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

                      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 December 31, 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 February 12, 1999, the Registrant had 5,642,058 shares of Common
Stock, $.001 par value, issued and outstanding.
 

================================================================================
 
             This report contains 24 consecutively numbered pages.
<PAGE>
 
                          SHOWSCAN ENTERTAINMENT INC.

                                     INDEX


<TABLE> 
<CAPTION> 
                                                                 Page
                                                                 ----
<S>                                                              <C>
PART I - FINANCIAL INFORMATION
 
 
Item 1. Financial Statements
----------------------------
 
Condensed Consolidated Balance Sheets as of December 31, 1998
and March 31, 1998                                                 3
 
Condensed Consolidated Statements of Operations for the Three
Months and Nine Months Ended December 31, 1998 and 1997            5
 
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended December 31, 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                          22
----------------------------------------                           
                                                                   
Signatures                                                        23
                                                                   
Exhibit Index                                                     24
</TABLE> 

                                       2
<PAGE>
 
PART I. - FINANCIAL INFORMATION
 
Item 1. - Financial Statements
------------------------------
 
                          SHOWSCAN ENTERTAINMENT INC.
                     Condensed Consolidated Balance Sheets
                (Dollars in Thousands Except Share Information)
 
<TABLE> 
<CAPTION> 
                                                                   December 31,             March 31,
                                                                      1998                    1998
                                                                   ------------             ---------
                                                                   (Unaudited)               (Note)
<S>                                                                <C>                      <C> 
                        ASSETS  
                        ------
Current assets:
  Cash and cash equivalents                                           $ 1,035                $ 2,492
  Accounts receivable (net of allowances)                               2,130                  2,161
  Unbilled receivables on uncompleted
   film and equipment contracts                                         1,503                    708
  Due from affiliated entities, net of allowances                                                   
   (Note 6)                                                               216                    794
   Equipment sales inventory                                            1,427                  1,186
   Prepaid expenses and other current assets                              521                    193
                                                                      -------                -------
Total current assets                                                    6,832                  7,534
 
Film library (net of amortization)                                      3,104                  3,765
 
Investment in and advances to O&O theatres (Note 2)                       333                    440
 
Patents and other intellectual properties (net of
   amortization)                                                          575                    900
 
Other assets, including equipment and leasehold
   improvements, net of accumulated depreciation and      
   amortization                                                           941                  1,072
                                                                      -------                -------
 
Total assets                                                          $11,785                $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>
 
                          SHOWSCAN ENTERTAINMENT INC.
               Condensed Consolidated Balance Sheets (continued)
                (Dollars in Thousands Except Share Information)
 
<TABLE> 
<CAPTION> 
                                                                    December 31,          March 31,
                                                                       1998                 1998
                                                                    ------------          ---------
                                                                    (Unaudited)            (Note)
<S>                                                                 <C>                   <C> 
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
------------------------------------
 
Current liabilities:                                                                                
 Accounts payable                                                     $    351             $    752 
 Customer advances on uncompleted film and                                                         
  equipment contracts                                                    3,408                2,317
 Accrued expenses and other current liabilities                          2,816                2,241
 11% note payable (Note 3)                                                 710                1,000
 8% convertible notes, due September 1, 1999 (Note 4)                    5,690                    -
                                                                      --------             --------
Total current liabilities                                               12,975                6,310
                                                                      --------             --------

8% convertible notes (Note 4)                                                -                5,690
 
Stockholders' equity (deficit):
 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                                                   (43,763)             (40,862)
                                                                      --------             --------
Total stockholders' equity (deficit)                                    (1,190)               1,711
                                                                      --------             --------
Total liabilities and stockholders' equity                            $ 11,785             $ 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>
 
                          SHOWSCAN ENTERTAINMENT INC.
                Condensed Consolidated Statements of Operations
              (Dollars in Thousands Except Per Share Information)
 

<TABLE>
<CAPTION>
                                                       Three Months Ended            Nine Months Ended
                                                          December 31,                  December 31,
                                                       1998         1997            1998           1997
                                                     ---------------------         ----------------------
                                                          (Unaudited)                  (Unaudited)
<S>                                                  <C>           <C>             <C>            <C>

Revenues:
 Film licensing and production services              $   767       $   791         $ 2,317        $ 2,922
 Equipment sales and related services                    569         2,634           3,450          4,214
                                                     -------       -------         -------        -------
                                                       1,336         3,425           5,767          7,136
                                                                                              
Costs of revenues                                        906         3,889           3,516          6,006
                                                     -------       -------         -------        -------
Gross profit                                             430          (464)          2,251          1,130
                                                                                              
Costs and expenses:                                                                           
 General and administrative expenses                   1,425         2,339           4,009          5,505
 Depreciation and amortization                           166           190             432            579
                                                     -------       -------         -------        -------
                                                       1,591         2,529           4,441          6,084
                                                     -------       -------         -------        -------
Operating loss                                        (1,161)       (2,993)         (2,190)        (4,954)
                                                                                              
Other income (expense):                                                                       
 Equity in net operations of O&O Theatres                (15)         (104)           (149)          (468)
 Other income, including interest                          5            23              62             64
 Interest and other expenses                            (194)         (190)           (624)          (517)
                                                     -------       -------         -------        -------
                                                        (204)         (271)           (711)          (921)
                                                     -------       -------         -------        -------
                                                                                              
Net loss                                             $(1,365)      $(3,264)        $(2,901)       $(5,875)
                                                     =======       =======         =======        =======

Basic and diluted net loss per common                                                         
 share (Note 5)                                      $  (.24)      $  (.58)        $  (.51)       $ (1.04)
                                                     =======       =======         =======        =======
</TABLE>


See accompanying notes to unaudited condensed consolidated financial statements.

                                       5
<PAGE>
 
                          SHOWSCAN ENTERTAINMENT INC.
                Condensed Consolidated Statements of Cash Flows
                            (Dollars in Thousands)

<TABLE> 
<CAPTION> 
                                                                                Nine Months Ended
                                                                                   December 31,
                                                                          1998                    1997
                                                                      -----------------------------------
                                                                                   (Unaudited)
<S>                                                                   <C>                      <C>
Cash flows from operating activities:
 Net loss                                                              $(2,901)                 $(5,875)
 Adjustments to reconcile net loss                                      
  to net cash provided by (used in) operating                           
  activities:                                                           
  Depreciation and amortization                                            432                      579
  Amortization of film library                                             763                      683
  Amortization of debt issue costs                                         193                        2
  Write down/provision for film library                                      -                    1,150
  Equity in net operations of O&O theatres                                 149                      468
  Accrued interest on debt                                                 342                      358
  Provision for doubtful accounts                                           90                      590
  Changes in operating assets and liabilities:                          
   Accounts receivable and due from affiliates                             519                     (779)
   Equipment sales inventory                                              (240)                    (566)
   Unbilled receivables on uncompleted film and                         
    equipment contracts                                                   (795)                    (695)
   Prepaid expenses                                                       (328)                     778
   Investment in and advances to O&O theatres                             (203)                   1,476
   Accounts payable, accrued expenses and other                         
    current liabilities                                                   (167)                    (581)
   Customer advances on uncompleted equipment                                 
    contracts                                                            1,091                    1,206
                                                                       -------                  -------
                                                                        
 Net cash used in operating activities                                 $(1,055)                 $(1,206)
                                                                       -------                  -------
                                                                        
Cash flows from investing activities:                                   
 Purchases of equipment and leasehold                                   
  improvements                                                              (7)                     (16)
 Additions to film library                                                (105)                  (1,022)
 Other assets                                                                -                      870
                                                                       -------                  -------
                                                                        
 Net cash used in investing activities                                 $  (112)                 $  (168)
                                                                       -------                  -------
</TABLE>

                                  (Continued)

                                       6
<PAGE>
 
                          SHOWSCAN ENTERTAINMENT INC.
          Condensed Consolidated Statements of Cash Flows (Continued)
                            (Dollars in Thousands)
 

<TABLE> 
<CAPTION> 
                                                                               Nine Months Ended
                                                                                  December 31,
                                                                          1998                    1997
                                                                      -----------------------------------
                                                                                   (Unaudited)
<S>                                                                   <C>                      <C>
   Balance forwarded                                                   $(1,167)                 $(1,374)
                                                                       -------                  -------
                                                                                                
Cash flows from financing activities: 
     11% note payable                                                     (290)                   1,000
                                                                       -------                  -------
                                                                                                
   Net cash (used in) provided by financing activities                    (290)                   1,000
                                                                       -------                  -------
                                                                                                
   Net decrease in cash and cash equivalents                            (1,457)                    (374)
                                                                                                
Cash and cash equivalents, beginning of period                           2,492                    2,562
                                                                       -------                  -------

Cash and cash equivalents, end of period                               $ 1,035                  $ 2,188
                                                                       =======                  =======
                                                                                                       
Supplemental disclosures of cash flow information:                                              
   Interest paid                                                       $   338                  $   234
                                                                       =======                  =======

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


See accompanying notes to unaudited condensed consolidated financial statements.

                                       7
<PAGE>
 
                          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 nine-month period ended
December 31, 1998 are not necessarily indicative of the results that may be
expected either for the last fiscal 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 21 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.  The note is secured by accounts receivable from
the distribution of the Company's film library and the proceeds thereof.
Principal and interest amounts were payable in full on November 15, 1998.  In
November 1998, the Company and the lender reached an agreement to modify the
note so that the principal will be repaid in installments through March 31,
1999.  As of December 31, 1998, aggregate payments of $400,000 have been made,
including $110,000 of accrued interest as of November 15, 1998.  The remaining
scheduled payments per the modified agreement are as follows:  December 31,
1998: $150,000 (paid in January 1999); January 31, 1999:  $150,000 (paid in
January 1999); February 28, 1999:  $150,000; March 31, 1999:  $260,000.
Interest that accrues after the commencement of the modified agreement is 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 December 31, 1998, $1,310,000 of
such notes had been converted into 

                                       8
<PAGE>
 
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 nine-months and the three-months ended
December 31, 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 originally 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 venture between UA and the Company (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 by UA, the
purchase by the Company of certain new simulation equipment and other assets
owned by UA, the offset of certain amounts and the payment by UA 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 $3,000,000, which is
contractually payable no later than August 19, 1999.  If UA fails to achieve
this requirement and/or fails to order and install 16 additional Simulation
Attractions by August 1999, then UA will be contractually obligated to pay the
Company liquidated damages in the amount of $5,100,000, which is also payable on
August 19, 1999.  It is the Company's belief that UA will not order or install
any additional Simulation Attractions.  The Company has removed the UATC systems
from its contract backlog.

     At December 31, 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 

                                       9
<PAGE>
 
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 fully reserved for such amounts in the March 31, 1998
consolidated balance sheet. On January 26, 1999, these directors and the Company
agreed to a settlement and payment of the outstanding obligations. Each director
agreed that Showscan could retain its respective estimated proceeds (aggregating
approximately $130,000) from the sale of the San Antonio O&O Theatre (which was
closed in September 1997) and to pay the remaining amounts due. As of February
11, 1999 one director has paid the agreed upon amount of $110,000.

                                       10
<PAGE>
 
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 nine-month period ended
December 31, 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 nine-month period ended December
31, 1998.

Comparison of the nine months ended December 31, 1998 and 1997:
---------------------------------------------------------------

     Revenues for the nine-month period ended December 31, 1998 (the "Nine Month
Period") decreased by $1,369,000 or 19% to $5,767,000 from revenues for the
nine-month period ended December 31, 1997.

     Film licensing and production service revenues in the Nine Month Period
decreased by $605,000 or 21% to $2,317,000 from $2,922,000 in the nine-month
period ended December 31, 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 Nine Month
Period decreased $764,000 or 18% to $3,450,000 from $4,214,000 in the nine-month
period ended December 31, 1997.  The decrease is due to the decrease in the
number of Showscan Attractions shipped during the Nine Month Period as compared
to the corresponding prior year nine-month period.  Four Showscan Attractions
were shipped in the Nine Month Period as compared to five units shipped in the
nine-month period ended December 31, 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-

                                       11
<PAGE>
 
out of the Showscan Attractions; and (iii) the shipment, delivery and
installation of the equipment and related services.

     Costs of revenues were 61% of revenues in the Nine Month Period as compared
to 84% in the nine-month period ended December 31, 1997.  Equipment cost of
sales to total equipment sales decreased to 65% in the Nine Month Period from
81% in the nine-month period ended December 31, 1997, primarily as a result of
modifications to two equipment sales contracts which adversely impacted costs of
revenues for the nine months ended December 31, 1997.  Film licensing cost of
sales to total film licensing sales was 56% in the Nine Month Period as compared
to 88% in the nine-month period ended December 31, 1997.  The decrease in film
licensing cost of sales in the Nine Month Period from the nine-month period
ended December 31, 1997 is due to an adjustment to the carrying value of two
films to their estimated realizable value of the $1,150,000 recorded in the
nine-month period ended December 31, 1997.  The film licensing cost of sales to
total film licensing sales as adjusted for the $1,150,000 amount recorded to the
carrying value of the two films was 49%, excluding the $1,150,000 provision in
the nine-month period ended December 31, 1997.

     Amortization of the film library for the Nine Month Period and the nine-
month period ended December 31, 1997 was $763,000 and $683,000, respectively.
The increase in film amortization is due to the additional amortization of three
films in the Nine 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
nine-month period ended December 31, 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 $1,496,000 or 27% in the Nine
Month Period from the nine-month period ended December 31, 1997. The decrease
can be primarily attributed to (i) a significant reduction in the number of
employees, (ii) a reduction in legal, marketing and merger-related expenses from
the nine-month period ended December 31, 1997, and (iii) a $500,000 increase in
the allowance for doubtful accounts that was recorded in the nine-month period
ended December 31, 1997.

     The loss on investment in O&O Theatres decreased to $149,000 in the Nine
Month Period from $468,000 in the nine-month period ended December 31, 1997, as
a result of the Company's closing of five of its O&O Theatres.  The loss for the
Nine Month Period is primarily the result of the following factors: (i)
operating losses at the Universal CityWalk theatre, and (ii) operating losses at
the two (2) London/Trocadero theatres through their closing on July 2, 1998 and
related costs of such closing.  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 $2,974,000 or 51% in the Nine Month Period
to $2,901,000 from $5,875,000 in the nine-month period ended December 31, 1997
primarily due to (i) the continued decrease in general and administrative
expenses, and (ii) the decrease in the equity loss from the net operations of
O&O Theatres.

Comparison of the three months ended December 31, 1998 and 1997:
----------------------------------------------------------------

     Revenues for the three-month period ended December 31, 1998 (the "1999
Third Quarter") decreased by $2,089,000 or 61% from revenues for the three-month
period ended December 31, 1997 (the "1998 Third Quarter") due to a decrease in
revenues recognized from equipment sales and related services in the 1999 Third
Quarter.

                                       12
<PAGE>
 
     Film licensing and production service revenues in the 1999 Third Quarter
decreased by $24,000 or 3% to $767,000 from $791,000 in the 1998 Third Quarter.

     Revenues from equipment sales and related services for the 1999 Third
Quarter decreased 78% to $569,000 from $2,634,000 in the 1998 Third Quarter.
The decrease is due to the reduction in number of Showscan Attractions shipped
from three in the 1998 Third Quarter (two of which were relocations) as compared
to one in the 1999 Third Quarter.

     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 39% of revenues in the 1999 Third Quarter as
compared to 114% in the 1998 Third Quarter.  Equipment cost of sales to total
equipment sales decreased to 64% in the 1999 Third Quarter from 87% in the 1998
Third Quarter primarily as a result of a higher gross profit margin on the
shipment during the 1999 Third Quarter as compared to lower average gross profit
margins for the three shipments in the 1998 Third Quarter.  The higher gross
profit margin earned on the shipments during the 1999 Third Quarter is related
to custom equipment specifications and services.  Film licensing cost of sales
to total film licensing sales was 56% in the 1999 Third Quarter as compared to
202% in the 1998 Third Quarter.  Amortization of the film library for the 1999
Third Quarter and the 1998 Third Quarter was $253,900 and $1,410,300,
respectively.  The decrease is due to a provision of $1,150,000 during the 1998
Third Quarter to adjust the carrying value of three films to their estimated
realizable value.  No provisions of this nature were necessary in the 1999 Third
Quarter.  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 $914,000 or 39% in the 1999
Third Quarter from the 1998 Third Quarter. The decrease can be primarily
attributed to (i) a significant reduction in the number of employees, and (ii) a
reduction in legal, consulting and marketing expenses from the 1998 Third
Quarter.

     The loss on investment in O&O Theatres decreased to $15,000 in the 1999
Third Quarter from $104,000 in the 1998 Third Quarter, as a result of the
Company's closing of five of its O&O Theatres.  The loss for the 1999 Third
Quarter is primarily the result of the operating loss at the Universal CityWalk
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 58% in the 1999 Third Quarter to
$1,365,000 from $3,264,000 in the 1998 Third Quarter primarily due to (i) the
decrease in equipment cost of sales, (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.

                                       13
<PAGE>
 
Liquidity and Capital Resources:
------------------------------- 

     At December 31, 1998, the Company's operating working capital decreased to
a deficit of $6,143,000 from $1,224,000 at March 31, 1998. The decrease in
operating working capital was primarily due to the reclassification of the
$5,690,000 outstanding balance of the 8% Convertible Notes to a current
liability and to the operating loss of the Company in the Nine Month Period.
The Company's 8% Convertible Notes mature on September 1, 1999 and, accordingly,
the related obligation of $5,690,000 has been reclassified as a current
liability in the December 31, 1998 balance sheet.  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.

     Cash and cash equivalents at December 31, 1998 decreased by $1,457,000 to
$1,035,000 from the cash level at March 31, 1998.  This reduction was the result
of $1,055,000 used in operating activities, $112,000 used in investing
activities, and $290,000 used in financing activities.

     Net cash used in operating activities was primarily due to (i) the net loss
of $2,901,000 in the Nine Month Period, (ii) a 65% increase in prepaid expenses,
unbilled receivables on uncompleted contracts and equipment sales inventory, and
(iii) a 53% 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.

     Net cash used in investing activities was primarily due to the amortization
of the film library.

     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 new Showscan Attractions and certain other projects.

     The Company's business strategy includes an increase in the installed base
of Showscan Attractions, creation of the largest thrill-ride film library in the
simulation industry (through new film productions and 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 existing capital resources, the proceeds to be received from its existing
contractual/installation backlog, existing film licensing agreements and
anticipated future equipment sales/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.

                                       14
<PAGE>
 
     During the past fiscal year and the Nine 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 currently from 61 at March 31, 1997, and
the closure of five of the seven previously 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.  The Company 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 which began November 15,
1998 and continue through March 31, 1999.  As of December 31, 1998, the Company
has made aggregate payments of $400,000, including $110,000 of accrued interest
as of November 15, 1998.  The Company is also in continuing discussions with its
European bank regarding additional financing in excess of the $5,690,000
currently outstanding balance of the 8% Convertible Notes 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 and the bank
has conducted certain due diligence procedures, 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.  The failure to fully repay either of these debts could result in
the foreclosure against the collateral securing each, which together constitute
substantially all of the assets of the Company.

     The Company believes that its existing funds, combined with generated cash
from future operations, the sale of non-performing assets, the re-negotiation of
existing indebtedness repayment schedules and other financing transactions, will
finance its revised levels of activities and operations, although the Company
anticipates that it will require additional financing or be required to further
restructure its business and operations.  Additionally, 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 (i) through the "sourcing" of projection and other
theatre equipment, or (ii) through the liquidated damages provisions of the
Theater Rights Agreement with UA (such contractual obligations are to range
between $3,000,000 and $5,100,000), 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 $50,000.

                                       15
<PAGE>
 
     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 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 currently contacting each site to determine
which components (hardware and/or software) require upgrade or replacement.  The
upgrades are scheduled for completion by June 30, 1999.

     The Year 2000 Committee has identified and contacted all key vendors to
insure their compliance with Year 2000 transition requirements.  The Committee
is reviewing responses received for compliance.  Vendors were asked to confirm
that they have addressed internal issues related to their continued operations
as well as compliance of their products or their ability to provide ongoing
services to Showscan.

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 

                                       16
<PAGE>
 
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 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 further and maybe significantly
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, 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 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 restructuring its business and operations, the Company has
debt obligations from two different financial institutions.  In November 1998
the Company reached an agreement with one of its lenders to revise the payment
schedule on the $1,000,000 obligation from being due on November 15, 1998 to
monthly payments beginning November 15, 1998 and continuing through March 31,
1999.  Through December 31, 1998, payments in the aggregate of $400,000 have
been paid, including $110,000 of accrued interest as of November 15, 1998.  The
Company is in continuing discussions with its European Bank with regard to re-
negotiation of its debt repayment schedule regarding potential 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 fully 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.

                                       17
<PAGE>
 
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 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 

                                       18
<PAGE>
 
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.

     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.  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 

                                       19
<PAGE>
 
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 December 31, 1998, the Company's closing
market price has ranged from a low of $0.0469 per share to a high of $1.875 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 twenty-one 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 some 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 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.

                                       20
<PAGE>
 
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.

                                       21
<PAGE>
 
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
  --------------                         -----------
  <C>                    <S> 
     10.38               First Amendment to Credit Agreement, dated as of
                         November 10, 1998, by and between Showscan
                         Entertainment Inc. and Eldee Foundation.

     27.1                Financial Data Schedule
</TABLE> 

(b)  Reports on Form 8-K
     -------------------

       None

                                       22
<PAGE>
 
                                 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 February, 1999.


                              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)

                                       23
<PAGE>
 
                                 EXHIBIT INDEX



<TABLE>
<CAPTION>
          Exhibit No.                     Description                         Page Number
          -----------                     -----------                         -----------
          <C>                     <S>                                   <C>
 
              10.38               First Amendment to Credit                        25
                                  Agreement, dated as of November
                                  10, 1998, by and between Showscan
                                  Entertainment Inc. and Eldee
                                  Foundation
 
              27.1                Financial Data Schedule                          35
</TABLE>

                                       24