================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

                     For the fiscal year ended June 30, 1999
OR
[  ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
         SECURITIES EXCHANGE ACT OF 1934

                         Commission file number 0-22558

                           IWERKS ENTERTAINMENT, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
             Delaware                                    95-4439361
   (STATE OR OTHER JURISDICTION             (I.R.S. EMPLOYER IDENTIFICATION NO.)
 OF INCORPORATION OR ORGANIZATION)
                            4540 West Valerio Street
                         Burbank, California 91505-1046
              (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
                                 (818) 841-7766
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES
           REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
                                      None
           SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                     Common stock, $.001 par value per share
                         Preferred Stock Purchase Rights
                                (Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes  X   No
    ---     ---

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

At September 20, 1999, there were outstanding, 12,069,981 shares of the Common
Stock of Registrant, and the aggregate market value of the shares held on that
date by non-affiliates of Registrant, based on the closing price ($1.188 per
share) of the Registrant's Common Stock on the NASDAQ National Market System was
$12,642,485. For purposes of this computation, it has been assumed that the
shares beneficially held by directors and executive officers of Registrant were
"held by affiliates;" this assumption is not to be deemed to be an admission by
such persons that they are affiliates of Registrant.

                       DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement relating to its 1999 Annual Meeting of
Stockholders are incorporated by reference in Part III of this Annual Report.

<PAGE>

                           IWERKS ENTERTAINMENT, INC.

                    FISCAL YEAR 1999 FORM 10-K ANNUAL REPORT

                                TABLE OF CONTENTS

                                                                           PAGE
                                                                           ____
PART I.

  Item 1.    Business..................................................        3

  Item 2.    Properties................................................       11

  Item 3.    Legal Proceedings.........................................       11

  Item 4.    Submission of Matter to a Vote of Security Holders........       11

PART II.

  Item 5.    Market for Registrant's Common Equity and Related
             Stockholder Matters.......................................       12

  Item 6.    Selected Financial Date...................................       13

  Item 7.    Management's Discussion and Analysis of Financial
             Condition and Results of Operations.......................       14

  Item 8.    Financial Statements and Supplementary Data...............       29

  Item 9.    Changes and Disagreements With Accountants On Accounting
             and Financial Disclosure..................................       46

PART III.

  Item 10.   Directors and Executive Officers of Registrant............       47

  Item 11.   Executive Compensation....................................       47

  Item 12.   Security Ownership of Certain Beneficial Owners and
             Management................................................       47

  Item 13.   Certain Relationships and Related Transactions............       47

  Item 14.   Exhibits, Financial Statement Schedules, and Reports On
             Form 8-K..................................................       47


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SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
         This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Exchange Act and Section
27A of the Securities Act. The words "expect," "estimate," "anticipate,"
"predict," "believe" and similar expressions and variations thereof are intended
to identify forward-looking statements. Such statements appear in a number of
places in this filing and include statements regarding the intent, belief or
current expectations of Iwerks, its directors or officers with respect to, among
other things (a) trends affecting the financial condition or results of
operations of Iwerks and (b) the business and growth strategies of Iwerks. The
stockholders of Iwerks are cautioned not to put undue reliance on such forward
looking statements. Such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties, and actual results may differ
materially from those projected in this Report, for the reasons, among others,
discussed in the Sections - "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and "Risk Factors". Iwerks undertakes no
obligation to publicly revise these forward looking statements to reflect events
or circumstances that arise after the date hereof. Readers should carefully
review the risk factors described in other documents the Company files from time
to time with the Securities and Exchange Commission, including the Quarterly
Reports on Form 10-Q to be filed by the Company in calendar years 1999 and 2000
and any Current Reports on Form 8-K filed by the Company.

                                     PART 1

                               BUSINESS OF IWERKS

ITEM 1.  BUSINESS.
-----------------

GENERAL

      Iwerks Entertainment, Inc. and its subsidiaries ("Iwerks" or "the
Company") designs, engineers, manufactures, markets and services high-tech
entertainment attractions which employ a variety of projection, show control,
ride simulation and software technologies. The Company: (a) sells and installs
ride simulation attractions in specialty theatres, (b) sells and installs Large
Format theatres (generally such theatres require projection technology which
utilize film sizes ranging between five perforations per frame by 70 millimeters
(5/70) and fifteen perforations per frame by 70 millimeter (15/70)), (c) sells
and installs specialty theatres which include special "4D" effects, (d) licenses
and distributes the films in its library to ride simulation and large format
theatres, (e) produces films in the 5/70, 8/70 and 15/70 film format for its
film library and for third parties, (f) invests in joint ventures by
contributing its ride simulation technology, design and equipment and
participating in the theatre profits, (g) operates a fleet of 16 mobile ride
simulation attractions and (h) leases camera equipment and renting of post
production facilities.

      Further, an important element of the Company's business strategy is the
participation in the operation of its fixed-base attractions either through
direct equity ownership or through other participation arrangements. The Company
is currently a participant in several joint ventures to own and operate multiple
ride simulation theatres in the United States and Australia. The Company
continues to evaluate new opportunities to participate in the operation of its
fixed-base attractions.

      The primary markets for the Company's attractions are theme parks,
museums, movie theatres, various types of location-based entertainment centers,
destination centers and special events. The popularity of entertainment
attractions of the type sold by the Company has led to their increasing use as
the featured attraction in these locations. The sale of Large Format theatres
into existing commercial exhibitor theatre sites is a new market the Company has
targeted. In addition, high-profile retail sites and casinos are expanding their
entertainment offerings to broaden appeal, extend the visitors stay, and
stimulate repeat visits.

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      The Company's attractions are well suited to meet this demand because, in
addition to their drawing power, they require relatively little space and can be
easily refreshed by changing the film or other software.

      The Company has installed more than 250 fixed-base theatres and touring
attractions in 28 countries. Of these, 119 were ride simulation theatres, which
the Company supports with a library of 48 ride simulation films, the industry's
largest premium ride simulation film library. The Company's ride simulation
films include: JOURNEY THROUGH THE CENTER OF THE EARTH, a 3D ride to the center
of the earth and back; KID KOSTER a roller coaster ride through a child's room,
ESCAPE FROM DINO ISLAND, a 3D sequel to its highly successful DINO ISLAND;
SUPERSTITION, a haunted scream park adventure hosted by Elvira, Mistress of the
Dark; SECRETS OF THE LOST TEMPLE, an explorer's adventure through a Mayan
temple; RED ROCK RUN, a computer generated high speed ride through a volcano;
ALIENS TM: RIDE AT THE SPEED OF FRIGHT, based on the futuristic movie
thriller of the same name and DINO ISLAND, a fantasy based on a newly discovered
volcanic island with prehistoric reptiles. Fiscal 2000 releases will include,
METEOR ATTACK, a futuristic science fiction adventure; WINGS, a film showing the
history of flight, along with new 3D films including: AQUA RIDE, a surreal
underwater voyage; and MAGIC CARPET RIDE, an adventure to save a princess set in
a mythical city, along with other film projects under development. The Company's
newest film project represents a partnership with Infogames, a computer game
designer and publisher for a ride simulator film based on their popular
Independence Wars franchise game. The Company has the largest installed base of
film ride simulation theatres and the largest library of ride simulation films
in the world.

      The Company is a Delaware corporation with principal executive offices
located at 4540 West Valerio Street, Burbank, California 91505, telephone number
(818) 841-7766. In addition to its principal executive offices, Iwerks has sales
offices in Sarasota, Florida and London, England. A sales representative
maintains offices in Hong Kong and Shanghai.

BUSINESS STRATEGY

      The Company's goal is to capitalize on its position as a leader in the
ride simulation attraction business to become the leading full-service provider;
offering a full range of support services and film-based software in the ride
simulation, Large Format and specialty venue 4D attractions.

      The Company's current strategies to achieve its objectives include the
following:

      FULL SERVICE PROVIDER OF COMPLETE ENTERTAINMENT BUSINESS SOLUTIONS. The
Company intends to expand its market penetration by offering its customers a
complete line of services and products to support the design, development and
operation of specialty format theater attractions. The Company has installed
over 250 specialty format theater attractions and currently licenses film
software to over 95 installed simulation theaters. The Company believes that
this track record of successes positions itself as a leader in terms of industry
experience and operating expertise in the specialty format theater market. By
focusing its services and products on solutions designed to assist its customers
in building their businesses, the Company believes that it will continue to
expand its own business opportunities in the future.

      EXTEND THE COMPANY'S PRODUCT LINE THROUGH INNOVATIVE USE OF ITS CURRENT
TECHNOLOGIES. Management believes that the Company has the opportunity of
increasing its product offerings without incurring significant additional
research and development costs. An example of this is the introduction of a
turn-key specialty theatre which utilizes "4D" effects, the first which will
open in Shenzhen, China in February 2000. These effects include a water mist,
wind and a seat drop among other visceral effects. Management believes there are
opportunities to leverage the Company's existing technology to provide new,
innovative products designed to meet current market requirements and
opportunities, including adding 4D effects to its ride simulation systems.

      EXPAND INTO NEW MARKETS. The Company is exploring potential new markets
for its attractions, products and services. The Company continues its expansion
efforts in Europe and South America. In addition, the Company is pursuing market
opportunities for its Giant Screen theaters in commercial locations, such as
movie theater multiplexes,

                                        4

<PAGE>

where it has made its first sales in fiscal year 1999, and its ride simulation
theaters in untapped commercial settings including casinos and retail
businesses.

      IDENTIFY NEW STRATEGIC PARTNERS. Management believes that the Company can
optimize its market position and performance through the formation of strategic
alliances with companies who have complementary technologies, manufacturing or
distribution. For example, an alliance with Media Technology Source, the world's
largest cinema equipment dealer, provides benefits especially in the Giant
Screen market.

      BRANDED PRODUCTS. The Company has launched two new product brands in an
effort to establish a recognizable and significant global market presence. The
Extreme Screen tm brand will be utilized to identify the Company's Giant Screen
theatre installations. The Exploration in Motion tm brand will be utilized to
identify a ride simulator program targeting institutional venues around the
world.

IWERKS PRODUCTS

         FIXED-BASE RIDE SIMULATION THEATRES. The Company's line of fixed-base
ride simulators are marketed under the brands IWERKS TURBORIDE tm and
EXPLORATION IN MOTION tm, and combine high-resolution projector film or video
software, digital surround sound and moving seats to fully involve the audience
in a realistic, simulated experience. The Company is also beginning to
incorporate digital projection technology into some of its installations.
Software currently available includes a variety of live action and fantasy
experiences such as taking a ride through the center of the earth, being chased
by dinosaurs, flying at supersonic speeds, racing with Indy cars, riding a
roller coaster, white-water rafting and space and underwater adventures. The
Company's ride simulation theatre product line is the broadest in the industry,
enabling the Company to offer its customers seat, and platform-based simulators
in a variety of configurations and at multiple price points. The Company derived
approximately 41%, 21% and 21% of its revenues from the sale of fixed-base ride
simulation theatres in fiscal 1997, 1998 and 1999, respectively. The Company's
ride simulators are designed to operate in theatres which typically seat 18 to
100 people, and feature screens up to 52 feet high, with six-channel digital
surround sound. In these rides, guests watch a high resolution film with a fast
action point-of-view perspective while sitting in seats that move in
synchronization with the action on the screen. Films for the Company's ride
simulation theatres typically range between three and five minutes. Ride
simulation theatres can be reprogramed to create new adventures.

         GIANT SCREEN THEATRES. The Company's Giant Screen theatres are marketed
under the name IWERKS EXTREME SCREEN TM, and feature screens which are much
larger than standard movie screens and projection systems that deliver a
sharper, brighter image than conventional movies. The result is a high-impact,
immersive, sensory experience for the audience. These theatres can seat up to
600 people, have steeply raked seating and exhibit films typically lasting
between 15 and 40 minutes. The Company offers both 15/70 (15 perforations, 70
millimeter film) and 8/70 (8 perforations, 70 millimeter film) format systems
including its exclusive patented Linear Loop projectors.

         The Company's Giant Screen theatres are available in a variety of
configurations. Its flat screen theatres use screens as large as 81 feet high by
110 feet wide, more than five times the size of most movie theatre screens. The
Company's domed screen theatres use a dome-shaped screen up to 85 feet in
diameter which wraps around and above the audience filling the audience's field
of vision. The Company also offers 3D systems which use dual projectors to
create a 3D image. The Company derived approximately 12%, 8% and 21% of its
revenues from the sale of Giant Screen theatre systems in fiscal 1997, 1998 and
1999, respectively.

         CUSTOM AND OTHER THEATRES. The Company offers a wide range of custom
film and video-based theatre systems utilizing 70 millimeter and 35 millimeter
film formats. Among its offerings is the Iwerks 4D Specialty Theatre, a theatre
which includes in-theatre physical effects of fog, rain, wind, speed and more.

                                        5

<PAGE>

         The Company's custom projects range from the sale of individual
projectors to complete theatre systems. The Company derived approximately 5%,
11% and 10% of its revenues from the sale of custom and other theatres in fiscal
1997, 1998 and 1999, respectively.

         PORTABLE RIDE SIMULATION THEATRES. The Company also operates a portable
ride simulation theatre called the "REACTOR", which is transported by tractor
trailers. The trailers transform to create a ride simulation theatre with a high
definition video projection system and digital surround sound. The simulation
theatres have on-board generators which enable them to operate independent of
other power sources. The REACTOR incorporates the same ride simulation
technology as the Company's TurboRide and can accommodate up to 18 people per
show. The REACTORS can be used to exhibit the Company's ride simulation films
developed for its fixed-base ride simulation theatres as well as films developed
specifically for use in the REACTOR at air shows, boat and car races, state
fairs and other special events. The Company also seeks corporate sponsors for
its touring REACTOR units. The Company derived approximately 17%, 22%, and 10%
of its revenues in fiscal 1997, 1998 and 1999, respectively, from the operation
and sponsorship of portable ride simulation theatres. The Company continues to
seek additional sponsors as well as looking at other alternatives for these
operations.

         FILM SOFTWARE. The Company produces film and video software for the
Company's attractions with a production strategy that is similar to that of a
movie studio, where a small core of executives hire supplemental production
talent and specialists on a project-by-project basis. This structure allows the
Company to maintain creative control of projects without incurring substantial,
continuing overhead expenses. In addition, the Company has acquired distribution
rights for ride simulation films purchased or owned by others. The Company also
provides executive producer and post production services to third parties
filming in the Company's film or video projection formats.

         The Company has a film library which includes, as of September 17,
1999, the distribution rights to 48 simulation films of which 7 are available in
3D, 6 Giant Screen films of which 2 are available in 3D and 5 3D attraction
films. The Company's library of ride simulation films is the largest in the
industry. In addition to the Iwerks' film library, owners of Iwerks' Giant
Screen theatres have access to a library of over 100 films. The Company believes
that the quality and size of its film library is a significant competitive
advantage in the markets in which it competes, particularly in the ride
simulation market. Growth in the installed base of theatres provides the Company
an opportunity to increase film licensing revenue. The Company derived
approximately 14%, 22 % and 23% of its revenue in fiscal 1997, 1998 and 1999,
respectively, from film license agreements.

         The Company's film distribution efforts are focused in three primary
market sectors: Simulation films, 3D/4D Attraction films and Giant Screen films.
The Company's recent ride simulation films include JOURNEY THROUGH THE CENTER OF
THE EARTH, a 3D ride to the center of the earth; ESCAPE FROM DINO ISLAND, a 3D
sequel to its highly successful film DINO Island; SUPERSTITION, a haunted scream
park adventure hosted by Elvira - Mistress of the Dark; MAD RACERS, Iwerks'
first ride simulation 3D film; SECRETS OF THE LOST TEMPLE, based on an
explorer's adventure through a Mayan temple; ALIENS TM RIDE AT THE SPEED OF
FRIGHT, based on the futuristic movie thriller of the same name; DINO ISLAND, a
fantasy ride through a dinosaur-inhabited island; MOON RAID ALPHA, a space chase
adventure fantasy; a film for Time Warner Six Flags theme parks called THE RIGHT
STUFF; a film for the IWERKS REACTOR called FLY WITH THE BLUE ANGELS featuring
the Blue Angels flight team; a film for Paramount theme parks based on the
motion picture DAYS OF THUNDER and a film based on the motion picture ROBOCOP.
Fiscal 2000 releases will include "WINGS," "MAGIC CARPET RIDE IN 3D," "AQUA RIDE
3D" and "INDEPENDENCE WARS 3D". The Company continues to look at additional
projects which may increase the number of films released in fiscal 2000. Many of
the Company's ride simulation and other productions have received industry
recognition. In November 1998 DINO ISLAND II won 1st place at the prestigious
London Effects and Animation Festival. Other awards for the Company were the
prestigious Marketing Award for Best Brand Pricing at the 1998 International
Association of Amusement Parks and Attractions (IAAPA) convention. Additionally,
the Company won the prestigious Image Award for Best Overall Presentation at the
November 1997 International Association of Amusement Parks and Attractions
(IAAPA) convention in Orlando, this was the second time the Company won this
award; the dramatic Iwerks TurboRide 3D! took first honors for best New
Entertainment


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Technology at the November 1996 IAAPA convention in New Orleans. SECRETS OF THE
LOST TEMPLE, premiered at IAAPA 1996, also received an award in the Best New
Product category. The Company recently made an agreement with Camber
Entertainment to provide Camber with the license to market approximately 30 of
the Company's simulation films. This agreement was designed to extend the value
of the Company's film assets that have already been shown in the Iwerks network
theaters. The Company intends to continue to seek other opportunities for
deriving additional revenue from its library of simulation films in fiscal year
2000.

      The Company also produces and distributes Large Format and specialty films
to theme parks. In fiscal 1999, the Company released "ENCOUNTER IN THE THIRD
DIMENSION" a Large Format 3D film based on the history and technology of 3D
effects. This film is available in 15/70 and 8/70 formats to the existing market
of approximately 40 Giant Screen 3D theaters. A shortened version of this film
will also be available for specialty theater exhibition.

MULTI-FORMAT FILM PRODUCTION STRATEGY

      Given the Company's presence in three unique market places, Iwerks has the
ability to select film properties that can be exploited across the three
separate film markets. In the case of the Company's investment in the Giant
Screen film "ENCOUNTER IN THE THIRD DIMENSION", Iwerks was able to derive three
different film products from the singular investment. This strategy greatly
reduces the risk of the film investment and facilitates entry into new markets
to increase revenue potential at a greatly reduced cost. This strategy was
duplicated with the release of "ALIEN ADVENTURE IN 3D" which also derived four
3D simulation films including "MAGIC CARPET RIDE IN 3D," "KID COASTER 3D," "AQUA
RIDE 3D" and "GLACIER RUN 3D" as well as a 12 minute 3D/4D specialty film.

FILM PRODUCTION

      The Company's internal executive production capability develops and
 oversees production of films for the Company's film productions as well as for
 third party custom film projects. In fiscal 1999 the production group
developed the "Wings" project in association with Discovery Channel Pictures, as
well as secured custom film contracts with Sony and Volkswagen which will be
completed in fiscal 2000.

         Typically, a film produced for exhibition on a theatre system is sold
or licensed to a customer as part of the sale of the theatre system. When sold,
the customer pays all or most of the production cost; the Company attempts to
retain limited distribution rights beyond an exclusive exhibition territory
retained by the customer. When licensed, the Company typically licenses the film
for a one-year period for a flat fee which varies based upon the film. In
limited cases, the Company will accept its fees as a percentage of the ticket
sales, usually against a guarantee minimum fee Film license fees vary according
to the quality of the film, the initial price paid for the theatre systems and
other factors.

CAMERAS AND OTHER PRODUCTION SERVICES

      The Company contracts with third parties to produce specialty films as
well as leasing its four 8/70 Large Format cameras and related equipment,
including lenses and accessories, generally from several days to several months.
The Company derived approximately 1%, 2% and 7% of its revenue in fiscal 1997,
1998 and 1999, respectively, from this revenue source.

      In fiscal 1998, the Company contracted with a third party to develop and
manufacture three 15/70 Large Format cameras, and a 3D rig for both 15/70 and
8/70 cameras. The 3D rig has been completed and the 15/70 cameras are expected
to be completed in fiscal 2000. The Company intends to rent these cameras to
third party film producers. The Company also provides technical and
post-production services to third party producers for a fee and maintains a
15/70 projection room at its Burbank facilities for rent to Giant Screen film
makers for use in the post-production process.

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MARKETING AND CUSTOMERS

         The Company distributes its theatre systems, software and services
through multiple distribution channels including a direct sales and marketing
force as well as independent sales representatives in selected areas. The sales
and marketing staff consists of 13 employees. A sales representative maintains
foreign sales offices in Hong Kong and Shanghai which provide support to the
Company's Asian marketing programs and assist in customer service. A sales
office was established in London, England in May 1997 to create a stronger sales
effort in the European market. In addition, the Company has sales professionals
located in Burbank, California and Sarasota, Florida.

         The Itochu Corporation has a non-exclusive distribution agreement to
sell the Company's product in Asia which expires in December 1999.

         The Company markets its attractions, including theatre systems and film
software, mainly to theme parks, museums, movie theaters, destination centers,
casinos, location-based entertainment centers and special event venues. The
Company's theatre systems include projection and audio equipment, show control
systems and film handling equipment. The Company also provides ride simulation
systems; these include motion bases, film projection and audio equipment, show
control and other effects as well as 4D specialty systems which include other
sensory effects. The customer supplies its own theatre space and other necessary
site improvements to operate the theatre. The Company provides installation,
training, design, marketing, maintenance and other support services.

         A primary market for the Company's 2D, 3D and 4D theatres has been the
worldwide amusement and theme park industry. Continuing sales will come from
existing parks looking for new attractions, parks under development looking for
an array of attractions and the expanding location-based entertainment industry.
Substantial new park development is occurring outside of the United States and
management believes that international operators will continue as important
customers for this product. The Company has also developed customers in the
family entertainment center, movie theater, institutional and casino markets as
well as tourist, vacation, destination shopping and convention locations for its
ride simulation theatres. The Company sells its ride simulation theatres at
prices which are separately negotiated, depending upon the product, the number
of motion bases, the configuration of the theatre space, optional components
selected and the level of design service provided. The Company licenses its ride
simulation films for a range of prices depending on the film and the license
term.

         The Company tours its REACTOR units at a variety of special events,
primarily air shows, boat and car races, state fairs, trade shows and other
outdoor events. Revenue is generated through admission tickets of between $3 and
$6 per person or through lease of the system to corporate sponsors who may use
the system for promotional campaigns in connection with new product
introductions and other promotional purposes.

         The primary markets for the Company's Giant Screen 2D and 3D theatres
have been museums, visitor destination centers, and other institutional
exhibition facilities frequented by large numbers of visitors. Increasingly,
commercial movie theatre operators are also viewing Giant Screen theatres as a
new entertainment option for their guests. The Company sells its Giant Screen
theatres at prices which are separately negotiated.

         No single customer accounted for more than 10% of revenues in fiscal
1997, 1998 and 1999.

         The Company's sales typically are made pursuant to written contracts,
and are denominated in United States dollars. International hardware sales are
generally backed by letters of credit. Consequently, the Company's operations
have not historically been subject to risks related to currency fluctuations.
During fiscal 1997, 1998 and 1999, 55%, 46% and 56% of the Company's revenues,
respectively, were derived from sales outside the United States. The Company's
sales contracts typically provide for progress payments which are timed to match
related expenditures by the Company. The customer generally has the right to
terminate the contract before completion by

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<PAGE>
 paying Iwerks its non-recoverable costs plus a termination fee. The Company
offers a warranty on sales of its products, generally for a period of 12 months.
The Company believes that its material contract terms are consistent with
industry practices.


ENABLING TECHNOLOGIES

         With limited exceptions, the underlying technologies employed by the
Company are in the public domain and generally available in the marketplace.
However, the Company possesses substantial expertise in the design, modification
and engineering of projection, film-handling, and camera and audio technologies
which it believes to be an important competitive factor.

         IMAGING SYSTEMS.  The Company offers a variety of technologically
advanced imaging systems.

         The Company's 8/70 is an eight perforation, 70-millimeter film system
that operates at 30 frames per second. By comparison, most motion picture
theatres use four perforation, 35-millimeter film that runs at 24 frames per
second and standard 70-millimeter film is five perforation which also runs at 24
frames per second. The larger frame size and faster speed gives the Company's
8/70 a brighter and sharper image without the flicker and stroboscopic effects
common with conventional 35- and 70-millimeter film systems. The Company's 8/70
is used in the Company's array of ride simulation systems and Giant Screen
theatres common to museums, movie theatres and other venues where screen sizes
smaller than 60' high and 80' wide or dome screens of 75' or less in diameter
are suitable.

         The Company's 15/70 is a fifteen perforation, 70-millimeter rolling
loop projection system which handles the largest commercially available film
size. This system projects an image area more than nine times that of
conventional 35-millimeter film and 300% larger than standard 70-millimeter
film. The Company's 15/70 is capable of achieving screen sizes up to 81' high
and 110' wide and dome screens up to 85' in diameter that are generally found in
high capacity theatres at world expositions and larger museums and visitor
centers. Iwerks, 8/70 and 15/70 are used in the Iwerks Dome and Giant Screen
Theatres.

         In fiscal 1997, the Company acquired Pioneer Technology Corporation and
the proprietary patented Linear-Loop Projection ("LLP") Technology to offer the
expanding Giant Screen market a genuine alternative to existing projection
techniques. The LLP gently pushes film through the projector on a column of air
unlike most projection systems that use levers to pull film through. The LLP is
designed to produce an image that is brighter and more stable than other
projectors available.

         The Company offers high resolution digital video imaging systems that
utilize a laser disc source and produce a high quality video image. This imaging
system is ideal for Iwerks' REACTORS and small ride simulation theatre systems.

         MOTION BASES. The Company's ride simulation theatres utilize seat-based
ride simulation technologies with per-base capacities of two and eight persons.
The TURBO TOUR is a two seat hydraulic base which is a compact and highly
responsive three-axis system, allowing a multitude of combinations of pitch
(tilt from front to rear), vertical (move up and down) and roll (tilt from side
to side) movements, which keep passengers in constant motion with the image. The
Company introduced a new eight seat electro-mechanical base which has six-axis
of motion capable of producing the most realistic ride simulation available.
This six-axis systems permit pitch, roll, vertical, sway, yaw (a turning
motion), and surge (forward and back), all the motions available within a given
motion envelope. Each motion base is a self-contained system, requiring only
electronic communications and electrical power connections.

         FILM STORAGE. The Company's film-based systems are offered with
specially designed film loop cabinets. These cabinets allow the film to be
spliced into an endless loop, more fully automating the projection system and
providing the fastest possible recycle time for maximum theatre throughput. The
loop cabinet also includes other important features: the film is housed in a
dust-free humidity-controlled environment; the film is cleaned twice on each
trip through the system so that dust picked up during projection doesn't
accumulate; and the film picture area never rubs on itself or any other surface,
eliminating degradation common on reel to reel and platter systems.

                                        9

<PAGE>

MANUFACTURING

         The Company manufactures and assembles its theatre systems at its
facilities in Burbank, California. A majority of the components for these
theatre systems are purchased from outside vendors. The Company's manufacturing
operations consist of assembly, testing, quality control and system integration
of its theatre system components, subassemblies and final assemblies, including
modifications and the programming of the show-control and motion-control
components, and installation of the completed theatre systems.

         The Company is the exclusive distributor of 15/70-format Giant Screen
projection systems manufactured by Cinema Technologies, Inc.. This distribution
agreement expires in September, 2003. In order to maintain its exclusive rights
under the agreement, Iwerks is required to meet certain minimum purchase and
other requirements.

         The Company's manufacturing operations utilize a wide variety of
electrical and mechanical components, raw materials and other supplies and
services. The Company has developed multiple commercial sources for most
components and materials, but it does use single sources for a limited number of
standard and custom components. While delays in delivery of such single source
components could cause delay in shipments of certain products by Iwerks, at this
time, the Company has no reason to believe that any of the single-source vendors
present a serious risk. Consistent with industry practice, the Company generally
purchases components of its theatre systems upon receipt of an order. Certain
components used by Iwerks, including lenses, hydraulic power sources and motion
bases must be ordered up to four months in advance to assure timely delivery.
The Company maintains an inventory of these items as it deems appropriate to
service forecasted demand. Research and development costs are incurred in the
design, construction and testing of prototype systems and are charged to expense
as incurred. The research and development expenses were $726,000, $766,000 and
$565,000 for the years ended June 30, 1997, 1998 and 1999, respectively. Of the
expenses, 23%, 66% and 91% in 1997, 1998 and 1999, respectively, were for
improvements to existing products and the remainder was for development of new
products.

         In fiscal 1997, the Company acquired the technology and patents to
produce the Linear Loop Projector ("LLP") which is a new technology in film
handling and projection. The Company utilizes LLP not only in its Giant Screen
Theatres, but also as its projector of choice in larger ride simulation
installations. Since the acquisition of this technology in 1997, the Company has
continued to make modifications and enhancements to the LLP and has not begun to
produce the projectors in large quantity. The LLP is not an upgrade or rework of
existing vendored products. The technology is unique, patented and has a
distinctive advantage compared to "geneva" driven models that preceded it.

         The Company acquires certain other projectors from third party
suppliers and makes modifications to the projectors to fit the Company's use.
Lenses and lamphouses incorporated in the projection systems are supplied to the
Company by third parties.

         The Company and Vickers Incorporated, a manufacturer of hydraulic
components, jointly developed the hydraulically actuated seats which are used in
the TURBO TOUR ride simulation theatre. Under the agreement pursuant to which
the hydraulically actuated seats were developed, the Company owns all rights in
and to the seats. Vickers continues as the sole manufacturer of these motion
bases on behalf of the Company; however, the Company has the right under its
agreement with Vickers to secure alternate sources of manufacturing at any time.
The Company also purchases other products from Vickers.

         The Company has also developed an electro-mechanical 8-seat base in
conjunction with a company named MOOG, Inc. to be used independently or in
groupings. This developed base actuates 6 degrees of movement and uses standard
110 volt electrical power as its source. In the development of the 8-seat
simulator, a manufacturer was secured to execute the fiberglass seat as a
finished product requiring no additional assembly or finishing by the Company.
The finished product will be dropped shipped directly to the installation site
for installation. The first 8-seat base was installed on June 18, 1999 at Dave
and Buster's restaurant in St. Louis, Missouri.

                                       10

<PAGE>


PATENTS AND TRADEMARKS

         With the exception of certain features of Iwerks' motion base and
motion control system used in its motion simulation theaters and certain
features of its linear loop projector, for which Iwerks owns United States
patents, Iwerks does not have United States or foreign patent protection on its
existing technology underlying its products. Iwerks does intend to seek patent
protection for any patentable technology developed in the future. Iwerks has
registered certain marks under United States and international trademark laws.
Iwerks intends to take all steps necessary to cause these trademarks to have a
perpetual existence, although Iwerks does not believe that its business is
dependent on any of these marks.

EMPLOYEES

         At September 17, 1999, the Company employed 115 persons, of whom 26
were employed in management, finance and administration, 13 were employed in
sales and marketing, and 76 were employed in operations (including 28 employees
working in the field on the Company's touring units). None of the Company's
employees are represented by a collective bargaining agreement. The Company
believes that its relations with its employees are satisfactory.

ITEM 2. PROPERTIES.
-------------------

         The Company maintains its principal facility in Burbank, California
where it leases space under three separate leases on adjacent facilities
consisting of 36,000, 23,460 and 7,596 square feet each, expiring between
September 30, 1999 and September 30, 2001. The Company leases the space for an
aggregate lease payment of approximately $38,000 per month. The Company believes
that its current facilities are adequate to meet its needs for the immediate
future; however the Company is evaluating the possibility of a facility
reduction in light of its efforts to reduce ongoing costs.

ITEM 3.  LEGAL PROCEEDINGS.
---------------------------

         The Company is a party to various other actions arising in the ordinary
course of business which, in the opinion of management, will not have a material
adverse effect on the Company's financial condition; however, there can be no
assurance that the Company will not become a party to other lawsuits in the
future, and such lawsuits could potentially have a material adverse effect on
the Company's financial condition and results of operations.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
-------------------------------------------------------------

         During the last quarter of the Registrant's fiscal year ended June 30,
1999, no matter was submitted to a vote of the security holders of the
Registrant.

                                       11

<PAGE>

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
-----------------------------------------------------------------------------

         The Company's Common Stock is listed for quotation on The NASDAQ
National Market. The table below sets forth, for the calendar quarters
indicated, the high and low closing sales prices per share as reported on The
NASDAQ National Market for the Iwerks Common Stock.


<TABLE>
<CAPTION>
                                                              HIGH        LOW
                                                              ----        ---

YEAR ENDED JUNE 30,  1998
--------------------------------
<S>                                                         <C>         <C>
First Quarter                                               $  5 5/8    $ 3 1/2

Second Quarter                                                 4 3/8      2 1/4

Third Quarter                                                  3 1/4      2 1/4

Fourth Quarter                                                 3 5/16     1 5/6


YEAR ENDED JUNE 30,  1999
--------------------------------
First Quarter                                               $ 1 15/16   $1 3/16

Second Quarter                                                  1 1/4    1

Third Quarter                                                   1 3/8    1

Fourth Quarter                                                  1 3/16    29/32
</TABLE>


         As of September 17, 1999, Iwerks had approximately 874 holders of
record and believe that it has more than 2,000 beneficial holders. No dividends
have been declared or paid since incorporation. Iwerks currently intends to
retain earnings for use in its business and does not anticipate paying any cash
dividends on its common stock in the foreseeable future.


                                       12

<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA
--------------------------------

<TABLE>
<CAPTION>

                                                                 Fiscal Year Ended June 30,
                                              ---------------------------------------------------------------
                                                  1995         1996       1997 (1)     1998 (2)       1999
                                              -----------  -----------  -----------  -----------  -----------
                                                         (IN THOUSANDS EXCEPT PER SHARE INFORMATION)
OPERATIONS:
<S>                                            <C>          <C>          <C>          <C>          <C>
Total revenue                                  $  44,975    $  48,516    $  39,584    $  25,073    $  34,869
(Loss) income from operations                    (13,893)       2,464      (10,573)     (12,132)      (4,986)
Net (loss) income                              $ (13,473)   $   3,099    $  (9,956)   $ (11,560)   $  (4,778)

Net (loss) income per share - basic            $   (1.32)   $    0.28    $   (0.84)   $   (0.95)   $   (0.39)
Net (loss) income per share - diluted          $   (1.32)   $    0.26    $   (0.84)   $   (0.95)   $   (0.39)
Weighted average shares outstanding -
  basic                                           10,210       10,945       11,855       12,212       12,320
Weighted average shares outstanding -
  diluted                                         10,210       12,144       11,855       12,212       12,320

FINANCIAL POSITION (AT PERIOD END):
Cash, cash equivalents and short-term
  investments                                  $  20,586    $  25,281    $  19,067    $  10,464    $   6,717

Total assets                                      71,626       72,926       64,529       50,803       50,768

Capital lease obligations and long-term
  debt                                             2,130        2,732        1,827        1,082        1,087

Stockholders' equity                              50,374       56,665       48,386       36,834       31,775

Total liabilities and stockholders' equity     $  71,626    $  72,926    $  64,529    $  50,803    $  50,768

PER SHARE DATA (AT END OF PERIOD):
Net book value per common share                $    4.76    $    4.89    $    3.97    $    2.98    $    2.63
Common shares outstanding                         10,592       11,588       12,160       12,345       12,069

(1)  Net loss for 1997 includes the write down of $5.6 million ($0.47 loss per
     share) for the asset impairment of long lived assets for the portable ride
     simulation business and other fixed assets.

(2)  Net loss for 1998 includes approximately $1.6 million of severance costs
     associated with a company-wide layoff and termination of certain officers,
     and an additional $1.6 million for merger related costs associated with the
     failed merger.
</TABLE>

                                       13

<PAGE>

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

GENERAL
-------

         The Company designs, engineers, manufactures, markets and services
high-tech entertainment attractions which employ a variety of projection, show
control, ride simulation and software technologies. The Company is currently in
the business of: (a) sells and installs ride simulation attractions in specialty
theatres, (b) sells and installs Giant Screen theatres (generally such theatres
require projection technology which utilize film sizes ranging between five
perforations per frame by 70 millimeters (5/70) and fifteen perforations per
frame by 70 millimeter (15/70)), (c) sells and installs specialty theatres
which include special "4D" effects, (d) licenses and distributes the films in
its library to ride simulation and Large Format theatres, (e) producing films in
the 5/70, 8/70 and 15/70 film format for its film library and for third parties,
(f) invests in joint ventures by contributing its ride simulation technology,
design and equipment and participating in the theatre profits, (g) operates a
fleet of 16 mobile ride simulation attractions and (h) leases camera equipment
and renting post production facilities.

         The Company's operating results in fiscal 1999 have improved from
fiscal 1998. This was mainly due to increased hardware sales in Asia, Europe and
North America as well as a strong effort on behalf of the Company to reduce
operating expenses.

         The Company's Touring business continues to struggle. The Company
derived $3.3 million, $1.4 million and $1.0 million of revenues in fiscal 1997,
1998 and 1999, respectively, from sponsorship of its fleet of touring motion
simulators. The Company currently has only limited sponsorship contracts and has
been unsuccessful in securing sponsorship arrangements that approach the levels
enjoyed prior to fiscal 1997. In fiscal 1997, the Company sold one touring unit
and continues to explore other strategic alternatives for the touring
operations.

         Results were also impacted by certain one-time charges. In the fourth
quarter of fiscal 1997, the Company took approximately $8.4 million in charges,
including a loss on impairment of assets, legal and dispute reserves, additional
film amortization expense and an increase in bad debt reserve. In fiscal 1998,
results were adversely impacted by nonrecurring expenses related to a proposed
merger between Iwerks and Showscan which did not receive the required
shareholder vote in March 1998. In the fourth quarter of fiscal 1999, results
were adversely impacted by approximately $1.0 million due to the termination of
one contract for a one-time research and development specialty project.

REVENUES FOR THE FISCAL YEAR ENDED JUNE 30, 1997, 1998 AND 1999 ARE ANALYZED IN
-------------------------------------------------------------------------------
THE FOLLOWING TABLE (IN THOUSANDS):
-----------------------------------

         The Company derives its revenues primarily from four sources: sales of
hardware systems, licensing of films, owned and operated (primarily portable
simulation theatres), and the production of films for third parties and rental
of facilities, camera equipment.

Revenues for the fiscal year ended June 30, 1997, 1998 and 1999 are analyzed in
the following table (in thousands):

<TABLE>
<CAPTION>
                                            Fiscal Year Ended June 30
                              -------------------------------------------------
                               1997     %         1998     %        1999     %
                              -----    --         ----     -        ----     -

<S>                         <C>       <C>      <C>       <C>     <C>       <C>
Hardware sales & service    $25,829   65%      $12,132   48%     $19,305   55%
Film licensing                5,358   14%        5,521   22%       7,858   23%
Owned and operated            8,072   20%        6,871   28%       5,118   15%
Film production and other       325    1%          549    2%       2,588    7%
                            -------  ----      -------  ----     -------  ----

                            $39,584  100%      $25,073  100%     $34,869  100%
                             =======  ====     =======  ====     =======  ====
</TABLE>

                                       14
<PAGE>
     Revenues on sales of theatre systems are recognized on the percentage-of-
completion method, measured by the ratio of percentage of labor hours incurred
to-date to estimated total labor hours for each fixed-price contract, over the
life of the contract. Accordingly, the timing of shipment schedules as dictated
by the customer can result in variability of quarterly revenues and earnings.
Likewise, the cash received and used for the contract can vary from quarter-to-
quarter with the revenue and cost recognition on the contract. The gross margin
for each contract varies based upon pricing strategies, competitive conditions
and product mix.

      Film Licensing revenues and related expenses are recognized at the
beginning of the license period at which time the customer is billed the license
fee and the film is delivered to the customer.

      Revenues from owned and operated (O&O) consist of portable ride simulation
theatre (touring) revenues derived primarily from corporate sponsorship or
ticket sales at state fairs, air shows, and similar events as well as revenues
derived from fixed site joint venture revenues which includes Iwerks'
contractual share of the sites' revenues or profits as applicable. Admission
revenues from the portable ride simulation theatres are subject to variability
due to the seasonal nature of these events and are higher during the summer
months. Revenues for the portable theatres are recognized ratably over the term
of the contract. In addition, revenues from O&O for fiscal 1997 were benefitted
by significant corporate sponsorships. Sponsorship revenues recognized in fiscal
1998 and 1999 were significantly lower than the fiscal 1997 level.

      Revenue from film production and other is generated primarily through the
production of films for third parties, leasing of camera equipment and the
rental of post production facilities. The Company recognizes revenues and costs
associated with the production of custom films on the percentage of completion
method. The Company typically realizes a smaller margin from the sale of custom
films in comparison to its theatre system sales.

      A significant portion of the Company's sales are made to customers located
outside of the United States, primarily in Asia, South America, Europe and
Canada. Revenues for the fiscal years ended June 30, 1997, 1998 and 1999
attributable to sales to these areas are summarized in the following table (in
thousands):
<TABLE>
<CAPTION>

                                     1997                         1998                         1999
                           -------------------------    -------------------------    -------------------------
                                      Percentage of                Percentage of                Percentage of
                            Amount    Total Revenue      Amount    Total Revenue      Amount    Total Revenue
                           --------  ---------------    --------  ---------------    --------  ---------------

<S>                        <C>            <C>            <C>           <C>           <C>             <C>
Asia                       $13,682        34.6%          $5,660        22.6%         $10,434         29.9%
South America                5,375        13.6%           2,493         9.9%             550          1.6%
  (including Mexico)
Europe                       2,085         5.3%           1,672         6.7%           8,148         23.4%
Canada                         516         1.3%           1,596         6.4%             503          1.4%
                           --------  ---------------    --------  ---------------    --------  ---------------
  Total Export Revenues    $21,658        54.7%         $11,421        45.6%         $19,635         56.3%
                           --------  ---------------    --------  ---------------    --------  ---------------
</TABLE>


      A sales representative maintains offices in Hong Kong and Shanghai to
support sales to Asia. The Company also maintains an office in London, England
to support its European sales. South American sales are supported out of the
Sarasota, Florida office. International operations and sales may be subject to
political and economic risks, including political instability, currency
fluctuations, changes in import/export regulations, tariff and freight rates. In
addition, various forms of protectionist trade legislation have been proposed in
the United States and in certain other countries. Any resulting change in
current tariff structures or other trade and monetary policies could adversely
affect Iwerks' international operations. Political and economic factors have
been identified by the Company with respect to certain markets in which it
competes. There can be no assurance that these factors will not result in
customers of the
                                       15

<PAGE>

Company defaulting on payments owed to Iwerks, or in the reduction of potential
purchases of the Company's products. For example, turmoil in the economies of
the countries in Asia have had a material adverse affect on the Company's
revenues and results of operations. Revenues attributable to sales in Asia
declined from $13.7 million for fiscal 1997 (representing 34.6% of the Company's
revenues) to $5.7 million in fiscal 1998 (representing 22.6% of the Company's
revenues). During the 1999 fiscal year however, the Company experienced an
increase in sales to Asia which increased to $10.4 million in fiscal 1999
(representing 29.9% of the Company's revenue). The Company is not able to
predict to what extent, or for what period, economic trends may adversely affect
the sales of its products. Typically, sales outside the United States are
denominated in United States dollars and are backed by bank letters of credit,
which reduce the risks related to international sales.

COMPARISON OF YEAR ENDED JUNE 30, 1999 TO YEAR ENDED JUNE 30, 1998
------------------------------------------------------------------

      REVENUES

         Revenue for the fiscal year ended June 30, 1999 increased $9.8 million
or 39% from the fiscal year 1998 revenue due to the factors described below.

         Hardware sales and service increased by $7.2 million or 59% from the
prior fiscal year. Hardware sales in the Asia region increased by $2.7 million,
North American hardware sales increased by $2.6 million and hardware sales in
Europe increased by $3.5 million. The only decline in hardware sales was in the
South America region where sales declined by approximately $1.0 million.

         Film licensing revenues increased by approximately $2.3 million or 42%
compared to the same period last year. These results are due to new film venues
in fiscal 1999 from new hardware sales, as well as new theme park attractions,
several of which have signed multiple year license agreements. Many of these new
venues are a direct result of new films which the Company released this year.

         Owned and Operated revenue decreased by approximately $1.8 million as
compared to the same period last year, primarily due to declining sales of
approximately $2.0 million in the touring division, partially offset by an
increase in revenue from the fixed site joint ventures of approximately
$279,000. The decline in sales, and related expenses, in the touring division is
due to the Company's decision to participate in fewer events than the prior
year, focusing on the more profitable events. The increase in joint venture
revenue is the result of three additional joint venture sites opened during the
second quarter of fiscal year 1999. The Company expects the lower touring
revenue trend to continue. The Company continues to seek additional sponsors as
well as other alternatives for the touring business.

         Film Production and other revenue increased by approximately $2.0
million. This was primarily due to the Company securing one major film
production deal in fiscal 1999 compared to none in fiscal 1998.

         COST OF SALES

      Cost of sales primarily includes costs of theatre systems sold, expenses
associated with operating portable ride simulation theatres, and costs
associated with film production and distribution. The cost of theatre systems
include the cost of components, customization, engineering, project management,
assembly, system integration, installation and estimated warranty expenses. Also
included in cost of sales are royalties payable to a former joint venture
partner. The costs associated with film distribution primarily reflect
amortization of film production costs over the lives of certain films and
royalties paid to third parties. The cost of sales associated with operating
portable ride simulation theatres include costs for personnel, depreciation and
amortization of $0.7 million, event fees, fuel, insurance and maintenance.

      Cost of sales as a percentage of sales was 78% for both fiscal years ended
June 30, 1998 and 1999. Included in the cost of sales in 1999 is a charge of
approximately $1.0 million due to the termination of one contract relating to a
one-time research and development specialty project.

                                       16

<PAGE>

      SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

      Selling, general and administrative expenses include, among other things,
personnel costs, trade shows and other promotional expenses, sales commissions,
travel expenses, public relation costs, outside consulting and professional
fees, depreciation on fixed assets, amortization of goodwill, departmental
administrative costs and research and development costs.

      Selling, general and administrative expenses were approximately $16.0
million and approximately $12.6 million, for the years ended June 30, 1998 and
1999, respectively. This decrease was primarily due to a reduction of $2.2
million in employee related expenses from the prior year. Of those expenses,
approximately $1.6 million was related to severance costs that were made to
fifteen employees including the former CEO and two other officers whose
employment terminated in the third quarter of fiscal 1998. In addition, bad debt
expense was approximately $0.8 million larger in the prior year than fiscal 1999
due to the economic problems affecting the Asian region in the prior year. Other
savings included a reduction in building leases and business insurance partially
offset by an increase in sales commissions and an increase in sales and
marketing expenses due to the Company's new corporate brand initiative launched
in the 1999 fiscal year as well as a more comprehensive marketing program to
support clients' efforts to build their Iwerks attractions.

      MERGER RELATED EXPENSES

      The Company incurred approximately $1.8 million of non-recurring expenses
related to the proposed merger with Showscan which did not receive the required
shareholder vote in March 1998. These costs were primarily professional legal,
accounting and investment banking fees of which approximately $1.6 million was
expensed in fiscal 1998.
Approximately $0.2 million was expensed in fiscal 1997.

      INTEREST INCOME & EXPENSE

      Interest income for fiscal 1998 and 1999 was approximately $0.8 million
and $0.4 million, respectively. The decrease from 1998 to 1999 resulted
primarily from a reduction in the invested cash balances during the 1999 fiscal
year.

      Interest expense for fiscal 1998 and 1999 was $247,000 and $156,000,
respectively. This decrease resulted primarily from the scheduled maturity of
capital lease obligations in fiscal 1999.

      INCOME TAXES

         The provisions for income taxes were $23,000 and $2,000 for the years
ended June 30, 1998 and 1999, respectively. As the Company has significant net
losses, the income tax provisions are primarily for foreign taxes and minimum
state taxes.

      NET LOSS

         The Company recorded net loss of $11,560,000 in 1998, compared to a net
loss of $4,778,000 in 1999 due aforementioned reasons.


                                       17

<PAGE>

COMPARISON OF YEAR ENDED JUNE 30, 1998 TO YEAR ENDED JUNE 30, 1997
------------------------------------------------------------------

       REVENUES

       Revenue for the fiscal year ended June 30, 1998 decreased $14.5 million
or 37% from the fiscal year 1997 revenue due to the factors described below.

       Hardware sales and service decreased by $13.7 million or 53% from the
prior fiscal year. Most severely impacted were hardware sales in the
Asia-Pacific region, which decreased $8.1 million due to the continued economic
downturn in that part of the world. North American and South American hardware
sales declined in 1998 by $6.0 million primarily as a result of timing of
projects. However, North American hardware bookings were higher in fiscal 1998
as compared to fiscal 1997.

      Film licensing revenue increased 3% from fiscal 1997 to fiscal 1998 due
primarily to a net increase in the number of theatres which license films
partially offset by pricing declines.

      Owned and operated revenue decreased $1.2 million or 15%, primarily from
the Company's 16 touring ride simulators (Reactors), due primarily to the loss
of a major sponsor (AT&T Corporation) during fiscal year 1997. In addition,
there was one less Reactor in 1998 as it was sold in June of 1997. The loss of
AT&T Corporation accounted for $1.4 million in lower revenues, however the
general admission portion of this business increased by $570,000. The Company
continues to actively seek other sponsors as well as other alternatives to
increase the utilization of the 16 Reactors.

         Film production and other revenue increased by approximately $224,000
primarily due to an increase in post production revenues. There were no revenues
derived from film production in fiscal 1998 or in fiscal 1997.

      COST OF SALES

      Cost of sales primarily includes costs of theatre systems sold, expenses
associated with operating portable ride simulation theatres, and costs
associated with film production and licensing fees. The cost of theatre systems
include the cost of components, customization, engineering, project management,
assembly, system integration, installation and estimated warranty expenses. Also
included in cost of sales are royalties payable to a former joint venture
partner. The costs associated with film license fees primarily reflect
amortization of film production costs over the lives of certain films and
royalties paid to third parties. The cost of sales associated with operating
portable ride simulation theatres include costs for personnel, depreciation and
amortization, event fees, fuel, insurance and maintenance.

      Cost of sales as a percentage of sales was 73% and 78% for the fiscal
years ended June 30, 1997 and 1998, respectively. The increase in cost of sales,
in 1998 compared with 1997, as a percentage of sales was primarily due to the
absorption of certain fixed overhead charges which did not decrease as revenues
decreased.

      SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

      Selling, general and administrative expenses include personnel costs,
trade shows and other promotional expenses, sales commissions, travel expenses,
public relations costs, amortization of goodwill, professional fees, research
and development costs and divisional administrative costs.

      Selling, general and administrative expenses were approximately $15.4
million and approximately $16.0 million, for the years ended June 30, 1997 and
1998, respectively.

                                       18

<PAGE>

      The $600,000 increase in selling, general and administrative expenses
between fiscal 1997 and 1998 was due primarily to a $1.6 million charge for
severance payments made to employees, including the former Chief Executive
Officer and other officers, partially offset by a 10 percent decrease in
employee related expenses. This decrease in employee related expenses was due
primarily to lower overall staffing levels than that of the prior year as a
result of work force reductions made in fiscal 1998.

      MERGER RELATED EXPENSES

         The Company incurred a total of approximately $1.8 million of
non-recurring expenses related to the proposed merger with Showscan which did
not receive the required shareholder vote in March 1998. These costs were
primarily professional legal, accounting and investment banking fees of which
approximately $1.6 million was expensed in fiscal 1998 and approximately
$250,000 expensed in fiscal 1997.

      INTEREST INCOME & EXPENSE

      Interest income for fiscal 1997 and 1998 was approximately $1.1 million
and approximately $0.8 million, respectively. The decrease from 1997 to 1998
resulted primarily from a reduction in the invested cash balances during the
1998 fiscal year.

      Interest expense for fiscal 1997 and 1998 was approximately $391,000 and
approximately $247,000, respectively. This decrease resulted primarily from the
scheduled maturity of capital lease obligations in fiscal 1998.

      INCOME TAXES

         The provisions for income taxes were $117,000 and $23,000 for the years
ended June 30, 1997 and 1998, respectively. As the Company has significant net
losses, the income tax provisions are primarily for foreign taxes and minimum
state taxes.

      NET LOSS

         The Company recorded net loss of $9,956,000 in 1997, compared to a net
loss of $11,560,000 in 1998 due aforementioned reasons.

SEASONALITY AND FLUCTUATING QUARTERLY RESULTS
---------------------------------------------

         The following tables set forth unaudited data regarding operations for
each quarter of fiscal 1998 and 1999 and the percentage of the Company's revenue
and expenses represented by each item of the respective quarter. This quarterly
information has been prepared on the same basis as the annual consolidated
financial statements and, in management's opinion, contains all adjustments
necessary to fairly state the information set forth herein. The operating
results for any quarter are not necessarily indicative of results for any future
period.

                                       19

<PAGE>
<TABLE>
<CAPTION>

                                               Fiscal 1998                                 Fiscal 1999
                                -----------------------------------------   -----------------------------------------
                                   First     Second      Third     Fourth      First     Second      Third     Fourth
  (Dollars in thousands)         Quarter    Quarter    Quarter    Quarter    Quarter    Quarter    Quarter    Quarter
------------------------------  --------   --------   --------   --------   --------   --------   --------   --------


<S>                             <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>
Revenue                         $ 8,052    $ 5,989    $ 4,483    $ 6,549    $ 7,373    $ 8,649    $10,423    $ 8,424
Cost of Sales                     4,789      5,168      4,195      5,501      5,378      6,146      7,669      8,017
                                --------   --------   --------   --------   --------   --------   --------   --------
Gross Margin                      3,263        821        288      1,048      1,995      2,503      2,754        407
Selling, general and
  administrative                  3,605      4,311      4,637      3,446      3,050      3,388      3,174      3,033
Merger related expenses             313        218        888        134          -          -          -          -
Interest (income) expense, net     (149)      (208)      (160)       (78)       (65)       (64)       (31)       (50)
                                --------   --------   --------   --------   --------   --------   --------   --------
Income (loss) before
  provision for taxes              (506)    (3,500)    (5,077)    (2,454)      (990)      (821)      (389)    (2,576)
Provision for taxes                   -          -          -         23          -          -          -          2
                                --------   --------   --------   --------   --------   --------   --------   --------
Net loss                        $  (506)   $(3,500)   $(5,077)   $(2,477)   $  (990)   $  (821)   $  (389)   $(2,578)
                                ========   ========   ========   ========   ========   ========   ========   ========
</TABLE>


         The Company's operating results fluctuate from quarter to quarter as a
result of the timing of theatre system shipments, the mix of theatre system
contracts, the completion of custom film contracts and the amount of revenues
from portable simulation theatre and film licensing agreements. Hardware sales
will likely continue to experience inexplicable quarterly fluctuations as they
are substantially dependent on the customers' varying delivery and installation
requirements.

         A significant portion of the Company's operating expenses are
relatively fixed, and planned expenditures are primarily based upon revenue
forecasts. The sales cycle for the sale of a single attraction by the Company
typically ranges between six and eighteen months. The Company has little control
over the timing of customer purchases. In fiscal 1999, the fourth quarter net
income was impacted by approximately $1.0 million relating to the loss of one
contract for a one-time research and development specialty project. In the
second and third quarters of fiscal 1998, the Company's selling, general and
administrative expenses increased due to severance costs associated with a
Company wide layoff and termination of certain others, including the Chief
Executive Officer, as well as recruitment costs for new management and
directors. Also as a result of this downsizing, the Company's selling, general
and administrative expenses were lower in the fourth quarter of fiscal 1998 and
continuing into fiscal 1999.

         The seasonal fluctuations in earnings also may cause volatility in the
stock prices of the Company. While a significant portion of the Company's
expense levels are relatively fixed, the timing of increases in expense levels
is based in large part on the Company's forecasts of future sales. If net sales
are below expectations in any given period, the adverse impact on results of
operations may be magnified by the Company's inability to adjust spending
quickly enough to compensate for the sales shortfall. The Company may also
choose to reduce prices or increase spending in response to market conditions,
which may have a material adverse effect on the Company's results of operations.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

         In fiscal 1999, approximately $0.7 million in cash was provided by
operating activities and $0.3 million provided by financing activities, offset
by $4.3 million used in investing activities. Investing activities, primarily
consisted of the purchase of property and equipment ($2.2 million), additions to
film inventory ($1.6 million) and investments in joint ventures ($1.0 million)
offset by the sale of debt securities ($0.4 million). Financing activities
consisted primarily of the issuance of a Note payable in conjunction with the
terminated research and development specialty project contract offset by
payments on capital leases ($0.8 million) and a stock repurchase ($1.5 million)
program in which the Company repurchased 320,600 shares of common stock for
approximately $0.3 million.

                                       20

<PAGE>

         In fiscal 1998, approximately $1.3 million in cash was used in
operating activities and $0.5 million was used in financing activities, offset
by $5.8 million provided by investing activities. Investing activities
primarily consisted of additions to film inventory ($3.9 million) and the
purchase of property and equipment ($2.3 million), offset by the sale of debt
securities ($12.5 million). Financing activities consisted primarily of payments
on capital leases ($0.7 million).

         At June 30, 1999 the Company had cash and short-term investments of
approximately $6.7 million compared to $10.5 million at June 30, 1998 and $19.1
million at June 30, 1997. The Company's cash and short-term investment balances
have continued to decline since June 30, 1999 and the Company expects to
experience further declining balances during the remainder of fiscal 2000.
Management believes that its existing cash balances and short-term investments,
combined with anticipated cash flow from operations, will continue to decline,
however they will be sufficient to meet its cash requirements through the end of
fiscal 2000. However, if the Company is unable to achieve its projected cash
flow from operations, the Company may experience significantly reduced cash and
short-term investments, which could result in the Company not being able to meet
its operating needs. The Company is actively exploring possible equity or debt
financing. Recent operating losses, the Company's declining cash balances, the
Company's historical stock performance, and a general decrease in investor
interest in the Company's industry, may make it difficult for the Company to
attract equity investments on terms that are deemed to be favorable to the
Company. In addition, the losses in fiscal 1998 and fiscal 1999 make it more
difficult for the Company to attract significant debt financing. In the event
that cash flow from operations is less than that anticipated and the Company is
unable to secure additional financing, in order to preserve cash, the Company
would be required to reduce expenditures for capital projects (including new
films) and research and development, or effect further reductions in its
corporate infrastructure, any of which could have a material adverse affect on
the Company's future operations. At June 30, 1999 the Company was committed to
approximately $1.4 million of capital expenditures to be made in fiscal 2000.

IMPACT OF YEAR 2000
-------------------

GENERAL DESCRIPTION OF THE YEAR 2000 ISSUE AND THE NATURE AND EFFECTS OF THE
YEAR 2000 ON INFORMATION TECHNOLOGY (IT) AND NON-IT SYSTEMS

         The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs or hardware that have date-sensitive software or
embedded chips may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in 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 determined that it will be required to modify or
replace significant portions of its software and certain hardware so that those
systems will properly utilize dates beyond December 31, 1999. The Company
presently believes that with modifications or replacements of existing software
and certain hardware, the Year 2000 Issue can be mitigated. However, if such
modifications and replacements are not made, or are not completed timely, the
Year 2000 Issue could have a material impact on the operations of the Company.

         The Company's plan to resolve the Year 2000 Issue involves the
following five phases: (1) inventorying Year 2000 items; (2) assessing the Year
2000 compliance of items determined to be material to the Company; (3) repairing
or replacing material items that are determined not to be Year 2000 compliant;
(4) testing material items; and (5) implementation. To date, the Company has
completed all phases. The non-IT systems were assessed and are not material to
the Company's operations. For example, the Company's engineers have reviewed the
Company's significant products and do not believe there is any date sensitive
software included in products sold by the Company since 1994. Some products sold
by Omni Entertainment, a company acquired in 1994, may have date-sensitive chips
which may result in incorrect date displays. The Company has notified these
customers of this concern and has provided the necessary tools to test their
equipment.

                                       21

<PAGE>

The Company has not incurred material costs to test or correct products
initially sold by the Company.

STATUS OF PROGRESS IN BECOMING YEAR 2000 COMPLIANT, INCLUDING TIMETABLE FOR
COMPLETION OF EACH REMAINING PHASE

         On May 3, 1999, the Company went live with its new general ledger,
billing and inventory system modules. There will be an ongoing implementation of
other modules the Company felt were of less critical nature.

NATURE AND LEVEL OF IMPORTANCE OF THIRD PARTIES AND THEIR EXPOSURE
    TO THE YEAR 2000

         The Company does not interface directly with third party vendors with
regard to shared information systems. The Company has queried its significant
suppliers and subcontractors that do not share information systems with the
Company (external agents). To date, the Company is not aware of any external
agent with a Year 2000 issue that would materially impact the Company's results
of operations, liquidity, or capital resources. However, the Company has no
means of ensuring that external agents will be Year 2000 ready. The inability of
external agents to complete their Year 2000 resolution process in a timely
fashion could materially impact the Company. The effect of non-compliance by
external agents is not determinable.

COSTS

         The Company has utilized both internal and external resources to
replace, test, and implement the software and certain hardware for Year 2000
modifications. The total cost of the Year 2000 project was approximately
$513,000 of which $489,000 was capitalized and approximately $24,000 was
expensed.

RISKS

         Management of the Company believes it has an effective program in place
to resolve the Year 2000 issue in a timely manner. As noted above, the Company
has completed the final phase of the Year 2000 program. However, disruptions in
the economy generally resulting from Year 2000 issues could also materially
adversely affect the Company. The Company could be subject to litigation for
computer systems product failure, for example, equipment shutdown or failure to
properly date business records. The amount of potential liability and lost
revenue cannot be reasonably estimated at this time.

         Readers are cautioned that forward-looking statements contained in this
Year 2000 disclosure should be read in conjunction with the Company's
disclosures under the heading, "Special Note on Forward-looking Statements,"
beginning on page 3 above. Readers should understand that the dates on which the
Company believes the Year 2000 project will be completed are based upon
Management's best estimates, which were derived utilizing numerous assumptions
of future events, including the availability of certain resources, third-party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved, or that there will not be a delay in, or
increased costs associated with, the implementation of the Company's Year 2000
Compliance Project. Specific factors that might cause differences between the
estimates and actual results include, but are not limited to, the availability
and cost of personnel trained in these areas, the ability to locate and correct
all relevant computer code, timely responses to and corrections by third parties
and suppliers, the ability to implement interfaces between the new systems and
the systems not being replaced, and other similar uncertainties. Due to the
general uncertainty inherent in the Year 2000 problem, resulting in part from
the uncertainty of the Year 2000 readiness of third parties and the
inter-connection of national and international businesses, the Company cannot
ensure its ability to timely and cost-effectively resolve problems associated
with the Year 2000 issue which may affect its business operations, or expose it
to third party liability.

                                       22

<PAGE>

RISK FACTORS
------------

         WE HAVE A HISTORY OF LOSSES AND THERE CAN BE NO ASSURANCE THAT WE WILL
BE ABLE TO ACHIEVE PROFITABLE OPERATIONS IN FISCAL 2000.

         We have not been profitable in four of the last five years and have an
aggregate net loss for the last five years of $36.7 million. During 1999, we
incurred a net loss of $ 4.8 million. Because a substantial portion of our
expenses are fixed and our gross margin is relatively low, achieving
profitability depends upon our ability to generate and sustain substantially
higher revenues. Although we have implemented plans to increase revenues and
operating margin, there can be no assurance that we will be able to do so and
consequently may have additional losses in fiscal 2000. If our cash on hand and
short-term investments, together with cash generated by operations, cannot
sufficiently fund future operating losses and capital requirements, we may be
required to raise additional funds. Additional financing may not be available in
amounts or on terms acceptable to us, if at all.

         IT IS POSSIBLE THAT OUR CURRENT FILM SOFTWARE MAY NOT SUSTAIN ITS
POPULARITY AND OUR NEW FILM SOFTWARE MAY NOT BECOME POPULAR.

         A substantial portion of our revenue is dependent upon the production
and distribution of entertainment and educational film software for exhibition
on our theatre systems. Each production is an individual artistic work. We try
to develop and produce film software that will achieve high market acceptance.
However, market acceptance depends upon many factors beyond our control,
including:

o         audience reaction;

o         competing programming;

o         other forms of entertainment;

o         perceived quality of programming.

         We cannot assure you that our film software will obtain market
acceptance. If our film software becomes less popular, we will most likely
derive less revenue from the license of our film library and from new hardware
sales.

         OUR COMPETITIVE POSITION IS DEPENDENT ON CONTINUING TO INVEST IN NEW
FILM PRODUCTIONS. IF WE ARE UNABLE TO DO SO, IT COULD HAVE A NEGATIVE IMPACT ON
OUT REVENUES.

         We believe that our extensive library of popular films is a competitive
advantage and that we must continue to add to this library if we are to be
successful. Film production is expensive. We generally spend $100,000 -
$2,000,000 to produce a film. Although we try to reduce the financial impact of
a new film by entering into licensing, participation or other financing
arrangements with third parties, prior to release we typically do not recoup our
costs until 2-3 years later. Even if we are able to reduce the costs of
production, we cannot assure you that the films we produce and acquire will be
popular. In addition, because our cash balances have continued to decline, we
have had to decrease the level of our investment in film software and this may
have an adverse impact on our revenues in future periods.

         WE HAVE SIGNIFICANT AMOUNTS RECORDED ON OUR BALANCE SHEET AS FILM
INVENTORY AND IF OUR COST OR REVENUE ESTIMATES WERE TO CHANGE WE COULD BE
REQUIRED TO WRITE DOWN ALL OR A PORTION OF THESE UNAMORTIZED COSTS.

         We follow Financial Accounting Standards Board Statement No. 53,
"Financial Reporting by Producers and Distributors of Motion Picture Films,"
regarding revenue recognition and amortization of production costs for films

                                       23

<PAGE>


in which we own or control all applicable rights. We capitalize as film
inventory all costs incurred in connection with an individual film, including
acquisition, development, production and allocable production overhead costs and
interest. If our revenue or cost estimates change with respect to a particular
film, we may be required to write down all or a portion of the unamortized cost
for such a film. We cannot assure you that such write-downs, if they occur, will
not have a material adverse effect on our results of operations or our financial
condition.

         OUR PRINCIPAL COMPETITORS DEVOTE GREATER FINANCIAL, PERSONNEL AND
MARKETING RESOURCES TO THE DEVELOPMENT AND EXPANSION OF COMPETITIVE PRODUCTS.

         We face significant competition in each of the markets in which we
operate. Our 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,
there is also competition from systems integrators and some amusement and theme
parks developing and constructing their own attractions. We have significantly
fewer financial, technical, manufacturing, marketing and other resources than
certain of our competitors and these limited resources may harm our business in
many ways. Our competitors may leverage their greater resources to:

o         develop, manufacture and market products that are less expensive or
          technologically superior to our products;

o         reach a wider array of potential customers through increased
          marketing and sales activities;

o         attend more trade shows and spend more on advertising and marketing;

o         operate at lower margins for longer periods;

o         respond more quickly to new or changing technologies, customer
          requirements and standards; or

o         reduce prices in order to preserve or gain market share.

         In addition, the out-of-home entertainment industry in general is
undergoing significant changes, primarily due to technological developments as
well as changing consumer tastes. Many companies are developing and are expected
to develop new entertainment products or concepts in response to these
developments that may be directly competitive with our products.

         We believe these competitive pressures are likely to continue. We
cannot guarantee that our resources will be sufficient to address this
competition or that we will manage costs and adopt strategies capable of
effectively utilizing our resources. If we are unable to respond to competitive
pressures successfully, our prices and profit margins may fall and our market
share may decrease.

         OUR FUTURE SUCCESS WILL DEPEND IN PART UPON OUR ABILITY TO ANTICIPATE
CHANGES IN TECHNOLOGY AND DEVELOP NEW AND ENHANCED PRODUCTS ON A TIMELY AND
COST-EFFECTIVE BASIS.

         We operate in a technology-driven segment of the entertainment
industry. Consequently, it is important for us to develop new and enhanced
products in response to technological changes. Risks inherent in the development
and introduction of new products include:

o         difficulty in forecasting customer demand accurately;

o         our inability to expand capacity fast enough to meet customer demand;

                                       24

<PAGE>

o         the possibility that new products may cannibalize current products;

o         delays or interruptions in the manufacture and installation of new
          products;

o         competitors' responses to our introduction of new products;

o         the desire by customers to evaluate new products for longer periods of
          time before making a purchase decision; and

o         the possibility the market may reject certain new technology and
          products.

         If we are unable, for technological or other reasons, to develop
products in a timely manner or the products or product enhancements that we
develop do not achieve market acceptance, our business could be harmed.

         A SIGNIFICANT PORTION OF OUR SALES AND CUSTOMERS ARE LOCATED OUTSIDE
THE UNITED STATES. CURRENCY FLUCTUATIONS AND THE INCREASED COSTS ASSOCIATED WITH
INTERNATIONAL SALES, COULD MAKE OUR PRODUCTS UNAFFORDABLE IN FOREIGN MARKETS,
WHICH COULD REDUCE OUR PROFITABILITY.

         Sales to customers outside the United States accounted for
approximately 55%, 46% and 56% of our revenues in fiscal 1997, 1998 and 1999,
respectively. We believe that international sales will continue to represent a
significant portion of our total sales. Our foreign sales subject us to a number
of risks including:

o        although we denominate our international sales in U.S. dollars,
         currency fluctuations could make our products unaffordable to foreign
         purchasers or more expensive compared to those of foreign
         manufacturers;

o        greater difficulty of administering business overseas may increase the
         costs of foreign sales and support;

o        foreign governments may impose tariffs, quotas and taxes on our
         products;

o        longer payment cycles typically associated with international sales and
         potential difficulties in collecting accounts receivable may reduce the
         profitability of foreign sales;

o        political and economic instability may reduce demand for our products
         or our ability to market our products;

o        restrictions on the export or import of technology may reduce or
         eliminate our ability to sell in certain markets; and

o        although we have met certain international manufacturing standards, our
         lack of ISO 9000 certification, a widely accepted method of
         establishing and certifying the technical characteristics and quality
         of our products, may hinder our foreign sales.

         These risks may increase our costs of doing business internationally
and reduce our sales or profitability.

         WE ARE DEPENDENT ON THE STRENGTH OF THE NATIONAL AND INTERNATIONAL
ECONOMIES. RECESSIONARY OR DEFLATIONARY CONDITIONS IN ANY OR OUR PRINCIPAL
MARKETS COULD REDUCE OUR SALES AND PROFITABILITY.

      Our revenues and profitability are dependent on the strength of the
national and international economies. In a recessionary or deflationary
environment, sales of our products may be adversely affected.

                                       25

<PAGE>

      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 us in order to maintain sales activity.

      For example, 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.

      Revenues attributable to sales in Asia declined from $17.3 million for
fiscal 1996 (representing 35.7% of the Company's revenues) to $5.7 million in
fiscal 1998 (representing 22.6% of the Company's revenues). Sales to Asia have
increased in fiscal 1999, as local economies recovered.

      OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE DIFFICULT TO FORECAST. IF
REVENUES AND OPERATING RESULTS FLUCTUATE UNEXPECTEDLY FROM QUARTER TO QUARTER,
OUR STOCK PRICES MAY FLUCTUATE.

      Our quarterly revenues and operating results are difficult to forecast. As
a result, we believe that the period-to-period comparison for operating results
are not necessarily reliable indicators of our future performance. A variety of
factors may affect our operating results, including factors which are outside
our control. These factors include the following:

      o   the size and timing of customer orders;

      o   the timing or introduction of enhancement of products by us or our
          competitors;

      o   the timing and level of our operating expenses.

      Any anticipated change in operating results may cause our stock prices to
fluctuate since such changes reflect new information for investors and analysts.
New information causes investors and analysts to revalue our stock and this in
the aggregate could cause our stock price to fluctuate.

      OUR CUSTOMERS HAVE THE RIGHT TO TERMINATE THEIR CONTRACTS WITH US IN
CERTAIN CIRCUMSTANCES. TERMINATIONS MAY REDUCE OUR SALES AND REVENUES.

         Our hardware sales contracts typically provide that the customer may
terminate our contract upon payment of certain costs at any time prior to
delivery. We also provide warranty service at a one year interval for our
customers on our products. We estimate and reserve for potential cancellations
and warranty service in our reported financial statements. The costs resulting
from actual cancellations and\or warranty service could exceed our estimates. If
the number of cancellations or the costs of warranty service exceed our
estimates, our financial results could be harmed for the periods during which
such returns or service are made.

      IF WE ARE SUED ON A PRODUCT LIABILITY CLAIM, OUR INSURANCE POLICIES MAY
NOT BE SUFFICIENT.

      Although we maintain general liability insurance and product liability
insurance, our insurance may not cover potential all types of product liability
claims to which manufacturors are exposed or may not be adequate to indemnify us
for all liability that may be imposed. Any imposition of liability that is not
covered by insurance or is in excess of our insurance coverage could harm our
business.

                                       26

<PAGE>

      IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS ADEQUATELY,
THE ADVANTAGES OF OUR RESEARCH, MANUFACTURING AND DISTRIBUTION SYSTEMS MAY BE
REDUCED AS COMPETITORS ADOPT SOME OR ALL OF THESE TECHNIQUES.

      Since our business depends in part on intellectual property rights, our
ability to compete effectively depends in part on our ability to develop and
maintain proprietary aspects of our technology in creative works. We currently
hold several patents on the design elements of our products and also rely on a
combination of trademark, trade secret, copyright and other intellectual
property laws to protect our proprietary rights. Such rights, however, may not
preclude competitors from developing products that are essentially equivalent or
superior to ours. In addition, may aspects of our product are not subject to
intellectual property protection and therefore may be reproduced by our
competitors.

         INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US COULD BE TIME
CONSUMING AND EXPENSIVE TO DEFEND AND MAY HARM OUR BUSINESS.

         In recent years there has been significant litigation in the United
States involving patents and other intellectual property rights. While we
currently are not engaged in any material intellectual property litigation or
proceedings, we may become involved in the future. An adverse outcome of
litigation could force us to do one or more of the following:

      o   stop selling, incorporating or using our products for services that
          use the challenged intellectual property;

      o   subject us to significant liabilities to third parties;

      o  obtain from the owners of the infringed intellectual property right a
         license to sell or use the relevant technology, which license may not
         be available on reasonable terms or at all; or

      o  redesign those products and services that use such technology, which
         redesign may be either economically or technologically infeasible.

         Whether or not an intellectual property litigation claim is valid, the
cost of responding to it, in terms of legal fees and expenses in the diversion
of management resources, could harm our business.

         THE ABILITY OF OUR BOARD OF DIRECTORS TO ISSUE PREFERRED STOCK AND OUR
STOCKHOLDER RIGHTS PLAN MAY MAKE TAKEOVER ATTEMPTS DIFFICULT OR IMPOSSIBLE.

         Our Board of Directors has the authority, without any action of the
shareholders, to issue up to one million shares of Preferred Stock and to fix
the rights and preferences of such shares. In addition, we have in place a
Stockholders Rights Plan. The ability of our Board to issue Preferred Stock
and\or the Stockholder Rights Plan may have the effect of delaying, deferring or
preventing a change of control, may discourage bids for our common stock at a
premium over its market price and may adversely affect the market price, and the
voting and rights of the holders of our Common Stock.

         OUR BUSINESS AND THE BUSINESS OF OUR SUPPLIERS COULD BE ADVERSELY
AFFECTED BY COMPUTER ERRORS OR FAILURES ASSOCIATED WITH THE YEAR 2000 PROBLEM.

         The Year 2000 readiness issue, which is common to most businesses,
arises from the inability of information systems, and other time and date
sensitive products and systems, to properly recognize the process date sensitive
information or system failures. Estimates of the potential costs and effects of
Year 2000 issues vary significantly among businesses, and it is extremely
difficult to predict the actual impact. Recognizing this uncertainty,
management is continuing to actively analyze, assess and plan for various Year
2000 issues across our business.

                                       27

<PAGE>

         The Year 2000 issue has an impact on both information and technology
systems and non-IT systems, such as manufacturing systems and physical
facilities including, but not limited to, securities systems and utilities.
Although our management believes that all of our mission critical systems are
not affected by the Year 2000 issue, there can be no assurance that we will not
experience some problems. Non-IT system issues are more difficult to identify
and resolve. We are actively identifying non-IT Year 2000 issues concerning our
products or services as well as our physical facilities. As non-IT areas are
identified, our management formulates the necessary actions to ensure minimal
disruption to our business processes. Although our management believes that its
efforts will be successful and the costs will be immateriality our consolidated
financial position and results of operations, it also recognizes that any
failure or delay could cause a potential adverse impact.

         The Year 2000 readiness of our customers varies. We are not
investigating whether or not our customers are evaluating and/or preparing their
own systems. These efforts by customers to address the Year 2000 issues may
affect the demand for certain products and services; however, the impact on our
revenue is highly uncertain.

         We have also begun to assess the Year 2000 readiness of our key
suppliers and business partners. Our direction of this effort is to ensure the
adequacy of resources and supplies to minimize any potential business
interruptions. The Year 2000 issue presents a number of other risks and
uncertainties that could impact us, such as public utility failures, potential
claims against us for damages arising from products or services that are not
Year 2000 compliant, and the responsibility of certain government commissions of
the various geographic areas where we conduct our business. While we continue to
believe that the Year 2000 issues described above will not materially affect our
financial position, it remains uncertain as to what extent, if any, we may be
impacted.

         If we, our customers or vendors are unable to resolve any Year 2000
compliance problems in a timely manner, we could face business interruptions or
shutdowns, financial loss, regulatory actions, reputational harm and/or legal
liability. Contingency plans that address a reasonable likely worse case
scenario have not yet been developed. We intend to determine whether any such
plans will be necessary in the coming months.

                                       28

<PAGE>

      ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

                         REPORT OF INDEPENDENT AUDITORS

      The Board of Directors
      Iwerks Entertainment, Inc.

      We have audited the accompanying consolidated balance sheets of Iwerks
Entertainment, Inc. as of June 30, 1998 and 1999, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended June 30, 1999. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.

      We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Iwerks Entertainment, Inc. at June 30, 1998 and 1999 and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended June 30, 1999, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.



     Los Angeles, California                               Ernst & Young LLP
     August 17, 1999, except as to
     Note 17 as to which the date is September 9, 1999


                                       29

<PAGE>


                           IWERKS ENTERTAINMENT, INC.

                           CONSOLIDATED BALANCE SHEETS

                                     ASSETS

                                 (IN THOUSANDS)
                                                        June 30,
                                         --------------------------------------

                                                 1998                1999
                                         ------------------   -----------------
Current assets:

  Cash and cash equivalents                 $     7,542          $    4,217

  Short-term investments                          2,922               2,500

  Trade accounts receivable, net of
    allowance for doubtful accounts               3,521               5,619

  Costs and estimated earnings in excess
    of billings on uncompleted contracts          1,574               1,495

  Inventories                                     3,366               5,110

  Other current assets                              706                 445
                                         ------------------   -----------------

     Total current assets                        19,631              19,386

Portable simulation theatres at cost,
     net of accumulated depreciation              3,413               2,783

Property and equipment at cost, net of
     accumulated depreciation and amortization    4,329               5,626

Film inventory at cost, net of accumulated
     amortization                                 5,308               4,861

Goodwill, net of accumulated amortization        14,742              14,115

Other assets                                      3,380               3,997
                                         ------------------   -----------------

     Total assets                          $     50,803         $    50,768
                                         ==================   =================


                             See accompanying notes.

                                       30

<PAGE>

                           IWERKS ENTERTAINMENT, INC.

                           CONSOLIDATED BALANCE SHEETS
                      LIABILITIES AND STOCKHOLDERS' EQUITY

                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

                                                        June 30,
                                         --------------------------------------
                                                1998                 1999
                                         ------------------    ----------------
Current liabilities:
   Accounts payable                         $      1,982          $    3,244

   Accrued expenses                                6,823               6,115

   Notes payable, current portion                     --                 737

   Billings in excess of costs and
     estimated earnings on uncompleted
     contracts                                     2,971               7,008

   Deferred revenue                                  308                  10

   Capital leases, current portion                   803                 792
                                         ------------------    ----------------

     Total current liabilities                    12,887              17,906

Notes payable, net of current portion                 --                 797

Capital lease obligations, net of
     current portion                               1,082                 290

                                         ------------------    ----------------
     Total liabilities                            13,969              18,993

Commitments and contingencies

Stockholders' equity:

  Preferred stock, $0.01 par value, 1,000,000          -                   -
     authorized, none issued and outstanding

  Common stock, $.001 par value, 50,000,000           57                  57
     shares authorized; 12,344,807 (1998) and
     12,389,498 (1999) issued and outstanding

Paid-in capital                                   78,024              78,084
Treasury stock, 320,600 shares at cost                 -               (341)
Accumulated deficit                             (41,247)            (46,025)
                                         ------------------    ----------------
   Total stockholders' equity                     36,834              31,775
                                         ------------------    ----------------

     Total liabilities and
       stockholders' equity                  $    50,803           $  50,768
                                         ==================    ================

                             See accompanying notes.

                                       31

<PAGE>

                           Iwerks Entertainment, Inc.

                      Consolidated Statements of Operations

                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

                                            Years ended June 30,
                             --------------------------------------------------
                                   1997              1998             1999
                             ---------------   ---------------   --------------

Revenue                        $   39,584       $    25,073        $   34,869

Cost of sales                      28,948            19,653            27,210
                             ---------------   ---------------   --------------

Gross margin                       10,636             5,420             7,659

Selling, general and
administrative expenses            15,373            15,999            12,645

Merger related expenses               250             1,553                --

Loss on impairment of assets        5,586                --                --
                              ---------------   ---------------   -------------

Loss from operations             (10,573)          (12,132)           (4,986)

Interest income                     1,125               842               366

Interest expense                    (391)             (247)             (156)
                              ---------------   ---------------   -------------

Loss before provision for
income taxes                      (9,839)          (11,537)           (4,776)

Provision for income taxes            117                23                 2
                              ---------------   ---------------   -------------

Net loss                      $   (9,956)       $  (11,560)       $   (4,778)
                              ===============   ===============   =============

Loss per common share -
basic and diluted             $    (0.84)       $    (0.95)       $    (0.39)
                              ===============   ===============   =============

Weighted average shares
outstanding -
basic and diluted                  11,855            12,212            12,320
                              ===============   ===============   =============

                             See accompanying notes.

                                       32

<PAGE>

                           Iwerks Entertainment, Inc.

                 Consolidated Statements of Stockholders' Equity

                                 (In Thousands)


<TABLE>
<CAPTION>

                                                 Common Stock    Paid-in
                                                                  Capital   Treasury    Accumulated
                                                                             Stock        Deficit
                                           Shares     Amount                                              Total
                                         ----------- ---------- ----------- --------- ------------ ------------
<S>             <C> <C>                      <C>     <C>         <C>              <C> <C>               <C>
Balance at June 30, 1996                     11,588  $      56   $  76,340        $-  $   (19,731)      $56,665
                                         ----------- ---------- ----------- --------- ------------ ------------

Common stock issued in connection with          299          1       1,200         -            -         1,201
the Purchase of Pioneer

Common stock options and warrants               273          -         476         -            -           476
exercised Net loss
                                                  -          -           -         -        (9,956)      (9,956)
                                         ----------- ---------- ----------- --------- ------------ ------------

Balance at June 30, 1997                    12,160          57      78,016         -       (29,687)      48,386
                                          ----------  --------    ---------  -------     ---------  -----------

Common stock options and warrants                25          -           8         -             -            8
exercised

Issuance of  common  stock issued in
connection with the
   class action  settlement                     160          -           -          -            -            -

Net  loss                                         -          -           -          -      (11,560)      (11,560)

Balance at June 30,  1998                    12,345         57      78,024          -      (41,247)       36,834
                                         ----------- ---------- ----------- ----------  ------------ -----------

Common stock options and warrants                44          -          60          -            -           60
exercised

Purchase of treasury stock                     (320)                             (341)                      (341)

Net  loss                                         -          -           -           -      (4,778)       (4,778)
                                         ----------- ---------- ----------- ----------  ------------ -----------

Balance at June 30,  1999                    12,069  $      57  $   78,084    $   (341)   $(46,025)     $ 31,775
                                         =========== ========== =========== ============= ============ ==========

</TABLE>
                             See accompanying notes.

                                       33

<PAGE>

                           IWERKS ENTERTAINMENT, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                              YEAR ENDED JUNE 30,
                                                                         -------------------------------------------------------
      OPERATING ACTIVITIES                                                         1997               1998               1999
                                                                         ------------------  -----------------  ----------------
<S>                                                                            <C>                 <C>                <C>
      NET LOSS                                                                 $    (9,956)        $  (11,560)        $  (4,778)
      ADJUSTMENTS TO RECONCILE NET LOSS
        TO NET CASH PROVIDED BY  (USED IN) OPERATING ACTIVITIES:
          DEPRECIATION AND AMORTIZATION                                               6,279              4,628             4,696
          WRITE-DOWN OF ASSETS TO NET REALIZABLE VALUE                                5,587                  -                 -
          CHANGES IN OPERATING ASSETS AND LIABILITIES:
              TRADE ACCOUNTS RECEIVABLE, NET                                          (639)              1,926           (2,098)
              COSTS AND ESTIMATED EARNINGS IN EXCESS OF
                 BILLINGS ON UNCOMPLETED CONTRACTS                                    (637)              4,765                79
              INVENTORIES                                                           (1,012)                469           (1,744)
              OTHER CURRENT ASSETS                                                    (152)              (139)               261
              ACCOUNTS PAYABLE AND ACCRUED EXPENSES                                   1,389            (3,423)               554
              BILLINGS IN EXCESS OF COSTS AND ESTIMATED
                 EARNINGS ON UNCOMPLETED CONTRACTS                                    (116)              1,981             4,037
              DEFERRED REVENUE                                                          217                 30             (298)
                                                                         ------------------  -----------------  ----------------
                 NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                    960            (1,323)               709

      INVESTING ACTIVITIES
      INVESTMENT IN LIMITED PARTNERSHIP AND JOINT VENTURES                          (1,162)              (426)             (991)
      INVESTMENT IN PORTABLE SIMULATION THEATRES AND PATENTS                          (108)               (46)              (34)
      PURCHASES OF PROPERTY AND EQUIPMENT                                           (1,247)            (2,333)           (2,168)
      ADDITIONS TO FILM INVENTORY                                                   (2,548)            (3,917)           (1,565)
      INVESTMENT IN DEBT SECURITIES                                                 (2,851)             12,537               422
      PURCHASE OF PIONEER AND ACQUISITION OF RELATED PATENT, NET OF
              CASH ACQUIRED AND STOCK ISSUED                                        (1,088)                  -                 -
      PROCEEDS FROM SALE OF PORTABLE SIMULATION UNIT                                  1,184                  -                 -
                                                                         ------------------  -----------------  ----------------
              NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES                   (7,820)              5,815           (4,336)

      FINANCING ACTIVITIES
      ISSUANCE OF NOTE PAYABLE                                                            -                  -             1,534
      REPAYMENT OF  NOTES PAYABLE TO RELATED PARTIES                                  (875)                  -                 -
      REPAYMENT OF  NOTES PAYABLE                                                     (571)               (81)                 -
      PAYMENTS ON CAPITAL LEASES                                                      (700)              (681)             (804)
      EXERCISE OF STOCK OPTIONS AND WARRANTS                                            476                  8                60
      REPURCHASE OF COMMON STOCK                                                          -                  -             (341)
      OTHER                                                                           (536)                196             (147)
                                                                         ------------------  -----------------  ----------------
              NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES                   (2,206)              (558)               302
                                                                         ------------------  -----------------  ----------------
      NET (DECREASE) INCREASE IN CASH                                               (9,066)              3,934           (3,325)
      CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                 12,674              3,608             7,542
                                                                         ------------------  -----------------  ----------------
      CASH AND CASH EQUIVALENTS AT END OF YEAR                                  $     3,608         $    7,542         $   4,217
                                                                         ==================  =================  ================
</TABLE>

                                       34

<PAGE>

<TABLE>
      SUPPLEMENTAL INFORMATION TO CONSOLIDATED STATEMENTS OF CASH FLOWS


<CAPTION>
                                      Year ended June 30,
                          -----------------------------------------------------
                                      1997               1998              1999
                          ----------------- ------------------ ----------------
Cash paid during the year for:
<S>                              <C>               <C>               <C>
    Interest                     $     411         $      244        $      163
                          ================= ================== ================
    Income taxes                 $      65         $       23        $       11
                          ================= ================== ================
</TABLE>


     Supplemental disclosures of non-cash investing and financing activities:

     In 1997, the Company purchased patents, other assets and all the
outstanding common stock of the Pioneer related entities for cash and Iwerks
common stock. The Common Stock issued was valued at $1.2 million (see Note 2).

     In 1999, the Company issued a note payable for approximately $1.5 million
in connection with the termination of a customer contract (see Note 10).

                           See accompanying notes.

                                       35

<PAGE>

                           IWERKS ENTERTAINMENT, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Consolidation and Basis of Presentation - Iwerks is a Delaware corporation.
Iwerks designs, manufactures, installs and services high resolution, proprietary
motion picture theatre attractions. Iwerks' attractions are built around a
variety of theatre systems, including fixed and portable simulators, Giant
Screen theatres, 3D theatres, 4D specialty theatres and the licensing of the
related software.

     Iwerks operates in one business segment, the manufacture, distribution and
operation of entertainment and educational hardware and software.

     The financial statements consolidate the accounts of Iwerks and its wholly
owned subsidiaries. All significant intercompany amounts and transactions have
been eliminated in consolidation.

     Certain reclassifications were made to the financial statements for the
year ended June 30, 1997 and 1998 in order to conform to the fiscal 1999
presentation.

     Revenue and Cost Recognition - Revenue from fixed-price-contracts are
recognized on the percentage-of-completion method, measured by the ratio of
percentage of labor hours incurred to date to estimated total labor hours for
each contract. Management considers expended labor hours to be the best
available measure of progress on such contracts. A contract is considered
substantially complete upon delivery and acceptance of the product by the
customer. These contracts average six to eighteen months in duration.

     Contract costs include direct materials, direct labor cost and indirect
costs related to contract performance, such as indirect labor, supplies and
tools. Costs and estimated earnings in excess of billings on uncompleted
contracts represents costs incurred and gross profit recognized in excess of
amounts billed. Billings in excess of costs and estimated earnings on
uncompleted contracts represents billings in excess of costs incurred and gross
profit recognized. Billings to customers are in accordance with the terms of the
contract and generally follow a payment schedule.

     Iwerks performs a quarterly review of uncompleted contracts. Changes in
estimates are reflected in the period of the change. Provisions for estimated
losses on uncompleted contracts are made in the period in which such losses are
determined.

     Iwerks provides a warranty for contracts generally for a period of twelve
months. Such warranty costs are included in cost of sales. The warranty accrual
as of June 30, 1998 and 1999 was $1,014,000, and $1,028,000, respectively, and
are included in accrued expenses in the accompanying consolidated balance
sheets.

     Iwerks also earns revenues for the production of films for outside parties.
Iwerks recognizes such producer fee revenue as the services are rendered.

     Iwerks generally licenses films at agreed-upon minimum amounts. Revenues
from film licenses are recognized when the license period begins and the
programming is available pursuant to the terms of the license agreement.

     Revenues from portable simulation theatres ticket sales are recorded at the
time collected and fees from leasing of these simulators are recognized over the
related lease periods.

                                       36

<PAGE>

     Trade Accounts Receivable primarily consists of amounts due on contracts
and film licenses. Allowance for doubtful accounts was $1,893,000 at June 30,
1998 and $1,823,000 at June 30, 1999.

     Inventories consist primarily of simulation system equipment components and
are stated at the lower of cost or market on an average cost basis.

     Film Inventory consists of production and print costs and are stated at
the lower of cost or net realizable value. The individual film forecast method
is used to amortize film costs. Costs accumulated in the production of a film
are amortized in the proportion that gross revenues realized bear to
management's estimate of total gross revenues expected to be received. Revenue
estimates on a film-by-film basis are reviewed quarterly by management and are
revised, if warranted, based upon management's appraisal of current market
conditions. Unamortized film costs are written down to net realizable value
based on this appraisal, where applicable. Estimated liabilities for royalties
and participation are accrued and expensed in the same manner as film costs are
amortized.

     Film inventory is comprised of the following (in thousands):


<TABLE>
<CAPTION>
                                                    June 30,
                                          -----------------------------
                                              1998             1999
                                          ------------     ------------
<S>                                        <C>              <C>
Films released                             $    19,968      $    22,200
Films in process and development                   792              125
                                          ------------     ------------
  Total                                         20,760           22,325
Less accumulated amortization                 (15,452)         (17,464)
                                          ------------     ------------
                                          $      5,308     $      4,861
                                          ============     ============
</TABLE>


     The Company estimates that approximately 82% of unamortized film costs at
June 30, 1999 will be amortized over the next three fiscal years. Many of the
Company's films that have been fully amortized continue to generate revenues.

Portable Simulation Theatres - Sixteen portable simulation theatres are in
operation at June 30, 1999. Depreciation on the portable simulation theatres is
computed using the straight line method over the estimated useful lives of the
related assets, which range from seven to ten years. Accumulated depreciation
was $4,977,000 at June 30, 1998 and $ 5,617,000 at June 30, 1999 (see Note 13).

Depreciation and Amortization of Property and Equipment is computed using the
straight line method over the estimated useful lives of the assets, which range
from three to ten years. Leasehold improvements are amortized over five years or
the term of the lease, whichever is shorter.

Goodwill (excess purchase price and liabilities assumed over the fair market
value of assets acquired) primarily resulted from the acquisition of Omni and is
being amortized over thirty years using the straight line method. The remaining
goodwill relates to the acquisition of Pioneer Marketing Corporation and a
related company (collectively referred to as "Pioneer") (see Note 2) and prior
acquisitions and is being amortized over 16 to 25 years. Goodwill is reviewed
periodically to determine if the facts and circumstances suggest that it may be
impaired. If this review indicates that goodwill will not be recoverable, as
determined based upon discounted cash flows of the acquired business over the
remaining amortization period, then the carrying value of the related goodwill
will be reduced by the estimated shortfalls of cash flows. Accumulated
amortization was $3,421,000 at June 30, 1998 and $ 4,047,000 at June 30, 1999.

Other Assets - Patents are stated at cost, and are being amortized using the
straight line method between 10 and 25 years. Iwerks acquired a patent in fiscal
1997 in connection with the Pioneer acquisition in the amount of

                                       35

<PAGE>

$1,094,000, and a covenant not to compete in the amount of $50,000 (see Note 2).
Accumulated amortization was $278,000 at June 30, 1998 and $354,000 at June 30,
1999. The Company has entered into joint venture arrangements whereby the
Company contributes ride simulation theatre equipment and the joint venture
partner contributes site improvements. The Company retains title to the assets
it contributes to certain joint ventures, and therefore its investment in joint
ventures is carried at historical cost and depreciated over 5 years. The Company
receives film licensing fees and cash flow income is split between the joint
venture partners.

Accrued Expenses - The Company provides for commission and applicable royalties
on revenue recognized in connection with certain agreements. The commission
accrual as of June 30, 1998 and 1999 was $427,000 and $820,000, respectively,
and the royalty accrual as of June 30, 1998 and 1999 was $2,847,000 and
$2,425,000, respectively. These amounts are included in accrued expenses in the
accompanying consolidated balance sheets.

     The Company had legal accruals as of June 30, 1998 and 1999 in the amounts
of $584,000 and $298,000, respectively. The Company also had severance accruals
in the amount of $215,000 and $0 as of June 30, 1998 and 1999, respectively.
These amounts are included in accrued expenses in the accompanying consolidated
balance sheets.

Deferred Revenue represents advance payments received for rental of portable
theatre systems and theatre service contracts and are recognized as revenue over
the life of the respective agreements.

Research and Development Costs are incurred in the design, construction and
testing of prototype systems and are charged to expense when incurred. Research
and development expenses amounted to $726,000, $766,000 and $565,000 for the
years ended June 30, 1997, 1998 and 1999, respectively and are included in
selling, general and administrative expenses in the accompanying consolidated
statements of operations.

Income Taxes - The Company has applied Statement of Financial Accounting
Standards No. 109, (Accounting for Income Taxes), which utilizes the liability
method. Deferred income taxes under the liability method arise primarily from
the difference between the timing of recognition of certain revenue and expense
items for financial reporting and income tax purposes.

Advertising cost are expensed as incurred. Advertising expense amounted to
approximately $296,000, $271,000 and $251,000 in the years ended June 30, 1997,
1998 and 1999, respectively, and is included in selling, general and
administrative expenses in the accompanying consolidated statements of
operations.

Cash and Cash Equivalents - The Company places its temporary cash investments
with one high quality financial institution. The investments mature within 30 to
90 days and therefore are subject to limited risk.

Concentration of Credit Risk - The Company conducts credit evaluations of
customers and believes the credit risk from its customers to be minimal.

Qualified 401k Plan - The Company has a Defined Contribution 401k Plan ("Plan")
for all of its eligible employees. Under the Plan, each employee who has
attained the age of eighteen and who has completed three months of service with
the Company is eligible to become a participant. Under the Plan, each
participant is permitted to make tax deferred voluntary contributions of an
amount not to exceed the lesser of 15% of his or her respective compensation and
the applicable statutory limitation. Effective July 1997, the Company began
making matching contributions not to exceed 3% of participants salaries to the
Plan, and has consequently recorded an expense of approximately $109,000 and
$96,000 in fiscal 1998 and 1999, respectively.

                                       36

<PAGE>

Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that effect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from these estimates.

Fair Value of Financial Instruments - The Company's financial instruments, other
than cash, accounts receivable at June 30, 1999. and accounts payable, consist
primarily of investments in debt securities. The fair value of investments in
debt securities is based on quoted market prices.

2. ACQUISITION OF PIONEER

     On March 4, 1997 two newly formed wholly-owned subsidiaries of the Company
acquired all the stock of Pioneer (a manufacturer of motion picture projectors)
in exchange for 299,101 shares of Iwerks Common Stock. Concurrently, the Company
purchased a patent from a partnership related to Pioneer for approximately
$1,114,000 in cash. These transactions were accounted for as a purchase with an
aggregate purchase price of approximately $2,784,000 including acquisition
costs. The aggregate purchase price of Pioneer in excess of the fair value of
the identifiable assets of Pioneer at the date of acquisition was $1,536,000 and
has been allocated to goodwill. The operations of Pioneer have been consolidated
with the operations of the Company from March 4, 1997.

3. SHORT-TERM INVESTMENTS

     The carrying amounts of the Company's investments in debt securities at
June 30, 1998 and 1999 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                     Carrying Amount
                                               ---------------------------
SECURITY                                            1998          1999
--------                                       --------------  -----------

<S>                                            <C>             <C>
Commercial Paper                               $        2,922  $     2,500
                                               --------------  -----------
Total Short-Term Investments                   $        2,922  $     2,500
                                               ==============  ===========
</TABLE>

    The principal amount, cost and fair value are not materially different than
the carrying amount as shown above. There were no sales of available for sale
securities for fiscal year 1999. Realized gains or losses from debt securities
sold during the year ended June 30, 1998 and 1999 were not material. The basis
on which cost was determined on calculating gains and losses was the specific
identification method.

4. BILLINGS IN EXCESS OF COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

     Billings in excess of costs and estimated earnings on uncompleted contracts
at June 30, 1998 and 1999 consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                        1998           1999
                                                    ------------   ------------
<S>                                                 <C>            <C>
Costs incurred on uncompleted contracts             $     14,486   $     20,704
Estimated earnings                                        13,228         19,521
                                                    ------------   ------------
                                                          27,714         40,225
Less billings to date                                   (29,111)       (45,738)
                                                    ------------   ------------
                                                    $    (1,397)   $    (5,513)
                                                    ============   ============
</TABLE>

     Such costs are included in the accompanying balance sheets at June 30, 1998
and 1999 under the following captions (in thousands):

                                       37

<PAGE>

<TABLE>
<CAPTION>
                                                   1998               1999
                                               ------------       ------------
<S>                                            <C>                <C>
Costs and estimated earnings in excess of
   billings on uncompleted contracts           $      1,574       $      1,495
Billings in excess of costs and estimated
   earnings on uncompleted contracts                (2,971)            (7,008)
                                               ------------       ------------
                                               $    (1,397)       $    (5,513)
                                               ============       ============
</TABLE>


5.   NET LOSS PER COMMON SHARE

     In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, Earnings Per Share, which is effective for annual and interim
financial statements issued for periods ending after December 15, 1997. The
statement requires restatement of prior years' earnings (loss) per share
("EPS"). SFAS No. 128 was issued to simplify the standards for calculating EPS
previously found in APB No. 15, Earnings Per Share. SFAS 128 replaces the
presentation of primary EPS with a presentation of basic EPS. Basic EPS excludes
the dilutive effects of stock options and warrants. Diluted EPS reflects all
potential dilutive securities.

     Options and warrants to purchase 425,430, 109,162 and 28,100 shares of
common stock during the years ended June 30, 1997, 1998 and 1999, respectively
were not included in the computation of diluted loss per common share as the
effect would be antidilutive.

6.   PROPERTY AND EQUIPMENT

     Property and equipment is stated at cost and is comprised of the following
at June 30, 1998, and 1999 (in thousands):


<TABLE>
<CAPTION>
                                                       1998           1999
                                                       ----           ----
<S>                                                    <C>             <C>
     Office equipment, furniture and fixtures          2,247           2,298
     Operating equipment                               1,226           2,062
     Film production equipment                         4,012           5,195
     Demonstration theatres                            3,548           3,555
     Leasehold improvements                            1,279           1,371
                                                    --------        --------
          Total                                       12,312          14,481
     Less accumulated depreciation                    (7,983)         (8,855)
                                                    --------        --------
                                                    $  4,329        $  5,626
                                                    ========        ========
</TABLE>


     Certain transportation equipment aggregating $3,711,000 at June 30, 1998
and 1999 were recorded under capital lease agreements. Accumulated depreciation
on this equipment was $1,307,293 and $ 1,594,967 at June 30, 1998 and 1999,
respectively.

     Depreciation expense amounted to $2,750,000, $1,797,000 and $1,945,000 for
the years ended June 30, 1997, 1998 and 1999, respectively, including amounts
related to assets under capital leases.

                                       38

<PAGE>

7.   RELATED PARTY TRANSACTIONS

Duringe1993, Itochu Corporation ("Itochu"), a stockholder, agreed to pay the
Company $5 million primarily for the right to become the Company's exclusive
distributor for a three year term in Asia for its Cinetropolis concept.
Cinetropolis is a location based entertainment attraction utilizing multiple
Iwerks products combined with food and beverage, retail and other entertainment
in a stand-alone 35,000 to 60,000 square foot facility. The $5 million was
recorded in deferred revenue and has been amortized over the three year
exclusivity period. In addition, Itochu became a nonexclusive agent for Iwerks'
other products for seven years. Itochu earns sales commissions on collections
from customers on any theatre systems and related software sold by Itochu or its
agents. During the years ended June 30, 1997, 1998 and 1999, $489,000, $291,000,
and $145,000 respectively, was paid to Itochu in connection with this
arrangement. This arrangement will terminate in December 1999.

                                       39

<PAGE>

8.   INCOME TAXES

     Significant components of the provision for income taxes are as follows:

<TABLE>
<CAPTION>

                                                                        Year ended June 30,
                                                    --------------------------------------------------------------
                                                          1997                  1998                   1999
                                                    -----------------     -----------------      -----------------

<S>                                                 <C>                  <C>                   <C>
Current
   Federal                                          $              40     $               -    $                 -
   State                                                           24                     8                      2
   Foreign                                                         53                    15                      -
                                                    -----------------     -----------------      -----------------
                                                                  117                    23                      2

Deferred:
   Federal                                                          -                     -                      -
   State                                                            -                     -                      -
                                                    -----------------     -----------------      -----------------
                                                    $             117     $              23      $               2
                                                    =================     =================      =================

The reconciliation of income tax computed at the U.S. federal statutory tax rates to income tax expense is:

                                                                         Year ended June 30,
                                                    -----------------     -----------------      -----------------
                                                          1997                  1998                   1999
                                                    -----------------     -----------------      -----------------

Provision for income taxes at statutory
   federal rate of 35%                              $         (3,444)     $         (3,828)      $         (1,672)
   State and local taxes                                           24                     8                      2
   Foreign taxes                                                   53                    15                      -
   Nondeductible items and
     nontaxable items                                           1,019                   266                    242
   Benefit of net operating loss
     not currently recognized                                   2,465                 3,562                  1,430
                                                    -----------------     -----------------      -----------------
                                                    $             117     $              23      $               2
                                                    =================     =================      =================

The deferred tax asset at June 30 consists of (in thousands):

                                                                                1998                   1999
                                                                          -----------------      -----------------

Net operating loss                                                        $           8,160      $          12,480
Reserves                                                                              (450)                  (661)
Asset impairment reserve                                                            (1,507)                (1,507)
Deferred revenues                                                                      (74)                     27
Film cost amortization                                                                  542                    767
Other                                                                                     9                     14
                                                                          -----------------      -----------------
                                                                                      6,680                 11,120
Valuation allowance                                                                 (6,680)               (11,120)
                                                                          -----------------      -----------------
                                                                          $               0      $               0
                                                                          =================      =================
</TABLE>

                                       40

<PAGE>

At June 30, 1999, Iwerks had available federal and state tax net operating loss
carryforwards of approximately $31,200,000 and $14,800,000, respectively,
expiring through 2018.

9.   STOCK OPTIONS AND WARRANTS

     The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of Iwerks' employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.

     The Company has three stock incentive plans adopted in 1987, 1993, and
1994, respectively, which provide for the granting to officers, directors,
employees and consultants options to purchase shares of Iwerks Common Stock. In
addition, the Company adopted a non-employee directors stock option plan in
fiscal 1999 (collectively with the 1987, 1993 and 1994 plans, the "Plans"). In
aggregate, 3,500,000 shares of Iwerks Common Stock are reserved for issuance
under the Plans. The Company has granted other options to purchase 100,000
shares of Iwerks Common Stock to certain officers outside of these plans.
Options generally vest over a four-year period and expire in ten years.

     Terminated employees have 90 days to exercise options, however certain
officers, having separation agreements, have as long as 36 months to exercise
options. At June 30, 1999, there were 588,718 vested options outstanding
relating to two terminated officers which expire at varying dates until July
2001.

     Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for fiscal year 1997, 1998 and 1999, respectively: risk-free
interest rates of 6.36%, 5.55% and 4.84%; weighted-average expected life of the
option of 4.19 years, 4.75 years and 5.00 years; zero dividend yields; and a
volatility factor of the expected market price of Iwerks' Common Stock of 51%,
57% and 86%.

     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

     For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Given this
method of amortization, the initial impact of applying FAS 123 on pro forma net
loss and pro forma loss per share is not representative of the potential impact
on pro forma amounts in future years when the effect of amortization from
multiple awards would be reflected. The Company's pro forma information follows
(in thousands except for per share information):

                                       41

<PAGE>
                                        1997           1998           1999
                                   -----------    -----------    -----------

Pro forma net loss                 $  (10,685)    $  (12,483)    $  (5,489)

Pro forma net loss per share       $    (0.90)    $    (1.02)    $   (0.44)

         A summary of the Company's stock option activities and related
information for the years ended June 30 are as follows:

<TABLE>
<CAPTION>
                                                                   Number of Shares                Weighted Average
                                                                    (IN THOUSANDS)                   EXERCISE PRICE
--------------------------------------------------------  ---------------------------------- -----------------------------

<S>                                                                    <C>                              <C>
Options outstanding July 1, 1996                                        1,926                            $4.26
Options granted                                                           660                            5.54
Options exercised                                                       (260)                            1.82
Options terminated                                                      (425)                            4.96
Options exercisable at June 30, 1997                                      696                            $4.30

Options outstanding July 1, 1997                                        1,901                            $4.88
Options granted                                                          615                             2.81
Options exercised                                                        (24)                            0.35
Options terminated                                                      (159)                            5.33
Options exercisable at June 30, 1998                                    1,414

Options outstanding July 1, 1998                                        2,333                            $4.35
Options granted                                                          450                             1.38
Options exercised                                                        (40)                            0.43
Options terminated                                                      (904)                            5.03
</TABLE>

The weighted-average fair value of options granted was $0.61 in fiscal year
1999, $1.45 in fiscal year 1998, and $2.64 in fiscal year 1997.

                                       42

<PAGE>

The following table summarizes information about stock options outstanding at
June 30, 1999:

<TABLE>
<CAPTION>

                            Options Outstanding                                                      Options
                              Weighted Average                                                      Exercisable
                         --------------------------------------                             ------------------

                                                  Weighted
                                                  Average
                           Outstanding           Remaining
    Range of                   at               Contractual          Weighted          Exercisable at          Weighted
    EXERCISE              June 30, 1999             Life             Average            June 30, 1999          Average
    --------
      PRICES             (IN THOUSANDS)           IN YEARS        EXERCISE PRICE       (IN THOUSANDS)       EXERCISE PRICE
     -------             --------------           --------        --------------       --------------       --------------

<S>                      <C>                     <C>              <C>                  <C>                 <C>
   $ .10-1.81                    524                 7.9               $1.34                 135               $1.43
   $2.16-3.00                    399                 7.7               $2.61                 205               $2.63
   $3.25-4.88                    338                 5.2               $4.12                 246               $4.38
   $5.00-7.38                    549                 4.2               $5.15                 470               $5.13
   $7.56-9.00                     29                 5.9               $8.06                  26               $8.12
                             -------                                                    --------
                               1,839                                                       1,082
                             =======                                                    ========
</TABLE>

    As of June 30, 1997, 1998 and 1999 the Company had 364,582, 23,099 and
575,115 shares available for future grants under the Plans. As of June 30, 1999
Iwerks has reserved 2,413,843 shares of unissued Iwerks Common Stock for
issuance upon exercise of options granted under the Plans and outside the Plans.

    At June 30, 1999 the Company had 8,000 warrants exercisable at $7.30 per
share expiring April, 2003. (See Note 15).

10.  NOTES PAYABLE

    In the fourth quarter of fiscal 1999, one customer contract relating to a
research and development specialty project was terminated. In connection with
the termination, the Company agreed to refund payments previously received from
the customer and establish a note payable for approximately $1.5 million. The
note payable accrues interest at a rate of 7.25% per annum. Approximately
$737,000 and $797,000 in principal payments under the note payable are due in
fiscal year 2000 and 2001 respectively.

11.  COMMITMENTS AND CONTINGENCIES

    The Company leases facilities under operating leases that expire through
2001. Leases that expire are expected to be renewed or replaced. Rental expense
for the years ended June 30, 1997, 1998 and 1999 was approximately $641,000,
$641,000 and $506,000, respectively.

                                       43

<PAGE>

Future minimum lease payments under capital and operating leases at June 30,
1999 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                              Capital             Operating
                                                                              leases               leases
                                                                          ---------------       -------------

<S>                                                                                  <C>                 <C>
2000                                                                                 $867                $240
2001                                                                                  294                  60
                                                                          ---------------       -------------
Total minimum lease payments                                                        1,161                $300
                                                                                                =============
Less amount representing interest                                                    (79)
                                                                          ---------------
                                                                                   $1,082
                                                                          ===============
</TABLE>

         The Company's only capital lease expires in August 2000. At the end of
the lease the Company has the following options: (a) purchase the equipment at a
mutually agreed upon price; (b) extend the lease for an additional twelve months
or (c) return the equipment and enter into a new lease. The Company has not yet
determined which option it will select. Included in capital lease obligations is
a reserve of $150,000 in connection with the termination of this lease.

         At June 30, 1999, the Company is committed to approximately $1.4
million in capital expenditures.

         The Company has also from time to time, provided standby letters of
credit to customers as performance bonds. The customers may draw on the letters
of credit should Iwerks fail to perform under the terms of the contracts. There
were no standby letters of credit outstanding as of June 30, 1999.

12.       SEGMENT AND GEOGRAPHIC INFORMATION

         The Company operates in one business segment - the manufacture,
distribution and operation of entertainment and educational hardware and
software.

         Geographic segment information is as follows (in thousands):

                                      1997             1998           1999
                                   ----------       ----------     ----------

          United States            $   15,686       $   13,787     $   15,234
          Asia                         18,217            6,885         10,434
          South America                 5,259            2,448            550
          Europe                          911            2,354          8,148
          Canada                          124              357            503
          Other                             -                -              -
                                   ----------       ----------     ----------

          Total export revenue     $   40,197       $   25,831     $   34,869
                                   ==========       ==========     ==========


     Nearly all of the Company's identifiable assets are located in the United
States. In fiscal 1997, 1998 and 1999, the Company had no customers who
accounted for more than 10% of consolidated revenues.

13.       ASSET IMPAIRMENT IN FISCAL 1997

    The fourth quarter of fiscal 1997 includes a non-cash charge of $5.6 million
to record the impact of the adoption of SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of."
This charge consisted primarily of a reduction in the carrying value of the
portable

                                       44

<PAGE>

simulation business (touring) to the net present value of the future cash flows
expected from these assets. Of the charge, $1.8 million reduced Goodwill, and
the balance reduced Iwerks' fixed assets. The Company lost AT&T as a major
sponsor of the Reactor(TM) fleet in the first quarter of fiscal 1997. The loss
of the major sponsor that utilized five of the Reactors throughout fiscal 1996
resulted in excess capacity between early fall and late spring of fiscal 1997.
Since that time, and through the fourth quarter of fiscal 1997, the Company
aggressively pursued new sponsorship opportunities and other options to replace
those revenues.

The failure to consummate those opportunities prior to the end of fiscal 1997
and the lack of sponsorship backlog as of June 30, 1997 prompted the Company to
take the charge under SFAS 121.

14. FOURTH QUARTER ADJUSTMENTS IN FISCAL 1997

     In the fourth quarter of fiscal 1997, certain events occurred which
resulted in changes in accounting estimates. These include additional film
amortization of $746,000 due to changes in revenue estimates; increased bad debt
reserve by $557,000 due to an account which was deemed uncollectible,
established a legal and dispute reserve of $850,000 for disputes that first
arose in the fourth quarter of fiscal 1997; increased the warranty reserve by
$147,000 due to increase work performed on a contract, increased accrued
expenses by $320,000 due to a regulatory audit and reduced previously recognized
earnings by $205,000 in connection with the cancellation of a contract.

15.  STOCKHOLDERS RIGHTS PLAN

     The Company has adopted a Stockholder Rights Plan (the "Agreement").
Pursuant to the Agreement each outstanding share of Iwerks' Common Stock has
received one right entitling the holder to purchase 1/100th of a share of
Series A Preferred Stock of Iwerks for each share of Iwerks Common Stock then
held by such holder. Each right becomes exercisable upon certain triggering
events related to an unsolicited takeover attempt of Iwerks.

16.  LITIGATION

     In the fourth quarter of fiscal year ended 1996, the Company reached an
agreement with the plaintiffs to settle all pending shareholder class action
suits against the Company and certain of its officers and directors in the
United States District Court of the Central District of California. In
accordance with the principal terms of the agreement, $1.75 million was paid by
the Company's insurance carrier (with unclaimed amounts being returned to the
carrier). In fiscal 1996 and 1998 an aggregate of 235,246 shares of Iwerks'
Common Stock and 470,494 warrants to purchase Iwerks' Common Stock were issued
by the Company to the plaintiffs and their attorneys. The warrants were
exercisable through July 2, 1999, at an exercised price of $8.78. The Company
received the proceeds from the exercise of the warrants when they were
exercised. The Company took a charge against earnings of $1.7 million in the
fourth quarter of fiscal 1995 to reflect the anticipated costs of the
settlement. Further, there can be no assurance that others not included in the
settlement will not file similar claims in the future.

     Fred Hollingsworth III, a former director of the Company and former chief
executive officer and founder of Omni Films International, Inc., filed suit in
1996 against the Company and seven of its current or former officers and
directors. In February, 1997 the Company and Mr. Hollingsworth reached an
out-of-court settlement. The Company made a cash payment to Mr. Hollingsworth
which the Company was reimbursed by its insurance carrier in the quarter ended
June 30, 1997.

     There are no material legal proceedings to which the Company is a party
other than ordinary routine litigation in the course of business. In the opinion
of management, based in part on the advice of counsel, resolution of these
matters will not have a material adverse impact on the Company's consolidated
financial position or results of operations.

                                       45

<PAGE>

17.       EVENTS SUBSEQUENT TO AUGUST 17, 1999

     On September 9, 1999 the Company announced the appointment of two new
outside members to its Board of Directors bringing the number of outside
Directors to eight. Peter Guber, co-founder of Mandalay Entertainment Group was
appointed Chairman of the Board of Directors and Paul Schaeffer, co-founder of
Mandalay entertainment Group was appointed Vice Chairman of the Board of
Directors. In connection with the transaction, the two new members received
warrants to purchase 1,550,000 shares of Iwerks common stock. The warrants were
issued in four tranches of equal amounts ranging in a per share price of $1.43
to $3.00. Certain restrictions apply to the exercise of these warrants which
have a life of five years. The purchase price of the warrants were $250,000 and
will be amortized over the life of the warrants.

ITEM 9.  CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------------
FINANCIAL DISCLOSURE.
--------------------

     None.


                                       46

<PAGE>

PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT.
--------------------------------------------------------

     On February 10, 1999 Jeffrey M. Dahl was appointed Chief Financial Officer
replacing Bruce C. Hinkley. Dahl was formerly the Vice President, Controller of
Iwerks Entertainment, Inc.

     On August 27, 1999 Jack Shishido resigned as Senior Vice President
Worldwide Sales and Marketing.

     On September 9, 1999 the Company announced the appointment of two new
outside members to its Board of Directors bringing the number of outside
Directors to eight. Peter Guber, co-founder of Mandalay entertainment Group was
appointed Chairman of the Board of Directors and Paul Schaeffer, co-founder of
Mandalay entertainment Group was appointed Vice Chairman of the Board of
Directors.

     Information regarding directors and executive officers of the Company will
appear in the Proxy Statement for the 1999 Annual Meeting of Stockholders, and
is incorporated herein by this reference.

ITEM 11.  EXECUTIVE COMPENSATION.
--------------------------------

     Information regarding executive compensation will appear in the Proxy
Statement for the 1999 Annual Meeting of Stockholders, and is incorporated
herein by this reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
------------------------------------------------------------------------

     Information regarding security ownership of certain beneficial owners and
management of the Company will appear in the Proxy Statement for the 1999 Annual
Meeting of Stockholders, and is incorporated herein by this reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
--------------------------------------------------------

     Information regarding certain relationships and related transactions will
appear in the Proxy Statement for the 1999 Annual Meeting of Stockholders, and
is incorporated herein by this reference.

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
--------------------------------------------------------------------------

(A)    FINANCIAL STATEMENTS:                                    PAGE NUMBER
                                                                -----------
       Report of Independent Auditors                               29

       Consolidated Balance Sheets                                 30-31
       June 30, 1998 and 1999

       Consolidated Statements of Operations                         32
       Years Ended June 30, 1997, 1998 and 1999

       Consolidated Statements of Stockholders'  Equity              33
       Years Ended June 30, 1997, 1998 and 1999

       Consolidated Statements of Cash Flows                       34-35

                                       47

<PAGE>

        Years Ended June 30, 1997, 1998 and 1999

        Notes to Consolidated Financial Statements                 36-48

     FINANCIAL STATEMENT SCHEDULES:

     Schedule II - Valuation and Qualifying Accounts for the years ended June
30, 1997, 1998 and 1999.

All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.

(B)  EXHIBITS: See Exhibit List attached to this Annual Report on Form 10-K.

(C) REPORTS ON FORM 8-K:       NONE

                                       48

<PAGE>

  SIGNATURES

Pursuant to the requirements of Section 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.

                                     IWERKS ENTERTAINMENT, INC.
                                            (Registrant)

                                     By:  /S/ CHARLES GOLDWATER
                                         -----------------------
                                         Charles Goldwater
                                         Chief Executive Officer

                                     Date:  September 23, 1999

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of Registrant and in
the capacities and on the dates indicated.

         SIGNATURE                       TITLE                       DATE
         ---------                       -----                       ----

  /S/ CHARLES GOLDWATER            President and CEO          September 23, 1999
  ----------------------     (Principal Executive Officer)
     Charles Goldwater

                                 Senior Vice President        September 23, 1999
   /S/ JEFFREY M. DAHL          Chief Financial Officer
  ----------------------      (Principal Finance Officer)
      Jeffrey M. Dahl

   /S/ BRUCE E. PALMORE        Vice President /Controller     September 23, 1999
  ----------------------     (Principal Accounting Officer)
     Bruce E. Palmore

      /S/ PETER GUBER            Chairman of the Board        September 23, 1999
    ------------------
        Peter Guber

    /S/ PAUL SCHAEFFER         Vice Chairman of the Board     September 23, 1999
    ------------------
      Paul Schaeffer

   /S/ DONALD W. IWERKS                 Director              September 23, 1999
   ---------------------
     Donald W. Iwerks

    /S/ DAG TELLEFSEN                   Director              September 23, 1999
   ---------------------
       Dag Tellefsen

     /S/ GARY J. MATUS                  Director              September 23, 1999
    -------------------
       Gary J. Matus

                                        Director
    -------------------
        Bruce Beda

     /S/ PETER HANELT                   Director              September 23, 1999
    -------------------
       Peter Hanelt

                                       49

<PAGE>

                                                                     SCHEDULE II

                           IWERKS ENTERTAINMENT, INC.
                        VALUATION AND QUALIFYING ACCOUNTS
                FOR THE YEARS ENDED JUNE 30, 1997, 1998 AND 1999


<TABLE>
<CAPTION>
                                     BALANCE AT
                                      BEGINNING                                                       BALANCE AT
CLASSIFICATION                         OF YEAR               ADDITIONS            WRITE-OFFS          END OF YEAR



<S>                                 <C>                   <C>                    <C>                <C>
FOR THE YEAR ENDED JUNE 30, 1997
ALLOWANCE FOR DOUBTFUL ACCOUNTS     $   292,990           $    843,495           $    25,171        $   1,111,315

FOR THE YEAR ENDED JUNE 30, 1998
ALLOWANCE FOR DOUBTFUL ACCOUNTS     $ 1,111,315           $  1,808,250           $ 1,026,333        $   1,893,232

FOR THE YEAR ENDED JUNE 30, 1999
ALLOWANCE FOR DOUBTFUL ACCOUNTS     $ 1,893,232           $    997,783           $ 1,068,340        $   1,822,675

</TABLE>

                                       50

<PAGE>

                                  EXHIBIT INDEX

  3.1      CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION DATED
           AUGUST 1, 1997. ***
  3.2      BYLAWS OF IWERKS. **
  4.1      SPECIMEN CERTIFICATE EVIDENCING COMMON STOCK OF IWERKS.*
  4.2      WARRANT AGREEMENT, DATED APRIL 30, 1993, BY AND BETWEEN IWERKS AND
           RICHARD KING INTERNATIONAL.*
  4.3      WARRANT TO PURCHASE 339,063 SHARES OF COMMON STOCK OF THE REGISTRANT,
           DATED SEPTEMBER 8, 1999, BY THE REGISTRANT TO THE GUBER FAMILY TRUST
           DATED OCTOBER 20, 1978.********
  4.4      WARRANT TO PURCHASE 339,063 SHARES OF COMMON STOCK OF THE REGISTRANT,
           DATED SEPTEMBER 8, 1999, BY THE REGISTRANT TO THE GUBER FAMILY TRUST
           DATED OCTOBER 20, 1978. ********
  4.5      WARRANT TO PURCHASE 339,062 SHARES OF COMMON STOCK OF THE REGISTRANT,
           DATED SEPTEMBER 8, 1999, BY THE REGISTRANT TO THE GUBER FAMILY TRUST
           DATED OCTOBER 20, 1978. ********
  4.6      WARRANT TO PURCHASE 339,062 SHARES OF COMMON STOCK OF THE REGISTRANT,
           DATED SEPTEMBER 8, 1999, BY THE REGISTRANT TO THE GUBER FAMILY TRUST
           DATED OCTOBER 20, 1978. ********
  4.7      WARRANT TO PURCHASE 48,438 SHARES OF COMMON STOCK OF THE REGISTRANT,
           DATED SEPTEMBER 8, 1999, BY THE REGISTRANT TO THE PAUL AND JUDY
           SCHAEFFER LIVING TRUST DATED FEBRUARY 28, 1992. ********
  4.8      WARRANT TO PURCHASE 48,438 SHARES OF COMMON STOCK OF THE REGISTRANT,
           DATED SEPTEMBER 8, 1999, BY THE REGISTRANT TO THE PAUL AND JUDY
           SCHAEFFER LIVING TRUST DATED FEBRUARY 28, 1992. ********
  4.9      WARRANT TO PURCHASE 48,437 SHARES OF COMMON STOCK OF THE REGISTRANT,
           DATED SEPTEMBER 8, 1999, BY THE REGISTRANT TO THE PAUL AND JUDY
           SCHAEFFER LIVING TRUST DATED FEBRUARY 28, 1992. ********
  4.10     WARRANT TO PURCHASE 48,437 SHARES OF COMMON STOCK OF THE REGISTRANT,
           DATED SEPTEMBER 8, 1999, BY THE REGISTRANT TO THE PAUL AND JUDY
           SCHAEFFER LIVING TRUST DATED FEBRUARY 28, 1992. ********
  10.1     FORM OF INDEMNIFICATION AGREEMENT AND SCHEDULE OF INDEMNIFIED
           PARTIES.*
  10.2     PURCHASE AGREEMENT DATED JANUARY 23, 1991, BY AND BETWEEN IWERKS AND
           RIDE AND SHOW ENGINEERING, INC.*
  10.3     AMENDED AND RESTATED 1987 STOCK OPTION, PURCHASE AND APPRECIATION
           RIGHTS PLAN OF IWERKS.*
  10.6     1993 STOCK INCENTIVE PLAN OF IWERKS.*
  10.7     LEASE FOR 4540 W. VALERIO STREET, BURBANK, CALIFORNIA 91505, DATED
           MAY 15, 1990, BY AND BETWEEN IWERKS AS LESSEE AND SHELDON PLUTSKY AS
           LESSOR.*
  10.8     LEASE FOR 4520 VALERIO STREET, BURBANK, CALIFORNIA 91505, DATED
           SEPTEMBER 1, 1992, AND THE AMENDMENT THERETO, DATED SEPTEMBER 22,
           1992, BY AND BETWEEN IWERKS AS LESSEE AND JAMES E. MCGRAW AS LESSOR.*
  10.9     LEASE FOR 4535 W. VALERIO STREET, BURBANK, CALIFORNIA 91505, DATED
           SEPTEMBER 11, 1991, BY AND BETWEEN IWERKS AS LESSEE AND R.C.
           ASSOCIATES AS LESSOR.*

                                       51

<PAGE>

  10.10    LEASE FOR 4525 W. VALERIO STREET, BURBANK, CALIFORNIA 91505, DATED
           MARCH 23, 1994 BY AND BETWEEN IWERKS AS LESSEE AND THE PENNEY FAMILY
           TRUST AS LESSOR.***
  10.12    1994 STOCK INCENTIVE PLAN OF IWERKS ENTERTAINMENT, INC.**
  10.15    LEASE AGREEMENT - MATRIX FUNDING CORPORATION***
  10.16    SEPARATION AGREEMENT DATED OCTOBER 31, 1997 BETWEEN THE COMPANY AND
           ROY A. WRIGHT *****
  10.17    SEPARATION AGREEMENT DATED OCTOBER 31, 1997 BETWEEN THE COMPANY AND
           BRUCE HINCKLEY *****
  10.18    SEPARATION AGREEMENT DATED OCTOBER 31, 1997 BETWEEN THE COMPANY AND
           WILLIAM J. BATTISON III *****
  10.22    EMPLOYMENT AGREEMENT DATED FEBRUARY 21, 1998 BETWEEN THE COMPANY AND
           CHARLES GOLDWATER ******
  10.23    EMPLOYMENT AGREEMENT DATED MARCH 2, 1998 BETWEEN THE COMPANY AND DAN
           GRIESMER *******
  10.24    EMPLOYMENT AGREEMENT DATED AUGUST 3, 1998 BETWEEN THE COMPANY AND
           JACK SHISHIDO.
  10.25    1998 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN.  INCORPORATED BY
           REFERENCE FROM REGISTRANT'S PROXY STATEMENT ON FORM 14-A FILED
           OCTOBER 28, 1998.
  10.26    RIGHTS AGREEMENT AMENDMENT DATED AS OF JULY 16, 1999, BETWEEN IWERKS
           ENTERTAINMENT, INC. AND U.S. STOCK TRANSFER CORPORATION.
           INCORPORATED BY REFERENCE FROM REGISTRANT'S CURRENT REPORT ON FORM
           8-K FILED ON JULY 23, 1999.
  22.1     SUBSIDIARY LIST.**
  23.1     CONSENT OF INDEPENDENT AUDITORS - ERNST & YOUNG LLP
  27.1     EXHIBIT 27.1 - SCHEDULE OF FINANCIAL INFORMATION
 --------------


 *        INCORPORATED BY REFERENCE FROM IWERKS' REGISTRATION STATEMENT ON FORM
          S-1, SEC FILE NO. 68022 DECLARED EFFECTIVE ON OCTOBER 19, 1993.

**        INCORPORATED BY REFERENCE FROM REGISTRANTS ANNUAL REPORT ON FORM 10-K
          FOR THE YEAR ENDED JUNE 30, 1995.

***       INCORPORATED BY REFERENCE FROM REGISTRANTS ANNUAL REPORT ON FORM 10-K
          FOR THE YEAR ENDED JUNE 30, 1996.

****      INCORPORATED BY REFERENCE FROM REGISTRANTS ANNUAL REPORT ON FORM 10-K
          FOR THE YEAR ENDED JUNE 30, 1997.

*****     INCORPORATED BY REFERENCE FROM REGISTRANTS QUARTERLY REPORT ON FORM
          10-Q FOR THE QUARTER AND SIX MONTHS ENDED DECEMBER 31, 1997.

******    INCORPORATED BY REFERENCE FROM REGISTRANTS REGISTRATION STATEMENT ON
          FORM S-4 FILED ON MARCH 4, 1998.

*******   INCORPORATED BY REFERENCE FROM REGISTRANTS QUARTERLY REPORT ON FORM
          10-Q FOR THE QUARTER AND NINE MONTHS ENDED MARCH 31, 1998.

********  INCORPORATED BY REFERENCE FROM REGISTRANT'S CURRENT REPORT ON FORM 8-K
          FILED SEPTEMBER 23, 1999.

                                       52

<PAGE>

                                  EXHIBIT 23.1


                         CONSENT OF INDEPENDENT AUDITORS


WE CONSENT TO THE INCORPORATION BY REFERENCE IN THE REGISTRATION STATEMENT (FORM
S-8 NO. 33-77816) PERTAINING TO THE EMPLOYEES' INCENTIVE STOCK OPTIONS AND OTHER
STOCK OPTION AND WARRANT AGREEMENTS OF IWERKS ENTERTAINMENT, INC. OF OUR REPORT
DATED AUGUST 17, 1999, EXCEPT FOR NOTE 17 AS TO WHICH THE DATE IS SEPTEMBER 9,
1999, WITH RESPECT TO THE CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE OF
IWERKS ENTERTAINMENT, INC. INCLUDED IN THE ANNUAL REPORT (FORM 10-K) FOR THE
YEAR ENDED JUNE 30, 1999.


                                              ERNST & YOUNG LLP

LOS ANGELES, CALIFORNIA
SEPTEMBER 27, 1999


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