<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 June 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
    (Address of principal executive offices)                       90232
                                                                (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 August 14, 1998, the Registrant had 5,642,058 shares of Common Stock,
$.001 par value, issued and outstanding.


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



<PAGE>   2
                           SHOWSCAN ENTERTAINMENT INC.

                                      INDEX


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


ITEM 1. FINANCIAL STATEMENTS                                                   3

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

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

Condensed Consolidated Statements of Cash Flows for the Three
  Months Ended June 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                                      21

Signatures                                                                    22

Exhibit Index                                                                 23
</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>
                                                        JUNE 30,        MARCH 31,
                                                          1998            1998
                                                         -------        -------
                                                       (unaudited)       (Note)
<S>                                                      <C>            <C>    
               ASSETS
Current assets:
  Cash and cash equivalents                              $ 2,195        $ 2,492
  Accounts receivable (net of allowances)                  2,244          2,161
  Unbilled receivables on uncompleted
    film and equipment contracts                           1,575            708
  Due from affiliated entities, net of
    allowances (Note 6)                                      851            794
  Equipment sales inventory                                1,333          1,186
  Prepaid expenses and other current assets                   25            193
                                                         -------        -------
Total current assets                                       8,223          7,534

Film library (net of amortization)                         3,517          3,765

Investment in and advances to O&O
   Theatres (Note 2)                                         425            440

Patents and other intellectual properties (net of
   amortization)                                             793            900

Other assets, including equipment and leasehold
   improvements, net of accumulated depreciation
   and amortization                                          936          1,072
                                                         -------        -------

Total assets                                             $13,894        $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>
                                                                              JUNE 30,         MARCH 31,
                                                                                1998             1998
                                                                              --------         --------
                                                                            (unaudited)         (Note)
<S>                                                                           <C>              <C>
    LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
 Accounts payable                                                             $    634         $    752
 Customer advances on uncompleted film and
   equipment contracts                                                           3,827            2,317
 Accrued expenses and other current liabilities                                  2,244            2,241
 11% note payable (Note 3)                                                       1,000            1,000
                                                                              --------         --------
Total current liabilities                                                        7,705            6,310
                                                                              --------         --------
8% convertible notes (Note 4)                                                    5,690            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                                                           (42,074)         (40,862)
                                                                              --------         --------
Total stockholders' equity                                                         499            1,711
                                                                              --------         --------
Total liabilities and stockholders' equity                                    $ 13,894         $ 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
                                                        JUNE 30,
                                                 1998             1997
                                                -----------------------
                                                      (Unaudited)
<S>                                             <C>             <C>    
Revenues:
   Film licensing and production service        $   626         $   939
   Equipment sales and related services           1,136             300
                                                -------         -------
                                                  1,762           1,239

   Costs of revenues                              1,280             735
                                                -------         -------
   Gross profit                                     482             504

Costs and expenses:
   General and administrative
      expenses                                    1,270           1,590
   Depreciation and amortization                    170             199
                                                -------         -------
                                                  1,440           1,789
                                                -------         -------
Operating loss                                     (958)         (1,285)

Other income (expenses):
   Equity in net operations of O&O
      Theatres                                      (58)           (162)
   Other income, including interest                  18              18
   Interest and other expenses                     (214)           (190)
                                                -------         -------

                                                   (254)           (334)
                                                -------         -------

Net loss                                        $(1,212)        $(1,619)
                                                =======         =======

Basic and diluted net loss per
   common share (Note 5)                        $  (.21)        $  (.29)
                                                =======         =======
</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>
                                                                    THREE MONTHS ENDED
                                                                         JUNE 30,
                                                                  1998             1997
                                                                ------------------------
                                                                       (Unaudited)
<S>                                                             <C>             <C>
Cash flows from operating activities:
  Net loss                                                      $(1,212)        $(1,619)
   Adjustments to reconcile net loss to net cash
     provided by (used in) operating activities:
      Depreciation and amortization                                 170             199
      Amortization of film library                                  255             175
      Equity in net operations of O&O Theatres                       58             162
      Accrued interest on debt                                      152             115
      Provision for doubtful accounts                                30              30
   Changes in operating assets and liabilities:
      Accounts receivable, including due from 
        affiliated entities                                        (170)          1,036
      Equipment sales inventory                                    (147)            (48)
      Unbilled receivables on uncompleted film
        and equipment contracts                                    (867)           (869)
      Prepaid expenses and other assets                             168             569
      Investment in and advances to O&O theatres                    (43)            (84)
      Accounts payable, accrued expenses and
        other current liabilities                                  (268)           (150)
      Customer advances on uncompleted film and
        equipment contracts                                       1,510           1,391
                                                                -------         -------

Net cash (used in) provided by operating
     activities                                                 $  (364)        $   907
                                                                -------         -------

Cash flows from investing activities:
  Purchases of short term investments                                --            (996)
  Purchases of equipment and leasehold
   improvements                                                      --             (12)
  Additions to film library                                          (6)           (539)
  Other assets                                                       73             520
                                                                -------         -------

Net cash provided by (used in) investing
      activities                                                $    67         $(1,027)
                                                                -------         -------
</TABLE>


                                   (continued)



                                        6

<PAGE>   7
                           SHOWSCAN ENTERTAINMENT INC.
           Condensed Consolidated Statements of Cash Flows (Continued)
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                                 THREE MONTHS ENDED
                                                                      JUNE 30,
                                                                1998            1997
                                                              -----------------------
                                                                     (Unaudited)
<S>                                                           <C>             <C>     
        Balance forwarded                                     $  (297)        $  (120)
                                                              -------         -------

Cash flows from financing activities:
   Net cash provided by (used in) financing activities             --              --
                                                              -------         -------

   Net decrease in cash and cash equivalents                     (297)           (120)

Cash and cash equivalents, beginning of period                $ 2,492         $ 2,562
                                                              =======         =======

Cash and cash equivalents, end of period                      $ 2,195         $ 2,442
                                                              =======         =======


Supplemental disclosures of cash flow information:            $    --         $     2
                                                              =======         =======
   Interest paid

   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 ended June 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:

        The Company retains an ownership interest in selected Showscan motion
simulation Theatre Attractions ("Showscan Attractions") through various joint
venture arrangements. The Company currently operates and/or has an ownership
interest in Showscan Attractions at Universal CityWalk in Universal City,
California (opened in November 1993) and Osaka, Japan (opened in August 1995)
(collectively, the "O&O Theatres"). 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. As of June 30, 1998, the Company had a 50% ownership interest in a
Showscan Attraction at the Trocadero Arcade in London which ceased theatre
operations on July 2, 1998.


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
are being amortized over the original term of the note. The Company has an
agreement in principal to revise the payment schedule to monthly payments
beginning in October 1998 and continuing through March 1999, where each payment
is based on a percentage of the film license revenues collected in the previous
month, with any remaining balance of the note due in full on March 31, 1999.



                                        8

<PAGE>   9
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") through an
unaffiliated third party. 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 June
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.


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 three months ended June 30, 1998 and 1997.


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 provide 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); provided, however, that if the UA Venture has not accepted one
of the theatre sites it has been offered by UA prior to the Maturity Date, the
Maturity Date will be extended 30 days after the date that the UA Venture does
accept, but in no event shall the Maturity Date be 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 equipment, in addition to simulation equipment,
through the Company. 50% of any such sourced projection equipment will



                                        9

<PAGE>   10
count toward UA's achievement of the $13,950,000 aggregate equipment purchase
requirement. If UA shall fail to achieve this requirement and 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. Any such sourcing of projection equipment must result in at least an
aggregate benefit (as defined) to the Company of $3,200,000.

        At June 30, 1998, affiliates of certain directors owed the Company a
combined balance of $453,000 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. 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 sheet at March 31 and June 30, 1998.



                                       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 three-month period ended
June 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 fiscal quarter ended June 30, 1998.


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

        Revenues for the three-month period ended June 30, 1998 (the "Three
Month Period") increased by $523,000 or 42% from revenues for the three-month
period ended June 30, 1997 due to an increase in revenues recognized from
equipment sales and related services.

        Film licensing and production service revenues in the Three Month Period
decreased by $313,000 or 33% to $626,000 from $939,000 in the three-month period
ended June 30, 1997. The decrease was primarily due to (i) 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 three of the Company's screens since the prior
year period.

           Revenues from equipment sales and related services for the Three
Month Period increased 279% to $1.1 million from $300,000 in the three-month
period ended June 30, 1997. The increase is due to the increase in the number of
Showscan Attractions shipped during the Three Month Period as compared to the
corresponding prior year three-month period. Two Showscan Attractions were
shipped in the Three Month Period as compared to no units shipped in the
three-month period ended June 30, 1997.



                                       11

<PAGE>   12
       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 73% of revenues in the Three Month Period as
compared to 59% in the three-month period ended June 30, 1997. This increase was
primarily due to the higher percentage of total revenues represented by
equipment sales in the Three Month Period, of which these revenues carry a
higher average cost of sales. Equipment cost of sales to total equipment sales
decreased to 77% in the Three Month Period from 83% in the three-month period
ended June 30, 1997. Film licensing cost of sales to total film licensing sales
was 64% in the Three Month Period as compared to 52% in the three-month period
ended June 30, 1997. The increase in film licensing cost of sales in the Three
Month Period from the three-month period ended June 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.

        Amortization of the film library for the Three Month Period and the
three-month period ended June 30, 1997 was $255,000 and $175,000, respectively.
The increase in film amortization is due to the additional amortization of three
films in the Three Month Period that were added to the Company's film library in
the past fiscal year and were not amortized in the three-month period ended June
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 $320,000 or 20% in the
Three Month Period from the three-month period ended June 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
three-month period ended June 30, 1997.

        The loss on investment in O&O Theatres decreased to $58,000 in the Three
Month Period from $162,000 in the three-month period ended June 30, 1997, as a
result of the Company's closing of three of its underperforming O&O Theatre
screens since June 30, 1997. The loss for the Three Month Period is primarily
the result of the following factors: (i) operating losses at the Trocadero
(closed on July 2, 1998) and Universal CityWalk theatres, (ii) offset by the
operating profits of the Osaka theatre. The Company earns film licensing
revenues (from both O&O Theatres) and management fees (from one of the O&O
Theatres) 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 25% in the Three Month Period to
$1,212,000 from $1,619,000 in the three-month period ended June 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.


Liquidity and Capital Resources:

        At June 30, 1998, the Company's working capital decreased to $518,000
from $1,224,000 at March 31, 1998. The decrease in working capital was primarily
due to the operating loss of the Company in the Three Month Period.

        Cash and cash equivalents at June 30, 1998 decreased by $297,000 from
March 31, 1998, which was the result of $364,000 used in operating activities
and $67,000 provided by investing activities.

        Net cash used in operating activities was primarily due to (i) the 24%
increase in accounts receivable (including receivables from affiliated
entities), unbilled receivables on uncompleted contracts and equipment sales
inventory, and (ii) a 16% 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.

        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 delay of certain projects and the Company believes that
it will have an adverse impact on revenues in future periods.

        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 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, 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.



                                       13

<PAGE>   14
        During the past fiscal year and the Three Month Period, the Company took
a substantial number of actions in order to reduce the negative cash flow from
operations. These actions include 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 to
approximately 20), the relocation of the Company's headquarters to smaller
office space and other actions. 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 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 an agreement in principal
to revise the payment schedule on the $1,000,000 obligation, from being due in
full in November 1998 to monthly payments beginning in October 1998 and
continuing through March 1999 where each such payment is based on a percentage
of the film license revenues collected in the previous month with any remaining
balance of the note due in full on March 31, 1999. The Company has also had
preliminary 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 preliminary
discussions with its European bank regarding additional financing, 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 all of the assets of the Company.

        A substantial portion of the aggregate losses for fiscal years ended
1998 and 1997 are attributable to non-cash expenditures in each of those years.
The Company believes that these write downs of certain non-performing assets,
particularly O&O theatres and certain simulation films, are complete and will
not reoccur in future periods.

        The Company believes that its existing funds, combined with the
Company's ability to generate cash from future operations, 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 order of projection and/or
motion simulation equipment or through the liquidated damages provisions of the
Theater Rights Agreement with UA (estimated to be at least $3,200,000). See Note
6 of Notes to Condensed Consolidated Financial Statements.

        The Company has received notification from the Nasdaq Stock Market that
it is not in compliance with the continued listing requirements of the Nasdaq
National Market(R). Nasdaq indicated that the Company has not maintained the
required $1 minimum closing bid price per share nor the required $5,000,000
minimum market value of public float, nor the required $4,000,000 minimum net
tangible assets. The Nasdaq Stock Market granted the Company until August 14,
1998 to be in compliance with the requirements. The Company requested and has
been granted an oral



                                       14

<PAGE>   15
hearing on September 10, 1998 to demonstrate its ability to meet all of the
continued listing requirements. Pending this hearing, Nasdaq has stayed its plan
to delist the Company's Common Stock from trading on the Nasdaq National
Market(R) at the opening of business on August 17, 1998. If delisted, the
Company's Common Stock would trade on the OTC Bulletin Board and/or the "Pink
Sheets." If moved to the Electronic Bulletin Board or Pink Sheets, the Company
would likely lose some or all of its present market makers with the result that
it would be more difficult to effect trades of the Company's shares and to
obtain timely and accurate quotations and reports of trading. Any such delisting
could also adversely affect the liquidity of the Company's shares and thus their
market value. Such delisting could also adversely affect the Company's ability
to obtain debt and/or equity financing.

        Management of the Company has reviewed the provisions of SFAS 130 and
131 and determined that the ultimate adoption of these accounting standards will
not have an impact on the Company's financial statements and related
disclosures.

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 would cost approximately $25,000.

        If necessary, these upgrades would be completed not later than June 30,
1999, which is prior to any anticipated impact on the operating systems. The
Company believes that with conversions to new software, the year 2000 issue will
not pose significant operational problems for its computer systems.

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


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



                                       15

<PAGE>   16
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, $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
could adversely effect the Company's ability to obtain financing in the future.

Business Strategy; Dilution

           Management of the Company has adopted a business strategy that
includes substantial investments in its sales and marketing organizations, the
creation of new research and development programs and increased funding of
existing programs. This strategy carries with it a number of risks, including a
level of operating expenses that may not be adequately covered by the Company's
revenues or by funds obtained by raising additional capital. Additional
financing may not be available to the Company at all or only on unfavorable
terms. 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 expected de-listing of the Common Stock
from Nasdaq, 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 1998 ($5,690,000). The
Company has had preliminary discussions with both creditors with regard to
re-negotiation of the debt repayment schedules. There can be no assurance that
either creditor will agree to extend its maturity date or other terms. The
failure to repay either of these debts could result in the foreclosure against
the collateral securing them which, between the two obligations, constitute 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.



                                       16

<PAGE>   17
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. This dependence has been
lessening as the percentage of the Company's revenues derived from recurring
film licensing revenues has increased though there can be no assurance that this
trend will necessarily continue. 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.

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.



                                       17

<PAGE>   18
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 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.

           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.



                                       18

<PAGE>   19
Volatility of Stock Price; Effect of Delisting

           The Company's stock price has been, and could continue to be, highly
volatile. During the 12 months prior to June 30, 1998, the Company's closing
market price has ranged from a low of $0.344 per share to a high of $3.50 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.

           In addition, the Company has received notification from the Nasdaq
Stock Market that the Company's shares will be delisted from the Nasdaq National
Market(R) on August 17, 1998 unless the Company is in compliance with the
continued listing requirements before such time. Any such delisting could
adversely affect the liquidity of the Company's shares and thus their market
value. Information regarding trading in the Company's shares could become more
difficult to obtain, and trading could become infrequent and low in volume.

Ability to Retain Key Personnel

           Over the past eighteen months, the Company has reduced its number of
employees from 61 to 29. The pendency of the merger, 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. In addition, the Company's insurance
coverage for its directors and officers is due for renewal. If coverage is
unavailable or is available only at a reduced level, then the Company may
experience additional departures at its Board and management level which could
have a materially adverse effect on the Company's operations.

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 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.



                                       19

<PAGE>   20
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 motion simulation business has two significant
concentrations. The first concentration involves ongoing film licenses and is
located in Japan where Imagine Japan presently operates or is otherwise
responsible for fifteen simulation attractions. The second concentration relates
to the Company's sales backlog where UA and King's Entertainment Co., Ltd.
individually and collectively represent a substantial portion of the outstanding
equipment orders to be delivered in the next few years. The Company's agreement
with United Artists Theatre Circuit, Inc. calls for a build out period extending
through August 1999 while that with Apex Science & Technology Corp. (assignee of
King's Entertainment Co., Ltd.) extends through May 2002. Each site opened under
each agreement shall have an initial film license period of at least three
years. In the fiscal year ended March 31, 1998, Showscan earned revenues from
Imagine Japan and United Artists Theatre Circuit, Inc. in the amounts of
$1,318,000 and $100,000, respectively. The Company's short and long-term
performance could be adversely impacted if disruptions were to occur in any of
these areas of concentration such as order cancellations, license terminations
or payment problems.

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. 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 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 assets to the
production of new motion simulation films. 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.



                                       20

<PAGE>   21
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>
        10.35               Memorandum of Understanding, dated July 27, 1998, by
                            and between Showscan Entertainment Inc. and United
                            Artists Theatre Circuit, Inc.
</TABLE>

(b)  Reports on Form 8-K

        None



                                       21

<PAGE>   22
                                          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 13th day of August, 1998.


                                       Showscan Entertainment Inc.
                                              (Registrant)



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



                                       22

<PAGE>   23
                                  EXHIBIT INDEX



<TABLE>
<CAPTION>
          Exhibit No.                        Description                    
          -----------                        -----------                    
<S>                               <C>                                       
              10.35              Memorandum of Understanding,                   
                                 dated July 27, 1998, by and
                                 between Showscan Entertainment
                                 Inc. and United Artists Theatre
                                 Circuit, Inc.
</TABLE>



                                              23