trocadero theatres through their closing on July 2, 1998 and related
costs of such closing, (iii) partially offset by the operating profits of the
Osaka theatre. The Company earns film licensing revenues and management fees (if
applicable) which are recorded separately in the accompanying consolidated
statements of operations, thereby inherently increasing the operating expenses
at the specific O&O Theatres.



                                       12

<PAGE>   13

        The Company's net loss decreased $1,075,000 or 41% in the Six Month
Period to $1,536,000 from $2,611,000 in the six-month period ended September 30,
1997 primarily due to (i) the increase in equipment sales revenues, (ii) the
continued decrease in general and administrative expenses, and (iii) the
decrease in the equity loss from the net operations of O&O Theatres.

Comparison of the three months ended September 30, 1998 and 1997:

        Revenues for the three-month period ended September 30, 1998 (the "1999
Second Quarter") increased by $196,000 or 8% from revenues for the three-month
period ended September 30, 1997 (the "1998 Second Quarter") due to an increase
in revenues recognized from equipment sales and related services in the 1999
Second Quarter.

        Film licensing and production service revenues in the 1999 Second
Quarter decreased by $268,000 or 22% to $924,000 from $1,192,000 in the 1998
Second Quarter. The decrease was primarily due to (i) the renegotiation of
certain film licensing contracts in Asia due to adverse economic conditions in
that region, and (ii) the reduction in film revenues collected from O & O
Theatres due to the closure of five such theatres since the 1998 Second Quarter.

        Revenues from equipment sales and related services for the 1999 Second
Quarter increased 36% to $1,744,000 from $1,280,000 in the 1998 Second
Quarter. The increase is due to the higher sales price of the two Showscan
Attractions that shipped during the 1999 Second Quarter as compared to the two
Showscan Attractions that shipped in the 1998 Second Quarter, and to certain
modifications of two equipment sales contracts which resulted in additional
non-refundable payments to the Company under such contracts.

        The Company recognizes equipment sales under the
percentage-of-completion method of accounting, generally measured by the
percentage that the labor hours incurred to date bears to the estimated total
labor hours of each contract. This results in a disparity in the comparison of
equipment sales revenues over different time periods, as the Company records
revenues under this method rather than on the date that the sales agreement is
signed. The actual signing of a Showscan Attraction sale precedes its delivery
and installation by an average of five to six months. Accordingly, the
recognition of revenue for equipment sales during the current and future
quarters is affected by (i) the timing of such sales; (ii) the schedule of the
build-out of the Showscan Attractions; and (iii) the shipment, delivery and
installation of the equipment and related services.

        Costs of revenues were 50% of revenues in the 1999 Second Quarter as
compared to 56% in the 1998 Second Quarter. Equipment cost of sales to total
equipment sales decreased to 54% in the 1999 Second Quarter from 70% in the 1998
Second Quarter primarily as a result of the modifications to two equipment sales
contracts. Film licensing cost of sales to total film licensing sales was 42% in
the 1999 Second Quarter as compared to 41% in the 1998 Second Quarter.

        Amortization of the film library for the 1999 Second Quarter and the
1998 Second Quarter was $255,000 and $248,000, respectively. The Company reviews
film library estimated revenues



                                       13

<PAGE>   14

on a quarterly basis (based on the then current market conditions) and, where
applicable, unamortized film costs are written down to estimated net realizable
value.

        General and Administrative expenses decreased $262,000 or 17% in the
1999 Second Quarter from the 1998 Second Quarter. The decrease can be primarily
attributed to (i) the significant reduction in the number of employees, and (ii)
a reduction in legal and marketing expenses from the 1998 Second Quarter.

        The loss on investment in O&O Theatres decreased to $55,000 in the 1999
Second Quarter from $202,000 in the 1998 Second Quarter, as a result of the
Company's closing of five of its O&O Theatres. The loss for the 1999 Second
Quarter is primarily the result of the following factors: (i) operating losses
at the Universal CityWalk theatre, (ii) costs related to the closing of the two
(2) London/Trocadero theatres on July 2, 1998, (iii) partially offset by the
operating profits of the Osaka theatre. The Company earns film licensing
revenues and management fees (if applicable) which are recorded separately in
the accompanying consolidated statements of operations, thereby inherently
increasing the operating expenses at the specific O&O Theatres.

        The Company's net loss decreased 67% in the 1999 Second Quarter to
$325,000 from $992,000 in the 1998 Second Quarter primarily due to (i) the
increase in equipment sales revenues, (ii) the continued decrease in general and
administrative expenses, and (iii) the decrease in the equity loss from the net
operations of O&O Theatres.

Liquidity and Capital Resources:

        At September 30, 1998, the Company's operating working capital decreased
to a deficit of $5,209,000 from $1,224,000 at March 31, 1998. The decrease in
operating working capital was primarily due to the operating loss of the Company
in the Six Month Period. Additionally, the Company's 8% convertible notes
mature within twelve months, on September 1, 1999 and accordingly, the
required reclassification of the $5,690,000 as a current liability in the
September 30, 1998 balance sheet results in negative working capital of
$5,209,000. The Company is in discussions with its European bank regarding an
extension of the maturity date of this debt and additional financing in excess
of the amounts currently outstanding, as further discussed below (also see note
4 to Condensed Consolidated Financial Statements).

        Cash and cash equivalents at September 30, 1998 decreased by $893,000 to
$1,599,000 from the cash level at March 31, 1998. This reduction was the
result of $803,000 used in operating activities and $90,000 used in investing
activities.

        Net cash used in operating activities was primarily due to (i) a 46%
increase in accounts receivable (net of allowances), unbilled receivables on
uncompleted contracts and equipment sales inventory, and (ii) a 66% decrease in
accounts payable. These changes are primarily attributable to variations in the
timing of Showscan Attractions sales and the specific contract terms of such
sales, which terms generally affect the timing of collections, shipments,
deliveries to customers, installations and the related payments to vendors.



                                       14

<PAGE>   15

        Net cash used in investing activities was primarily due to expenditures
related to the post-production of one motion simulation film.

        As the Company derives 60-85% of its business from export sales, its
liquidity may be adversely affected by changes in worldwide economic or
political conditions. Such factors as changes in foreign currency exchange rates
(which can significantly affect the affordability of the Company's products and
services), trade protection measures, and policies with respect to currency and
fiscal controls may negatively affect liquidity. The current Asian economic
situation has caused the re-negotiation of certain film licensing agreements and
the delay of certain projects.

        The Company's business strategy includes an increase in the installed
base of Showscan Attractions, new film productions, the securing of distribution
rights to motion simulation films produced by other companies, the licensing and
distribution of its motion simulation library (including films produced using
the Showscan process and films acquired from other producers) to all operators
of simulation attractions (including those installed by the Company and those
previously installed by competitors of the Company), new product development and
new product lines, enhancement of existing product lines, possible investments
in O&O Theatres and the continued reduction of overhead.

        The Company intends to finance the foregoing business strategy by
utilizing its current working capital resources, the proceeds to be received
from its existing contract backlog and anticipated future equipment sales and
film licensing agreements, together with proceeds derived from one or more of
the following financing alternatives: the sale of securities, the sale of
non-performing assets, additional financing from banking institutions, the
renegotiation of existing indebtedness repayment schedules, and/or the formation
of strategic alliances, joint ventures or off- balance sheet financing. There
can be no assurance that the Company will be able to obtain any of the
aforementioned financing alternatives.

        During the past fiscal year and the Six Month Period, the Company took a
substantial number of actions to reduce its negative cash flow from operations.
These actions included implementing significant cost reductions, such as the
reduction in employee head-count to 29 from 61 at March 31, 1997, and the
closure of five of the seven existing O&O Theatre screens. The Company's
management is evaluating further cost reductions, including the out-sourcing of
certain operating functions (thereby further reducing employee head-count) and
the relocation of the Company's headquarters to smaller office space. There can
be no assurance that these cost-cutting measures will be sufficient to eliminate
the negative cash flow or that they will not further adversely impact the
Company's operations.

        The Company has limited capital resources and has debt obligations from
two different financial institutions, which mature in November 1998 ($1,000,000)
and in September 1999 ($5,690,000). The Company has reached an agreement with
the holder of the $1,000,000 note to revise the payment schedule on the note,
from being due in full in November 1998 to monthly payments beginning November
15, 1998 and continuing through March 31, 1999. The Company is also in
discussions with its European bank regarding additional financing in excess of
the $5,690,000 currently outstanding and an extension of the maturity date of
repayment of this debt. Although the Company has held discussions with its
European bank regarding additional financing,



                                       15

<PAGE>   16

there can be no assurance that the Company will be successful in obtaining any
such financing. There can also be no assurance that this creditor will agree to
extend its maturity date or other terms. Each creditor is secured by certain
assets which together constitute substantially all of the assets of the Company.

        The Company believes that its existing funds, combined with the
Company's ability to generate cash from future operations, the sale of
non-performing assets, the re-negotiation of existing indebtedness repayment
schedule and other financing transactions, will be adequate to finance its
revised levels of activities and operations. However, based on the Company's
current cash flow projections, it is anticipated that cash generated from
operations will not be sufficient to pay all of the $5,690,000 due on September
1, 1999. The Company is considering possible alternatives available to it in
order to pay the debt due in September 1999, including the possible sale and/or
licensing of assets to others, the re-negotiation of debt re-payment schedules,
the raising of cash through debt and/or equity financings, the further
curtailment of operating expenses and the receipt of payments by the Company
from UA by August 1999 either through the "sourcing" of projection and other
theatre equipment, or through the liquidated damages provisions of the Theater
Rights Agreement with UA (estimated to range from $3,200,000 to $5,280,000),
since the Company does not believe that UA will order any additional Showscan
Attractions. See Note 6 of Notes to Condensed Consolidated Financial Statements.

Impact of the Year 2000:

        Some of the Company's older computer software systems were written using
two digits rather than four to define the applicable year. As a result, those
computer programs have time-sensitive software that recognize a date using "00"
as the year 1900 rather than the year 2000. This software could cause a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.

        The Company has completed an assessment of its existing software systems
and after reviewing various factors, one of which being the year 2000 issue, has
determined which systems would need to be replaced or upgraded. The necessary
upgrades will cost approximately $25,000.

        The Company believes that the required changes to its existing computer
systems will be completed and tested not later than June 30, 1999, which is
prior to any anticipated impact on the operating systems. Although the Company
believes that with the conversions to the software, the year 2000 issue will not
pose significant operational problems for its computer systems, there can be no
assurance that the Company will not experience serious unanticipated negative
consequences and/or material additional costs caused by an undetected error or
defect in the technology used in the Company's internal systems that were
acquired from third parties.

        The costs of the project and the date on which the Company believes it
will complete the conversion are based on management's best estimates, which
were derived utilizing numerous assumptions of future events, including the
continued availability of certain resources and other



                                       16

<PAGE>   17

factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.

        The Company has assigned several key employees as a Year 2000 committee,
whose sole purpose is to determine the compliance of all Company products,
software systems and key vendors with the necessary conversion requirements.
This committee (the "Year 2000 Committee") is responsible for identifying all
potential issues which must be addressed. The Year 2000 Committee's
recommendations will be followed by the Company.

        The Year 2000 Committee is in the process of reviewing all of the
products of the Company in order to identify any Year 2000 sensitive software
included in the products sold currently or in the past. The Company has
identified some potential software problems and has not yet determined if a
material cost will be incurred to test or correct products initially sold by the
Company.

        The Year 2000 Committee is also beginning the process of surveying key
vendors to insure their compliance with Year 2000 transition requirements. As of
November 11, 1998, the Company is unaware of any key vendors who are not in
compliance. At this date, the survey is in its initial stages, and will be
continuing into the next few fiscal quarters of the Company.

FACTORS THAT MAY AFFECT FUTURE RESULTS

        Portions of this report on Form 10-Q (this "Report") may contain
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The reader is cautioned that all forward-looking
statements are necessarily speculative and there are certain risks and
uncertainties that could cause actual events or results to differ materially
from those referred to in such forward-looking statements. The discussion below,
together with portions of the discussion elsewhere in this Report and in the
Company's other reports on file with the Securities and Exchange Commission,
highlight some of the more important risks identified by the management of the
Company but should not be assumed to be the only things that could affect future
performance.

History of Operating Losses

        For the fiscal years ending March 31, the Company had net profits of
$79,000 in fiscal 1995, net profits of $101,000 in fiscal 1996, a net loss of
$3.9 million in fiscal 1997 and a net loss of $8.5 million in fiscal 1998. At
March 31, 1998, the Company had an accumulated deficit of $40.9 million. For the
fiscal years ended March 31, 1995, 1996, 1997 and 1998, the Company's ratio of
indebtedness to stockholders equity was 23.6%, 49.8%, 55.6% and 390%,
respectively. This history of losses has had a negative impact on the Company's
stock price and will adversely effect the Company's ability to carry out its
business strategy, increase stockholder value, and to obtain financing in the
future.

        The Company received notification from the Nasdaq Stock Market in the
fiscal quarter ended June 30, 1998, that it was not in compliance with the
continued listing requirements of the Nasdaq National Market(R). Nasdaq
indicated that the Company had not maintained the required $1 minimum closing
bid price per share nor the required $5,000,000 minimum market value of public
float, nor



                                       17

<PAGE>   18

the required $4,000,000 minimum net tangible assets. The Company was granted an
oral hearing on September 10, 1998 to demonstrate its ability to meet all of the
continued listing requirements. After the hearing, Nasdaq decided to delist the
Company's Common Stock from trading on the Nasdaq National Market(R) at the
opening of business on September 17, 1998. The Company's Common Stock now trades
on the OTC Bulletin Board. Since the Company has moved to the Electronic
Bulletin Board, the Company has lost some of its market makers with the result
that it may now be more difficult to effect trades of the Company's shares and
to obtain timely and accurate quotations and reports of trading. This delisting
could also adversely affect the liquidity of the Company's shares and thus their
market value. This delisting could also adversely affect the Company's ability
to obtain debt and/or equity financing.

Ability to Obtain Additional Financing

        To date, the Company's primary source of capital has been from debt and
equity financings. Unless the Company is able to obtain additional proceeds from
such financing sources the Company will have to restructure its business and
operations. A number of factors will make it difficult for the Company to obtain
equity financing in the future, including the significant losses the Company
incurred in the last fiscal year, the de-listing of the Common Stock from the
Nasdaq National Market(R), the on-going financial turmoil in Asia (historically
the Company's largest market and principal source of operating revenues), the
Company's historical stock performance, and a general decrease in investor
interest in the Company's industry. The Company's lack of assets that are
available for collateral and its cash flow fluctuations may make it difficult
for the Company to attract additional debt financing. Any investor or lender may
require a significant equity position in the Company that could result in
dilution of the Company's present stockholders. In addition to curtailing its
business strategy, the Company has debt obligations from two different financial
institutions which mature in November 1998 ($1,000,000) and in September 1999
($5,690,000). The Company has an agreement to revise the payment schedule on the
$1,000,000 obligation from being due in November, 1998 to monthly payments
beginning November 15, 1998 and continuing through March 31, 1999, and is in
discussions with its European Bank with regard to re-negotiation of its debt
repayment schedule and additional financing. There can be no assurance that the
European bank will agree to extend its maturity date or provide additional
financing. The failure to repay either of these debts could result in the
foreclosure against the collateral securing them which, between the two
obligations, constitute substantially all of the assets of the Company. Based on
current cash flow projections, the management of the Company anticipates that
cash generated from operations will not be sufficient to pay all of the $5.7
million due on September 1, 1999. The Company has various alternatives available
to it in order to pay this debt. There can be no assurance that any of these
alternatives will be successful.

Ability to Produce Additional Films

        One of the primary factors considered by potential purchasers of motion
simulation attractions is the quality and extent of the films available to be
shown at the attraction. In addition, existing sites considering licensing the
Company's films will consider the type and number of films available to them.
The Company believes that a large portion of its competitive advantage resides
in its popular and extensive library of ride films. To maintain this competitive
edge, the Company



                                       18

<PAGE>   19

must produce or acquire the distribution rights to several new films each year.
Film production is expensive and requires the investment of Company funds (to
the extent that investors cannot be located) with no assurance that the films
produced will be popular. To the extent that the Company does not have its own
funds available to invest and financing cannot be found on acceptable terms,
then the Company's ability to produce new films could be restricted. Other
competitors have each indicated that they are devoting substantial portions of
their financial resources to the production of new motion simulation films. The
Company's recent operating losses and declining cash balances have caused it to
decrease the level of its investments in film software, which may have an
adverse effect on revenues in future periods. Both the short- and long-term
financial performance of the Company will be adversely affected if the perceived
quality and popularity of the Company's film library declines either alone or in
comparison to the films of the Company's competitors.

Period to Period Fluctuations

        The Company has experienced quarterly fluctuations in operating results
and anticipates that these fluctuations will continue in future periods.
Operating results and cash flow can fluctuate substantially from quarter to
quarter and periodically as a result of the timing of theatre system deliveries,
contract signings, the mix of theatre systems shipped, the completion of custom
film contracts, the amount of revenues from film licensing agreements, the
timing of sales of Showscan Attractions, the timing of delivery and installation
of such sales (pursuant to percentage of completion accounting) and any delays
therein caused by permitting or construction delays at the customer's site, the
size, type and configuration of the attractions sold, the timing of film rental
payments from existing attractions and the performance of those attractions that
pay film rental based on a percentage of box office and the timing of sales and
marketing efforts and related expenditures. In particular, fluctuations in
theatre system sales and deliveries from quarter to quarter can materially
affect quarterly and periodic operating results, and theatre system contract
signings can materially affect quarterly or periodic cash flow. Accordingly, the
Company's revenues and earnings in any particular period may not be indicative
of the results for any future period. The seasonal fluctuations also cause
gyrations in the Company's stock price.

        The Company's performance depends primarily upon the number of motion
simulation attractions that it can sell and install. The Company's results have
followed a seasonal pattern, with revenues tending to be stronger in the second
and fourth fiscal quarters, reflecting the buying patterns of the Company's
customers for new motion simulation attractions.

New Product Development

        The Company operates in a technology driven segment of the entertainment
business. As such, the Company must continually improve its products to increase
their entertainment value while also facing pressure to continually reduce the
price of its products to respond to competitive pressures. Since several of the
Company's competitors have significantly more capital than the Company, the
Company has had to rely more on its suppliers and other third-parties to improve
the Company's existing products and to develop new ones. The inability of the
Company to develop new products and to respond to technological developments of
its competitors could have a materially adverse effect on the Company's
business, operations and financial condition.



                                       19

<PAGE>   20

International Operations

        A significant portion of the Company's sales and film licensing are made
to customers located outside of the United States, primarily in the Far East,
Europe, Middle East and Australasia. During the fiscal years ended 1998, 1997,
1996 and 1995, 85%, 62%, 61% and 69% of the Company's revenues, respectively,
were derived from sales outside the United States. International operations and
sales of the Company may be subject to political and economic risks, including
political instability, currency controls, exchange rate fluctuations (which, in
the event of a decrease in value of foreign currency to the dollar, can
significantly affect the affordability of the Company's products overseas),
changes in import/export regulations, tariff and freight rates, longer accounts
receivable collection patterns, changes in regional or worldwide economic or
political conditions and natural disasters. The Company typically denominates
the prices of its films and equipment in United States Dollars. As a result of
the recent devaluation of a number of Asian countries' currencies relative to
the U.S. Dollar, the price of the Company's products to prospective buyers in
such countries has increased significantly. This effective price increase could
adversely affect the Company's future sales in the region and its ability to
continue to negotiate and receive its current levels of film rental from
existing sites in the region. In addition, various forms of protectionist trade
legislation have been proposed in the United States and certain other countries.
Any resulting changes in current tariff structures or other trade and monetary
policies could adversely affect the Company's international operations.
Political and economic factors have been identified by the Company with respect
to certain of the markets in which it competes. There can be no assurance that
these factors will not result in customers of the Company defaulting on payments
due to it, or in the reduction of potential purchases of the Company's products.
The Company has not engaged in any currency hedging programs.

Intellectual Property

        The Company has several United States patents on various processes and
elements related to film projection and motion simulation. The most important of
these patents expire in October 2001. Though the Company's patents have never
been challenged and the Company believes that they are valid, third parties
could still challenge the patents and a court could determine that one or more
of them are invalid. Declarations of invalidity, particularly of the Company's
key patents, could adversely affect the marketability of the Company's products
and services. In addition, the Company always faces the risk that new
technologies could be discovered that are superior to the Company's patents.

Competition

        Competition in each of the markets in which the Company competes is
intense. The principal direct competition for customers comes from manufacturers
of competing movie-based attractions, and in the case of amusement and theme
parks, manufacturers of traditional amusement park attractions. In addition to
direct competitors, there is also competition from systems integrators and some
amusement and theme parks developing and constructing their own attractions.
Many of the Company's competitors have better name recognition, and
substantially greater financial and other resources than the Company.



                                       20

<PAGE>   21

        Additionally, the out-of-home entertainment industry in general is
undergoing significant changes, primarily due to technological developments as
well as changing consumer tastes. Numerous companies are developing and are
expected to develop new entertainment products or concepts for the out-of-home
entertainment industry in response to these developments that are or may be
directly competitive with existing products. There is severe competition for
financial, creative and technological resources in the industry and there can be
no assurance that existing products will continue to compete effectively or that
products under development will ever be competitive. Further, the commercial
success of products is ultimately dependent upon audience reaction. Audience
reaction will to a large extent be influenced by the audience's perception of
how the Company's products compare with other available entertainment options
out of the home. There can be no assurance that new developments in out-of-home
entertainment will not result in changes in consumer tastes that will make the
Company's products less competitive.

Volatility of Stock Price

        The Company's stock price has been, and could continue to be, highly
volatile. During the 12 months prior to September 30, 1998, the Company's
closing market price has ranged from a low of $0.0625 per share to a high of
$3.375 per share. Future announcements concerning the Company or its
competitors, quarterly variations in operating results, introduction of new
products or changes in product pricing policies by the Company or its
competitors, the acquisition or loss of significant customers, or changes in
earnings estimates by analysts, among other factors, may affect or be perceived
to affect the Company's operations and could cause the market price of the
Company's shares to fluctuate substantially. In addition, stock markets have
experienced extreme price and volume volatility in recent years. 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 the specific companies. These broad market fluctuations may adversely affect
the market price of the Company's shares.

Ability to Retain Key Personnel

        Over the past eighteen months, the Company has reduced its number of
employees from 61 to 29. The possible merger of the Company, the financial
losses, the potential for additional staff reductions and a tight job market
have resulted in some departures by key personnel. While none of the departures
have had a significant effect upon the Company's operations, there can be no
assurance that there will not be additional departures.

Environmental Matters and Other Governmental Regulations

        Under various Federal, state and local environmental laws and
regulations, a current or previous owner or occupant of real property may become
liable for the costs of removal or remediation of hazardous substances at such
real property. Such laws and regulations often impose liability without regard
to fault. The Company could be held liable for the costs of remedial actions
with respect to hazardous substances at its corporate headquarters under the
terms of the governing lease and/or governing law. Although the Company has not
been notified of, nor is otherwise aware of, any current environmental
liability, claim or non-compliance, there can be no assurance that the



                                       21

<PAGE>   22

Company will not be required to incur remediation or other costs in the future
in connection with these properties. The Company believes it is in compliance
with all applicable Federal, state and local environmental laws and regulations.

Business Disruption

        The Company's corporate headquarters, including its research and
development operations, are located in Los Angeles, California, a region known
for seismic activity. Operating results could be materially affected by a
significant earthquake or other natural disaster.

Dependence on Major Customers

        The Company's film licensing business has a concentration located in
Japan where Imagine Japan presently operates or is otherwise responsible for
fifteen simulation attractions. In the fiscal year ended March 31, 1998,
Showscan earned revenues from Imagine Japan in the amount of $1,318,000. The
Company's short and long-term performance could be adversely impacted if
disruptions were to occur in this area of concentration, such as license
terminations or payment problems.

Current Trends in the Global Economy

        The Company's revenues and profitability are dependent on the strength
of the national and international economies. In a recessionary or deflationary
environment, sales of the Company's products and products of other entertainment
companies may be adversely affected. Theme parks and other out-of-home
entertainment venues may also experience a downturn in sales which could reduce
the funds available for capital improvements and film licensing, resulting in
price and other concessions and discounts by the Company in order to maintain
sales activity. Recent turmoil in the economies of the countries in Asia have
had a material adverse affect on the Company's revenues and results of
operations. If recent economic problems experienced in Asia, Russia, and Eastern
Europe were to spread to Europe, South America or the United States, it could
have a material adverse affect upon the Company's revenues and results of
operations. The Company is not able to predict to what extent, or for what
period, these economic trends may adversely affect the sales of its products.



                                       22

<PAGE>   23

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 

a)  Exhibits

        The exhibits listed below are filed as part of this Report.

<TABLE>
<CAPTION>
     Exhibit Number                           Description
     --------------                           -----------
<S>                           <C>
        10.36                 Amendment to Employment Agreement, dated 
                              October 1, 1998, by and between the Company
                              and Dennis Pope.
</TABLE>



(b)  Reports on Form 8-K

        None



                                       23

<PAGE>   24

                                   SIGNATURES


Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the City of Culver City,
State of California on the 16th day of November, 1998.


                                       Showscan Entertainment Inc.
                                       ---------------------------
                                             (Registrant)



                                       By /s/ DENNIS POPE
                                          --------------------------------------
                                          Dennis Pope
                                          President  - Chief Executive Officer
                                          (Authorized Officer and Principal
                                          Executive Officer)


                                       By /s/ MARC SABELLA
                                          --------------------------------------
                                          Marc Sabella
                                          Vice President  - Corporate Controller
                                          (Authorized Officer and Principal
                                          Accounting Officer)



                                       24

<PAGE>   25

                                         EXHIBIT INDEX



<TABLE>
<CAPTION>
      Exhibit No.                            Description                             Page Number
      -----------                            -----------                             -----------
<S>                           <C>                                                    <C>
        10.36                 Amendment to Employment Agreement, dated                 
                              October 1, 1998, by and between the Company 
                              and Dennis Pope.
</TABLE>






                                       25