<PAGE>
 
   AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 10, 1997
================================================================================
                      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, 1997

[ ]  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

                        Preferred Stock Purchase Rights

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 October 3, 1997, there were outstanding, 12,160,600 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 ($4.125 per
share) of the Registrant's Common Stock on the NASDAQ National Market System was
$43,750,983.  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 1997 Annual Meeting of
Stockholders are incorporated by reference in Part III of this Annual Report.
<PAGE>
 
                                     PART 1
                                        
                               BUSINESS OF IWERKS
                                        
ITEM 1.  BUSINESS.
----------------- 

GENERAL

  Iwerks Entertainment, Inc. and its subsidiaries ("Iwerks" or "the Company") is
a leading provider of high-tech software-based theatre attractions for the out-
of-home entertainment market.  The Company's products combine advanced theatre
systems with entertainment or educational software to create high-impact
"attractions" which immerse audiences in the action.  The Company's products
include ride simulation, giant screen, 360 degree, 3-D, and various other
specialty attractions.  In addition, the Company owns and operates a fleet of
touring ride simulation theatres.  The Company also produces film and video
software for ride simulators and special format theatres.

  The primary markets for the Company's attractions are theme parks, museums,
various types of location-based-entertainment centers, visitor centers, world
expositions 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.  In addition, high-profile retail sites and
casinos are expanding their entertainment offerings to broaden appeal and
stimulate repeat visits.  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 also owns and operates a fleet of 16 portable ride simulation
theatres and is exploring other potential touring opportunities.  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-based
attractions.

-------------------------------------------------------------------------------
OUTLOOK
  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 that any such forward-looking 
statements are not guarantees of future performance and involve risks and 
uncertainties, and that actual results may differ materially from those 
projected in this Report, for the reasons, among others, set forth under "Risk 
Factors."
--------------------------------------------------------------------------------

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<PAGE>
 
  Since inception in 1986 through August 15, 1997, the Company has installed in
excess of 230 fixed-base theatres and touring attractions in 28 countries. Of
these, 111 were ride simulation theatres, which the Company supports with a
library of 39 ride simulation films, the industry's largest ride simulation film
library. The Company's ride simulation film projects include: Super Speedway, A
thrill ride through seven North American race tracks hosted by Craig T. Nelson;
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; Dino Island, a fantasy based on a newly discovered volcanic
island with prehistoric reptiles; Days of Thunder: The Ride, featuring a "200
mph race" to the checkered flag at the Daytona 500, for Paramount Parks;
RoboCop: The Ride, a futuristic fantasy ride through the streets of Detroit with
the popular movie character, "RoboCop"; The Right Stuff: Mach One Adventure, a
film based upon the theatrical release of the same name for Time Warner Six
Flags theme parks; as well as projects for The Walt Disney Company, Universal
Studios-Florida and NASA. The Company has the largest installed base of 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, London, England and Hong Kong.

Recent Developments
-------------------

  On August 5, 1997 the Company and Showscan Entertainment, Inc. ("Showscan") 
announced they signed a definitive agreement to merge. The transaction calls for
each share of Showscan Common Stock to be converted into 0.85 of a share of
Iwerks Common Stock. The Showscan Preferred Stock will be exchanged for Iwerks
Common Stock at the 0.85 ratio on an as converted basis. Iwerks expects to issue
approximately 5.62 million shares of Iwerks Common Stock in the Merger
(excluding shares issuable upon exercise of outstanding Showscan options and
warrants and the 8% Notes), resulting in an estimated transaction value of
approximately $27.4 million (based upon a closing price of Iwerks Common Stock
on the NASDAQ National Market on August 4, 1997 of $4.875 per share). The
transaction will be accounted for as a pooling of interests, after which
Showscan will become a wholly owned subsidiary of Iwerks.

  The Company believes that the Merger will enhance Iwerks' position as a
leading provider of high-tech software-based theatre attractions and establish
the combined company as the premier company in that segment of the out-of-home
entertainment market. The combined company will have a larger installed base of
theatres, consisting of 160 simulation thrill ride screens in 28 counties (the
largest in the world), 16 Portable Reactor simulation thrill rides, and 76 giant
and large screen theatres. The combined company will have an expanded film
library including 68 ride simulation titles and 47 specialty films. The Company
also believes that the merger will provide the combined business with
significant opportunities to realize efficiencies and synergies by operating
with one corporate overhead and the economies of scale.

  Consummation of the Merger is subject to approval by the stockholders of the
Company and Showscan, as well as other customary closing conditions. If
shareholder approval is not obtained or other closing conditions are not
satisfied or if the parties mutually agree to terminate or modify the terms of
the merger agreement, the transaction may not be consummated pursuant to the
existing terms of the merger agreement, or at all. The stockholders' meetings
are scheduled to take place in the fourth calendar quarter of 1997.

BUSINESS STRATEGY

  Historically, the Company's  primary source of revenue has been the sale of
its attractions to customers who own and operate them.  Although hardware sales
accounted for a majority of revenues in fiscal 1997,  a key strategy of  the
Company is to  continue building a recurring revenue base.  To further this
goal, the Company  produces and licenses its entertainment and educational
software for exhibition on its installed base of attractions.  The Company also
owns and operates a fleet of 16 touring ride simulation theatres from which it
derives admission and sponsorship revenue and the Company is pursuing other
opportunities to participate in the operation of  attractions.

  A key strategy to build recurring revenues began in fiscal 1996 with the
Company's entry into joint venture and partnership relationships with operators
of entertainment centers. In Spring 1996, the Company entered into a joint
venture arrangement with Hoyt's Cinemas, an international multi-plex theatre
operation, and opened the first theatre in Melbourne, Australia in July 1996.
Another venture was formed with Dave and Buster's Inc., a Texas based operator
of entertainment centers in the United States. In fiscal 1997, the Company
opened 3 simulation theatres pursuant to this joint venture: Bethesda, MD,
Philadelphia, PA and Ontario, CA. These recent agreements supplement the
Company's existing partnership at PIER 39 San Francisco and its royalty
interests in the Company's theatre system at the Foxwoods Casino in Ledyard,
Connecticut.

IWERKS PRODUCTS

     FIXED-BASE RIDE SIMULATION THEATRES.  The Company's line of fixed-base ride
simulators is marketed as Iwerks TurboRide and combines high-resolution
projector film or video software, digital surround sound and moving seats to
fully involve the audience in a realistic,  but simulated experience.  Software
currently available includes a variety of live action and fantasy experiences
such as flying at 

                                       3
<PAGE>
 
supersonic speeds, 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, row
and platform-based simulators in a variety of configurations and at multiple
price points. The Company derived approximately 40%, 44% and 41% of its revenues
from the sale of fixed-base ride simulation theatres in fiscal 1995, 1996 and
1997, 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 and six-channel 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. The Iwerks TurboRide can be reprogrammed to create new adventures.

     PORTABLE RIDE SIMULATION THEATRES. The Company also has developed a
portable ride simulation theatre called the "Reactor," which is transported by
tractor trailers.  The trailers transform to create a theatre with a high
definition video projection system and digital surround sound.  The Reactor
incorporates the same ride simulation technology as the Company's Turbo Ride 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 18%, 20%, and 17%  of its revenues in fiscal 1995, 1996
and 1997, respectively, from the operation and sponsorship of portable ride
simulation theatres.

     GIANT SCREEN THEATRES.  The Company's giant screen theatres are marketed
under the name Iwerks CineDome and Iwerks Theatres, 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 seat up
to 630 people, have steeply raked seating and exhibit films typically lasting
between 15 and 40 minutes.

     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 a standard movie theatre
screen.  The Company's domed screen theatres use a dome-shaped screen up to 88
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 6%, 9% and
12% of its revenues from the sale of giant screen  theatres in fiscal 1995, 1996
and 1997, respectively.

     360 DEGREE THEATRES.  The Iwerks Video 360 Theatre  is a video-based
cylindrical theatre.  Because the video image is created from a digital source,
it can be manipulated through a show control system to make real-time
modifications to the projected image or to insert additional images from other
sources, such as audience members.

     CUSTOM THEATRES.  The Company offers a wide range of custom film and video-
based theatre systems utilizing 70 millimeter and 35 millimeter film formats.
Custom projects range from the sale of individual projectors to complete
theatre systems.

                                       4
<PAGE>
 
     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 and budgetary control of projects without incurring
substantial, continuing overhead expenses.   The Company also provides executive
producer and postproduction services to third parties filming in the Company's
film or video projection formats.

     The Company has a film library which includes, as of August 15, 1997, the
distribution rights to 39 ride simulation films, 4 giant screen films and seven
3D 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 which are generally
available in the marketplace.  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.  As the installed base
of theatres grows, film licensing revenue is expected to increase. The Company
derived approximately 18%, 11 % and 14% of its revenue in fiscal 1995, 1996 and
1997, respectively, from film license agreements and film production contracts.

     The Company's  recent ride simulation films include 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; a fantasy ride
through a dinosaur-inhabited island, Dino Island; a space chase adventure
fantasy, Moon Raid Alpha; 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; a film based on the motion picture RoboCop;
and SOS, an underwater fantasy created by computer generated animation. Many of
the Company's ride simulation and other productions have received industry
recognition. The dramatic new Iwerks TurboRide 3D! took First Place honors for
Best New Entertainment Technology at the November 1996 International Association
of Amusement Parks and Attractions (IAAPA) convention in New Orleans. The
Company also won the prestigious Image Award for Best Overall Presentation.
Secrets of the Lost Temple, premiered at IAAPA, also received an award in the
Best New Product category. Dino Island was rated the best new attraction at the
IAAPA convention, 1994.

     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.  Film rentals vary according to the quality of the film, the initial
price paid for the theatre systems and other factors.


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 agents in selected areas.  The sales and marketing
staff consists of 24 employees.  A foreign sales office located in Hong Kong

                                       5
<PAGE>
 
provides support to the Company's Japanese and Asian marketing programs and
assists in customer service.  A satellite sales office was established in
London, England in May 1997 to support the European and Middle East
marketplaces.  In addition, the Company has sales professionals located in
Burbank, California and Sarasota, Florida. The Company also has agreements with
independent sales representatives covering the countries of Japan, Taiwan,
Thailand,  Hong Kong, Korea, and other parts of Asia, Australia, Brazil, China,
Germany, Israel, Spain, and  Switzerland.

     The Company markets its attractions, including theatre systems and film
software, mainly to theme parks, museums, visitor centers, casinos, world
expositions, location-based-entertainment centers and special event venues.  The
Company's theatre systems include projection and audio equipment, show control
systems, film handling equipment and, in most instances, ride simulation
systems.  The customer supplies its own theatre space and other necessary site
improvements to operate the theatre. The Company provides installation,
training, design, maintenance and other support services.

     The primary market for the Company's 3D and 2D ride simulation theatres has
been the worldwide amusement and theme park industry.  Continuing sales will
come from previously existing parks looking for new attractions, and parks under
development looking for an array of attractions and the expanding location-
based-entertainment industry.  Most 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, 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 $5 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 and 3D theatres have
been museums, visitor destination centers, world expositions and other
institutional exhibition facilities frequented by large numbers of visitors.
Increasingly, Cineplex operators are viewing giant screen theaters as a new
entertainment option for their guests. The Company sells its giant screen and
360 degree theatres at prices which are separately negotiated.

     One of the Company's customers, AT&T,  accounted for more than 10% of
Iwerks' revenues in fiscal 1995.   No single customer accounted for more than
10% of revenues in fiscal 1996 and 1997.

     The Company's sales typically are made pursuant to written contracts, and
are denominated in United States dollars.  International 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 1995, 1996 and 1997, 55%, 49% and 55% of the Company's revenues,
respectively, were derived 

                                       6
<PAGE>
 
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 paying Iwerks its nonrecoverable 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, 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.

     Iwerks Quatro(TM) is a 70-millimeter projection system designed to offer
small ride simulation venues high-clarity film quality in locations which were
previously limited to video systems. The Iwerks Quatro(TM) houses four ride
simulation films on one reel, reduction printed from the larger format 8/70 to
35mm image size; two operating in the forward direction and two in the reverse
direction. This eliminates the need for a film storage system while providing
fast cycle times. All claims have been allowed on the Company's patent
application on certain features of the Quatro(TM) projection system and the
Quatro(TM) is now a patented proprietary projection technology.

     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 destination theatres
common to museums and visitor centers 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 88' 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  CineDome and Iwerks Theatres.

       In fiscal 1997, the Company acquired Pioneer Technology Corporation and
  the proprietary 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 produces an image that is brighter and more stable than other projectors
  available.

                                       7
<PAGE>
 
     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.  In the Iwerks Video 360  theatre, the video imaging and show control
systems allow real-time manipulation of the projected image to allow a variety
of special effects.

     MOTION BASES.  The Company's  ride simulation theatres utilize seat-based
and platform-based ride simulation technologies with per-base capacities ranging
from two to thirty.  The Turbo Tour 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.  Each motion base is a
self-contained system, requiring only electronic communications and electrical
power connections.  The Motion Master is four-axis seat-based technology which
permits pitch, vertical, roll and sway (a lateral side-to-side movement).  This
system provides every rider an identical experience, generally requires less
space per seat and is very cost effective.  The Transporter is a two- and four-
seat, six-axis motion base capable of producing the most realistic ride
simulation available.  These 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.  The Freedom Six is a large platform-
based six-axis system which has generally been custom designed to meet a
customers requirements for capacity.

     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.

MANUFACTURING

     The Company manufactures and assembles its theatre systems at its
facilities in Burbank, California.  A majority of the components for the
Company's  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'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 

                                       8
<PAGE>
 
incurred in the design, construction and testing of prototype systems and are
charged to expense as incurred. The research and development expenses were
$848,000 $358,000 and $726,000 for the years ended June 30, 1995, 1996 and 1997,
respectively. Of the expenses, 47%, 32% and 23% in 1995, 1996 and 1997,
respectively, were for improvements to existing products and the remainder was
for development of new products.

     The Company recently acquired the technology and patents to produce the
Linear Loop Projector ("LLP") which is a new technology in film handling and
projection.  The Company is currently building its first 25 LLP projectors and
will utilize them not only in its Large Format Theatres, but also as its
projector of choice in larger ride simulation installations.  The LLP is
manufactured by the Company and is not an upgrade or rework of an existing
vendored product.  The technology is unique, patented and a distinctive
advantage compared to "geneva" driven models that preceded it.

     Ballantyne of Omaha, a leading manufacturer of professional motion picture
projectors, supplies the Company with its 8/70 projectors.  The Company makes
substantial modifications to the projectors to make them suitable for the
Company's  use.  Lenses and lamphouses incorporated in the projection systems
are supplied to the Company by third parties.  If the Ballantyne projectors were
for any reason to become unavailable, the Company believes that it would be able
to substitute other projectors.

     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 metal fabrication portion of the Motion Master is performed by a third
party. To the extent that the outside supplier may be unable to produce
acceptable quality or produce within acceptable lead times, the Company may
experience a temporary reduction in its ability to deliver this product. This
could have a material adverse impact on the Company's business.

RISK FACTORS

INTEGRATION OF IWERKS AND SHOWSCAN; ANTICIPATED NET LOSS

     Iwerks has entered into the Merger Agreement with Showscan with the
expectation that the transaction will result in beneficial synergies for the
combined business. Iwerks believes that the Merger will expand Iwerks'
leadership position in simulation, better position Iwerks to develop higher
quality software, bring Iwerks additional technologies at a lower cost than
initiating research and development efforts, strengthen Iwerks' geographic
presence worldwide, provide for access to new markets and increase recurring
revenues while allowing significant cost savings.

     Achieving these anticipated business benefits will depend in part on
whether the operations of Showscan can be integrated with the operations of
Iwerks in an efficient, effective and timely manner. There can be no assurance
that this will occur. The combination of the companies will require, among other
things, integration of the companies' management staffs, coordination of the
companies sales and marketing efforts, integration and coordination of the
companies' film production and distribution efforts, acceptance by the
companies' respective theatre networks of film software originally produced in
the other company's format, and the identification and elimination of redundant
and/or unnecessary overhead. The success of this process will be significantly
influenced by the ability of the combined business to retain key management,
marketing and production personnel. There is no assurance that this integration
will be accomplished smoothly or successfully or that Iwerks will be successful
in retaining key members of management. The difficulties of such integration may
be increased by the necessity of coordinating theatre networks based on
differing projection technologies and distinct operating cultures. The
integration of operations of the companies following the Merger will require the
dedication of management resources, which may temporarily distract management's
attention from the day-to-day business of the combined business. The inability
of management to integrate successfully the operations of the companies could
have an adverse effect on the business and results of the combined business. In
addition, even if the operations of the companies are ultimately successfully
integrated, it is anticipated that the integration will be accomplished over
time and, in the interim, the combination may have an adverse effect on the
business, results of operations and financial condition of the combined
business. In particular, as a result of nonrecurring costs associated with the
Merger, a reduction in hardware contracts in fiscal 1997 and due to seasonal
factors, Iwerks anticipates that it will report a net loss for the first and
second quarters of fiscal 1998. The estimated non-recurring costs of $6.3
million to be incurred in the first and second quarter of fiscal 1998 include
investment banking, legal, accounting, printing, severance, expenses for
consolidation of facilities and other expenses, some of which will be incurred
even if the Merger is not consummated.

     In addition, there can be no assurance that the present and potential 
customers of Iwerks and Showscan will continue their current utilization 
patterns without regard to the proposed merger.  Any significant reduction in 
utilization patterns by Iwerks and Showscan customers, could have an adverse 
effect on the near-term business and results of operations of the combined 
business.

ANTICIPATED EFFECTS OF THE MERGER

     Iwerks currently is evaluating the operations of the business of Showscan
for purposes of developing a plan for the integration of the business to be
acquired with Iwerks' existing operations. Although this plan is not complete,
it is anticipated that a significant restructuring of the combined operations
will be required as a result of the Merger. As a consequence of this
restructuring and the consummation of the Merger, Iwerks anticipates that a
significant restructuring of the combined operations will be required as a
result of the Merger. As a consequence of this restructuring and the
consummation of the Merger, the Company anticipates incurring one-time
restructuring and related charges of $6.3 million in the first and second
quarters of fiscal 1998. 

     The Merger will be accounted for on a pooling of interests basis.  Under 
the pooling rules, the historical financial results of Iwerks will be restated 
to reflect the combination, following certain adjustments.  Following the 
consummation of the Merger, the historical results of Iwerks will be restated to
reflect the historical profits and losses of Showscan.  Showscan generated 
profits in each of fiscal years ended 1995 and 1996 and incurred losses in the 
fiscal year ended March 31, 1997 and in the first quarter of fiscal 1998 which 
ended June 30, 1997.  In addition, Showscan is expected to incur losses in its 
second fiscal quarter of 1998.  Further, under the pooling rules, the costs 
incurred by Iwerks and Showscan in consummating the Merger will be expensed 
during Iwerks' first and second fiscal quarters of 1998.

     The combined effect of the restructuring and other charges discussed above 
and the pooling accounting treatment in the Merger will have an adverse effect 
on the results of operations of Iwerks in each of the first and second fiscal 
quarters of 1998.

DEPENDENCE ON PRODUCTION OF FILM SOFTWARE; FINANCIAL RISKS OF FILM PRODUCTION

     The Company's ability to implement its business strategy depends in large
part upon its ability to successfully create, produce and market entertainment
and educational film software for exhibition in its theatre systems. The size
and quality of the Company's library of film software titles is a material
factor in competing for sales of the Company's attractions and developing the
Company's base of recurring revenue. The Company has invested $2.6 million, $0.8
million and $2.5 million in film software during fiscal 1995, 1996 and 1997,
respectively.

     The Company generally produces and develops specialty films and videos for
its library with production budgets in a range of approximately $100,000 to $2.0
million. While the Company may enter into participation, licensing or other
financing arrangements with third parties in order to minimize its financial
involvement in production, the Company generally is subject to substantial
financial risks relating to the production and development of new entertainment
and educational software. The Company
                                       9
<PAGE>
 
typically is required to pay for the production of software during the
production period prior to release and typically is unable to recoup these costs
from revenues from exhibition licenses prior to 24 to 36 months following
release. There can be no assurance that Iwerks will be able to create and
produce additional software for its library which will be perceived by its
customers to be of high quality or high entertainment value.

  At June 30, 1997, the Company  had recorded on its balance sheet $3.4 million,
in film library costs. The Company periodically reviews the net realizable value
of its film inventory and makes adjustments to its carrying value when
appropriate.  In fiscal 1995, the Company reduced its film inventory by $3.5
million.  While the current carrying value of the Company's film inventory
reflects management's belief that it will realize the net value recorded on its
balance sheet, there can be no assurance that it will be able to do so.

DEPENDENCE OF OWNED AND OPERATED OPERATIONS UPON SPONSORSHIP REVENUES

       The Company derived $3.7 million, $7.4 million and $2.9 million of
  revenues for fiscal 1995, 1996 and 1997 respectively, from sponsorship of its
  fleet of touring motion simulators. Sponsorship revenues prior to January 1996
  were primarily derived from a single contract with a major telecommunications
  company (AT&T Corp.) that has sponsored the Company's touring motion
  simulators from March 1994 through September 1996. Revenues from AT&T Corp.
  were 11.5%, 9.9% and 3.7% of total revenue for fiscal 1995, 1996 and 1997,
  respectively. The AT&T Corp. contract expired in September 1996. In January
  1996, the Company entered into a sponsorship contract with a foreign sponsor,
  which expired in August 1996. The Company currently has limited sponsorship
  contracts. There can be no assurance that the Company will be able to extend
  or replace its existing sponsorship arrangements when they expire. 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
  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, the
  Company has aggressively pursued new sponsorship opportunities and other
  options to replace these revenues. The failure to consummate these
  opportunities prior to the end of the fiscal year and the lack of sponsorship
  backlog as of June 30, 1997 prompted the Company to take the charge under SFAS
  121. If the Company is unable to maintain sponsorship revenues in the future
  at levels commensurate with that experienced in the past, it could have a
  material adverse effect on the revenues and gross profit margins derived by
  the Company from its Owned and Operated attractions which would be mitigated,
  in part, by any additional revenues derived by the Company from deployment of
  the touring units at other venues.

INTENSE COMPETITION; UNPREDICTABILITY OF CONSUMER TASTES

  Competition in each of the markets in which the Company competes is intense.
The principal direct competition for customers comes from manufacturers of
competing movie-based attractions, and in the case of amusement and theme parks,
manufacturers of traditional amusement park attractions.  In 

                                       10
<PAGE>
 
addition to direct competitors, there is also competition from systems
integrators and some amusement and theme parks developing and constructing their
own attractions. Many of the Company's competitors have better name recognition,
and substantially greater financial and other resources than the Company.

  Imax Corporation ("Imax") and a number of smaller competitors are growing
competitors of the Company in the ride simulation business and have dedicated
substantial resources to entering this market.  In the large screen, special
format motion picture business, Iwerks' main competitor is Imax.  The 15
perforation 70 millimeter ("15/70") film format appears to be emerging as the
most popular large format due primarily to the large number of films available
in that format.  Imax is by far the dominant company in this market.

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

HISTORY OF OPERATING LOSSES; FLUCTUATING PERIODIC OPERATING RESULTS AND CASH
FLOW

  The Company has sustained substantial operating losses in three of its last
five fiscal years.  As of June 30, 1997, the Company's accumulated deficit was
$29.7 million. For the fiscal years ended June 30, 1995, 1996 and 1997, the
Company's ratio of indebtedness to total capitalization was 4.2%, 4.8% and 3.8%,
respectively.  For fiscal year ended June 30, 1995, the Company had a net
decrease in cash of $2.7 million primarily as a result of large cash investments
in the touring business and additions to film inventory partially offset by cash
provided by operating activities.  For the fiscal year 1996, the Company had a
net increase in cash of $6.9 million due to the cash provided by operating
activities being only partially offset by the relatively low amounts of spending
on film inventory and other investing activities and an increase in cash
provided by financing activities.  For the fiscal year 1997, the Company had a
net decrease in cash of $9.1 million primarily resulting from cash used in
investing activities including investments in joint ventures, purchase of
property and equipment, additions to film inventory, the purchase of Pioneer and
related patent and the investment in additional debt securities.  The Company
has experienced quarterly fluctuations in operating results and anticipates that
these fluctuations will continue in future periods. The Company expects to
report a net loss for the first and second quarters of fiscal 1998. Operating
results and cash flow can fluctuate substantially from quarter to quarter and
periodically as a result of the timing of theatre system deliveries, contract
signings, sponsorships, the mix of theatre systems shipped, the completion of
custom film contracts, the existence of world expos, amount of revenues from
portable simulation theatre and film licensing agreements, the timing of sales
of ride simulation attractions, the timing of delivery and installation of such
sales (pursuant to percentage of completion accounting) and any delays therein
caused by permitting or construction delays at the customer's site, the size,
type and configuration of the attractions sold, the timing of film rental
payments

                                       11
<PAGE>
 
from existing attractions and the performance of those attractions that pay film
rental based on a percentage of box office and the timing of sales and marketing
efforts and related expenditures. In particular, fluctuations in theatre system
sales and deliveries from quarter to quarter can materially affect quarterly and
periodic operating results, and theatre system contract signings can materially
affect quarterly or periodic cash flow. Accordingly, the Company's revenues and
earnings in any particular period may not be indicative of the results for any
future period.

  The seasonal fluctuations 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.

  Over the last four years certain events have contributed to fluctuations in
the Company's results of operations and financial condition.  In the fourth
quarter of fiscal 1994, the Company experienced certain cost overruns on two of
its new products, along with some accelerated research and development costs
associated with those products.  In the third quarter of fiscal 1995, the
Company's cost of sales increased dramatically as a percent of sales as a result
of a one-time $4.5 million write-down of certain assets, primarily film costs,
and third and fourth quarter sales and general administration expenses increased
as a result of restructuring charges related to the closure of the Company's
Sarasota, Florida facility, its consolidation of its operations and litigation
costs associated with the settlement of a securities class action lawsuit,
pursuant to which certain common stock and warrants have been issued.  In the
fourth quarter of fiscal 1997, the Company took approximately $8.7 million in
charges, including a loss on impairment of assets, legal and dispute reserve,
additional film amortization expense and an increased bad debt reserve.  See
"MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Comparison of Year Ended June 30, 1997 to Year Ended June 30,
1996" and Note 14 of Notes to Consolidated Financial Statements.


NEW PRODUCT DEVELOPMENT

  The Company operates in a technology driven segment of the entertainment
business.  As such the Company must continually improve its products to increase
their entertainment value while also facing pressure to continually reduce the
price of its products to respond to competitive pressures.  The inability of the
Company to develop new products and to respond to technological developments of
its competitors could have a materially-adverse effect on its business,
operations and financial condition.

INTERNATIONAL OPERATIONS

  A significant portion of the Company's sales and film licensing are made to
customers located outside of the United States, primarily, in the Far East,
Europe, South America and Canada.  During fiscal 1995, 1996 and 1997, 55%, 49%
and 55% of the Company's revenues, respectively, were derived from sales outside
the United States.   During fiscal 1997, the Chinese market was the only foreign

                                       12
<PAGE>
 
market with revenues over 10% of the Company's revenues with 14%. The Company
expects a significant portion (between 45% and 65%) of the Company's sales in
fiscal 1998 and 1999 will be to customers outside of the United States, similar
to the percentage experienced in the past three years. The Company maintains one
office in Hong Kong to support sales in Asia and one office in London to support
sales in Europe. International operations and sales of the Company may be
subject to political and economic risks, including political instability,
currency controls, exchange rate fluctuations (which, in the event of a decrease
in value of foreign currency to the dollar can significantly affect the
affordability of the Company's products overseas), changes in import/export
regulations, tariff and freight rates, longer accounts receivable collection
patterns, changes in regional or worldwide economic or political conditions and
natural disasters. Specifically, in the first quarter of fiscal 1998, the
Company has entered into fewer hardware contracts in Asia than it anticipated.
In addition, various forms of protectionist trade legislation have been proposed
in the United States and certain other countries. Any resulting changes in
current tariff structures or other trade and monetary policies could adversely
affect the Company's international operations. Political and economic factors
have been identified by the Company with respect to certain markets in which it
competes. There can be no assurance that these factors will not result in
customers of the Company defaulting on payments due to it, or in the reduction
of potential purchases of their products. The Company does not engage in any
hedging programs.

CURRENT TRENDS IN THE GLOBAL ECONOMY

  The Company's revenues and profitability are dependent on the strength of the
national and international economies. In a recessionary environment, sales of
the Company's products and products of other entertainment companies may be
adversely affected.  Theme parks and other out-of-home entertainment venues may
also experience a downturn in sales which could reduce the funds available for
capital improvements resulting in price and other concessions and discounts by
the Company in order to maintain sales activity. Although the Company has not
experienced a reduction in unit sales of its products to date, certain of its
competitors have reported that the recent recession in the United States has had
an adverse impact on their sales activity. Consequently, the Company is not able
to predict to what extent, or for what period, a recessionary climate would
adversely affect sales of its products.

DEPENDENCE ON SENIOR MANAGEMENT; RECENT CHANGES TO KEY PERSONNEL

  Since January 1995, all of the Company's executive officers and all except two
members of the Company's Board have changed. Current executive officers are Roy
Wright, Chairman of the Board and Chief Executive Officer, Bruce C. Hinckley,
Executive Vice President, Chief Financial Officer and Secretary and Bill
Battison, Executive Vice President.  The recruitment, retention and motivation
of skilled directors, executives, sales, technical and creative personnel and
other employees are important to the operations of the Company.  The Company's
turnover in management personnel has placed, and could continue to place, a
significant strain on Iwerks' management and other resources.  In addition,
there is competition for management and creative personnel in the industries in
which the Company operates.  There can be no assurance that the combined company
will not encounter difficulties in recruiting and retaining qualified personnel
in the future. Should any key executive officer cease to be affiliated with the
Company before a qualified replacement is found, the Company's  business could
be materially adversely affected.

                                       13
<PAGE>
 
VOLATILITY OF STOCK PRICE

  The Company's stock price has been, and could continue to be, highly volatile.
The market price of the Company's Common Stock has fluctuated substantially in
recent periods.  During the 1997 fiscal year and through  October 3, 1997, the
Company's market price has ranged from a low of $3  1/2, to a high of $10 3/8
per share.  Future announcements concerning the Company or its competitors,
quarterly variations in operating results, introduction of new products or
changes in product pricing policies by the Company or its competitors and
acquisition or loss of significant customers may affect or be perceived to
affect the Company's operations, or changes in earnings estimates by analysts,
among other factors, could cause the market price of the Company's Common Stock
to fluctuate substantially.  In addition, stock markets have experienced extreme
price and volume volatility in recent years.  This volatility has had a
substantial effect on the market prices of securities of many smaller public
companies for reasons frequently unrelated to the operating performance of the
specific companies.  These broad market fluctuations may adversely affect the
market price of the Company's Common Stock.

ENVIRONMENTAL MATTERS AND OTHER GOVERNMENTAL REGULATIONS

  Under various Federal, state and local environmental laws and regulations, a
current or previous owner or occupant of real property may become liable for the
costs of removal or remediation of hazardous substances at such real property.
Such laws and regulations often impose liability without regard to fault.  The
Company leases its corporate headquarters and manufacturing facilities.  The
Company could be held liable for the costs of remedial actions with respect to
hazardous substances on such properties under the terms of the governing lease
and/or governing law.  Although the Company has not been notified of, and is not
otherwise aware of, any current environmental liability, claim or non-
compliance, there can be no assurance that the Company will not be required to
incur remediation or other costs in the future in connection with its leased
properties.  In addition, the Company's subcontractors and other third parties,
with which it has contractual relations, are similarly subject to such laws.

EFFECT OF ANTI-TAKEOVER PROVISIONS

  The Company's Board has the authority to issue up to 1,000,000 shares of
preferred stock and to determine the price, rights, preferences and privileges
of those shares without any further vote or action by the Company's
stockholders.  The rights of the holders of the  Common Stock will be subject
to, and may be adversely affected by, the rights of the holders of preferred
stock.  While the Company has no present intention to issue shares of preferred
stock, such issuance, while providing desirable flexibility in connection with
the possible acquisitions and other corporate purposes, could have the effect of
delaying, deferring or preventing a change in control of the Company and
entrenching existing management.  In addition, such preferred stock may have
other rights, including economic rights senior to the Company's Common Stock,
and, as a result, the issuance thereof could have a material adverse effect on
the market value of the Company's Common Stock.

  A number of provisions of the Company's' Certificate of Incorporation and By-
Laws and the Delaware General Corporation Law ("DGCL") and regulations relating
to matters of corporate governance, certain rights of Directors and the issuance
of preferred stock without stockholder approval, 

                                       14
<PAGE>
 
may be deemed to have and may have the effect of making more difficult, and
thereby discouraging, a merger, tender offer, proxy contest or assumption of
control and change of incumbent management, even when stockholders other than
Iwerks' principal stockholders consider such a transaction to be in their best
interest.

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

PATENTS AND TRADEMARKS

  The Company has several United States and selected other countries' patents on
various processes and elements related to film projection and ride simulation.
The Company has registered its principal trademarks in the United States and
selected other countries. While the Company's patents have not  been challenged
and the Company believes that its patents are valid, third parties could still
challenge the patents and a court could determine that one or more of them are
invalid.  Declarations of invalidity, particularly of key patents, could
adversely affect the marketability of the Company's products and services.

EMPLOYEES

  At August 22, 1997, the Company employed 170 persons, of whom 37 were employed
in management, finance and administration, 24 were employed in sales and
marketing, and 109 were employed in operations.  Although the Company has not
experienced difficulties in obtaining qualified personnel and anticipates that
it will be able to continue to recruit qualified personnel for its operations,
there can be no assurance that such personnel will be available when required.
None of the Company's employees are represented by a collective bargaining
agreement.  The Company believes that its relations with its employees are good.

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

     The Company maintains its principal facility in Burbank, California where
it leases space under four separate leases on adjacent facilities consisting of
36,000, 23,460, 7,596 and 5,184  square feet each, expiring between September
30, 1999 and September 30, 2001.  The Company leases the space for an aggregate
lease payment of approximately $41,000 per month.  The Company believes that its
current facilities are adequate to meet its needs for the immediate future.  If
the Company's  operations were to expand, the Company may require additional
office, warehouse and manufacturing facilities.  The Company believes that
suitable facilities nearby the Company's principal facility in Burbank,
California are generally available.

                                       15
<PAGE>
 
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 impact 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,
1997, no matter was submitted to a vote of the security holders of the
Registrant.

                                       16
<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, 1996                                         ----            --- 
-------------------------------------
<S>                                                              <C>             <C> 
             
First Quarter                                                 $ 6 3/8            $ 4
Second Quarter                                                  6 7/8              4 5/8
Third Quarter                                                   8 1/4              6 1/8 
Fourth Quarter                                                     12              6 15/16

Year Ended June 30, 1997
-------------------------------------
First Quarter                                                 $10 3/8            $ 6 3/8
Second Quarter                                                  7 1/4              4 5/8 
Third Quarter                                                       6              4 1/4
Fourth Quarter                                                  5 1/4              3 11/16 

Year Ended June 30, 1998
-------------------------------------
First Quarter                                                   5 5/8              3 1/2
</TABLE>

          As of October 3, 1997, Iwerks had approximately 400 holders of record.
     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 it's common stock in the
     foreseeable future.

                                       17
<PAGE>
 
ITEM 6. SELECTED FINANCIAL DATA
-------------------------------


<TABLE> 
<CAPTION> 
                                                                        Year Ended June 30
                                                  -------------------------------------------------------------
                                                    1993      1994 (1)     1995 (1)        1996        1997 (2)
                                                  -------     -------      --------      -------       --------
                                                       (Dollars in Thousands Except Per Share Information)
OPERATIONS:
<S>                                               <C>         <C>          <C>           <C>           <C> 
Total revenue                                     $32,239     $36,625      $ 44,975      $48,516       $ 39,584 
Income from operations                              1,412      (8,522)      (13,893)       2,464        (10,573)
Net income (loss)                                 $ 1,247     $(8,055)     $(13,473)     $ 3,099       $ (9,956)

Net income (loss) per share                       $  0.18     $ (1.05)     $  (1.32)     $  0.26       $  (0.84)
Weighted average shares outstanding                 6,967       7,666        10,210       12,144         11,855 

FINANCIAL POSITION (AT PERIOD END):
Cash, cash equivalents and short-term
  investments                                     $ 2,101     $26,526      $ 20,586      $25,281       $ 19,067 

Total assets                                       25,386      81,235        71,626       72,926         64,529

Capital lease obligations and long-term
  debt                                              2,757       3,349         2,130        2,732          1,827

Stockholders' equity                                7,278      62,335        50,374       56,665         48,386

Total liabilities and stockholders' equity        $25,386     $81,235      $ 71,626      $72,926       $ 64,529

PER SHARE DATA:
Net book value per common share                   $  2.44     $  6.25      $   4.76      $  4.89       $   3.97
Common shares outstanding                           2,985       9,968        10,592       11,588         12,160
</TABLE> 


(1) Selected financial data includes Omni Films International, Inc. since the
    acquisition date of May 18, 1994.

(2) 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.

                                       18
<PAGE>

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

General
-------

     The Company is engaged in the business of designing, engineering,
manufacturing, marketing and servicing specialty theatre systems which employ a
variety of projection, show control, ride simulation and software technologies.
The Company is currently in the business of: (a) selling and installing ride
simulation attractions in specialty theatres, (b) selling and installing giant
screen theatres (generally such theatres require projection technology which
utilizes film sizes ranging between five perforations per frame by 70
millimeters (5/70) and fifteen perforations per frame by 70 millimeter (15/70)),
(c) licensing and distributing the films in its library to ride simulation
theatres previously sold by the Company, (d) producing films in the 5/70, 8/70
and 15/70 film format for its film library as well as producing films in these
formats for third parties, (e) investing in joint ventures by contributing its
ride simulation technology, design and equipment and participating in the
theatres profits, and (f) operating a fleet of 16 mobile ride simulation
attractions which it owns.  In addition, during March 1997, the Company
acquired the technology and patents for a state-of-the-art movie projector which
Iwerks uses to manufacture and sell projectors used primarily on theatres
systems designed by Iwerks. The selling and installation of both ride simulation
theatres and large screen theatres includes providing all or part of the design
of such theatres, sale of the projector screens, show control systems, motion
simulators and sound systems.

RECENT DEVELOPMENTS
------------------

     On March 4, 1997 two newly formed wholly-owned subsidiaries of Iwerks
acquired all the stock of Pioneer 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 which has been allocated to goodwill. The operations
of Pioneer have been consolidated with the operations of the Company from March
4, 1997.

     On August 5, 1997 the Company and Showscan announced they signed a 
definitive agreement to merge.  The combined company, which will bring together 
the two largest ride simulation companies, will be the largest provider of ride 
simulation entertainment attractions and software in the world.

     The transaction calls for each share of Showscan Common Stock to be 
converted into 0.85 of a share of Iwerks Common Stock.  The Showscan Preferred 
Stock will be exchanged for Iwerks Common Stock at the 0.85 ratio on an as 
converted basis.  Iwerks expects to issue approximately 5.62 million shares of 
Iwerks Common Stock in the Merger (excluding shares issuable upon exercise of 
outstanding Showscan options and warrants and the 8% Notes), resulting in an 
estimated transaction value of approximately $27.4 million (based upon a closing
price of Iwerks Common Stock on The NASDAQ National Market on August 4, 1997 of 
$4.875 per share).  The transaction will be accounted for as a pooling of 
interests, after which Showscan will become a wholly owned subsidiary of Iwerks.

     Consummation of the Merger is subject to approval by the stockholders of
the Company and Showscan, as well as other customary closing conditions. If
shareholder approval is not obtained or other closing conditions are not
satisfied or if the parties mutually agree to terminate or modify the terms of
the merger agreement, the transaction may not be consummated pursuant to the
existing terms of the merger agreement, or at all. The stockholders' meetings
are scheduled to take place in the fourth calendar quarter of 1997. The Company
anticipates incurring approximately $6.3 million of transaction expenses related
to the Merger in the first and second fiscal quarter of 1998. These include
investment banking, legal, accounting, printing, severance, expenses for
consolidation of facilities and other expenses, some of which will be incurred
even if the Merger is not consummated. These factors plus the seasonality of the
mobile simulation portion of the business and a reduction in hardware contracts
in fiscal 1997 are expected to result in the combined company having losses in
the first two quarters of fiscal 1998.

RESULTS OF OPERATIONS
---------------------

     The Company derives its revenues primarily from three sources: sales of
hardware systems, owned and operated (primarily portable simulation theatres),
and licensing of films.   To a lesser extent, revenues are also earned from
service to existing theatre owners and production of films for third parties.


Revenues for the fiscal year ended June 30, 1995, 1996 and 1997 are analyzed in
the following table (in thousands):

                                       19
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                Fiscal Year Ended June 30
                                            ------------------------------------------------------------------------

                                               1995          %             1996          %           1997          %
                                               ----          -             ----          -           ----          -
<S>                                         <C>           <C>           <C>          <C>          <C>           <C> 
            Hardware sales & service        $24,745        55%          $27,998        58%        $25,829        65%
            Owned and operated                9,279        21%           13,469        28%          8,072        20%
            Film licensing                    4,096         9%            4,800        10%          5,358        14%
            Film production and other         6,855        15%            2,249         4%            325         1%
                                            -------       ---           -------       ---         -------       ---

                                            $44,975       100%          $48,516       100%        $39,584       100%
                                            =======       ===           =======       ===         =======       ===
</TABLE>

  Revenues on sales of theatre systems are recognized on the percentage-of-
completion method 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.  The gross margin for each contract varies
based upon pricing strategies, competitive conditions and product mix.

  Revenues from owned and operated (O & O) consist of portable ride simulation
theatre 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's 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.  Sponsorship and
contract revenues for the portable theatres are recognized ratably over the term
of the contract.

  The Company  typically licenses its film software under one year film license
agreements. Revenues and related expenses are recognized at the beginning of the
license period at which time the customer is billed the license fee and film is
delivered to the customer.

  The Company recognizes revenues and costs associated with the production of
custom films at the time of completion and acceptance by the customer.
Accordingly, the timing of completion of custom films can result in substantial
variability of quarterly revenues and gross margin.  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, Canada,  Europe and South
America. Revenues for the fiscal years ended June 30, 1995, 1996 and 1997
attributable to sales to these countries are analyzed in the following table (in
thousands):
<TABLE> 
<CAPTION> 
                                     Percentage of                     Percentage of                      Percentage of
                             1995    Total Revenue          1996       Total Revenue           1997       Total Revenue
                           -------   -------------        -------      -------------         -------      -------------    
<S>                        <C>            <C>             <C>              <C>               <C>             <C> 
Asia                       $23,029        51.3%           $17,311           35.7%            $13,682           34.6%
South America                   47         0.1%               972            2.0%              5,375           13.6%
  (including Mexico)   
Europe                       1,185         2.6%             4,409            9.1%              2,085            5.3%
Canada                         417         0.9%             1,131            2.3%                516            1.3%
                           -------   -------------        -------      -------------         -------      -------------    
  Total Export Revenues    $24,678        54.9%           $23,823           49.1%            $21,658           54.7%
</TABLE> 

                                       20
<PAGE>
 
    Iwerks expects the percentage of international sales to total sales will not
likely fluctuate significantly in the next twelve months.  The Company maintains
an office in Hong Kong to support sales to Asia.  A sales office was opened in
London, England in May 1997 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 Company defaulting on payments due
to Iwerks, or in the reduction of potential purchases of the Company's products.
Typically, sales are denominated in United States dollars and are backed by
letters of credit, which reduce the risks related to international sales.


COMPARISON OF YEAR ENDED JUNE 30, 1997 TO YEAR ENDED JUNE 30, 1996
-------------------------------------------------------------------

REVENUES

  Revenue for the fiscal year ended June 30, 1997 decreased $8.9 million or 18%
from the fiscal year 1996 revenue.  Owned and operated revenue decreased $5.4
million or 40%, primarily from the Company's  17 touring ride simulators
(Reactors), due primarily to the loss of a major sponsor (AT&T Corp.)in the
first quarter of fiscal 1997.  In addition, fiscal 1996 revenue included a $2.5
million cancellation settlement for an event which was to be held at World Expo
in Tokyo, Japan and there were no such cancellation revenue in fiscal 1997.
During the remaining portion of the fiscal year the Company aggressively pursued
new sponsorship opportunities and looked at other options to replace these
revenues.  The loss of the major sponsor, that utilized 5 of the Reactors
throughout fiscal 1996, resulted in excess capacity between early Fall and late
Spring of fiscal 1997.  In June, 1997 one of the Reactors was sold to a customer
in Korea and the Company continues to actively seek alternatives to increase the
utilization of the remaining 16 Reactors.  The $2.2 million reduction in
hardware sales and service resulted from a reduced number of hardware contracts
in fiscal 1997 compared with fiscal 1996.  Film licensing revenue increased 12%
from fiscal 1996 to fiscal 1997 due primarily to an increase in the number of
theaters which license films.  The decrease in film production and other was due
to no films produced in fiscal 1997 compared to two films produced in fiscal
1996.

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 and installation.  Also included are royalties
payable to a former joint venture partner and estimated warranty expenses.  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.  The Company's 

                                       21
<PAGE>
 
results of operations may vary significantly from quarter to quarter depending
on the timing of theatre system shipments, the mix of theatre system contracts,
the completion of custom film sales, the amount of revenue attributable to
portable ride simulation theatres and film licensing agreements.

  Cost of sales as a percentage of sales was 59% and 73% for the fiscal years
ended June 30, 1996 and 1997, respectively.

  One of the primary reasons for the decrease in the gross margins between
fiscal 1997 and 1996 was due to $1.5 million of charges to cost of sales made in
the fourth quarter of fiscal 1997 due to changes in accounting estimates.  These
included additional film amortization expense on films which have not achieved
their projected revenue ($746,000), additional reserve for disputes ($450,000),
increased warranty reserve ($147,000) due to increased work performance on a
contract, and a reduction of previously recognized earnings by $205,000 in
connection with the cancellation of a contract.  In addition, the costs related
to the revenue received from the cancellation settlement of the Tokyo World Expo
in 1996 were nominal resulting in an unusually high margin in fiscal 1996 which
did not occur in fiscal 1997.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

  Selling, general and administrative expenses (SG&A) include personnel costs,
trade shows and other promotional expenses, sales commissions, travel expenses,
public relations costs, amortization of goodwill, professional fees and
divisional administrative costs.

  Selling, general and administrative expenses were $17.4 million and $15.6
million, for the years ended June 30, 1996 and 1997, respectively.

  The $1.8 million reduction in selling, general and administrative expenses
between fiscal 1997 and 1996 was due primarily to reduced employee related
compensation ($2.3 million), legal and accounting expenses ($0.6 million) and
travel and entertainment expenses ($0.6 million). These reductions were
partially offset by an increase in the provision for doubtful accounts ($0.8
million), increased research and development expenditures ($0.4 million),
increased accrued expenses related to a regulatory audit ($0.3 million) and
expenses related to the proposed Merger ($0.2 million).  (See Note 14 of Notes
to Consolidated Financial Statements).

LOSS ON IMPAIRMENT OF ASSETS

  Due to the Company being unable to replace the major sponsorship revenue from
AT&T Corp. for its portable simulation theatre business and the resulting
excess capacity this generated during the winter months as described above in
the "Revenue" section, the Company recognized a non-cash charge of $5.6 million
in fiscal 1997 primarily for its portable simulation theatres in accordance with
Financial Accounting Standards Board (FASB) release Number 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of". The loss was calculated as the excess of the carrying value of the portable
simulation theatres assets over the estimated future discounted cash flow from
these theatres during the next six fiscal years. (See Note 14 of Notes to
Consolidated Financial Statements). The impairment occurred in the fourth
quarter of fiscal 1997 as a result of disappointing

                                       22
<PAGE>
 
results and an underutilization of Reactors during the quarter, sponsorship and
general admission events below expectations, and the lack of significant
sponsorship backlog as of June 30, 1997.

INTEREST INCOME & EXPENSE

  Interest income for fiscal 1996 and 1997 was $1.2 million and $1.1 million,
respectively.  The slight decrease from 1996 to 1997 resulted primarily from
changes in the invested cash balances during the respective periods.

  Interest expense for fiscal 1996 and 1997 of $380,000 and $391,000 resulted
primarily from financing costs on the portable ride simulation theatres.

INCOME TAXES
------------

The provisions to income taxes were $149,000 and $117,000 to the years ended
June 30, 1996 and 1997, respectively.  As the Company has significant net
operating loss carry forwards, the income tax provisions are primarily for
foreign taxes and state taxes.

NET INCOME (LOSS)
-----------------

The Company recorded net income of $3,099,000 in 1996, compared to a net loss of
$9,956,000 in 1997 due to the reasons mentioned above.

Comparison of Year Ended June 30, 1996 to Year Ended June 30, 1995
------------------------------------------------------------------

REVENUES

   Revenue in fiscal 1996 increased compared with fiscal 1995 in all three
primary revenue sources with a 13% increase in hardware, a 45% increase in owned
and operated (especially from foreign sources) and a 17% increase in film and
other software licensing.  The revenue increase was partially offset by a
decrease in film production.  The Company had several custom film contracts in
fiscal 1995 with no similar contracts in fiscal 1996.

   Owned and operated (O&O)  revenues increased 45% from 1995 to 1996.  In
fiscal 1996, these revenues include foreign source revenues from Taiwan, Puerto
Rico and Argentina.  The fleet of touring ride simulation theatres grew from 12
at the close of fiscal 1995 to 17 early in fiscal 1996.  Sponsorship events
during fiscal year 1996 were primarily with one customer.  Also, fiscal 1996
revenue included a $2.5 million cancellation settlement for an event as
mentioned previously.   Film licensing revenues increased 17% from 1995 to 1996
because of the increase in the number of film license agreements.

   Theatre hardware sales increased 13% from 1995 to 1996 on increased demand
for the Company's theatre systems.  Other revenues have various sources
including exclusivity agreements, distribution rights, forfeited deposits and
settlements on canceled contracts.

                                       23
<PAGE>
 
COST OF SALES

   The gross profit margin improved in fiscal 1996 compared to fiscal 1995 from
26% to 41% primarily because of the Company's focus on hardware profit margins
as well as attention to pricing and improved margins in O&O, particularly in the
portable theatre events where the margin was favorably impacted by cancellation
fees associated with a canceled contract, which amounts were partially offset by
costs incurred in anticipation of performance under the contract.

SELLING GENERAL AND ADMINISTRATIVE EXPENSES

   Selling General and Administrative Expenses were $25.8 million and $17.4
million for the fiscal years ended June 30, 1995 and 1996.  The 32% decrease in
Selling, General and Administrative expenses from 1995 to 1996 resulted
primarily from reduction in administrative costs associated with the closure of
the Sarasota, Florida facility ($2,900,000), and from the 1995 litigation costs
($2,600,000) and bad debt charges ($1,200,000), for which there were no
comparable charges in 1996.

INTEREST INCOME AND EXPENSE

   Interest income for fiscal 1995 and 1996 was $1.0 million and $1.2 million,
respectively.  This increase resulted primarily from changes in the invested
cash balances during the respective periods.

   Interest expense for fiscal 1995 and 1996 was $537,000 and $380,000,
respectively.  This decrease is directly related to the amount of outstanding
debt during the years then ended.

INCOME TAXES
------------

The provisions for income taxes were $85,000 and  $149,000 for the years ended
June 30, 1995 and 1996, respectively.  As the Company had significant net
operating loss carry forwards, the income tax provisions are primarily for
foreign taxes and state taxes.

NET INCOME (LOSS)
-----------------

The Company recorded a net loss of $13,473,000 in 1995, compared to net income
of $3,099,000 in 1996 due to the reasons mentioned above.

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

    The following tables set forth unaudited data regarding operations for each
quarter of fiscal 1996 and 1997 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.

                                       24
<PAGE>
 
<TABLE>
<CAPTION>
                                                    Fiscal 1996
                               -----------------------------------------------------
                                First         Second          Third          Fourth
    (Dollars in thousands)     Quarter        Quarter        Quarter         Quarter
-----------------------------  -------        -------        -------         -------
<S>                            <C>            <C>            <C>             <C>
Revenue                        $10,096        $13,207        $13,825         $11,388
Cost of sales                    5,720          8,239          7,642           7,074
                               -------        -------        -------         -------
Gross Margin                     4,376          4,968          6,183           4,314
Selling, general and
   administrative                4,331          4,648          5,031           3,366
Loss on impairment of assets        --             --             --              --
Interest (income) expense, net     (96)          (284)          (226)           (177)
                               -------        -------        -------         -------
Income (loss) before provision
   for taxes                       141            604          1,378           1,125
Provision for taxes                 --             --             --             149
                               -------        -------        -------         -------
Net income (loss)              $   141        $  $604        $ 1,378         $   976
                               =======        =======        ========        ========
<CAPTION>

                                                    Fiscal 1997
                               -----------------------------------------------------
                                First         Second          Third          Fourth
   (Dollars in thousands)      Quarter        Quarter        Quarter         Quarter
-----------------------------  -------        -------        -------        --------
<S>                            <C>            <C>            <C>             <C>
Revenue                        $ 9,594        $10,023        $11,042        $  8,924
Cost of sales                    6,236          6,955          7,335           8,422
                               -------        -------        -------        --------
Gross Margin                     3,358          3,068          3,707             502
Selling, general and
   administrative                3,381          3,322          3,582           5,338
Loss on impairment of assets        --             --             --           5,586
Interest (income) expense, net    (197)          (197)          (145)           (195)
                               -------        -------        -------        --------
Income (loss) before provision
   for taxes                       174            (57)           270         (10,226)
Provision for taxes                 --             --             --             117
                               -------        -------        -------        --------
Net income (loss)              $   174        $   (57)       $   270        $(10,343)
                               =======        ========       =======        ========

</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. Historically,
the first and fourth fiscal quarters generates the lower quarterly revenue due
to the seasonality of the portable simulation theater operations. Hardware sales
will likely continue to experience inexplicable quarterly fluctuations as they
are substantially dependent on the customers' varying delivery and installation
requirements.

     Over the last eight quarters, certain events have caused unusual
fluctuations. In fiscal 1996, selling, general and administrative expenses
increased in the third quarter as performance compensation was accrued upon
achieving a level of profitability, and revenues and profit margin were
favorably impacted in the third quarter because of cancellation fees received in
respect to a canceled contract.  A significant portion of the Company's
operating expenses are relatively fixed, and planned expenditures are primarily
based upon forecasts.  However, 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
1997, the fourth quarter was impacted by the charge for the asset impairments of
$5.6 million as well as cost of sales expenses totaling $1.5 million for
additional film amortization expense on films which have not achieved their
projected revenue, additional reserve for disputes, increased warranty reserve
and a reduction of previously recognized earnings in connection with the
cancellation of a contract.  Also Selling, General and Administrative expenses
increased in the fourth quarter due to an increase to bad debt reserve due to
accounts which were deemed uncollectible, a legal reserve that first arose in
the fourth quarter, increased accrual due to a regulatory audit and increased
expenses relating to the proposed merger.  (See Note 14 of Notes to Consolidated
Financial Statements).

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

     Since its inception, the Company has financed its operations primarily from
net proceeds from the private placement of $10.3 million in preferred stock, net
proceeds of $47 million from the initial public offering of the Company's Common
Stock in fiscal 1994, and cash flow from operations. The Company  has also
received cash in the amount of $5 million for the sale of certain distribution
rights during the three fiscal years ending June 30, 1996 and proceeds from the
financing of certain equipment purchases.

                                       25
<PAGE>
 
     The Company expects a significant portion (between 45% and 65%) of its
sales in fiscal 1998 and 1999 will be from customers outside the United States,
similar to the percentages of the past three fiscal years.  Fluctuations in
foreign currency in comparison to the U.S. dollar will make the Company's
products either more or less costly to foreign customers than such sales have
been in the past.

     In fiscal 1997, approximately $1.0 million was provided by operating
activities. The Company's  major investing activities included investments in
joint ventures for $1.2 million, additions to film library of approximately $2.5
million, acquisition of Pioneer (see Note 3 of Notes to Consolidated Financial
Statements) and related patent for $1.09 million, and purchase of property and
equipment for $1.2 million.  Financing activities included repayment of notes
payable of $2.1 million.

     In fiscal 1996, approximately $3.7 million in cash was provided by
operating activities, primarily from net income of $3.1 million, depreciation
and amortization of $6.4 million, and a decrease in accounts receivable of $1.3
million.  Offsetting these cash sources were increases in inventories and costs
and estimated earnings in excess of billings on uncompleted contracts, and
decreases in accounts payable and accrued expenses of $4.2 million.   Iwerks'
major investing activities included the purchase of debt securities and to a
lessor extent the purchases for property and equipment and additions to the film
library.   During fiscal 1996, the major financing activities were the repayment
of notes payable and the $3,000,000 proceeds from the financing of five Reactors
that were placed in service early in the fiscal year.

     At June 30, 1997, the Company had cash and short-term investments of
approximately $19.0 million.  In addition, the Company has a $5 million bank
line of credit, none of which was drawn down at June 30, 1997.  The Company
anticipates that its acquisition activities, operating and investment activities
in fiscal 1997 and beyond, including expected investments in O & O joint
ventures will use cash and expects that its cash balance will decline.  If the 
merger is consummated, it is anticipated that the transaction fees associated 
with the merger which effect cash would be approximately $5.3 million.  In 
addition, the Company entered into an agreement to purchase three camera systems
at a cost of $1.8 million. However, the Company believes that its existing cash
balances, the proceeds of the debt securities it owns as they mature, financing
available from the Company's $5 million unused line of credit, and cash flow
from operations will be sufficient to meet its cash requirements through fiscal
1998, after which time it may be required to raise additional cash through the
sale of equity or debt securities, lease financing or other borrowings. In
addition, to the extent Iwerks experiences growth in the future, or its cash
flow from operations is less than anticipated, the Company may be required to
obtain additional sources of cash.

NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------

     In June 1997, the FASB issued Statement No. 130, Reporting Comprehensive 
Income.  The Statement establishes standards for the reporting and display of 
comprehensive income and its components in a full set of general purpose 
financial statements.  The Statement applies to all enterprises that provide a 
full set of general purpose financial statements.  The Statement becomes 
effective for all financial statements for fiscal years beginning after December
15, 1997, with earlier application permitted.  Further, in June 1997, the FASB 
issued Statement No. 131, Disclosures about Segments of an Enterprise and 
Related Information.  The Statement changes the way public companies report 
segment information in annual financial statements and also requires those 
companies to report selected segment information in interim financial reports to
shareholders.  The proposal supersedes FASB Statement No. 14 on segments and 
does not apply to nonpublic enterprises or to not-for-profit organizations.  
The Statement becomes effective for all financial statements for fiscal years 
beginning after December 15, 1997, with earlier adoption permitted.  The Company
has reviewed those Statements and does not believe that they will have a 
material impact on its financial statements and related disclosures.

OUTLOOK AND RISK FACTORS
------------------------
                                       26
<PAGE>
 
With the exception of the historical information, the matters discussed above
include forward-looking statements that involve risks and uncertainties.  Among
the important factors that could cause actual results to differ from those
indicated in the forward-looking statements are revenue, costs of sales and the
ability of the Company to maintain pricing at a level to maintain gross profit
margins, the level of selling, general and administrative costs, the performance
by the Company under its existing purchase contracts and the ability to obtain
new contracts, the success of the Company's owned and operating strategy, the
ability of the Company to find additional sponsors for its Reactors or
alternative sources of revenue, the ability of the Company to identify and
successfully negotiate arrangements with joint venture and other strategic
partners, the success of the Company's film software, the effects of
competition, general economic conditions and acts of God and other events
outside the control of the Company.

                                       27
<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, 1996 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended June 30, 1997.  Our audits also included the
financial statements listed in the Index at Item 14(a).  These financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these financial statements 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, 1996 and 1997 and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended June 30, 1997, 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,
present fairly in all material respects the information set forth therein.



Los Angeles, California                      Ernst & Young LLP
August 5, 1997

                                       28
<PAGE>
 
                          Iwerks Entertainment, Inc.

                          Consolidated Balance Sheets

                                    Assets

                                (in Thousands)

<TABLE> 
<CAPTION> 
                                                                                                  June 30,
                                                                                         --------------------------
                                                                                          1996               1997
                                                                                         -------            -------
Current assets:
<S>                                                                                      <C>                 <C> 
     Cash and cash equivalents                                                           $12,674             $3,608

     Short-term investments (Note 4)                                                       6,782             15,459

     Trade accounts receivable, net of allowance for doubtful                              4,808              5,447
       accounts (Note 1)

     Costs and estimated earnings in excess of billings on                                 5,583              6,339
       uncompleted contracts (Note 5)

     Inventories                                                                           2,798              3,835

     Other current assets                                                                    432                567
                                                                                         -------            -------
         Total current assets                                                             33,077             35,255

Investment in debt securities, excluding current portion                                   5,826                  -

Portable simulation theatres at cost, net of                                               9,084              4,018
         accumulated depreciation

Property and equipment at cost, net of                                                     3,519              2,920
         accumulated depreciation and amortization (Note 7)

Film inventory at cost, net of amortization (Note 1)                                       3,372              3,439

Goodwill, net amortization (Notes 1 and 3)                                                17,360             15,367

Other assets                                                                                 688              3,530
                                                                                         -------            -------
         Total assets                                                                    $72,926            $64,529
                                                                                         =======            =======
</TABLE> 

                            See accompanying notes.

                                       29
<PAGE>
 
                          Iwerks Entertainment, Inc.
 
                          Consolidated Balance Sheets
                     Liabilities and Stockholders' Equity
 
                     (In Thousands, Except Share Amounts)
<TABLE> 
<CAPTION> 
                                                                                               June 30,
                                                                                      ---------------------------
                                                                                        1996               1997
                                                                                      --------           --------
Current liabilities:
<S>                                                                                  <C>               <C>
     Accounts payable                                                                 $  2,815           $  3,435
 
     Accrued expenses                                                                    7,486              8,793
 
     Notes payable to related parties, (Note 8)                                            875                  -
 
     Notes payable, current portion (Note 9)                                               571                 81
 
     Billings in excess of costs and estimated                                           1,106                990
          earnings on uncompleted contracts (Note 5)
 
     Deferred revenue                                                                       61                278
 
     Capital leases, current portion (Note 12)                                             615                739
                                                                                      --------           --------
 
         Total current liabilities                                                      13,529             14,316
 
Notes payable, excluding current portion (Note 9)                                           81                  -
 
Capital lease obligations, excluding                                                     2,651              1,827
         current portion (Note 12)
                                                                                      --------           --------
         Total liabilities                                                              16,261             16,143
 
Commitments and contingencies (Note 12)
 
Stockholders equity (Note 11):
 
     Preferred stock, $0.01 par value, 1,000,000  authorized                                 -                  -
         none issued and outstanding
 
     Common stock, $.001 par value,  20,000,000 shares                                      56                 57
         authorized; 11,588,048 (1996) and 12,160,102 (1997)
         issued and outstanding
 
Paid-in capital                                                                         76,340             78,016
Deficit                                                                                (19,731)           (29,687)
                                                                                      --------           --------
     Total stockholders' equity                                                         56,665             48,386
                                                                                      --------           --------
 
         Total liabilities and stockholders' equity                                   $ 72,926           $ 64,529
                                                                                      ========           ========
</TABLE>
                            See accompanying notes.

                                       30
<PAGE>
 
                          Iwerks Entertainment, Inc.
 
                     Consolidated Statements of Operations
 
               (Dollars in Thousands, Except Per Share Amounts)
 
<TABLE> 
<CAPTION> 
                                                              Years ended
                                                               June 30,
                                                          ---------------------------------------------------------------------
                                                                   1995                        1996                      1997
                                                                 --------                     -------                  --------
 
<S>                                                             <C>                          <C>                      <C>
Revenue                                                          $ 44,975                     $48,516                  $ 39,584
 
Cost of sales                                                      33,081                      28,675                    28,948
                                                                 --------                     -------                  --------
 
Gross margin                                                       11,894                      19,841                    10,636
 
Selling, general and administrative expenses                       25,788                      17,377                    15,623
 
Loss on impairment of assets                                            -                           -                     5,586
                                                                 --------                     -------                  --------

(Loss) income from operations                                     (13,894)                      2,464                   (10,573)
 
Interest income                                                     1,043                       1,164                     1,125
 
Interest expense                                                     (537)                       (380)                     (391)
                                                                 --------                     -------                  --------
 
(Loss) income before provision for income taxes                   (13,388)                      3,248                    (9,839)
 
Provision for income taxes (Note 10)                                   85                         149                       117
                                                                 --------                     -------                  --------
 
Net (loss) income                                                $(13,473)                    $ 3,099                  $ (9,956)
                                                                 ========                     =======                  ========

Net (loss) income per common share
                                                                 $  (1.32)                    $   .26                  $   (.84)
                                                                 ========                     =======                  ========
 
Weighted average shares outstanding                                10,210                      12,144                    11,855
                                                                 ========                     =======                  ========
</TABLE> 
                            See accompanying notes.

                                       31
<PAGE>
 
                          IWERKS ENTERTAINMENT, INC.
                Consolidated Statements of Stockholders' Equity
                                (in thousands)
<TABLE> 
<CAPTION> 
                                                           Common Stock                                  Retained
                                                           --------------      Paid-in   Unearned stock  Earnings
                                                           Shares  Amount      capital    compensation   (deficit)       Total
                                                           ------  ------     ---------  --------------  --------       -------- 
<S>                                                       <C>        <C>       <C>          <C>         <C>            <C> 
Balance at June 30, 1994                                    9,968     $55       $72,031      $(395)      $ (9,357)      $ 62,334
                                                                                             
Common stock options exercised (Note 11)                      309       -           192          -              -            192
                                                                                             
Issuance of common stock in connection with the                                       -          -              -
minority interest acquisition of Iwerks                                                      
Touring Technologies, Inc. (Note 8)                           315       -         1,188          -              -          1,188
                                                                                             
Amortization of unearned stock compensation                     -       -             -        132              -            132
                                                                                             
Net (loss)                                                      -       -             -          -        (13,473)       (13,473)
                                                           ------     ---       -------      -----       --------       -------- 
                                                                                             
Balance at June 30, 1995                                   10,592      55        73,411       (263)       (22,830)        50,373
                                                           ------     ---       -------      -----       --------       -------- 
                                                                                             
Issuance of common stock in connection with the                75       -         1,600          -              -          1,600
class action settlement (Note 16)                                                            
                                                                                             
Common stock options and warrants exercised  (Note 11)        961       1         1,579          -              -          1,580
                                                                                             
Retirement of common stock                                    (40)      -          (250)         -              -           (250)
                                                                                             
Amortization of unearned stock compensation                     -       -             -        263              -            263
                                                                                             
Net income                                                      -       -             -          -          3,099          3,099
                                                           ------     ---       -------      -----       --------       -------- 
                                                                                             
Balance at June 30, 1996                                   11,588      56        76,340          -        (19,731)        56,665
                                                           ------     ---       -------      -----       --------       -------- 
                                                                                             
Common stock issued in connection with the Purchase of        299       1         1,200                                    1,201
Pioneer (Note 3)                                                                             
                                                                                             
Common stock options and warrants exercised (Note 11)         273       -           476                                      476
Net (loss)                                                                                                 (9,956)        (9,956)
                                                           ------     ---       -------      -----       --------       -------- 
Balance at June 30, 1997                                   12,160     $57       $78,016      $           $(29,687)      $ 48,386
                                                           ======     ===       =======      =====       ========       ======== 
</TABLE> 
 
                                      See accompanying notes.

                                       32
<PAGE>
 
                          IWERKS ENTERTAINMENT, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (in thousands)

<TABLE> 
<CAPTION> 
                                                                                    Year ended June 30,
                                                                    -------------------------------------------------
                                                                      1995                  1996                1997
                                                                    --------               -------            -------
OPERATING ACTIVITIES                                                                                          
<S>                                                                <C>                    <C>                <C> 
Net (loss) income                                                   $(13,473)              $ 3,099            $(9,956)
Adjustments to reconcile net (loss) income                                                                    
  to net cash provided by operating activities:                                                               
    Loss (income) from limited partnership                               101                   (46)               (21)
    Depreciation and amortization                                      6,033                 6,438              6,279
    Write-down of assets to net realizable value                       2,492                     -              5,587
    Write-down of film inventory to net realizable value               3,507                     -                  -
    Changes in operating assets and liabilities:                                                              
        Trade accounts receivable, net                                (1,530)                1,282               (639)
        Costs and estimated earnings in excess of                                                             
           billings on uncompleted contracts                           1,201                (2,772)              (637)
        Inventories                                                      862                  (656)            (1,012)
        Other current assets                                             675                   458               (131)
        Accounts payable and accrued expenses                          6,470                  (775)             1,389
        Billings in excess of costs and estimated                                                             
           earnings on uncompleted contracts                              29                (1,424)              (116)
        Deferred revenue                                              (1,486)               (1,873)               217
                                                                    --------               -------            -------
           Net cash provided by operating activities                   4,881                 3,731                960
                                                                                                              
INVESTING ACTIVITIES                                                                                          
Investment in limited partnership and joint ventures                    (218)                    -             (1,162)
Investment in portable simulation theatres and patents                (3,628)                 (184)              (108)
Purchases of property and equipment                                   (1,223)                 (312)            (1,247)
Additions to film inventory                                           (2,624)                 (790)            (2,548)
Investment in debt securities                                          3,214                 2,247             (2,851)
Purchase of minority interest in ITT, net of common stock issued      (2,646)                    -                  -
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           (7,125)                  961             (7,820)
                                                                                                              
FINANCING ACTIVITIES                                                                                          
Proceeds from issuance of debt                                         1,365                     -                  -
Proceeds from captial lease                                                -                 3,000                  -
Repayment of Notes payable to related parties                           (399)                 (372)              (875)
Repayment of Notes payable                                            (1,651)               (1,819)              (571)
Payments on capital leases                                              (121)                 (129)              (700)
Exercise of stock options and warrants                                   192                 1,580                476
Retirement of common stock                                                 -                  (250)                 -
Other                                                                    131                   241               (536)
                                                                    --------               -------            -------
        Net cash provided by (used in) financing activities             (483)                2,251             (2,206)
                                                                    --------               -------            -------
Net increase (decrease) in cash                                       (2,727)                6,943             (9,066)
Cash and cash equivalents at beginning of year                         8,458                 5,731             12,674
                                                                    --------               -------            -------
Cash and cash equivalents at end of year                            $  5,731               $12,674            $ 3,608
                                                                    ========               =======            =======
</TABLE>

                                      33
<PAGE>
 
Supplemental disclosures of cash flow information (in thousands):
 
<TABLE>
<CAPTION>
                                               Year ended June 30,
                                           ----------------------------
                                           1995          1996      1997
                                           -----         ----      ----
<S>                                           <C>        <C>       <C>
Cash paid during the year for:
   Interest, net of amount capitalized     $ 386         $ 419     $ 411
                                           =====         =====     =====
   Income taxes                            $  78         $  61     $  65
                                           =====         =====     =====
</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 3).

In 1996, $1,600,000 was recorded to stockholders' equity from accrued expenses
due to the issuance of common stock and warrants in connection     with the
finalization of the class action settlement.

Capital lease obligations increased by $3,000,000, in 1996, due to the purchase
of portable simulation theatres.

In 1995, the Company increased film inventory by $574,750 with a corresponding
increase in notes payable.

In 1995, the Company acquired the  minority interest  of Iwerks Touring
Technologies, Inc. for $1,400,000, in exchange for Company Common Stock valued
at $360,000 and cash.

                            (See accompanying notes)

                                       34
<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 theaters, and 3D 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, 1996 and 1995 in order to conform to the fiscal 1997
  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.

       Iwerks also earns revenues for the production of films for outside
  parties. Iwerks recognizes revenue from such projects when the film is
  complete and has been accepted by the customer.

       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 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, 1996 and 1997 was $1,113,000, and $1,205,000,
  respectively, and are included in accrued expenses in the accompanying
  consolidated balance sheet.

       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 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 

                                       35
<PAGE>
 
  the terms of the license agreement.

       TRADE ACCOUNTS RECEIVABLE primarily consists of amounts due on contracts.
  Allowance for doubtful accounts was $293,000 in 1996 and $1,111,000 in 1997.

       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,
                                           ------------------------------
                                             1996                  1997
                                           --------              --------
<S>                                      <C>                    <C>
Films released                             $ 13,623              $ 15,204
Films in process and development                722                 1,639
                                           --------              --------
  Total                                      14,345                16,843
Less accumulated amortization               (10,973)              (13,404)
                                           --------              --------
                                           $  3,372              $  3,439
                                           ========              ========
</TABLE>

       Iwerks estimates that all of its unamortized released film cost will be
  amortized over the next three years.

  PORTABLE SIMULATION THEATRES -  Sixteen portable simulation theatres are in
  operation at June 30, 1997.   Revenues from ticket sales are recorded at the
  time collected and fees from leasing of these simulators are recognized over
  the related lease periods. 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 $3,070,000 in 1996 and $4,327,000 in 1997 (see Note 14).

  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") and prior

                                       36
<PAGE>
 
  acquisitions  and is being amortized over 16 to 25 years (see Note 3).
  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.  (See Note 14).  Accumulated amortization was $1,892,000 in 1996
  and $2,737,000 in 1997.

  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
  $1,094,000, and a covenant not to compete in the amount of $50,000 (see Note
  3).  Accumulated amortization was $283,000 in 1996 and  $329,000 in 1997. The
  Company  has entered into joint venture arrangements whereby the Company
  contributes ride simulation theater equipment and the joint venture partner
  contributes site improvements.  The Company receives film licensing fees and
  cash flow income is split between the joint venture partners.  The Company's
  investment in the joint ventures is depreciated over 5 years.

  ACCRUED EXPENSES -  The Company provides for commission and applicable
  royalties on revenue recognition in connection with such agreements.  The
  commission accrual as of June 30, 1996 and 1997 was $1,074,000 and $1,683,000,
  respectively, and the royalty accrual as of June 30, 1996 and 1997 was
  $871,000 and $2,285,000, respectively.  These amounts are included in accrued
  expenses in the accompanying consolidated balance sheets.

       The Company  had legal accruals as of June 30, 1996 and 1997 in the
  amounts of $209,000 and $671,000, respectively.  The Company also had
  compensation accruals in the amount of $950,000 and $250,000 as of June 30,
  1996 and 1997, 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 theater 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.  The
  research and development expenses amounted to $848,000, $358,000 and $726,000
  for the years ended June 30, 1995, 1996 and 1997, respectively.

  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.

  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 ongoing credit evaluations
  of all customers and believes the credit risk from its customers is 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 

                                       37
<PAGE>
 
  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 lessor 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.

  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 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.  RESTRUCTURING CHARGES

       During the third quarter of fiscal 1995 Iwerks approved a restructuring
  plan for the closure of its Sarasota, Florida ("Sarasota") manufacturing
  facility.  The restructuring plan consolidated the manufacturing operations
  into one facility at Iwerks' corporate headquarters in Burbank, California.
  The Company provided $1,027,000 for this restructuring plan, which is included
  in selling, general and administrative expenses in the 1995 statement of
  operations.  The major components of the charge include a combination of cash
  outlays for severance payments and lease cancellations of approximately
  $500,000 and non-cash charges relating to the write-off of certain property
  and equipment at the Sarasota facility.

       The restructuring plan was executed over the period from April 1995 to
  November 1995.  Since the operations of the Sarasota facility have been
  incorporated into Iwerks' Burbank facility, there was no effect on revenues or
  net operating income other than the costs associated with the restructuring.

       Termination benefits totaling $250,000 for 32 employees accrued in the
  third quarter of fiscal 1995 were paid ratably during the first and second
  quarters of fiscal 1996.  The employees affected were primarily production and
  engineering staff at the Sarasota facility.  The difference between the
  estimated costs accrued in the third quarter of fiscal 1995 and actual costs
  were immaterial.

       The estimated costs associated with the cancellation of leases of
  $250,000 and the write-off of certain property and assets at the Sarasota
  facility of $527,000 were accrued in the third quarter of fiscal 1995.  The
  ultimate negotiated settlement of the Sarasota leases included the turnover of
  certain property and assets at the Sarasota facility along with a cash payment
  of $86,000.  This settlement was recorded in the first quarter of fiscal 1996
  and resulted in an immaterial adjustment to the estimated accrual.  In the
  fourth quarter of fiscal 1995, property and certain assets were charged to the
  reserve in the amount of $446,000 with the balance charged to the reserve in
  the first quarter of fiscal 1996.

       Costs associated with the relocation and consolidation were charged to
  operations in the periods in which they occurred.  Charges of $53,100 were
  made in the fourth quarter of fiscal 1995.  Charges of $115,531 and $82,950
  were made in the first and second quarters of fiscal 1996, respectively, and
  were less than the original estimate of $550,000.  The relocation and

                                       38
<PAGE>
 
  consolidation was completed in November 1995.

  3.  ACQUISITION OF PIONEER

       On March 4, 1997 two newly formed wholly-owned subsidiaries of the
  Company acquired all the stock of Pioneer 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 which has been
  allocated to goodwill.  The operations of Pioneer have been consolidated with
  the operations of the Company  from March 4, 1997.

       Unaudited pro forma combined statements of operations for the years ended
  June 30, 1997 and 1996, which would combine the results of operations of the
  Company and Pioneer are not presented herein as such information is not
  material to the combined results of operations.

       Pioneer is in the business of designing and manufacturing motion picture
  projectors.

  4.  SHORT-TERM INVESTMENTS

       The carrying amounts of the Company's  investments in debt securities at
  June 30, 1996 and 1997 (maturing from 1-6 months) are as follows (in
  thousands):

<TABLE>
<CAPTION>
                                                       Carrying Amount
                                                    ------------------------
Security                                             1996              1997
--------                                            -------          -------
<S>                                                 <C>              <C>
U.S. Treasury Notes                                 $11,076          $ 8,542
FNMA Discount Notes                                   1,532            1,532
Banker's Acceptances                                      -            5,385
                                                    -------          -------
   Total                                             12,608           15,459
Less current portion                                  6,782                -
                                                    -------          -------
                                                    $ 5,826          $15,459
                                                    =======          =======
</TABLE>



  The principal amount, cost and fair value are not materially different than
  the carrying amount as shown above.  Realized gains or losses from debt
  securities sold during the year ended June 30, 1996 and 1997 were not
  material.  The proceeds from sales of available for sale securities for the
  years ended 1996 and 1997 was $24,518,000 and $5,369,000 respectively.  The
  basis on which cost was determined on calculating gains and losses was the
  specific identification method.

  In fiscal 1996, in accordance with the Guide to Implementation of Statement
  115 on Accounting for Certain Investments in Debt and Equity Securities
  (Special Report - November 1995), Iwerks reassessed the classification of its
  investments in debt securities under Statement 115.  In light of this
  reassessment, Iwerks reclassed its entire investment in debt securities from
  held to maturity to available-for-sale.  The realized and unrealized gain and
  loss at the date of transfer was not material.   Investments in debt
  securities at June 30, 1996 and 1997 are classified as available-for-sale, and
  the unrealized gains and losses, net of tax, were not material for any year
  presented.

                                       39
<PAGE>
 
  5.  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, 1996 and 1997 consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                   1996                1997
                                             -------------      --------------
<S>                                             <C>                <C>
Costs incurred on uncompleted contracts           $ 14,156            $ 17,684
Estimated earnings                                  13,912              15,513
                                             -------------      --------------
                                                    28,068              33,197
                                                   (23,591)            (27,848)
                                             -------------      --------------
Less billings to date                             $  4,477            $  5,349
                                             =============      ==============
</TABLE>



       Such costs are included in the accompanying balance sheets at June 30,
  1996 and 1997 under the following captions (in thousands):

<TABLE>
<CAPTION>
                                                    1996                   1997
                                              -------------          -------------
<S>                                              <C>                    <C>
Costs and estimated earnings in excess of           $ 5,583                 $6,339
   billings on umcompleted contracts
Billings in excess of costs and estimated            (1,106)                  (990)
   earnings on uncompleted contracts
                                              -------------          -------------
                                                    $ 4,477                 $5,349
                                              =============          =============
</TABLE>



  6.  NET (LOSS) INCOME PER COMMON SHARE

       The net (loss) income per share for the years presented are based on the
  weighted average number of common and common equivalent shares outstanding
  during the period.  Common equivalent shares consisting of outstanding stock
  options and warrants have been included in the calculation to the extent they
  are dilutive.  Fully diluted amounts do not materially differ from the amounts
  presented herein.

       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
  and early adoption is not permitted.  When adopted, 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.  The new rules also require dual
  presentation of basic and diluted EPS on the face of the statement of
  operations for companies with a complex capital structure.  For the Company,
  basic EPS will exclude the dilutive effects of stock options and warrants.
  Diluted EPS for Iwerks will reflect all potential dilutive securities.  Under
  the provisions of FAS 128, basic EPS would have been ($1.32), $.28, and ($.84)
  for the years ended June 30 1995, 1996 and 1997 respectively.  Diluted EPS
  would have been the same as the reported amounts.

  7.  PROPERTY AND EQUIPMENT

       Property and equipment, at cost, are summarized as follows at June 30,
  1996, and 1997 (in thousands):

                                       40
<PAGE>
 
                                                       1996        1997
                                                     -------     -------
          Office equipment, furniture and fixtures   $ 2,076     $ 2,120
          Operating equipment                          1,809       1,417
          Film production equipment                    2,106       2,346
          Demonstration theatres                       2,474       2,878
          Leasehold improvements                       1,269       1,279
                                                     -------     -------
            Total                                      9,734      10,040
          Less accumulated depreciation               (6,215)     (7,120)
                                                     -------     -------
                                                     $ 3,519     $ 2,920
                                                     =======     =======

       Certain transportation and computer equipment aggregating $3,711,000 at
  June 30, 1996 and 1997 were recorded under capital lease agreements.
  Accumulated depreciation on this equipment was $566,000 and $ 1,018,000 at
  June 30, 1996 and 1997, respectively.

       Depreciation expense amounted to $3,368,000, $3,113,000 and $3,038,000
  for the years ended June 30, 1995, 1996 and 1997, respectively, including
  amounts related to assets under capital leases.


  8.  NOTES TO RELATED PARTIES AND RELATED PARTY TRANSACTIONS

       At June 30, 1996, notes payable to related parties consisted of
  promissory notes due stockholders, interest at 10%, due semiannually over 5
  years with remaining principal and accrued interest on October 1, 1996;
  collateralized by portable simulation equipment.  The balance as of  June 30,
  1996 was $875,000.   The Company had no notes payable to related parties at
  June 30, 1997.

       In connection with the promissory notes due stockholders at June 30,
  1996, the stockholders were granted 29,433 warrants at an exercise price of
  $.01 per share that expire in 2002.  The aggregate difference between the fair
  market value and the exercise price of the warrants was $44,000 and such
  amount was recorded as paid in capital.

       During 1993, 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, 1995, 1996 and 1997,
  $281,000, $610,000, and $489,000, respectively, was paid to Itochu in
  connection with this arrangement.

       In May 1994, for $1,600,000 and the issuance of 115,000 shares of Iwerks
  Common Stock valued at $828,000, the Company purchased a 10% minority interest
  in Iwerks Touring Technologies (ITT) from an employee, including amending a
  future bonus arrangement with that employee.  The cash payment of $1,600,000
  was made in July 1994.  Of the 115,000 shares of Iwerks Common Stock issued,
  23,014 shares became fully vested on July 1, 1994, with the remainder vested
  through December 31, 1995.  Aggregate purchase price of the minority interest
  in 

                                       41
<PAGE>
 
  excess of the fair value of the identifiable assets at the acquisition date
  was $2,428,000, of which $235,000 was attributable to the future bonus and was
  expensed in the fourth quarter of 1994 with the remaining balance being
  allocated to goodwill.  In June 1995, for $1,040,000 and the issuance of
  200,000 shares of Iwerks Common Stock valued at $360,000, the Company
  purchased the remaining 5% minority interest in ITT from the same employee.
  The cash payment of $1,040,000 was made in June 1995.  Of the 200,000 shares
  of Iwerks Common Stock issued, 6,666 shares became fully vested on July 1,
  1995, and the remainder vested through December 31, 1995.  The aggregate
  purchase price of the minority interest was $1,400,000 which was allocated to
  goodwill.  The goodwill related to the acquisition of the minority interest
  was written off in 1997 (see Note 14).

  9.  BANK LINE OF CREDIT

       During fiscal 1997, the Company maintained a $5 million bank line of
  credit which it did not draw upon during the fiscal year.  Subsequent to June
  30, 1997, the Company entered into a new revolving line of credit with a bank
  for $5 million which expires on October 30, 1998.  Interest is at the bank's
  prime rate plus 1/4%  or 3% in excess of the bank's LIBOR rate and is payable
  on or before October 30, 1998.  The Company has agreed to pay a bank
  commitment fee of $10,000.  The line of credit has covenants that include
  maintenance of minimum net worth and compliance with certain financial ratios.
  At August 5, 1997 no amounts have been borrowed under this line of credit.
  The line of credit is secured by all of the Company's assets.

                                       42
<PAGE>
 
<TABLE>
<CAPTION>
 
<S>        <C>
  10.      INCOME TAXES


       Provision for income taxes for the three years ended June 30 consists of
  (in thousands):

 
                                                                       1995       1996       1997
                                                                     --------   --------   --------
<S>                                                                  <C>        <C>        <C>
Current:
 Federal                                                             $     -    $    47    $    40
 State                                                                     7         25         24
 Foreign                                                                  78         77         53
                                                                     -------    -------    -------
                                                                          85        149        117
Deferred:
 Federal                                                                   -          -          -
 State                                                                     -          -          -
                                                                     -------    -------    -------
                                                                     $    85    $   149    $   117
                                                                     =======    =======    =======
 
 The deferred tax asset at June 30  consists of (in thousands):
 
                                                                        1995       1996       1997
                                                                     -------    -------    -------
 
 Net operating loss                                                  $ 7,512    $ 7,298    $ 7,461
 Reserves                                                              2,056        512       (405)
 Asset impairment reserve                                                  -          -     (1,507)
 Deferred revenues                                                       774         24        (62)
 Film cost amortization                                                 (595)       875        785
 Other                                                                  (119)      (30 )         8
                                                                     -------    -------    -------
                                                                       9,628      8,679      6,280
   Valuation allowance                                                (9,628)    (8,679)    (6,280)
                                                                     -------    -------    -------
                                                                     $     -    $     -    $    -
                                                                     =======    =======    =======
 
 Reconciliation of effective rate of income taxes:
 
                                                                        1995       1996       1997
                                                                     -------    -------    -------
 Provision for income taxes at statutory
  federal rate of 35%                                                $(4,716)   $ 1,137    $(3,444)
 State and local taxes                                                     7         25         24
 Foreign taxes                                                            78         77         53
 Nondeductible items and
  nontaxable items                                                         -        399      1,019
 NOL benefit                                                               -     (1,489)         -
 Benefit of net operating loss
  not currently recognized                                             4,716          -      2,465
                                                                     -------    -------    -------
                                                                     $    85    $   149    $   117
                                                                     =======    =======    =======
 
</TABLE>

       At June 30, 1997, Iwerks had available federal and state tax net
  operating loss carryforwards of approximately $18,650,000 and $7,720,000,
  respectively, expiring through 2012.

                                       43
<PAGE>
 
  11.  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's 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, (the "Plans") which provide for the granting to officers,
  directors, employees and consultants options to purchase shares of Iwerks
  Common Stock.  In aggregate, 3,250,000 shares of Iwerks Common Stock are
  reserved for issuance under the Plans.  In addition the Company has granted
  other options to purchase 100,000 shares of Iwerks Common Stock to certain
  officers and directors outside of the Plans.  Options generally vest over a
  four-year period and expire in ten years.

       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 1996 and 1997, respectively: risk-free
  interest rates of 5.74% and 6.36%; weighted-average expected life of the
  option of 4.64 years and 4.19 years;  zero dividend yields; and a volatility
  factor of the expected market price of Iwerks' Common Stock of 51%.

       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 income (loss) and pro forma earnings (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):

<TABLE>
<CAPTION>
 
                                                          1996                       1997
                                                          ----                       ----                   
<S>                                                       <C>                        <C> 
Pro forma net income (loss)                             $2,717                    $(10,685)
                                                        
Pro forma net income (loss) per share                   $ 0.23                    $  (0.90)


</TABLE>

       A summary of the Company's stock option activities and related
  information for the years 

                                       44
<PAGE>
 
ended June 30 are as follows:

<TABLE>
<CAPTION>
 
                                                         Number of Shares             Weighted Average      
                                                          (in thousands)               Exercise Price        
                                                         -----------------            ----------------
<S>                                                      <C>                            <C>
 
Options outstanding July 1, 1994                              1,522                         $ 5.26           
Options granted                                               1,049                           4.45                   
Options exercised                                              (309)                           .73                   
Options terminated                                             (554)                         11.54                   
Options exercisable at June 30, 1995                            651                         $ 2.08                   
                                                                                                                     
Options outstanding July 1, 1995                              1,708                         $ 3.54                   
Options granted                                                 877                           5.23                   
Options exercised                                              (385)                          1.64                   
Options terminated                                             (274)                          6.46                   
Options exercisable at June 30, 1996                            604                         $ 3.07                   
                                                                                                                     
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 outstanding June 30, 1997                             1,901                         $ 4.88                     
</TABLE>

The weighted-average fair value of options granted was $2.64 in fiscal year 1997
and $ 2.57 in fiscal year 1996.

The following table summarizes information about stock options outstanding at
June 30, 1997:
 
<TABLE> 
<CAPTION> 
                                              Options Outstanding                                 Options Exercisable
                                               Weighted  Average                                        Number   
                       ---------------------------------------------------------------    ------------------------------------
                                                 Weighted Average
                       Number Outstanding at        Remaining                             Exercisable at
   Range of               June 30, 1997 in       Contractual Life     Weighted Average     June 30, 1997      Weighted Average
Exercise Prices              Thousands               in Years          Exercise Price      in Thousands        Exercise Prices
---------------              ---------               --------          --------------      ------------        ---------------
<S>                          <C>                     <C>                <C>                <C>                 <C> 
   $  .10-.74                     91                     4.3                 $ .43               91                 $ .43       
   $3.00-3.69                    102                     8.1                 $3.03               48                 $3.00       
   $4.00-5.88                  1,518                     8.5                 $4.96              525                 $4.87       
   $6.63-7.56                    160                     7.8                 $6.95               24                 $7.50       
   $9.00-9.75                     30                     8.0                 $9.37                8                 $9.37        
                               -----                                                            ---     
                               1,901                                                            696      
</TABLE>

     As of June 30, 1996, 580,593 shares were available for future grants under
the Plans and outside the Plans, and as of June 30, 1997, 364,582 shares were
available for future grants under the Plans and outside the Plans. As of June
30, 1997 Iwerks has reserved 2,265,751 shares of unissued Iwerks Common Stock
for issuance upon exercise of options granted under the Plans and outside the
Plans.

     At June 30, 1996 Iwerks had a total of 20,794 warrants outstanding to
purchase Iwerks Common Stock at exercise prices ranging from $.01 to $7.30,
exercisable through 2003. In 1997,

                                       45
<PAGE>
 
  warrants were exercised for 12,794 shares of Iwerks Common Stock at exercise
  prices ranging from $.01 to $1.25, leaving a remainder of 8,000 warrants
  exercisable at $7.30 per share through 2003. Additional warrants are expected
  to be issued in connection with the settlement of the class action law suits.
  (See Note 16.)

  12.  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, 1995, 1996 and 1997 was approximately
  $869,000, $617,000  and $641,000, respectively.

       Future minimum lease payments under capital and operating leases at June
  30, 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
 
                                          Capital    Operating
                                           leases     leases
                                          -------    ---------
<S>                                       <C>        <C>
 
   1998                                    $  984       $  539
   1999                                       963          427
   2000                                       867          240
   2001                                       236           60
   2002                                         -            -
                                           ------       ------
   Total minimum lease payments             3,050       $1,266
                                                        ======
   Less amount representing interest         (484)
                                           ------
                                           $2,566
                                           ======
</TABLE> 
       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 is currently one letter of credit outstanding totaling
  approximately $110,000.

       The Company entered into an agreement dated May 29, 1997 to design and
  manufacture three camera systems at a cost of $1.8 million.

  13.  SIGNIFICANT CUSTOMERS AND GEOGRAPHIC INFORMATION

       In 1996 and 1997, Iwerks had no customers who accounted for more than 10%
  of consolidated revenue.  In 1995, the Company earned revenues from one
  significant customer of approximately $5,160,000 (11%).

       Export revenue by geographic area for the years ended June 30 consist of
  (in thousands):

                                       46
<PAGE>
 
                                  1995     1996     1997
                                -------  -------  -------

          Canada                $   417  $ 1,131  $   516
          Europe                  1,185    4,409    2,085
          Asia                   23,029   17,311   13,682
          South America              47      972    5,375
                                -------  -------  -------

          Total export revenue  $24,678  $23,823  $21,658
                                =======  =======  =======
 
  14.  Asset Impairment and Fourth Quarter Adjustments

       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 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 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, the
  Company has aggressively pursued new sponsorship opportunities and other
  options to replace these revenues.  The failure to consummate these
  opportunities prior to the end of the fiscal year and the lack of sponsorship
  backlog as of June 30, 1997 prompted the Company to take the charge under SFAS
  121.

       Further, 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; increased the warranty reserve by $147,000 due to
  increased work performed on a contract, increased accrued expenses by $320,000
  due to a regulatory audit, reduced previously recognized earnings by $205,000
  in connection with the cancellation of a contract, and incurred $250,000 of
  expenses relating to the proposed merger.

  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 

                                       47
<PAGE>
 
  officers and directors in the United States District Court of the Central
  District of California. The principal terms of the agreement called for the
  establishment of a settlement fund consisting of: (1) $1.75 million, to be
  paid by the Company's insurance carrier (with unclaimed amounts being returned
  to the carrier); and (2) 250,000 shares of Iwerks' Common Stock and 500,000
  warrants to purchase Iwerks' Common Stock, to be issued by the Company (with
  unclaimed stock and warrants being returned to the Company). The warrants will
  be exercisable through July 2, 1999, and the exercise price has been set at
  $8.78 which is $2.00 below the average trading price of Iwerks' stock during
  the 30 day period following May 3, 1996. As of August 5, 1997, 75,000 shares
  and 150,000 warrants have been issued to counsel for the plaintiffs leaving a
  balance of 175,000 shares and 350,000 warrants to be claimed by the class. The
  Company will receive the proceeds from the exercise of the warrants if and
  when they are 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, resolution of these matters will not have a material
  adverse impact on the Company's  financial position or results of operations.

  17.  SUBSEQUENT EVENTS

       On August 5, 1997, Iwerks and Showscan announced that they signed a
  definitive agreement to merge.  The combined company will bring together the
  two largest ride simulation companies and will be the largest provider of ride
  simulation entertainment attractions and software in the world.

       The transaction calls for each share of Showscan Common Stock to be
  converted into 0.85 of a share of Iwerks' Common Stock.  Outstanding Showscan
  Preferred Stock will be exchanged for Iwerks' Common Stock at the 0.85 ratio
  on an as converted basis.  Iwerks expects to issue approximately 5.62 million
  shares of Iwerks' Common Stock in the merger (plus shares issuable upon
  exercise of outstanding Showscan options, warrants and 8% Notes) resulting in
  an estimated transaction value of approximately $27.4 million (based upon a
  closing price of Iwerks' Common Stock on The NASDAQ National Market on August
  4, 1997 of $4.875 per share).  The transaction will be accounted for as a
  pooling of interests, after which Showscan will become a wholly owned
  subsidiary of the Company.

       Completion of the Merger is subject to approval by the stockholders of
  the Company and Showscan, as well as other customary closing conditions. If
  shareholder approval is not obtained or other closing conditions are not
  satisfied or if the parties mutually agree to terminate or modify the terms of
  the merger agreement, the transaction may not be consummated pursuant to the
  existing terms of the merger agreement, or at all. The stockholders' meetings
  are scheduled to take place in the second fiscal quarter ending December 31,
  1997.

                                       48
<PAGE>
 
In August, 1997 the Company amended its Certificate of Incorporation to increase
its authorized shares of Common Stock from 20,000,000 to 50,000,000.

Item 9.  Changes and Disagreements with Accountants on Accounting and Financial
-------------------------------------------------------------------------------
Disclosure.
---------- 

     None.
                                    PART III
                                        

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

     Information regarding directors and executive officers of the Company will
appear in the Proxy Statement for the 1997 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 1997 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 1997 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 1997 Annual Meeting of Stockholders, and
is incorporated herein by this reference.

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
---------------------------------------------------------------------------
<TABLE>
<CAPTION>
 
(a)      FINANCIAL STATEMENTS:                              PAGE NUMBER
                                                            -----------
<S>      <C>                                                <C>
 
         Report of Independent Auditors                              28
 
         Consolidated Balance Sheets                              29-30
         June 30, 1996 and 1997
 
         Consolidated Statements of Operations                       31
         Years Ended June 30, 1995, 1996 and 1997
 
         Consolidated Statements of Stockholders'  Equity            32
         Years Ended June 30, 1995, 1996 and 1997

</TABLE> 
                                       49
<PAGE>
 
<TABLE> 
<S>      <C>                                                <C>
         Consolidated Statements of Cash Flows                    33-34
         Years Ended June 30, 1995, 1996 and 1997
 
         Notes to Consolidated Financial Statements               35-49
</TABLE>

          FINANCIAL STATEMENT SCHEDULES:

     Schedule II - Valuation and Qualifying Accounts for the years ended June
30, 1995, 1996 and 1997.

     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:

     During the last quarter of the Registrant's fiscal year which ended on June
     30, 1997, there were no reports on Form 8-K.

                                       50
<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/ Roy A. Wright
                                         ---------------------     
                                         Roy A. Wright
                                         Chief Executive Officer

                                     Date:

   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.
<TABLE>
<CAPTION>
           Signature                               Title                             Date
           ---------                               -----                             ----                 
<S>                                   <C>                                      <C>
 
   /s/ Roy A. Wright                    Chairman, President and CEO             October 7, 1997
-------------------------------        (Principal Executive Officer)
       Roy A. Wright
 
                                        
  /s/ Bruce C. Hinckley                  Executive Vice President               October 7, 1997
-------------------------------          Chief Financial Officer
      Bruce C. Hinckley                 (Principal Finance Officer)
 
 
  /s/ Jeffrey M. Dahl                    Vice President /Controller             October 7, 1997
-------------------------------         (Principal Accounting Officer)
      Jeffrey M. Dahl
 
 
   /s/ Donald W. Iwerks                 Vice Chairman of the Board              October 7, 1997
-------------------------------
       Donald W. Iwerks
 
 
   /s/ Dag Tellefsen                              Director                      October 7, 1997
-------------------------------
       Dag Tellefsen
 
 
   /s/ Gary J. Matus                              Director                      October 7, 1997
-------------------------------
       Gary J. Matus
</TABLE>

                                      51
<PAGE>
 
                                                                     SCHEDULE II
                                                                                
                           IWERKS ENTERTAINMENT, INC.
                       VALUATION AND QUALIFYING ACCOUNTS
                FOR THE YEARS ENDED JUNE 30, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
 
---------------------------------------
 
                                           Balance at
                                            beginning                                                               Balance at  
Classification                              of year                 Additions                  Retirements         end of year
---------------------------------------   -------------         ------------------         ----------------    -----------------

<S>                                        <C>                     <C>                       <C>                <C>
For the year ended June 30, 1995
 Allowance for doubtful accounts              $  404,500               $  527,755                        -       $  932,255
 Accumulated film amortization                 2,304,298                6,376,804                        -        8,681,102
 Accumulated amortization of goodwill            241,026                  746,539                        -          987,565
 Accumulated amortization of patents              84,501                   70,158                        -          154,659
    and covenant not to compete
</TABLE>


<TABLE>
<S>                                        <C>                     <C>                       <C>                <C>
FOR THE YEAR ENDED JUNE 30, 1996
 Allowance for doubtful accounts              $   932,255                      -                 $ 639,265      $   292,990
 Accumulated film amortization                  8,681,102             $2,291,963                         -       10,973,065
 Accumulated amortization of goodwill             987,565                904,850                         -        1,892,415
 Accumulated amortization of patents              154,659                128,186                         -          282,845
    and covenant not to compete
 
FOR THE YEAR ENDED JUNE 30, 1997
 Allowance for doubtful accounts              $   292,990              $  843,495                $  25,171      $ 1,111,315
 Accumulated film amortization                 10,973,065               2,431,138                        -       13,404,203
 Accumulated amortization of goodwill           1,892,415                 937,022                    92,570       2,736,867
 Accumulated amortization of patents              282,845                  46,454                         -         329,299
     and covenant not to compete
</TABLE>

                                       52
<PAGE>
 
--------------------------------------------------------------------------------
                               EXHIBIT INDEX    
--------------------------------------------------------------------------------
<TABLE>

<S>       <C>
    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 January 29, 1991, by and between Iwerks and
          Baccarat Development Partnership.*
    4.3   Warrant Agreement, dated April 30, 1993, by and between Iwerks and
          Richard King International.*
    4.4   Warrant Agreement, dated November 12, 1992, by and between Iwerks and
          Baccarat Development Partnership.*
    4.5   Warrant Agreement, dated November 12, 1992, by and between Iwerks and
          Douglas Broyles.*
   10.1   Form of Indemnification Agreement and schedule of indemnified
          parties.*
   10.2   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.*
   10.4   Secured Promissory Note and Credit and Security Agreement, dated June
          30, 1993, by and among Iwerks, Iwerks Touring Technologies, Inc. and
          Meriken Nominees Limited as nominee for Glenwood Ventures IIA, L.P.*
   10.5   Secured Promissory Note and Credit and Security Agreement, dated July
          23, 1993, by and among Iwerks, Iwerks Touring Technologies, Inc., Doug
          Broyles and Baccarat Development Partnership.*
   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, 1992, by and between Iwerks as lessee and R.C.
          Associates as lessor.*
  10.10   Lease for 4525 W. Valerio Street, Burbank, California 91505, dated
          March 24, 1994 by and between Iwerks as lessee and the Penney Family
          Trust as lessor.*****
</TABLE> 

                                       53
<PAGE>
 
<TABLE>

<S>       <C>
   10.11   Financing Arrangement, dated June 29, 1993, by and among Iwerks,
           Iwerks Touring Technologies, Inc. and Heller Financial, Inc.*
   10.12   1994 Stock Incentive Plan of Iwerks Entertainment, Inc.****
   10.13   Agreement, dated as of June 30, 1996, by and between Iwerks and
           Donald Iwerks.*****
   10.14   Line of Credit- Agreement with Imperial Bank
   10.15   Lease Agreement - Matrix Funding Corporation*****
   10.16   Settlement Agreement and Release with Paula Douglass*****
    11.1   Earnings Per Share.
    22.1   Subsidiary List.****
    23.1   Consent of Independent Auditors - Ernst & Young LLP
    27.1   Exhibit 27.1 - Schedule of Financial Information
</TABLE>
______________

    * 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 Amendment No. 1 to Iwerks' Registration
        Statement on Form S-4, SEC File No. 76984 which Amendment was filed on
        April 12, 1994.
 
  *** Incorporated by reference from Registrants Annual Report on Form 10-K for
        the year ended June 30, 1994.

 **** 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.

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