<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    FORM 10-K


                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                    FOR THE FISCAL YEAR ENDED MARCH 31, 1998.


                         COMMISSION FILE NUMBER 0-15939



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

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

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

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


Securities registered pursuant to Section 12(b) of the Act:  NONE

Securities registered pursuant to Section 12(g) of the Act:  TITLE OF EACH CLASS
                                                             Common Stock,
                                                             $.001 par value

     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
filing requirements for the past 90 days.
           YES [X]     NO [ ]

     The aggregate market value of the voting stock held by non-affiliates of
the registrant as of June 30, 1998 was approximately $1,886,879 (based on last
NASDAQ-reported sale price of $.375 per share of Common Stock on that date).
There were 5,642,058 shares of registrant's common stock outstanding as of June
30, 1998.

     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 Form 10-K or any amendment to this
Form 10-K. [X]


                       DOCUMENTS INCORPORATED BY REFERENCE

                                      NONE

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                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
Item                                                                           Page
                                                                               ----
<S>                                                                            <C>
                                     Part I

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

2.  Properties................................................................  19

3.  Legal Proceedings.........................................................  19

4.  Submission of Matters to a Vote of Security Holders.......................  19


                                     Part II

5.  Market for Registrant's Common Equity and Related Stockholder Matters.....  20

6.  Selected Financial Data...................................................  22

7.  Management's Discussion and Analysis of Financial
      Condition and Results of Operations.....................................  23

8.  Financial Statements and Supplementary Data...............................  33

9.  Changes in and Disagreements with Accountants
      on Accounting and Financial Disclosure..................................  33


                                    Part III

10. Directors and Executive Officers of the Registrant........................  34

11. Executive Compensation....................................................  36

12. Security Ownership of Certain Beneficial Owners and Management............  38

13. Certain Relationships and Related Transactions............................  41


                                     Part IV

14. Exhibits, Consolidated Financial Statement Schedules,
      and Reports on Form 8-K.................................................  45
</TABLE>



                                       2.

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FORWARD-LOOKING STATEMENTS

           In addition to historical information, this Annual Report on Form
10-K contains forward-looking statements. The forward-looking statements
contained herein are subject to certain risks and uncertainties that could cause
actual results to differ materially from those reflected in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors That May
Affect Future Results." Readers are cautioned not to place undue reliance on
these forward-looking statements which reflect management's analysis only as of
the date hereof. Showscan Entertainment Inc. undertakes no obligation to
publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof. Readers should carefully review
the risk factors described in other documents the Company files from time to
time with the Securities and Exchange Commission, including the Quarterly
Reports on Form 10-Q to be filed by the Company in calendar 1998 and 1999 and
any Current Reports on Form 8-K filed by the Company.

                                     PART I
ITEM 1.  BUSINESS

GENERAL
           Showscan Entertainment Inc. (the "Company") is a leading provider of
movie-based motion simulation theatre attractions to the expanding out-of-home
entertainment market. The Company's motion simulation theatre attractions
("Showscan Attractions") combine the exhibition of a short action film with
multi-channel sound systems and synchronized theatre seat movement to produce an
immersive entertainment experience in which the theatre patron has the
perception of actually participating in the on-screen action. The entertainment
creates a "thrill ride" or action entertainment experience (such as riding a
run-away train or racing through outer space). The Company's attractions
incorporate various proprietary technologies, including the award winning and
patented 70mm filming and projection process known as Showscan(R). The Company
believes that films made and exhibited in the Showscan process create a visual
effect of depth, clarity and realism that is superior to any other film format.
The Showscan process is also used for the exhibition of films in large screen
special format movie theatres. The Company's films have been exhibited in such
specialty theatres at world fairs, tourist destinations, trade conventions and
other locations where the operator desires the impact of the large-screen,
intense image that a Showscan film provides.

           As of June 30, 1998, the Company had 60 Showscan Attractions screens
operating around the world. The Company had 10 additional Showscan Attractions
screens in its delivery and installation backlog, and has contractual
commitments for an additional 29 Showscan Attractions screens including 16
screens which United Artists Theatre Circuit, Inc. (UA) has contractually agreed
to purchase and install, prior to August 19, 1999. The Company believes that UA
is unlikely to order and install all 16 remaining screens by such date and may
instead satisfy its obligations to the Company through the order of projection
and/or motion simulation equipment. See "Item 1. Business--Motion Simulation
Attractions--Owned and Operated Theatres--The United Artists Venture," below.
The Company includes in its backlog all sales for which it has a signed
agreement or letter of intent, in each case supported by a letter of credit,
cash deposits or damage provisions, such as the substantial per screen
liquidated damage payments to be made by UA to the Company in the event that it
does not install all of the remaining 16 screens or otherwise satisfy its
obligations through the order of projection and/or motion simulation equipment
by August 1999. The Company has an ownership interest in motion simulation
theatres ("O&O Theatres") at Universal CityWalk, Universal City, California and
the Asian Trade Center in Osaka, Japan.

           As part of its business, the Company produces and licenses specialty
films in the Showscan process which are then exhibited in conventional theatres
equipped to show Showscan films. The Company also markets all of the cameras,
projectors, motion bases and other equipment necessary to establish and operate
Showscan Attractions and Showscan specialty theatres. There are 6 permanent
specialty theatres operating as of June 30, 1998, which license the Company's
films.

           On August 5, 1997, the Company announced its plan to merge with a
wholly-owned subsidiary of Iwerks Entertainment, Inc. (the "Merger"). As a
result of the Merger, the Company would have become a wholly-owned subsidiary of
Iwerks and the Company's stockholders would have received shares of Iwerks stock
in exchange for their Company shares. The terms of the Merger were amended on
December 29, 1997 to reduce the share exchange ratio from .85 to .62. On March
31, 1998, the stockholders of the Company overwhelmingly approved the Merger but
the stockholders of Iwerks did not approve it by the required majority vote. The
Merger was therefore terminated on March 31, 1998.

           The Board of Directors of the Company believes that the Merger would
have created significant value for the Company's stockholders by permitting them
to be stockholders in a combined company that would have benefitted from
significant synergies and economies of scale. Management of the Company believes
that the pendency of the Merger caused a near cessation in the Company's new
sales activity. Given the long lead times and significant ongoing relationships
attendant to each sale of a Showscan Attraction, potential purchasers were
reluctant to sign contracts until the Merger was completed. The Company believes
that this near cessation of sales activity resulted in a significant decrease in
sales in the fiscal year ended March 31, 1998. 

                                       3.

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           The Company was incorporated in Delaware in August 1984 under the
name Showscan Film Corporation. In August 1990, the Company's name was changed
to Showscan Corporation, and in August 1994 the name was changed again to
Showscan Entertainment Inc. The Company's principal executive office is located
at 3939 Landmark Street, Culver City, California 90232. The Company's telephone
number at its executive office is (310) 558-0150. Unless the context otherwise
requires, the term "Company" as used in this Report refers to Showscan
Entertainment Inc. and its wholly owned subsidiaries, Showscan Productions,
Inc., Showscan CityWalk, Inc., Showscan Attractions, Inc., Showscan Framingham,
Inc. and Showscan Entertainment B.V.

BUSINESS STRATEGY

           The Company believes that there is a rapidly increasing worldwide
consumer demand for a variety of out-of-home entertainment options. The
Company's goal has been to capitalize on its position as a leader in the
entertainment motion simulation attraction business and on the growing demand
for entertainment alternatives by making its movie-based products available to
consumers worldwide at high-visibility and high-traffic locations, such as urban
entertainment complexes, tourist destinations, family entertainment centers,
amusement/theme parks, movie theatre complexes, gaming casinos, and shopping
centers.

           The Company has focused its primary business strategy on the
development of high-margin recurring revenues from the licensing and
distribution of its motion simulation and specialty films. The Company's goal
has also been to enhance the recognition of the Showscan(R) brand name
worldwide. In response to the unsatisfactory results and the need to manage its
personnel resources, the Company's current management has recently revised
certain of its prior business strategies. For example, the Company has decided
to reduce its marketing of other large format projection systems and its
investment in O&O Theatres and will concentrate its limited resources on its
core business of selling Showscan Attractions to third parties and licensing its
film library. The Company's current strategies to achieve its objectives are as
follows:

           INCREASE FILM LICENSING REVENUES. The Company's principal strategy
continues to be to increase the recurring revenues it derives from licensing its
films by increasing the number of motion simulation attractions. As this
installed base grows, each film will be licensed to a greater number of
exhibitors thereby increasing royalty revenue, while also amortizing the fixed
film production costs of Showscan owned films over a larger revenue base. To
increase this recurring revenue, the Company's focus continues to be on:

             (i)     Marketing to a wide range of potential customers worldwide
                     while maintaining reasonable profit margins;

            (ii)     Enhancing and expanding its film library by producing
                     internally or with third parties new films while also
                     obtaining distribution rights to motion simulation films
                     produced by others;

           (iii)     Offering Showscan films for distribution, and films for
                     which Showscan has obtained distribution rights from other
                     producers, to all operators of simulation attractions
                     including those previously installed by competitors of
                     Showscan;

           (iv)      Enhancing its projection and motion base technology;

            (v)      Entering into additional strategic sales arrangements to
                     supplement existing strategic agreements which cover Japan,
                     USA, Austria, Australia, Taiwan, Hong Kong and selected
                     portions of China; and

           (vi)      Emphasizing sales having multi-location possibilities. (To
                     date, the Company has sold 18 Showscan Attractions to
                     Imagine Japan, 10 Showscan Attractions in Taiwan to Apex
                     Science & Technology Corp., four Showscan Attractions in
                     China to Jenor International, 24 Showscan Attractions to
                     United Artists Theatre Circuit, Inc. ("UA"), five Showscan 
                     Attractions to Auscinemagic/Reality Cinema in Australia, 
                     two Showscan Attractions to Lotte World in Korea,



                                       4.

<PAGE>   5
                     two Showscan Attractions to Parc du Futuroscope in 
                     France and two Showscan Attractions to Kraftwerk in 
                     Austria.)

           INVESTMENTS IN SHOWSCAN ATTRACTION THEATRES. The Company has
historically participated directly in the recurring revenues from ticket sales
and film distribution and licensing by having an ownership interest in certain
Showscan Attractions ranging from 25% to 50%. Although the start-up and the
pre-opening marketing and advertising costs of O&O Theatres are sometimes high
(which costs the Company has defrayed in part through strategic alliances), the
Company believes it can generate a recurring revenue stream from such investment
because variable costs of ticket sales are low. The Company's management,
recognizing the losses incurred at certain of these theatres, has thoroughly
revised its O&O Theatre strategy and has successfully closed five of the seven
existing O&O Theatre screens. The Company, however, still believes that limited
investing in Showscan Attractions for its own account should be part of its
overall business strategy. As a matter of corporate policy, the Company has
determined to generally limit its investments in O&O Theatres to a 10%-15%
ownership interest, although it may still invest up to 50% in selected venues.
The Company intends to selectively continue its investment in Showscan
Attractions on this basis. The Company has entered into several alliances that
provide the Company with the capability of participating in the ownership of
Showscan Attractions with other investors. See "Item 1. Business -- Motion
Simulation Attractions -- Owned and Operated Theatres," below.

           EXPAND DISTRIBUTION; EXPLOIT PROPRIETARY ASSETS. In addition to
increasing its recurring film revenue through the addition of more sites,
another objective of the Company is to expand its distribution base and to find
and exploit other commercial and entertainment opportunities and revenue sources
for its existing assets.

           The Company believes that its current and future library of motion
simulation and specialty films will become increasingly more valuable, not only
to Showscan Attractions currently showing Showscan films but



                                       5.

<PAGE>   6
also to third-party sites that will be interested in licensing films from the
Company. Accordingly, the Company plans to continue to increase the number of
films it offers by producing patented and/or acquiring additional suitable
films. In the fiscal year ended March 31, 1998, the Company acquired twelve
films that were not filmed using the patented Showscan process. Since these
films were not produced in the Showscan process, the Company will convert some
to 60 fps and will distribute the remainder in their existing format. Showscan
has converted two of such films to the Showscan process and is evaluating
whether any of the remaining films should be converted. The cost of conversion
is not significant. In addition, the Company also is pursuing various financing
alternatives, including limited partnerships and other similar arrangements to
finance the production of additional Showscan motion simulation films. The
Company has begun to market its films, and films for which Showscan has obtained
distribution rights from other producers, to all operators of motion simulation
attractions either in conjunction with, or as a replacement for, the films that
they are currently showing.

           The Company believes that the Showscan process can also be used to
enhance the effectiveness, appeal and commercial potential of other filmed
products, including feature-length motion pictures, specialty films, commercial
and corporate presentations, educational films, documentaries and other forms of
entertainment, such as interactive and virtual reality attractions. In addition,
the Company is exploring potential additional entertainment applications of the
Showscan process, including the development of video games based on its existing
and future film products.

           The Company plans to enter into additional strategic alliances, joint
ventures and other similar arrangements (i) to facilitate the production of its
motion-simulation software, (ii) to expand the out-of-home entertainment venues
in which its products can be exhibited, (iii) to reduce financial risks, and
(iv) to expand the Company's access to distribution networks, urban
entertainment locations and destination centers, and technological innovations.
The Company has become a representative in the Peoples Republic of China for
Spitz, Inc., a manufacturer of planetariums, space theatres and flight
simulators. The Company is currently considering alliances with motion picture
exhibitors, retail shopping center developers and operators, and others for the
establishment of additional Showscan Attractions and specialty theatres in
motion picture multiplexes, shopping malls, casinos and other gaming venues, and
other high-traffic locations and destinations. Furthermore, the Company may
consider the acquisition of motion simulation film libraries and/or other
companies in its line of business or in other businesses.

THE MOTION SIMULATION AND SPECIALTY FILM LIBRARY

           The Company derives revenues in the following ways from its film
library: (i) a royalty fee for use of the patented Showscan filming and
projection process, (ii) fees based on the revenues derived from all films
including those that are not solely owned by the Company; and (iii) receipt of
all or a percentage of the licensing revenues remaining after the payment of any
distribution fees or expenses. The amount the Company receives from co-owned
films varies, and is based on the participation agreements negotiated with the
other owners of the films.

           The Company's film library consists of a motion simulation film
library and a specialty film library. The motion simulation film library is one
of the world's largest entertainment motion simulation film libraries and
currently contains 38 action/thrill-ride films. The Company also has one motion
simulation film in post-production which is owned by the Company. The specialty
film library contains 16 Showscan specialty films available for exhibition in
specialty theatres. The Company is the sole owner of 16 of the motion simulation
films, a joint owner of seven motion simulation films and the distributor of 15
motion simulation films owned by unaffiliated companies. Of the 16 Showscan
specialty films, seven are owned by the Company. The Company has not produced
any specialty films in the past three years and currently has no active plans to
commit any of its resources to producing additional specialty films.

           The Company's film library consists of such films as the live-action
motion simulation film Street Luge (a high-speed downhill ride just inches
from the asphalt), Cosmic Pinball (depicting a race through a giant, futuristic



                                       6.

<PAGE>   7
pinball park), and the highly-acclaimed Devil's Mine Ride (a ride through an
abandoned mine on a runaway rail car). The Company has obtained distribution
rights through May 1, 2002 to two films (Funhouse Express and Asteroid
Adventure) which were produced by Imax Corporation. These two films may be
distributed to Showscan's existing installed base and contractual backlog of
Showscan Attractions as of April 30, 1997 (an aggregate of approximately 100
sites). Of the 38 films in the Company's simulation thrill-ride library, 33 are
available in high-definition video format and it is unlikely that the Company
will transfer the other 5 films. The costs of transfer are not significant. 

           The films that the Company produces are either fully financed by
third parties or co-produced and financed by the Company and third parties. When
the Company produces films, it typically hires a production company or team of
specialists on a project-by-project basis, similar to the major movie studios.
This allows the Company to retain creative and quality control without the
burden of significant ongoing production overhead expenses. As the film's
producer, the Company typically has control over the creative and technical
aspects of the production and is designated as the film's exclusive distributor.

           The Company has obtained the exclusive, perpetual worldwide right to
distribute in the Showscan format certain of the Showscan motion simulation
films and specialty films that are not owned by the Company, except that in
certain circumstances the Company does not own the right to distribute such
films in the country in which the owner of the distributed film is located. On
some films, the Company only has the right to distribute the film to its network
of simulation attractions.

           The Company's specialty film library consists of such films as
Niagara Wonders, a 23-minute Showscan film produced for exhibition in a
permanently erected 300-seat theatre in Niagara Falls, New York; France, a
40-minute Showscan film that was produced by Source Perrier for the 1989
bicentennial celebration of the French revolution and exhibited in a first-run
theatre in Paris, France; and Discovery, a 16-minute Showscan film produced by
the government of British Columbia and exhibited in a temporary specialty
theatre at the Expo '86 World's Fair in Vancouver, Canada. Two Showscan
specialty films, Nature Rediscovered and Concerto for the Earth, were in
exhibition at temporary Showscan specialty theatres at the Expo '92 World's Fair
in Seville, Spain. Both films explore biodiversity, ecological awareness and the
fragile balance of nature. Concerto for the Earth is the first Showscan film in
3-D; however, the film can be exhibited in the standard 2-D format.

MOTION SIMULATION ATTRACTIONS

           A Showscan Attraction is a theatre (typically 18 to 84 seats) in
which the on-screen action of a short action film is synchronized with the
motion of the theatre seats to simulate various realistic or action experiences.
The Showscan Attraction "rides" are short, approximately four-to-five-minute
entertainment experiences. Each Showscan Attraction is equipped with a
high-quality, multi-channel sound system and a seat motion system (motion base).
Motion bases are available in various theatre configurations to suit the needs
of the various locations, and are manufactured by Intamin, A.G., McFadden
Systems, Inc., Shostar Ltd., and others. The potential market for motion
simulation theatre attractions includes any location with high pedestrian
traffic, including tourist attractions, amusement parks, theme parks, resorts,
large regional shopping centers, motion-picture multiplexes, urban entertainment
centers, and hotel casinos.

           Showscan Attractions are either the standard film-based theatres in
which the Company's 70mm motion simulation films are exhibited using the
Company's patented projector, or are HD Simulation Attractions in which the
motion simulation films are projected using standard, commercially available
high-definition video projection equipment. To date, most Showscan Attractions
have exhibited Showscan motion simulation films using 70mm film and the
Company's projectors. However, the Company has seen increasing demand for its



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HD Simulation Attractions in which the Showscan films are transferred to a
high-definition video format on laser discs and projected using high definition
video projectors. See "Item 1. Business -- Equipment," below. Because the
Showscan film is transferred directly from frame-to-field to high-definition
video, the Company believes that the image projected is the sharpest image
available in that format. The HD Simulation Attractions, when combined with any
of the available motion bases, utilize less space than the standard film-based
Showscan Attractions. Due to the lesser space requirements of HD Simulation
Attractions, such Showscan Attractions can be installed in locations previously
not feasible.

           The Company licenses its films and, in standard film-based motion
simulation theatre attractions, sells its Showscan projection equipment to third
party owners and operators of Showscan Attractions. The Company is the sole
source of both the film projectors used to exhibit Showscan motion simulation
films and the show control system. In addition, the Company generally sells the
motion bases, control panels, video equipment and other equipment used in the
Showscan Attractions and assists in installing the attraction. Licensees of the
Company's motion simulation films are not obligated to purchase the motion bases
or the other equipment and services offered by the Company. Other than the
patented Showscan film projectors and the Company's show control system, all
motion simulation equipment, including the various motion bases, the sound
system and the video projection equipment, can be purchased by the third party
owner/operator from other sources. The initial term of the Company's licensing
agreements generally range from two to five years (normally with fixed or
minimum annual royalty payments and film rental obligations).

           Historically, Showscan Attraction installations outside North America
have represented a significant portion of the Company's total revenues
(constituting 85%, 62% and 61% of the Company's revenues for the fiscal years
ending March 31, 1998, 1997 and 1996, respectively).

           As of March 31, 1998, Showscan Attractions have been sold or licensed
in the United Kingdom, Australia, Saudi Arabia, Spain, Hong Kong, People's
Republic of China, United States, Canada, Japan, South Korea, Taiwan, Indonesia,
Singapore, France, Belgium, Italy, Austria, South Africa, United Arab Emirates,
Egypt, Kuwait, New Zealand and Germany. The Showscan Attractions sold in Japan
have been purchased or distributed by Imagine Japan, Inc. ("Imagine"), which has
exclusive distribution rights to Showscan Attractions in Japan through December
31, 1999. See "Item 1. Business -- Sales and Marketing," below.

           OWNED AND OPERATED THEATRES. In 1993, the Company began developing
and operating Showscan Attractions in which the Company has an ownership
interest (the "O&O Theatres"). These O&O Theatres have, to date, been
established through the various strategic alliances described below. The Company
has recently revised its strategy with respect to O&O Theatres so that it will
generally limit its investment in future O&O Theatres to between 10-15%. In
addition, the Company has closed 5 of the 7 total O&O Theatre screens to date
because of their financial performance. For certain financial information
regarding these strategic alliances, see "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations."

           The United Artists Venture. Under the terms of a Joint Venture
Agreement dated as of August 19, 1994 (the "Joint Venture Agreement"), the
Company and UA have agreed to be equal partners in a venture called
Showscan/United Artists Theatres Joint Venture (the "UA Venture"). The dates for
the capital contributions are to be agreed upon by the venture partners, which
dates will depend on the actual build-out schedule of each project. UA and the
Company are required to equally contribute additional capital as necessary for
all projects undertaken by the UA Venture.

           The Company is managing partner of the UA Venture while UA is the
administrative partner. The Company, as managing partner, will implement all
decisions of the UA Venture and, together with UA, develop the business plan and
long-term strategic plans for the UA Venture. UA, as administrative partner,
will be responsible for all financial aspects of the UA Venture, including
overseeing record keeping and other financial matters.



                                       8.

<PAGE>   9
           Pursuant to a Theater Rights Agreement dated as of August 19, 1994,
as amended (the "Theater Rights Agreement"), UA has agreed to offer to the UA
Venture for ownership and operation by the UA Venture, up to 24 theatre sites at
any time prior to August 19, 1999 for the installation of Showscan Attractions
in existing or to-be-built UA theatre complexes. If the UA Venture declines to
acquire a particular location, then UA must install a Showscan motion simulation
attraction theatre at the first 24 sites that the UA Venture declines to
acquire. As of June 30, 1998 UA has installed 8 Showscan Attractions. Whenever
UA or the UA Venture builds a Showscan Attraction theatre, such entity will have
the exclusive rights to exhibit Showscan motion simulation attraction films
within a pre-agreed area surrounding such location. Also, pursuant to a Master
Management and Development Agreement, dated as of August 19, 1994, by and among
the Company, UA and the UA Venture (the "Master Management Agreement"), UA will
develop and coordinate the construction of new and/or the conversion of existing
theatres to Showscan Attractions and will manage each theatre pursuant to
pre-negotiated terms. The Master Management Agreement expires on August 19,
1999, unless the Theater Rights Agreement is extended, in which case the Master
Management Agreement will be extended for the same period. The UA Venture, in
turn, has agreed to accept prior to August 19, 1999 at least one of the theatre
sites offered to it by UA. The Company has agreed to pre-negotiated terms for
the sale of Showscan equipment, installation, servicing and the licensing of
Showscan motion simulator films. The Company will also make available to both
the UA Venture and UA its library of specialty films which utilize the patented
Showscan process, to the extent that either the UA Venture or UA builds or
converts existing theatres into specialty theatres for the exhibition of
specialty films. The Theater Rights Agreement contains certain provisions that
require UA to make payments to the Company if UA is unable to meet its
obligations and that require the Company to make payments to UA if the UA
Venture is unable to meet certain of its obligations. UA is obligated to pay
$330,000 to the Company for each Showscan Attraction which is not purchased and
installed by August 1999 (presently 16 theatre sites) and the Company is
obligated to pay UA $165,000 if the UA Venture does not select a joint venture
site by August, 1999.  Any such payments are payable in August 1999. UA may also
satisfy its obligations to the Company by actually paying to the Company at
least $13,950,000 in the aggregate for motion simulation and/or projection
equipment; provided, however, that only 50% of each order for projection
equipment sourced through the Company shall be counted towards the target and
any orders of projection equipment must result in an aggregate benefit (as
defined) to the Company of at least $3,200,000. To date, UA has purchased
approximately $7 million of equipment from the Company or approximately one-half
of the target amount.

           To date, UA has offered to the UA Venture eight sites at new or
existing UA movie theatre multiplexes. The UA Venture has declined seven of
these sites because they did not meet the criteria of the UA Venture and
therefore, UA has completed construction for its own account Showscan
Attractions at those seven sites. On July 1, 1997, the UA Venture exercised its
rights under the Theater Rights Agreement to accept the offer by UA of the
Showscan Attraction site in Austin, Texas. This site was completed by UA and was
already open prior to acceptance by the UA Venture. Subsequently, however, UA
entered into a merger transaction with other large theatre chains and the
circumstances surrounding the merger transaction created uncertainty with
respect to the Austin site. In conjunction therewith, UA advised the UA Venture
not to proceed with the Austin site acquisition, accordingly, the UA Venture has
terminated its plans to acquire ownership of the Showscan Attraction at the
Austin site.

                     Moss/DiBenedetto Ventures. The Company and affiliates of
certain of its directors entered into (i) the Showscan CityWalk Venture (the
"CityWalk Venture"), a venture formed solely to own and operate an O&O Theatre
in Universal City, California and (ii) the Showscan Attractions Venture, a
venture formed for the purpose of, directly or through other jointly-owned
entities, developing, owning and operating additional O&O Theatres throughout
the world (the "Attractions Venture", and together with the CityWalk Venture,
the "Moss/DiBenedetto Ventures").

                     The CityWalk Venture. The first O&O Theatre opened in
November 1993 at Universal CityWalk, adjacent to Universal Studios in Universal
City, California. This O&O Theatre is owned by the CityWalk Venture, a venture
50% owned by Showscan CityWalk, Inc. (a wholly owned subsidiary of the Company),
25% owned by Moss Family LA Corp., a California corporation, and 25% owned by
DiBenedetto CityWalk Limited Partnership, a Delaware limited partnership
(collectively, the "Investors"). Moss Family LA Corp. and DiBenedetto CityWalk
Limited Partnership are controlled by Mr. Charles B. Moss, Jr. and Mr. Thomas R.
DiBenedetto, respectively. Mr. Moss and Mr. DiBenedetto are directors and
stockholders of the Company. See "Item 10. Directors and Executive Officers of
the Registrant," below. The term of the CityWalk Venture expires on December 31,
2050.



                                       9.

<PAGE>   10
           Universal CityWalk is a diversified-use entertainment/shopping
facility that is controlled by Universal Studios Recreation Group ("Universal").
The facilities are leased from Universal pursuant to a profit sharing lease (the
"Lease") entered into with MCA Inc., the predecessor of Universal, under which
Universal paid approximately one-half of the total tenant costs of the theatre
(as defined), which costs included the projection equipment and the motion
bases. The Lease expires in November 2002, subject to options to extend the
Lease for three five-year periods. In general, the CityWalk Venture is obligated
to pay a base rent plus 50% of the cash flow (as defined) from the operations of
the theatre. Accordingly, the CityWalk Venture will retain 50% of the cash flow
from the theatre's operations. The base rent will be adjusted annually based on
the percentage increase in the consumer price index up to a maximum of 5% per
year. Of the 50% of cash flow retained by CityWalk Venture, 50% will be retained
by the Company and 50% will be paid to the Investors. Thus, the Company's share
of the total cash flow from the theatre's operations will be 25% plus the annual
film rentals, royalties and management fees that the CityWalk Venture is
separately required to pay the Company, each of which is subject to annual
increases based on the consumer price index up to a maximum of 5% per year.

                     The Attractions Venture. The parties to the Attractions
Venture are (i) Showscan Attractions, Inc., a wholly owned California subsidiary
of the Company and the managing partner of the Attractions Venture, (ii) Moss
Family O&O Corp., a California corporation controlled by Mr. Moss (the "Moss
Partner"), and (iii) DiBenedetto O&O Limited Partnership, a Delaware limited
partnership controlled by Mr. DiBenedetto (the "DiBenedetto Partner").

           The Attractions Venture agreement states that the parties intend to
develop, own and operate O&O Theatres through the Attractions Venture or through
other corporations, joint ventures, partnerships or other entities to be owned
by the parties to the Attractions Venture. The agreement further provides that
if any O&O Theatre is owned by any such other corporation, venture, partnership
or other entity, the partners to the Attractions Venture shall own and operate
such other entity on the same terms and conditions as the agreement of the
Attractions Venture.

           Pursuant to a Proprietary Property Acquisition and Management
Agreement, dated as of September 27, 1993, between the Company and the
Attractions Venture, the Company granted to the Attractions Venture rights to
utilize proprietary property and rights of the Company in connection with the
development and operation of additional O&O Theatres. Under the terms of this
agreement, the Company will manage any and all Showscan Attractions developed
and operated by the Attractions Venture. The Attractions Venture is required to
purchase simulation equipment and license Showscan motion simulation films from
the Company on terms and conditions that are substantially the same as those
offered to unaffiliated third parties, except that the Attractions Venture
receives a discount on certain equipment prices and film rental and royalty
fees. Moss Entertainment Corp., a corporation controlled by Moss, and
DiBenedetto Corp., an affiliate of DiBenedetto, were retained by the Attractions
Venture to provide certain services in connection with the acquisition of
properties for the additional O&O Theatres and the disposition of those
theatres. For such services, Moss Entertainment Corp. and DiBenedetto Corp. are
to receive fees upon the sale or other disposition of certain of the O&O
Theatres developed by the Attractions Venture. The term of the Attractions
Venture expires on December 31, 2050.

           The Attractions Venture agreement further provides that neither the
Company, the Moss Partner, nor the DiBenedetto Partner may develop, own or
operate any additional Showscan Attractions without first offering all of the
other parties to the Attractions Venture the opportunity to invest in such
additional Showscan Attractions in proportion to each party's Percentage
Interest (as defined below). No party is, however, obligated to invest in any
such additional Showscan Attractions. If the parties to the Attractions Venture
do not collectively contribute all funds necessary to establish and operate any
such additional Showscan Attraction, the parties may admit additional
unaffiliated investors as part owners of the additional Showscan Attraction.



                                       10.

<PAGE>   11
           Showscan Attractions, Inc. currently owns a 50% interest in the
Attractions Venture, and each of the Moss Partner and the DiBenedetto Partner
owns a 25% interest in the Attractions Venture (the "Percentage Interests"). In
the event that the Company and the Moss Partner and/or the DiBenedetto Partner
elect to jointly invest in any additional Showscan Attraction, the parties will
share all profits, loss and distributions of cash, if any, derived from the
operation and ultimate disposition of each additional Showscan Attraction in
proportion to the capital contributions made by the partners (and any
unaffiliated investor) into the account established for the additional Showscan
Attraction.

           The first O&O Theatre owned by the parties to the Attractions Venture
was the twin O&O Theatre that opened in late September 1994 in the Trocadero
Arcade at Piccadilly Circus, London, England. As permitted by the Attractions
Venture agreement, the London O&O Theatre is owned by the partners of the
Attractions Venture through a corporation formed under the laws of England
rather than directly through the Attractions Venture. Cinemania (UK) Limited,
the corporation formed to own the London O&O theatre, is owned by Showscan
Attractions, Inc., the Moss Partner and the DiBenedetto Partner in proportion to
their Percentage Interests. The London theatre was closed on July 3, 1998 and
Cinemania (UK) Limited was put into liquidation on July 4, 1998.

           In connection with the UA Venture, the Attractions Venture agreement
was amended to exclude from the territories in which the Attractions Venture can
operate certain specific areas that are made available to UA under the Theater
Rights Agreement. In exchange for such amendment, the Company agreed to pay each
of Messrs. Moss and DiBenedetto a specified amount upon the opening of each new
O&O Theatre that is owned by the UA Venture in the specific excluded areas and
to pay Messrs. Moss and DiBenedetto a percentage of certain profits (as defined)
from the Company's share of profits from each such Showscan Attraction owned by
the UA Venture.

                     The Framingham Venture. In April 1995, Showscan Framingham,
Inc., a wholly owned Delaware subsidiary of the Company, and General Cinema of
Framingham Inc. ("GCF"), a wholly owned Massachusetts subsidiary of General
Cinema Corp. of Massachusetts ("GCC"), entered into a venture (the "Framingham
Venture") to own and operate twin Showscan Attractions at the 14-screen movie
theatre multiplex owned and operated by GCC in Framingham, Massachusetts, a
suburb of Boston.

           The partners of the Framingham Venture closed the twin Showscan
Attractions on October 5, 1997 and sold the equipment back to the Company. The
Company has since resold one theatre to an unaffiliated third party, and is
negotiating to sell the other theatre to the same third party. The remainder of
the assets were allocated as defined in the Venture Agreement back to the
partners.

                     The Osaka Venture. In June, 1995, Showscan Entertainment
B.V., a wholly owned subsidiary of the Company, organized under the laws of the
Netherlands, and Imagine Japan, Inc., a company organized under the laws of
Japan, entered into a venture (the "Osaka Venture") to own and operate a
Showscan Attractions theatre at the Asia Trade Center in Osaka, Japan.

           Showscan Entertainment B.V. and Imagine Japan, Inc. agreed to be
equal partners in the Osaka Venture. Day-to-day operations of the theatre are
managed by Sega Enterprises, Ltd. As theatre manager, Sega receives a percentage
of the gross box office receipts of the theatre as a combined rent/management
fee, as well as reimbursement of its operating expenses. The Company separately
receives film rental and royalty fees from the Osaka Venture. The term of the
Osaka Venture is for five years from June, 1995 and can be extended for an
additional five years at the option of Showscan Entertainment B.V. at the end of
the initial term. Because of the structure of the Osaka Venture under Japanese
law, ownership and title of all property is held by Imagine Japan.



                                       11.

<PAGE>   12
                     The Maloney Venture. In August, 1995, the Attractions
Venture and Maloney Development Partnership Ltd. ("Maloney"), an unaffiliated
Texas limited partnership, formed a Texas limited liability company called
Showscan Maloney, LLC to own and operate a Showscan Attraction theatre in the
San Antonio Riverwalk District, in San Antonio, Texas.

           The partners of Showscan Maloney, LLC closed the theatre on September
7, 1997 and liquidated its assets. The partners have further agreed to
distribute the theatre equipment to the Company, which is in the process of
negotiating to sell the equipment to a non-affiliated third party.

                     Universal Agreement. Pursuant to the Lease entered into
with Universal in connection with the CityWalk Venture, Universal has the right,
exercisable at Universal's election, to participate in the Company's share of
any future O&O Theatres located in California. If Universal makes any such
election, Universal will be entitled to receive one-half of the Company's rights
in such O&O Theatre and will assume one-half of the Company's obligations
related to such O&O Theatre. To date, Universal has not exercised its option to
participate in any additional O&O Theatres.

SPECIALTY THEATRES

           The Company also receives revenues from the production, licensing and
exhibition of specialty films. These films are typically 15 to 40 minutes in
duration, are produced in the Showscan process and are exhibited at expositions,
theme parks, major fairs and festivals and other larger tourist areas. Specialty
theatres are either theatres permanently dedicated to the exhibition of Showscan
specialty films or temporary theatres erected for such purposes. Often,
specialty theatres exhibit Showscan specialty films that are produced
specifically for the theatre or the exhibition. Examples of specialty theatres
and specialty films include the two films produced for and exhibited at the Expo
'92 World's Fair held in Seville, Spain.

           In the past, the Company has financed its specialty film production
through a third party who usually was the owner and operator of the specialty
theatre venue. The Company received production fees for its services, revenues
from the sale of Showscan projector equipment (and possibly the theatre
installation, sound system and seats, etc.) and worldwide distribution rights to
the specific films. As of June 30, 1998, nine permanent and twelve temporary
specialty theatres had been sold by the Company. Of the nine permanent theatres,
six are currently operating and the remaining three theatres are permanently
closed.

           The Company has agreed to make available, for a fee, to both the UA
Venture and UA its library of specialty films which utilize the patented
Showscan process, to the extent that either the UA Venture or UA builds or
converts existing theatres into specialty theatres for the exhibition of
specialty films.

THE SHOWSCAN PROCESS

           Standard films are currently projected at 24 frames per second (fps)
on 35mm film with each frame being shown twice. In contrast to conventional
filming and projection systems, a Showscan motion picture is photographed on
65mm film at a rate of 60 fps and is projected using 70mm film at a rate of 60
fps and at a higher illumination level (the 65mm film is projected using 70mm
film in order to accommodate the sound track, which occupies approximately 5mm
of the film strip). In addition, each frame in a Showscan film is shown only
once. The Company believes that the bigger image and increased visual cues
perceived by the viewer of a Showscan film result in greater picture clarity and
an enhanced sense of depth and realism.

           Photography of 65mm film at a frame rate of 60 fps offers a number of
improvements to the quality of a motion picture image and permits the screen
size to be substantially enlarged without significant degradation



                                       12.

<PAGE>   13
of the image. The images are significantly brighter with more saturated and
vibrant colors. Because of the frame rate of Showscan film, the motion of the
cameras and the subject can be substantially increased without noticeable
distortion, greatly heightening the impact of action scenes. The larger 70mm
format and faster exposure time also greatly reduce blurring, thus recording
images more accurately and in finer detail. To enhance the visual impact, and to
take maximum advantage of the realism and detail of the Showscan process,
Showscan film is usually projected onto a specially designed, curved screen.

           Showscan motion pictures can be transferred to conventional 35mm/24
fps format for use in conventional movie theatres to other large film formats
and to all standard video formats. Showscan motion pictures can also be directly
transferred (one frame to each field) to high-definition video for exhibition
with standard high-definition video projectors. Although a Showscan film
transferred to alternative formats, including to the high-definition laser
projection system used by the Company, does not contain the clarity, depth and
realism of the original Showscan film projected in 70mm film at 60 fps, the
Company believes that the visual quality of Showscan film transferred to such
alternative film formats (such as the 8/70 - 30 fps and 24 fps, 5/70 - 30 fps
film formats) exceeds the quality that could be obtained in such formats using
conventional films.

SALES AND MARKETING

           The Company's sales and marketing activities are coordinated by the
Company's Vice President of Worldwide Sales and Marketing, and effected through
the Company's employees, its independent sales representatives worldwide and its
strategic sales alliances. The Company participates in trade shows and regularly
advertises in trade periodicals. The companies that provide Showscan with motion
bases also market motion simulation theatre attractions worldwide that license
the Company's motion simulation attraction films and equipment.

           Effective January 1997, the Company extended its agreement with
Imagine Japan, Inc. ("Imagine") through December 31, 1999, which included an
extension of Imagine's exclusive right to sell and acquire Showscan Attractions
and specialty theatres in Japan. The price and other terms on which the Showscan
Attractions are sold to Imagine are substantially the same as the price and
terms offered by the Company to other Showscan Attraction customers. Imagine is
permitted to resell in Japan any and all of the Attractions it purchases from
the Company. The price and terms at which Imagine resells the Attractions are
established by Imagine. However, notwithstanding such resales, Imagine remains
liable to the Company for all annual film licensing obligations related to all
of the Showscan Attractions sold to Imagine. The Company has also granted
Imagine a non-transferable license to exhibit Showscan films in the Company's
motion simulation library for a rental fee that is based on the number of
Showscan Attractions operating in Japan and on the films exhibited at the
various attractions. This exclusive agreement with Imagine expires on December
31, 1999 although Imagine will continue to remain liable thereafter for all
annual film rental and royalty obligations.



                                       13.

<PAGE>   14
           Historically, the majority of the Company's revenues have been
derived from export sales. These sales by geographic region for each of the
three fiscal years ended March 31, 1998, 1997 and 1996 consisted of:


<TABLE>
<CAPTION>
                                         1998            1997            1996
                                      ==========     ===========     ===========
<S>                                   <C>            <C>             <C>        
AFRICA                                $        0     $   215,000     $   281,000
AUSTRALASIA                              647,000       1,976,000       2,574,000
EUROPE                                 1,753,000       1,206,000       1,992,000
FAR EAST                               4,051,000       6,048,000       5,628,000
MIDDLE EAST                            2,399,000       1,340,000          48,000
OTHER                                          0         159,000         125,000
                                      ----------     -----------     -----------

     TOTAL EXPORT REVENUES            $8,850,000     $10,944,000     $10,648,000
                                      ==========     ===========     ===========
</TABLE>


           The Company sells internationally through independent sales
representatives and its own worldwide sales and marketing staff. The Company's
international sales are subject to customary restrictions on foreign operations,
including restrictions on imports and exports, longer collection periods for
accounts receivable and risks associated with fluctuations in foreign exchange
rates. The Company's contracts for the sale of equipment generally provide for
payment in United States dollars and for letters of credit as the means of
payment. The Company's policy is to require annual film rental and royalty
payments to be made in United States dollars.
The Company does not engage in any hedging activities.

EQUIPMENT

           The photography and exhibition of Showscan motion pictures require
specially equipped or modified cameras and projectors. In addition, certain
other products and equipment are needed to produce Showscan motion pictures and
to convert Showscan film to the conventional 35mm/24 fps format.





                                       14.

<PAGE>   15
           The Company and Intamin, A.G., a Liechtenstein corporation and a
leading manufacturer of amusement park rides, jointly developed the
hydraulically-actuated seats that are used in the bench motion simulation
attractions marketed by the Company. The Company and Intamin jointly own three
United States patents on various elements of the motion simulation seats. A
similar patent was approved under the European Patent Convention, which resulted
in the issuance of patents in those European countries in which the Company
elected to seek patent protection. See "Item 1. Business -- Patents and Other
Intellectual Property," below. In addition to the Intamin bench motion bases,
the Company markets the two-passenger and four-passenger pod, including a
six-axis motion base manufactured by Intamin.

           The Company, in conjunction with McFadden Systems, Inc., jointly
designed and developed a four-person, six-axis motion system (the "Quadra Motion
System") as well as an 18-seat, six-axis dynamic platform. The Company currently
markets the Quadra Motion System, the 18-person dynamic platform as well as six
and 15-person platforms and a 12-seat self-contained capsule manufactured by
McFadden Systems, Inc. McFadden Systems, Inc. has filed for Chapter 11
bankruptcy protection but is continuing to operate pending its reorganization.

           The Company also markets an electromagnetically-driven (as opposed to
hydraulically-driven) motion base called the "EM4." The "EM4" has been installed
at two locations to date. The "EM4" has several advantages over a
hydraulically-driven motion base including lower electrical consumption, lower
noise levels, lower operating costs and a decrease in construction costs due to
elimination of hydraulic pump rooms, less air conditioning requirements and
elimination of environmental concerns as no hydraulic fluids are used.

           Films made in the Showscan process can be projected with certain 
conventional 70mm projectors that are modified to project a motion picture at 60
fps. The modification does not entail significant expense or effort and does not
have an adverse effect on the reliability of the projector. In order to
facilitate the projection of Showscan motion simulation films, however, the
Company has developed an automatic electronic projector that uses low-inertia
motors to achieve the intermittent projection of frames of film rather than the
conventional use of gears and geneva-drive sprockets. Film storage is contained
within the projector which eliminates the need for complicated film loop
cabinets. The projector permits computer-controlled automatic cuing,
synchronization and rewinding necessary for the continuous showing of a variety
of short films without requiring that the film be changed or a projectionist
used. The Company owns a patent on certain circuitry included in this projector.

           The HD Simulation Attractions use standard, commercially available
high definition video projectors and laser disc players. The video projectors
and laser disc players are manufactured by a number of companies, including NEC,
Sony Corp., Hughes JVC, and Barco Inc.

RESEARCH AND DEVELOPMENT

           The Company, directly or in conjunction with other companies, has
from time to time been engaged in a limited program of research and development.
For the last three years, the Company's research and development program did
not, however, require a significant expenditure of funds.

           The Company's research and development efforts are currently directed
at creating new simulation attractions. Also, the Company is developing theatre
computer control system software programs to further enhance the ease by which
simulation attractions can be operated and maintained by a minimum number of
on-site personnel.

COMPETITION

           The Company faces intense competition in all of its business
activities. Some of the Company's competitors and potential competitors are
well-established, have substantially greater financial and other resources than
the Company, and have an established reputation for success in the development
and marketing



                                       15.

<PAGE>   16
of filmed products. There can be no assurance that the Company will be able to
compete successfully with such other companies.

           In addition to competing directly against other firms in the
marketplace of the Company's products, the Company also generally competes for
customers with other out-of-home location-based entertainment alternatives. The
entertainment business in general is undergoing significant changes in
technology and in consumer demands for more stimulating entertainment both
within the home and outside of the home. As the demand for increasingly
sophisticated forms of technology increases, the Company competes for customers
to some extent with theme parks, traditional motion pictures and other forms of
filmed or computer-related entertainment. As a result of technological advances
and the increased availability of alternative forms of leisure entertainment,
including expanded pay and cable television service and advanced home audio and
video systems, consumer demands and tastes may continue to change. Computer
simulation, interactive and virtual reality products are improving rapidly and
could become competitive with the Company's products. The Company is unable to
predict what effect technological and other changes will have on the future
success of the Company's products and services.

           MOTION SIMULATION THEATRE ATTRACTIONS. Although the Company is aware
of a substantial number of other distributors of entertainment motion simulation
equipment worldwide, including Iwerks Entertainment, Inc., Simex, Thomson
Entertainment, Camber Entertainment, Doron Simulation, Dynamax and Imax
Corporation, which compete directly with the Company in the motion simulation
attraction market, the Company believes that it is one of the leading companies
in the sale of motion simulation attractions. Most of the Company's competitors
have significantly greater financial resources than the Company and are
substantially larger than the Company. Because of the significant costs involved
in the development and promotion of motion simulation attractions, companies
with superior financial resources may have an advantage. However, the Company
also believes that the Company's record of motion simulation attraction
operations to date, the size of its film library and the quality and enhanced
sense of depth and realism of its Showscan motion simulation films permits the
Company to effectively compete in the motion simulation attractions market.

           The most widely-recognized motion simulation theatre attractions
include Star Tours in Disneyland, and Back to the Future in a Universal Studios
theme park. The Company is not aware of any plans by The Walt Disney Company or
Universal Studios, which operate these parks, to make these motion simulation
theatre attractions available outside of their respective theme parks. In fact,
in May 1992, MCA, Inc. entered into a participating lease with the Company in
connection with the Company's first O&O Theatre located at Universal's CityWalk
complex at Universal City near Hollywood, California. However, any decision by
The Walt Disney Company, Universal or other major studios to market their own
motion simulation theatre attractions outside their respective theme parks could
have a material adverse effect on the Company's business.

           SPECIALTY THEATRES. The Company competes with a number of companies
that distribute other well-established large and giant-screen and special
projection systems, including Imax and Iwerks. Imax and Iwerks are
well-established in the specialty film markets and have significantly more
theatres currently exhibiting films produced in these formats. In addition, each
has substantially greater financial and other resources and an established
reputation for developing and marketing products competitive with the Company's
specialty theatres.

PATENTS AND OTHER INTELLECTUAL PROPERTY

           The Company owns two United States patents on the Showscan process.
These patents cover the combined process of filming and projecting 35mm or
larger negative film having high resolution images, at a constant frame rate of
at least 50 fps, with the film being projected at a high illumination level.
Both patents expire in October 2001. The patents are important to the Company
because it believes that a frame rate of 50 fps or more is necessary to achieve
the desired degree of depth and realism, and that enforcement of these patents



                                       16.

<PAGE>   17
could prevent others from achieving the same result. Although the Company
believes that its existing patents are valid, there can be no assurance that the
Company's patents, if challenged, will be upheld, nor can there be any assurance
that competitors will not develop a different technology that offers comparable
or better visual effects. Moreover, the Company may elect, for financial or
commercial reasons, not to enforce its rights under its patents.

           The Company has obtained additional patents for the Showscan process
in Australia, Canada and Japan. The Company's patent on the Showscan process has
been approved under the European Patent Convention, which resulted in the
issuance of patents in those European countries in which the Company elected to
seek patent protection. To date, most of the Company's motion simulation
attraction sales have been outside the United States and no assurance can be
given that the Company's patents will adequately protect the Company's exclusive
rights to the Showscan process outside the United States or that any additional
foreign patents will be granted.

           The Company also has obtained U.S. patents on its electronic
projector, the rapid start-up feature of the CP-65 camera, a system for
projecting a 360-degree motion picture image, and a process for converting high
frame-rate film to standard frame-rate film. In addition, the Company, in
conjunction with Intamin, has obtained three U.S. patents on certain aspects of
the Showscan motion simulation attractions and has a joint interest with another
party in another motion simulation patent. The patents expire between the years
2004 and 2006. The Company and Intamin have also obtained a patent under the
European Patent Convention covering certain aspects of the Showscan motion
simulation attractions, which has resulted in the issuance of patents in those
European countries in which the Company elected to seek patent protection.
However, there can be no assurance that these patents, if challenged, will be
upheld, nor can there be any assurance that competitors will not develop a
different or more effective competing technology.

           Although the Company believes that its patented and non-patented
products and processes have been independently developed and do not infringe the
patents of others, third parties could claim that the Company's products and
processes infringe the rights of others. If it were determined that the
Company's products or processes did infringe the property rights of third
parties, the Company may be required to modify its design or obtain a license.
No assurance can be given that the Company will be able to do so in a timely
manner or upon acceptable terms and conditions; and the failure to do either
could have a material adverse effect upon the Company's business. There are no
claims that the Company's products and processes infringe the rights of others.

           The mark "Showscan(R)" has been registered with the United States
Patent and Trademark Office for use with the Showscan process and Showscan
products. The Company has also registered the design of its logo as well as
"Showscan's The Edge" and "Emaginator" for use as the name of motion simulation
theatres. The Company has registered other marks in connection with certain of
its products such as the "EM4" and the "Quadra 6," and with the marketing of its
films such as "Movies That Move You," "Unleashing the Power of Film," and
"Virtual Thrill Ride."

ROYALTY ARRANGEMENTS

           The Company acquired all of the rights to the Showscan process from
Paramount Pictures Corporation ("Paramount") and its subsidiary, FGC, Douglas
Trumbull and WLS Partners ("WLS") in consideration for, among other things,
agreements to pay royalties on future revenues from the exploitation of the
Showscan process. The terms of such royalties are described below.

           WLS. Pursuant to a royalty agreement (the "Royalty Agreement") with
WLS, the Company is required to pay WLS a royalty based, in general, on the
gross receipts (as defined) of the Company from the worldwide



                                       17.

<PAGE>   18
exploitation of Showscan motion pictures and any other use of the Showscan
process. The royalty is 3% of such gross receipts until August 31, 1999, or
until WLS has been paid an aggregate of $3,500,000. The Company has paid a total
of $2,689,000 in royalties under the Royalty Agreement through March 31, 1998.

           Future General Corporation/Paramount. Pursuant to the agreement with
Paramount and FGC (the "FGC Agreement"), the Company is obligated to pay FGC a
royalty, in perpetuity, equal to 2% of the Company's gross receipts (as defined)
from the worldwide exploitation of the Showscan technology in excess of 180% of
the sum of (i) $21,100,000, (ii) actual cash contributions for debt or equity of
the Company during the period from June 27, 1985 to June 27, 1987, (iii) the
Company's actual cost, if any, of converting and equipping theatres for
exhibition of Showscan motion pictures, and (iii) any Showscan feature-length
motion picture production costs incurred by the Company. For the purpose of
determining FGC's royalty, "gross receipts" are defined as all monies received
by the Company from the exploitation of the Showscan technology, provided that
if the Company is the exhibitor of a Showscan feature-length motion picture,
gross receipts will be deemed to be one-half of box office receipts less taxes
paid. When gross receipts reach the $65 million level, FGC will begin to earn
royalties. The current level of gross receipts (as defined) is $36 million at
March 31, 1998, so no royalties have been earned under the FGC Agreement as of
yet. The Company projects royalties to FGC will begin accruing in approximately
five to seven years.

           If the Company produces feature-length motion pictures in Showscan
and grants distribution rights to such a film to a third-party distributor,
Paramount will have the right of first negotiation with respect to distribution
of the first three of the Showscan motion pictures produced by the Company.
However, the Company does not currently intend to produce any feature-length
motion pictures itself.

           Douglas Trumbull. Pursuant to its agreement with Douglas Trumbull,
the Company is required to pay royalties to Mr. Trumbull until the year 2015,
subject to the maintenance of certain levels of working capital as established
by the Board of Directors of the Company. In general, the payments equal 1% of
revenues (as defined) received by the Company from the worldwide exploitation of
the Showscan technology, except that if the Company operates a full-length
motion picture theatre, Mr. Trumbull is entitled to 1% of the box office
receipts of that theatre. The Company does not currently intend to operate any
full-length motion picture theatres.

EMPLOYEES

           As of June 30, 1998, the Company had 29 employees, five of whom were
employed in management, three in sales and marketing, twelve in engineering,
assembly and installation, and four in production, film licensing and
distribution. The remaining full-time employees are administrative and support
staff. This compares to 41 employees at June 20, 1997 and 58 employees at June
11, 1996. 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. See Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Factors That
May Effect Future Results."

           The Company considers its relationship with its employees to be
satisfactory.



                                       18.

<PAGE>   19
ITEM 2.  PROPERTIES

           The Company leases a 37,000-square-foot building in Culver City,
California, pursuant to a lease expiring on June 30, 2003. Under the lease, the
current monthly rental is $34,303, subject to annual cost-of-living adjustments.
The maximum annual rental increase is 7%. The Company is responsible for all
costs and expenses of maintaining the building, including the payment of all
property taxes and insurance premiums. The Company's corporate headquarters,
demonstration theatre and film studio are located at this site.

           The Company considers its facilities adequate to meet its current
needs.

ITEM 3.  LEGAL PROCEEDINGS

           On May 6, 1997, the Company sued Boomtown Inc., Boomtown Hotel &
Casino, Inc., and Mississippi-I Gaming, LP in the Los Angeles County Superior
Court. The suit alleges, among other things, breach of contract in connection
with the defendants failure to make scheduled contract payments. The suit seeks
unspecified monetary damages.

           On November 13, 1997, the Company sued Transcontinental Insurance
Company and Pacific Indemnity Company in the Los Angeles County Superior Court.
The suit alleges, among other things, breach of contract in connection
with the defendants' denial of coverage with respect to certain advertising
injuries. The suit seeks unspecified damages and declaratory relief.

          On March 17, 1998, the Company sued Reality Cinema Pty Ltd. and its
individual directors in the Supreme Court of New South Wales, Australia. The
suit alleges among other things, breach of contract in connection with
Reality's failure to make scheduled contract payments. The suit seeks payment
of US$607,366 together with other unspecified monetary damages as well as
injunctive relief prohibiting the use by Reality of certain of the Company's 
intellectual properties.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS

           On March 31, 1998, a Special Meeting of Stockholders of the Company
was held to consider and vote upon the proposed merger between the Company and a
wholly-owned subsidiary of Iwerks Entertainment, Inc. In order to pass, the
merger proposal needed to receive the affirmative vote of at least a majority of
the shares eligible to vote on it. At the meeting, the merger proposal received
the affirmative vote of 4,147,231 shares or 62.7% of the total shares eligible
to vote. 1,508 shares were voted against and 2,350 shares abstained. Though the
merger proposal was passed by the Company's stockholders, the stockholders of
Iwerks rejected the merger at a meeting held on the same day and therefore the
proposed merger was terminated.



                                       19.

<PAGE>   20
                                    PART II

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

           The Common Stock is traded on the Nasdaq National Market(R) under the
symbol "SHOW."

           The following table sets forth the high and low sales prices for the
Common Stock for the periods indicated as reported by Nasdaq. The prices do not
include retail mark-ups, mark-downs or fees.


<TABLE>
<CAPTION>
                                                                Sales Prices
                                                            ---------------------
                                                            High             Low
                                                            ----            -----
<S>                                                         <C>            <C> 
           Year Ended March 31, 1997
                     1st Quarter                            $ 8 1/8        $ 5 7/8
                     2nd Quarter                              7 7/8          5
                     3rd Quarter                              6 3/4          4 7/8
                     4th Quarter                              5 3/8          2 1/4

           Year Ended March 31, 1998
                     1st Quarter                            $ 3            $ 2 1/8
                     2nd Quarter                              3 1/2          2 1/8
                     3rd Quarter                              3 3/8          1
                     4th Quarter                              1 7/8            5/8
</TABLE>


           The Company has never paid dividends on its Common Stock and does not
currently anticipate that it will do so in the foreseeable future. The future
payment of dividends, if any, on the Common Stock, is within the discretion of
the Board of Directors and will depend on the Company's earnings, its capital
requirements and financial condition, and other relevant factors. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations." The payment of any dividends on the Common Stock also obligates the
Company to pay dividends on the outstanding shares of Series C Preferred Stock.
Each share of Series C Preferred Stock is entitled, on an "as converted" basis,
to 110% of any cash dividends declared on each share of Common Stock, subject to
adjustments for stock splits, combinations or dividends.

           As of March 31, 1998, the Company had 129 holders of record of the
Company's Common Stock. However, based solely upon its proxy solicitation
procedures for last year's annual meeting of stockholders, the Company believes
that it has more than 1,000 beneficial owners of its Common Stock.

           The Company has received notification from the Nasdaq Stock Market
that it is not in compliance with the continued listing requirements of the
Nasdaq National Market(R). Nasdaq indicated that the Company has not maintained
the required $1 minimum closing bid price per share nor the required $5,000,000
minimum market value of public float. The Nasdaq Stock Market has granted the
Company until August 14, 1998 to be in compliance with the requirements. If the
Company is not in compliance by such time and has not initiated an appeal or
other procedural remedy, the Company's Common Stock will be delisted from
trading on the Nasdaq National Market(R) at the opening of business on August
17, 1998. If delisted, the Company's Common Stock would trade on the OTC
Bulletin Board and/or the "Pink Sheets." If moved to the Electronic Bulletin
Board or Pink Sheets, the Company would likely lose some or all of its present
market makers with the result that it would be more difficult to effect trades
of the Company's shares and to obtain timely and accurate quotations and reports
of trading. Any such delisting could also adversely affect the liquidity of the
Company's shares and thus their market value.



                                       20.

<PAGE>   21

           The Company is evaluating its procedural options with the Nasdaq
Stock Market as well as exploring ways to be in compliance with the listing
requirements. No assurance can be given that the Company will be able to achieve
compliance in the time permitted or, if an extension, waiver or other
dispensation is sought, that it will be granted.



                                       21.

<PAGE>   22
ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                   1998           1997          1996              1995               1994
                                               -----------    -----------    -----------       -----------       -----------
                                                                     (Dollars in thousands, except share amounts)
<S>                                            <C>            <C>            <C>                     <C>         <C>        
Statement of Operations Data:
  Revenues:
    Film licensing and production services ..  $     5,726    $     6,236    $     9,039       $     5,978       $     2,970
    Equipment sales and related
     services ...............................        4,688         11,475          8,426             9,459             2,245
                                               -----------    -----------    -----------       -----------       -----------

    Total revenues ..........................       10,414         17,711         17,465            15,437             5,215
  Cost of Revenues ..........................        8,756         10,854          8,399             8,584             3,967
                                               -----------    -----------    -----------       -----------       -----------
  Gross profit ..............................        1,658          6,857          9,066             6,853             1,248

  Other costs and expenses:
    General and administrative ..............        7,860          6,904          7,576             5,560             5,566
    Depreciation and amortization ...........          875            961            971             1,025             2,827
    Provision for contract modifications ....           --             --             --                --               673
                                               -----------    -----------    -----------       -----------       -----------
                                                     8,735          7,865          8,547             6,585             9,066
                                               -----------    -----------    -----------       -----------       -----------


    Operating income (loss) .................       (7,077)        (1,008)           519               268            (7,818)
    Other income (expense):
     Equity in operations of owned and
        operated theatres ...................         (540)          (694)          (217)             (502)               --
      Effect of impairment loss on equity in
       operations of owned and operated
       theatres .............................         (313)        (1,771)            --                --                --
      Other income ..........................          127            250            358               444               171
     Interest and other expense .............         (725)          (692)          (555)             (128)              (98)
   Provision for income taxes ...............           (4)            (4)            (4)               (3)               --
                                               -----------    -----------    -----------       -----------       -----------
   Net income (loss) ........................  $    (8,532)   $    (3,919)   $       101       $        79       $    (7,745)
                                               ===========    ===========    ===========       ===========       ===========
   Basic net income (loss) per common share .  $     (1.51)   $      (.70)   $       .02       $       .02       $     (1.68)
                                               ===========    ===========    ===========       ===========       ===========
   Diluted net income (loss) per 
     common share ...........................  $     (1.51)   $      (.70)   $       .01       $       .01       $     (1.68)
                                               ===========    ===========    ===========       ===========       ===========
Basic weighted average number of
 common shares ..............................    5,642,058      5,594,245      5,344,945         5,073,294         4,679,519
                                               ===========    ===========    ===========       ===========       ===========
Diluted weighted average number of 
 common shares ..............................    5,642,058      5,594,245      7,471,949         6,800,512         4,679,519
                                               ===========    ===========    ===========       ===========       ===========
Balance Sheet Data (at end of period):
  Cash, cash equivalents and short-term
    investments .............................  $     2,492    $     2,562    $     8,141       $     6,791       $     2,371
  Accounts receivable, net ..................        2,955          3,600          3,101             2,943             2,569
  Equipment sales inventory .................        1,186          1,289          1,547             2,142             1,440
  Other current assets ......................          901          1,072          1,244               980             1,221
  Film library (net) ........................        3,765          5,520          3,481             1,394             1,003
  Property and equipment (net) ..............          447            868          1,313             1,728             2,140
  Owned and operated theatres ...............          440          2,123          4,424             2,598               644
  Patents and other (net) ...................        1,525          2,894          2,764             2,654             2,994
                                               -----------    -----------    -----------       -----------       -----------
  Total assets ..............................  $    13,711    $    19,928    $    26,015       $    21,230       $    14,382
                                               ===========    ===========    ===========       ===========       ===========

  Current liabilities .......................  $     6,310    $     3,995    $     6,097       $     4,860       $     4,632

  Convertible notes and other ...............        5,690          5,690          6,620(2)          3,121(1)          2,998
  Series B Preferred Stock ..................           --             --             --                --             1,678

  Stockholders' equity ......................        1,711         10,243         13,298            13,249             5,074
                                               -----------    -----------    -----------       -----------       -----------
  Total liabilities and stockholders' equity   $    13,711    $    19,928    $    26,015       $    21,230       $    14,382
                                               ===========    ===========    ===========       ===========       ===========
</TABLE>


----------
(1)  Paid in full in April, 1995.

(2)  The Company completed a private placement of convertible notes in 
     September, 1995.



                                       22.

<PAGE>   23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

RESULTS OF OPERATIONS

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

           The principal sources of the Company's revenues are the licensing of
the Showscan film library and technologies, the sale and installation of
projectors, screens, sound systems and other equipment used to exhibit Showscan
films, and the sale of motion bases and other equipment used in most Showscan
Attractions. The Company derived, for each of the three years in the period
ended March 31, 1998, 60-85% of its revenues from export sales. See Note 10 to
the Consolidated Financial Statements and "Item 1. Business -- Sales and
Marketing." The Company does not believe that inflation has had a material
impact on the Company's net revenues or on its results of operations for the
three most recent fiscal years.

           Comparison of Year Ended March 31, 1998 and Year Ended March 31,
1997.

           Revenues for the fiscal year ended March 31, 1998 (hereafter "Fiscal
1998") decreased $7.3 million or 41% from revenues for the fiscal year ended
March 31, 1997 (hereafter "Fiscal 1997").

           Film licensing and production service revenues decreased $510,000 or
8% in Fiscal 1998. The decrease was due primarily to (i) renegotiation of
certain film licensing contracts in Asia due to adverse economic conditions in
that region, and (ii) the reduction in film revenues collected from the O&O
Theatres, due to the closure of three (two screens in London closed July 3, 
1998) of the Company's screens.

           Revenues from equipment sales and related services decreased $6.8
million or 59% in Fiscal 1998. The decrease is due to a decrease in the number
of Showscan Attractions shipped during Fiscal 1998 as compared to Fiscal 1997.
The actual number of Showscan Attractions shipped in Fiscal 1998 decreased to 3
units plus the completion of two relocation projects as compared to 16 such
units plus the completion of three relocation projects in Fiscal 1997. At June
30, 1998, the Company had 60 Showscan Attraction screens open with 10 additional
Showscan Attraction screens in its delivery and installation backlog and had
contractual commitments for an additional 29 Showscan Attraction screens in its
backlog including the 16 screens which UA has contractually agreed to purchase
and install prior to August 1999. The Company believes that UA is unlikely to
order and install all 16 remaining screens by such date. If UA is unable to meet
these obligations, UA is obligated to pay the Company $330,000 for each Showscan
Attraction which is not purchased and installed by August, 1999 and the Company
is obligated to pay UA $165,000 if the UA Venture does not select a joint
venture site by August, 1999. UA may also satisfy its obligations to the Company
by actually paying to the Company at least $13,950,000 in the aggregate for
motion simulation and/or projection equipment; provided, however, that only 50%
of each order for projection equipment sourced through the Company shall be
counted towards the target and any orders of projection equipment must result in
an aggregate benefit (as defined) to the Company of at least $3,200,000. To
date, UA has purchased approximately $7 million of equipment from the Company or
approximately one-half of the target amount. This backlog amount compares to 61
Showscan Attraction screens open with 8 additional Showscan Attraction screens
in its delivery and installation backlog and 29 contractual commitments for
Showscan Attraction screens in its backlog at June 20, 1997. The Company did not
sell any permanent or temporary specialty theatres in Fiscal 1998.

           The decrease in equipment revenues can be attributed to the
significant slow down in new sales orders since the announcement on August 5,
1997 of the Merger with Iwerks Entertainment, Inc. Although the Merger
eventually failed on March 31, 1998, the Company believes that the uncertainty
of the Merger and its possible effects on the Company adversely affected sales.
Equipment revenues were also negatively impacted by the delay in timing of
certain projects in the Asian market. The Company believes this delay is
primarily due to the economic situation in Asia and that its adverse impact on
the Company's revenues will continue in future periods since Asia is the largest
market for the Company's products and films.

           The Company recognizes equipment sales under the
percentage-of-completion method of accounting, generally measured by the
percentage that the labor hours incurred to date bears to the estimated total
labor hours of each contract. This results in a disparity in the comparison of
equipment sales revenues over different time periods, as the Company records
revenues under this method rather than on the date that the sales agreement is
signed. The actual signing of a Showscan Attraction sale precedes its delivery
and installation by



                                       23.

<PAGE>   24
an average of five to six months. Accordingly, the recognition of revenue for
equipment sales during the current and future quarters is affected by (i) the
timing of such sales; (ii) the schedule of the build-out of the
Attractions; and (iii) the shipment, delivery and installation of the equipment
and related services.

           Cost of revenues was 84% in Fiscal 1998 as compared to 61% in Fiscal
1997. Equipment cost of sales to total equipment sales increased to 95% in
Fiscal 1998 from 77% in Fiscal 1997. Film licensing costs to total film
licensing sales increased to 75% in Fiscal 1998 from 32% in Fiscal 1997. The
increase in equipment cost of sales to total equipment sales is due to the fact
that, of the five sales in Fiscal 1998, two were for relocations of existing
equipment. Relocation sales provide substantially less gross margin than new
sales. In addition, in Fiscal 1998 the Company reduced the carrying value by
$325,000 of certain non-performing assets held for sale in order to state them
at their net realizable value. The increase in film licensing cost of sales to
total film licensing costs is due to (i) a $1,725,000 provision to adjust the
carrying value of two films to their estimated realizable value, (ii) a $330,000
provision pursuant to a film distribution guarantee given by the Company (this
amount represents an estimate of the amount the Company will have to pay the
producer of the film over and above any net revenues that will be generated from
the distribution of the film over the next two years), and (iii) the additional
amortization of new films added in Fiscal 1998. The amortization of the film
library (which includes all adjustments) was $2,782,000 in Fiscal 1998 compared
to $613,000 in Fiscal 1997.

           General and administrative expenses increased $956,000 or 14% in
Fiscal 1998. The increase can be primarily attributed to (i) $650,000 in
expenses incurred with respect to the failed Merger with Iwerks Entertainment,
Inc., (ii) an increase to the allowance for doubtful accounts to reflect
degrading economic conditions with respect to certain of the Company's Asian and
other customers ($970,000), and certain other accounts receivable from
affiliates which are being disputed ($279,000) at March 31, 1998, (iii) offset
by a significant reduction in the Company's overhead.

           Depreciation and amortization expense decreased by $86,000 or 9% in
Fiscal 1998 from Fiscal 1997.

           The Company accounts for its ownership position in O&O Theatres using
the equity method of accounting. The equity loss of $540,000 on the operations
of O&O Theatres for Fiscal 1998 was the result of operating losses at the
Trocadero in London, at the Riverwalk in San Antonio, Texas, at the Framingham
theatres and at CityWalk. Although the O&O Theatre in Osaka had an operating
profit, the profit was not sufficient to offset the losses of the other O&O
Theatres. The Company earns film licensing revenues (from all O&O Theatres) and
management fees (from some of the O&O Theatres) which are recorded separately in
the accompanying consolidated statements of operations, thereby increasing the
operating expenses at the specific O&O Theatres. The Company has ceased
operations at the Framingham (closed in October 1997), San Antonio (closed in
September 1997), and London (closed in July 1998) theatres. The Company has
either sold or is negotiating to sell the equipment from the Framingham and San
Antonio theatres to nonaffiliated third parties. The joint venture partners of
each respective theatre have agreed to these sales.

           Additionally, a non-cash charge of $313,000 was recorded to reflect
an impairment loss recognized on the Company's investment in the London
theatres, which is recorded separately in the financial statements. The Company
does not believe that the effects of future impairment losses, if any, will be
significant.

           The Company incurred a net loss of $8,532,000 in Fiscal 1998 as
compared to a net loss of $3,919,000 recorded in Fiscal 1997, primarily due to
(i) the significant decrease in equipment sales revenues, (ii) the increase in
cost of revenues to total revenues, (iii) the poor performance of the O&O
Theatres, (iv) the $2 million adjustments to the carrying values of certain
films to their estimated realizable values, and (v) the increase in general and
administrative expenses caused by the failed Merger with Iwerks Entertainment,
Inc. and (vi) the increase to the accounts receivable reserves. Certain of the
expenses the Company incurred (e.g. the failed Merger costs) are non-recurring
items. In addition, the Company has taken steps to decrease on-going losses
(i.e. the closure of the five O&O Theatre screens and the significant reduction
of its work force and overhead). Accordingly, the Company does not believe that
these results are necessarily indicative of future operating results.



                                       24.

<PAGE>   25
           Comparison of Year Ended March 31, 1997 and Year Ended March 31,
1996.

           Revenues for Fiscal 1997 increased $246,000 or 1% from revenues for
the fiscal year ended March 31, 1996 (hereafter "Fiscal 1996").

           Film licensing and production service revenues decreased $2.8 million
or 31% in Fiscal 1997. The decrease was due primarily to (i) the renewal of an
agreement with the Company's major Japanese customer (Imagine Japan), which
renewal changed the timing of film licensing revenue recognition such that
approximately $1.1 million was recognized in Fiscal 1996 that would have been
recognized in Fiscal 1997; (ii) the inclusion in Fiscal 1996 of revenues from
two specific one-time license agreements, which revenues constituted all of the
revenues to be received with respect to such agreements, in the amounts of
$550,000 and $300,000, respectively; and (iii) the early renewals in Fiscal 1996
of certain film licensing agreements, which renewals changed the timing of film
licensing revenue recognition (reflected in the fourth quarter of Fiscal 1996
rather than in Fiscal 1997) of approximately $700,000. After adjusting for the
aforementioned items, the recurring film licensing revenues were $6.2 million in
Fiscal 1997 and $6.4 million in Fiscal 1996. Revenues from film licensing are
based on new license agreements as well as renewals of existing agreements and
results fluctuate from quarter to quarter, with such fluctuations being a result
of the seasonality in the way that licensing agreements are entered into and how
the license agreements are structured.

           Revenues from equipment sales and related services increased $3
million or 36% in Fiscal 1997. The increase is due to an increase in the number
of Showscan Attractions shipped during Fiscal 1997 as compared to Fiscal 1996.
The actual number of Showscan Attractions shipped in Fiscal 1997 increased to 16
units plus the completion of three relocation projects compared to ten such
units in Fiscal 1996. Equipment sales in Fiscal 1996 also included $360,000 of
one-time revenues recognized as a result of the expiration under a customer
agreement of a required installation of two theatre sites. At June 20, 1997, the
Company had 61 Showscan Attractions screens with 8 additional Showscan
Attractions screens in its delivery and installation backlog and has contractual
commitments for an additional 29 Showscan Attractions screens in its backlog, as
compared to 55 Showscan Attractions screens with 11 additional Showscan
Attractions screens in its delivery and installation backlog and 27 contractual
commitments for Showscan Attractions screens in its backlog at June 20, 1996.
The Company did not sell any permanent or temporary specialty theatres in Fiscal
1997.

           Cost of revenues was 61% in Fiscal 1997 as compared to 48% in Fiscal
1996. The increase was primarily the result of (i) two one-time agreements which
were recognized ($550,000 and $660,000 respectively) in Fiscal 1996, each of
which had significantly lower associated cost of revenues; and (ii) a lower
gross profit percentage associated with sales to a major customer in Fiscal
1997. Cost of revenues also increased as a percentage of total revenues because
film licensing revenues (which traditionally have a higher gross profit margin)
represented less of a percentage of total revenues in Fiscal 1997 than in Fiscal
1996. Amortization expense of the film library for Fiscal 1997 was $613,000, up
27% from the amortization expense of $481,000 in Fiscal 1996.



                                       25.

<PAGE>   26
           General and administrative expenses decreased $672,000 or 9% in
Fiscal 1997. The decrease can be primarily attributed to an overall reduction in
payroll and consultant expense due to the reduction in Company staff in the
fourth quarter of Fiscal 1997 resulting from the decline in business activity.

           Depreciation and amortization expense remained relatively unchanged
in Fiscal 1997 from Fiscal 1996.

           The Company accounts for its ownership position in O&O Theatres using
the equity method of accounting. The equity loss of $694,000 on the operations
of O&O Theatres for Fiscal 1997 was primarily the result of the following
factors: (i) expenses incurred in connection with the acquisition and
development of future O&O Theatre locations; (ii) operating losses at the
Trocadero in London due to disruptions to theatre operations and attendance
caused by the major renovation of the building and the theatre access
impediments created thereby; (iii) operating losses, including start-up and
marketing expenses at the Riverwalk in San Antonio, Texas; and (iv) operating
losses at the Framingham theatres and at CityWalk. Although the O&O Theatre in
Osaka had an operating profit, the profit was not sufficient to offset the
losses of the other O&O Theatres. The Company earns film licensing revenues
(from all O&O Theatres) and management fees (from some of the O&O Theatres)
which are recorded separately in the accompanying consolidated statements of
operations, thereby inherently increasing the operating expenses at the specific
O&O Theatres. A formal claim that was filed with the owner of the Trocadero
building to recover damages and lost revenues resulting from the renovation of
the Trocadero building and the related access problems has resulted in a
favorable settlement, in which the company holding that theatre will be
reimbursed for a portion of the lost revenue incurred during the renovation
period.

           The Company recognized a non-cash charge of $1,771,000 in Fiscal 1997
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" by
certain of its O&O Theatres joint ventures. The loss was calculated as the
excess of the carrying value of joint venture fixed assets for each impaired O&O
Theatre over the estimated discounted cash flows or fair value of each O&O
Theatre impaired. Under the equity method of accounting, the Company has
recognized its share of the joint venture charges.

           The Company incurred a net loss of $3,919,000 in Fiscal 1997 as
compared to net income of $101,000 recorded in Fiscal 1996, primarily due to the
decrease in film licensing and production service revenues, an increase in cost
of revenues to total revenues, and the performance of the O&O Theatres,
including the effect of the impairment loss on equity in the operations of
certain O&O Theatres joint ventures.

LIQUIDITY AND CAPITAL RESOURCES

           At March 31, 1998, the Company's working capital decreased to
$1,224,000 from $4,528,000 at March 31, 1997. Cash, cash equivalents and
short-term investments decreased to $2,492,000 from $2,562,000 at March 31,
1997. The decrease in working capital is primarily due to the operating loss for
Fiscal 1998 and in part, to the expenditures related to the production of one
new motion simulation film, post-production work on three other films (two of
which were acquired from Imax) and the acquisition of eleven new films.

           Cash and cash equivalents at March 31, 1998 decreased by $70,000 from
March 31, 1997, which was the result of $757,000 used in operating activities,
$183,000 used in investing activities and $870,000 provided by financing
activities.

           Net cash used in operating activities was primarily due to (i) the
18% net decrease in accounts receivable and amounts due from affiliated
entities, and (ii) the unbilled receivable balance on uncompleted equipment
contracts in Fiscal 1998 that did not exist in Fiscal 1997.



                                       26.

<PAGE>   27
           Net cash used in investing activities was primarily due to (i)
expenditures related to the production of one motion simulation film,
post-production of three other films (two of which were acquired from Imax) and
the acquisition of eleven new films, offset by (ii) the 60% decrease in other
assets.

           Net cash provided by financing activities was due to a $1,000,000
($870,000 net of expenses) borrowing obtained in connection with a promissory
note from a private institution on November 1, 1997. The note bears interest at
11 percent per annum, with principal and interest due and payable on November
15, 1998. The note is secured by accounts receivables from the distribution of
the Company's film library and the proceeds thereof.

           As the Company derives 60-85% of its business from export sales, its
liquidity may be adversely affected by changes in worldwide economic or
political conditions. Such factors as changes in foreign currency exchange rates
(which can significantly affect the affordability of Showscan's products and
services), trade protection measures, and policies with respect to currency and
fiscal controls may negatively affect liquidity. The current Asian economic
situation has already caused the delay of certain projects and the Company
believes that it will have an adverse impact on revenues in future periods.

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

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

           The Company has, since inception, incurred recurring losses and had
net losses aggregating $12,451,000 during the fiscal years ended March 31, 1998
and 1997. During Fiscal 1998, the Company took a substantial number of actions
in order to implement significant cost reductions, including the reduction in
employee head-count to 29 from 61 a little more than a year ago, and the closure
of five of the seven existing O&O theatre screens. The Company's management has
taken these steps without, to date, severely impacting operations. The Company's
management is evaluating further cost reductions, including the out-sourcing
of certain operating functions (thereby further reducing employee head count to
approximately 20), the relocation of the Company's headquarters to smaller
office space and other actions. There can be no assurance that these cost-
cutting measures will be sufficient or that they will not further impact the
Company's operations.



                                       27.

<PAGE>   28
           The Company has limited capital resources and has debt obligations
from two different financial institutions, which mature in November 1998
($1,000,000) and in September 1999 ($5,690,000). The Company has held
preliminary discussions with its European bank regarding additional financing in
excess of the $5,690,000 currently outstanding and has had preliminary
discussions with both creditors with regard to re-negotiation of the debt
repayment schedules. Although the Company has held preliminary discussions with
its European bank regarding additional financing, there can be no assurance that
the Company will be successful in obtaining any such financing. There can also
be no assurance that either creditor will agree to extend its maturity date or
other terms. Each creditor is secured by certain assets which together
constitute all of the assets of the Company.

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

           The Company believes that its existing funds, combined with the
Company's ability to generate cash from future operations, will be adequate to
finance its revised levels of activities and operations for the next twelve
months, however, based on the Company's current cash flow projections, it is
anticipated that cash generated from operations will not be sufficient to pay
all of the $5,690,000 due on September 1, 1999. The Company has certain
alternatives available to it in order to pay the debt due in September 1999,
including the possible sale and/or licensing of assets to others, the
re-negotiation of debt re-payment schedules, the raising of cash through debt
and/or equity financings, the further curtailment of operating expenses and the
receipt of payments by the Company from UA by August 1999 either through the
order of projection and/or motion simulation equipment or through the liquidated
damages provisions of the Theater Rights Agreement with UA (estimated to be at
least $3,200,000). SEE ITEM 13, "Certain Relationships and Related Transactions
-- The United Artists Venture" and NOTE 7 of Notes to Consolidated Financial
Statements. 

           The Company has received notification from the Nasdaq Stock Market
that it is not in compliance with the continued listing requirements of the
Nasdaq National Market(R). Nasdaq indicated that the Company has not maintained
the required $1 minimum closing bid price per share nor the required $5,000,000
minimum market value of public float. The Nasdaq Stock Market has granted the
Company until August 14, 1998 to be in compliance with the requirements. If the
Company is not in compliance by such time and has not initiated an appeal or
other procedural remedy, the Company's Common Stock will be delisted from
trading on the Nasdaq National Market(R) at the opening of business on August
17, 1998. If delisted, the Company's Common Stock would trade on the OTC
Bulletin Board and/or the "Pink Sheets." If moved to the Electronic Bulletin
Board or Pink Sheets, the Company would likely lose some or all of its present
market makers with the result that it would be more difficult to effect trades
of the Company's shares and to obtain timely and accurate quotations and reports
of trading. Any such delisting could also adversely affect the liquidity of the
Company's shares and thus their market value. Such delisting could also
adversely affect the Company's ability to obtain debt and/or equity financing.



                                       28.

<PAGE>   29
           Management of the Company has reviewed the provisions of SFAS 130 and
131 and determined that the ultimate adoption of these accounting standards will
not have an impact on the Company's financial statements and related
disclosures.

IMPACT OF THE YEAR 2000

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

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

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

           The costs of the project and the date on which the Company believes
it will complete the conversion are based on management's best estimates, which
were derived utilizing numerous assumptions of future events, including the
continued availability of certain resources and other factors. However, there
can be no guarantee that these estimates will be achieved and actual results
could differ materially from those anticipated.

           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 is 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 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. See "Factors That May Affect Future Results."

FACTORS THAT MAY AFFECT FUTURE RESULTS

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



                                       29.

<PAGE>   30

History of Operating Losses

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

Business Strategy; Dilution

           Management of the Company has adopted a business strategy that
includes substantial investments in its sales and marketing organizations, the
creation of new research and development programs and increased funding of
existing programs. This strategy carries with it a number of risks, including a
level of operating expenses that may not be adequately covered by the Company's
revenues or by funds obtained by raising additional capital. Additional
financing may not be available to the Company at all or only on unfavorable
terms. To date, the Company's primary source of capital has been from debt and
equity financings. Unless the Company is able to obtain additional proceeds from
such financing sources the Company will have to restructure its business and
operations. A number of factors will make it difficult for the Company to obtain
equity financing in the future, including the significant losses the Company
incurred in the last fiscal year, the expected de-listing of the Common Stock
from Nasdaq, the on-going financial turmoil in Asia (historically the Company's
largest market and principal source of operating revenues), the Company's
historical stock performance, and a general decrease in investor interest in the
Company's industry. The Company's lack of assets that are available for
collateral and its cash flow fluctuations may make it difficult for the Company
to attract additional debt financing. Any investor or lender may require a
significant equity position in the Company that could result in dilution of the
Company's present stockholders. In addition to curtailing its business strategy,
the Company has debt obligations from two different financial institutions which
mature in November 1998 ($1,000,000) and in September 1998 ($5,690,000). The
Company has had preliminary discussions with both creditors with regard to
re-negotiation of the debt repayment schedules. There can be no assurance that
either creditor will agree to extend its maturity date or other terms. The
failure to repay either of these debts could result in the foreclosure against
the collateral securing them which, between the two obligations, constitute all
of the assets of the Company. Based on current cash flow projections, the
management of the Company anticipates that cash generated from operations will
not be sufficient to pay all of the $5.7 million due on September 1, 1999. The
Company has various alternatives available to it in order to pay this debt.
There can be no assurance that any of these alternatives will be successful.

Period to Period Fluctuations

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

           The Company's performance depends primarily upon the number of motion
simulation attractions that it can sell and install. This dependence has been
lessening as the percentage of the Company's revenues derived from recurring
film licensing revenues has increased though there can be no assurance that this
trend will necessarily continue. The Company's results have followed a seasonal
pattern, with revenues tending to be stronger in the second and fourth fiscal
quarters, reflecting the buying patterns of the Company's customers for new
motion simulation attractions.

New Product Development

           The Company operates in a technology driven segment of the
entertainment business. As such, the Company must continually improve its
products to increase their entertainment value while also facing pressure to
continually reduce the price of its products to respond to competitive
pressures. Since several of the Company's 



                                       30.

<PAGE>   31
competitors have significantly more capital than the Company, the Company has
had to rely more on its suppliers and other third-parties to improve the
Company's existing products and to develop new ones. The inability of the
Company to develop new products and to respond to technological developments of
its competitors could have a materially adverse effect on the Company's
business, operations and financial condition.

International Operations

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

Intellectual Property

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

Competition

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

           Most of the Company's competitors, have dedicated substantial
resources to this market. In the large screen, special format motion picture
business, the Company's main competitor is Imax, though Iwerks is also a
competitor. The 15 perforation 70 millimeter 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



                                       31.

<PAGE>   32
developing and are expected to develop new entertainment products or concepts
for the out-of-home entertainment industry in response to these developments
that are or may be directly competitive with existing products. There is severe
competition for financial, creative and technological resources in the industry
and there can be no assurance that existing products will continue to compete
effectively or that products under development will ever be competitive.
Further, the commercial success of products is ultimately dependent upon
audience reaction. Audience reaction will to a large extent be influenced by the
audience's perception of how the Company's products compare with other available
entertainment options out of the home. There can be no assurance that new
developments in out-of-home entertainment will not result in changes in consumer
tastes that will make the Company's products less competitive.

Volatility of Stock Price; Effect of Delisting

           The Company's stock price has been, and could continue to be, highly
volatile. During the 12 months prior to June 30, 1998, the Company's closing
market price has ranged from a low of $0.344 per share to a high of $3.50 per
share. Future announcements concerning the Company or its competitors, quarterly
variations in operating results, introduction of new products or changes in
product pricing policies by the Company or its competitors, the acquisition or
loss of significant customers, or changes in earnings estimates by analysts,
among other factors, may affect or be perceived to affect the Company's
operations and could cause the market price of the Company's shares to fluctuate
substantially. In addition, stock markets have experienced extreme price and
volume volatility in recent years. This volatility has had a substantial effect
on the market prices of securities of many smaller public companies for reasons
frequently unrelated to the operating performance of the specific companies.
These broad market fluctuations may adversely affect the market price of the
Company's shares.

           In addition, the Company has received notification from the Nasdaq
Stock Market that the Company's shares will be delisted from the Nasdaq National
Market(R) on August 17, 1998 unless the Company is in compliance with the
continued listing requirements before such time. Any such delisting could
adversely effect the liquidity of the Company's shares and thus their market
value. Information regarding trading in the Company's shares could become more
difficult to obtain, and trading could become infrequent and low in volume.
See "Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters."

Ability to Retain Key Personnel

           Over the past eighteen months, the Company has reduced its number of
employees from 61 to 29. The pendency of the Merger, the financial losses, the
potential for additional staff reductions and a tight job market have resulted
in some departures by key personnel. While none of the departures have had a
significant effect upon the Company's operations, there can be no assurance that
there will not be additional departures. In addition, the Company's insurance
coverage for its directors and officers is due for renewal. If coverage is
unavailable or is available only at a reduced level, then the Company may
experience additional departures at its Board and management level which could
have a materially adverse effect on the Company's operations.          



Environmental Matters and Other Governmental Regulations

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

Business Disruption

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

Dependence on Major Customers

           The Company's motion simulation business has two significant
concentrations. The first concentration involves ongoing film licenses and is
located in Japan where Imagine Japan presently operates or is otherwise



                                       32.

<PAGE>   33
responsible for fifteen simulation attractions. The second concentration relates
to the Company's sales backlog where UA and King's Entertainment Co., Ltd.
individually and collectively represent a substantial portion of the outstanding
equipment orders to be delivered in the next few years. The Company's agreement
with United Artists Theatre Circuit, Inc. calls for a build out period extending
through August 1999 while that with Apex Science & Technology Corp. (assignee of
King's Entertainment Co., Ltd.) extends through May 2002. Each site opened under
each agreement shall have an initial film license period of at least three
years. In the fiscal year ended March 31, 1998, Showscan earned revenues from
Imagine Japan and United Artists Theatre Circuit, Inc. in the amounts of
$1,318,000 and $100,000, respectively. The Company's short and long-term
performance could be adversely impacted if disruptions were to occur in any of
these areas of concentration such as order cancellations, license terminations
or payment problems.

Ability to Produce Additional Films

           One of the primary factors considered by potential purchasers of
motion simulation attractions is the quality and extent of the films available
to be shown at the attraction. The Company believes that a large portion of its
competitive advantage resides in its popular and extensive library of ride
films. To maintain this competitive edge, the Company must produce or acquire
the distribution rights to several new films each year. Film production is
expensive and requires the investment of Company funds (to the extent that
investors cannot be located) with no assurance that the films produced will be
popular. To the extent that the Company does not have its own funds available to
invest and financing cannot be found on acceptable terms, then the Company's
ability to produce new films could be restricted. Other competitors have each
indicated that they are devoting substantial portions of their assets to the
production of new motion simulation films. Both the short and long term
financial performance of the Company will be adversely affected if the perceived
quality and popularity of the Company's film library declines either alone or in
comparison to the films of the Company's competitors.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

           The Financial Statements are listed under Item 14 in this report.

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

           Not applicable.



                                       33.

<PAGE>   34
                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

           Set forth below is certain information with respect to the directors
and executive officers of the Company:


<TABLE>
<CAPTION>
                                                                                     DIRECTOR
NAME                         AGE                       TITLE                           SINCE
----                         ---                       -----                         -------
<S>                          <C>      <C>                                            <C>
William D. Eberle            74       Chairman of the Board of Directors               1988
William C. Soady             54       Director                                         1994
Charles B. Moss, Jr.         53       Director                                         1993
Thomas R. DiBenedetto        48       Director                                         1993
Kurt C. Hall                 38       Director                                         1994
Dennis Pope                  53       President, Chief Executive Officer
                                        and Director                                   1997
Gregory W. Betz              49       Vice President and Director of Finance            --
W. Tucker Lemon              36       Senior Vice President, General Counsel            
                                        and Secretary                                   --
Michael B. Ellis             46       Vice President-Engineering and                    
                                        Product Development                             --
Russell H. Chesley           40       Vice President-Worldwide Sales                    --
</TABLE>

           William D. Eberle was elected Chairman of the Board of Directors of
the Company in May 1993. Mr. Eberle has been a private investor in various
companies for more than five years and is Of Counsel to Kaye, Scholer, Fierman,
Hays & Handler. From 1993, he was Of Counsel to Donovan, Leisure, Newton &
Irvine. He currently is also the chairman of Manchester Associates, Ltd.,
American Service Group and Barry's Jewelers, Inc. and is Deputy Chairman of
Mid-States plc. He is a director of Ampco Pittsburgh Corp., Mitchell Energy &
Development Corp., FAC Realty Trust, Inc. and Sirrom Capital Corporation. Mr.
Eberle served as the U.S. Trade Representative for President Nixon and President
Ford. In addition, he served as the President's Special Representative for Trade
Negotiations from 1971 through 1975, and as the executive director of the
Cabinet Council on International Economics from 1974 to 1975. Other positions
previously held by Mr. Eberle include Chairman of the Board, President and Chief
Executive Officer of American Standard, Inc. and officer and director of Boise
Cascade Corp.

           William C. Soady has been the President of Distribution for PolyGram
Filmed Entertainment Distribution, Inc. since March 1997. Previously, Mr. Soady
served as President and Chief Executive Officer of the Company since March 1994,
and was elected as a director of the Company in April 1994. Prior to joining the
Company, Mr. Soady served as Executive Vice President of Distribution at Tri
Star Pictures, Inc. from September 1988 to July 1992, at which time he was
promoted to President of Domestic Distribution of Tri-Star Pictures, Inc., the
position he held immediately prior to joining the Company. Mr. Soady has been
involved in motion picture distribution in various capacities for over 20 years,
including serving as President of Universal Pictures Distribution.

           Charles B. Moss, Jr. has been the President and Chief Executive
Officer of The B.S. Moss Enterprises, Inc. since 1979. Mr. Moss is also a
director of Robins Cinemas, Ltd., a United Kingdom corporation and a director of
Cinemania (UK) Limited since 1994.

           Thomas R. DiBenedetto has served as the President of Junction
Investors, Ltd. since 1991 and as the President of Boston International Group
since 1983. He is also currently a director of National Wireless Inc.
and of Alexander's, Inc.



                                       34.

<PAGE>   35
           Kurt C. Hall was appointed the President and Chief Executive Officer
of United Artists Theatre Circuit, Inc. ("UA") in March 1998, after holding the
positions of Chief Operating Officer during 1997 through March 1998 and as
Executive Vice President and Chief Financial Officer of UA since 1992. Mr. Hall
held several positions with United Artists Entertainment Company, the
predecessor to UA, since joining that company in 1988, including Director of
Finance from 1988 to 1990 and Vice President and Treasurer from 1990 to 1992.

           Dennis Pope was appointed the President and Chief Executive Officer
of the Company in March 1997. Mr. Pope had been the Executive Vice President and
Chief Financial Officer of the Company since May 1994. From January 1993 until
May 1994, Mr. Pope was the Managing Partner - Entertainment Business Group with
Kenneth Leventhal & Co. Prior to joining Kenneth Leventhal, Mr. Pope had served
as a consultant to that firm on entertainment industry matters in November and
December 1992.

           Gregory W. Betz joined the Company as Controller in June 1986, was
promoted to Vice President-Controller in December 1990, and became the
Company's Vice President and Director of Finance in October 1993.

           W. Tucker Lemon was appointed Senior Vice President, General Counsel
and Secretary of the Company in March 1997. Previously, Mr. Lemon was the Vice
President, General Counsel and Secretary, the position he held since he joined
the Company in August 1994. From February 1993 until he joined the Company, Mr.
Lemon was Of Counsel to Corey, Croudace, Dietrich & Dragun and prior thereto,
Mr. Lemon was associated with Latham & Watkins.

           Michael B. Ellis joined the Company as its Vice President-Engineering
and Product Development in July 1994. From February 1993 until he joined the
Company, Mr. Ellis was a consultant providing technical support to entertainment
and commercial construction industries. Mr. Ellis was the Corporate Director-
Engineering and Project Development of Knott's Berry Farm from May 1989 through
February 1993.

           Russell H. Chesley joined the Company as Vice President-Worldwide
Sales in August 1995. From March 1994 until he joined the Company, Mr. Chesley
was Director of Marketing and Sales at Westrex, an entertainment technology and
equipment manufacturer. From November 1992 until February 1994, Mr. Chesley was
Sales and Marketing Director and an Executive Producer at Starfax/The Editing
Company, a post production facility. Prior thereto, Mr. Chesley was an
independent producer and consultant.

           The Company has five wholly owned subsidiaries (Showscan Productions,
Inc., Showscan CityWalk, Inc., Showscan Attractions, Inc., Showscan Framingham,
Inc. and Showscan Entertainment B.V.). Showscan Attractions, Inc. currently owns
50% of the outstanding capital stock of Cinemania (UK) Limited. Mr. Pope is the
sole director and President of Showscan Productions, Inc., Showscan CityWalk,
Inc., Showscan Attractions, Inc. and Showscan Framingham, Inc. Mr. Soady
currently is director and President of Showscan Entertainment B.V.; however, the
process is under way to replace Mr. Soady with Mr. Pope in each such capacity.
Mr. Lemon is the Vice President - Secretary of these subsidiaries. Mr. Pope, Mr.
Moss and Mr. Lemon are the directors of Cinemania (UK) Limited.

COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934

           Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors and executive officers, as well as persons who own more than
ten percent of the Company's Common Stock, to file with the Securities and
Exchange Commission (the "SEC") initial reports of beneficial ownership and
reports of changes in beneficial ownership of the Common Stock. Directors,
executive officers and greater-than-ten-percent stockholders are required by
SEC regulations to furnish the Company with copies of all Section 16(a) forms
they file.

           Based solely on a review of copies of reports filed with the SEC and
submitted to the Company since April 1, 1997 and on written representations by
certain directors and executive officers of the Company, the



                                       35.

<PAGE>   36
Company believes that all persons subject to the reporting requirements of
Section 16(a) filed all required reports on a timely basis during the past
fiscal year.

ITEM 11.  EXECUTIVE COMPENSATION

           The following tables set forth certain information concerning the
annual and long-term compensation for services rendered to the Company in all
capacities for the fiscal years ended March 31, 1998, 1997 and 1996 of (i) all
persons who served as the Chief Executive Officer of the Company during the
fiscal year ended March 31, 1998 and (ii) each of the four other most highly
compensated executive officers of the Company. (The Chief Executive Officer and
the other named officers are collectively referred to as the "Named
Executives.")


                           SUMMARY COMPENSATION TABLE


<TABLE>
<CAPTION>
                                                 ANNUAL COMPENSATION          LONG-TERM COM-
                                                                              PENSATION AWARD
  NAME AND PRINCIPAL POSITION             YEAR     SALARY ($)      BONUS ($)   OPTIONS (#)
  ---------------------------             ----     ----------      ---------  ---------------
<S>                                       <C>      <C>             <C>        <C>
Dennis Pope, ........................     1998     $250,000        $     -0-       -0-
   President and Chief Executive          1997     $220,000(1)     $     -0-     115,000
   Officer                                1996     $213,846        $     -0-       -0-

W. Tucker Lemon, ....................     1998     $150,577        $     -0-       -0-
   Senior Vice President, General         1997     $127,501        $     -0-      35,000
   Counsel and Secretary                  1996     $125,000        $     -0-       -0-

Michael B. Ellis, ...................     1998     $127,336        $     -0-       -0-
  Vice President-Engineering and          1997     $115,442        $     -0-       -0-
  Product Development                     1996     $115,000        $     -0-       -0-
               

Russell H. Chesley, .................     1998     $172,886(2)     $     -0-       -0-
  Vice President-Worldwide Sales          1997     $124,458(2)     $     -0-       -0-
                                          1996     $ 66,346(2)     $     -0-      17,500

Rui C. Guimarais, ...................     1998     $123,284(3)     $     -0-       -0-
  Vice President-Film Licensing           1997     $101,397        $     -0-       -0-
                                          1996     $102,278        $     -0-      10,000
</TABLE>


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

(1)        Mr. Pope became President and Chief Executive Officer in March 1997.
           Prior to Mr. Pope assuming the office of President and Chief
           Executive Officer, he served as the Company's Executive Vice
           President and Chief Financial Officer.

(2)        Mr. Chesley's compensation consisted of a base salary of $110,000
           plus commissions on certain sales of the Company's equipment and
           films.

(3)        Mr. Guimarais resigned from all his positions that he held with the
           Company and its subsidiaries in May, 1998.



                                       36.

<PAGE>   37
           The following table contains information concerning stock options
exercised in the last fiscal year and stock options remaining unexercised on
March 31, 1998 with respect to the Named Executives.

         AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED MARCH 31, 1998
                        AND FISCAL YEAR-END OPTION VALUE


<TABLE>
<CAPTION>
                                                                    NUMBER OF SECURITIES
                                                                   UNDERLYING UNEXERCISED            VALUE OF UNEXERCISED IN-THE-
                                                                OPTIONS/SARs AT FISCAL YEAR-         MONEY OPTIONS/SARs HELD AT
                                                                       END (#) (2)                     FISCAL YEAR-END ($) (1)
                                                             ---------------------------------       ----------------------------
                          SHARES ACQUIRED      VALUE
                            ON EXERCISE       REALIZED
     NAME                       (#)            ($) (1)        EXERCISABLE        UNEXERCISABLE       EXERCISABLE    UNEXERCISABLE
     ----                 ---------------     --------        -----------        -------------       -----------    -------------
<S>                       <C>                 <C>             <C>                <C>                 <C>            <C>
Dennis Pope                     -0-              -0-            178,750              86,250              -0-              -0-
W. Tucker Lemon                 -0-              -0-             38,750              26,250              -0-              -0-
Michael B. Ellis                -0-              -0-             13,125               4,375              -0-              -0-
Russell H. Chesley              -0-              -0-              8,750               8,750              -0-              -0-
Rui C. Guimarais                -0-              -0-             11,250               6,250              -0-              -0-
</TABLE>

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

(1)        Value is determined by subtracting the exercise price from the fair
           market value (the closing price for Common Stock as reported on the
           Nasdaq National Market(R)) as of March 31, 1998, the last trading day
           in the fiscal year ($.625 per share) and multiplying the resulting
           number by the number of underlying shares of Common Stock.

DIRECTOR COMPENSATION

           Members of the Board of Directors who are not officers of the Company
receive a fee of $500 for each Board meeting that they attend and are also
reimbursed for the travel expenses incurred to attend such meetings.

BOARD OF DIRECTOR INTERLOCKS AND INSIDER PARTICIPATION

           The Compensation Committee of the Board of Directors made all
compensation determinations during the past fiscal year for the Company's
executives. Dennis Pope was during the fiscal year ended March 31, 1998, both an
officer and a director of the Company though he was not a member of the
Compensation Committee.

EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS

           Mr. Pope has entered into an employment agreement, dated May 3, 1994,
and amended on June 15, 1995, pursuant to which he agreed to be Executive Vice
President and Chief Financial Officer of the Company. Effective March 1, 1997,
Mr. Pope was made President and Chief Executive Officer and his employment
agreement was amended so that he will receive an annual salary of $250,000. The
agreement is terminable by either Mr. Pope or the Company upon 30 days notice to
the other party. However, if the Company terminates the agreement without cause
(where "cause" is defined to mean conviction of a felony, commission of fraud or
embezzlement, neglect of duties, death, permanent disability or breach of duty
of loyalty to the Company), then the Company is obligated to pay Mr. Pope his
salary and benefits for up to one year, subject to Mr. Pope's best efforts to
mitigate such obligation. In addition, the Company has granted Mr. Pope options
to purchase 150,000 shares of the Company's Common Stock at $8.125 per share,
35,000 shares at $6.125 per share and 80,000 shares at $3.625 per share. Such
options vest at the rate of 25% per year, commencing on the first anniversary of
the agreement by which they were granted.



                                       37.

<PAGE>   38
           Mr. Lemon has entered into an employment agreement, dated August 15,
1994, pursuant to which he agreed to be Vice President, General Counsel and
Secretary of the Company. Effective March 1, 1997, Mr. Lemon was made Senior
Vice President, General Counsel and Secretary and his employment agreement was
amended so that he will receive an annual salary of $150,000. In addition, the
Company has granted Mr. Lemon options to purchase 30,000 shares of Common Stock
at $7.75 per share, 20,000 shares at $6.125 per share and 15,000 shares at
$3.625 per share. Such options vest at the rate of 25% per year, commencing on
the first anniversary of the agreement by which they were granted. If the
Company terminates the agreement without cause, then the Company is obligated to
pay Mr. Lemon in one lump sum his salary for four months.

           The Company's Board of Directors entered into agreements with Messrs.
Pope, Lemon, Ellis, Chesley and Gregory W. Betz that would protect each such
officer in the case of a change in control of the Company. These agreements are
intended to provide certain benefits to the officers upon a "Change of Control"
which is defined to mean (a) the acquisition by any person of 20% or more of
Common Stock and Common Stock equivalents of the Company or 20% of the Company's
voting power, (b) a liquidation, merger or consolidation of the Company, or (c)
a change in the membership of the Company's Board of Directors over any period
of two (2) years or less such that the directors sitting at the beginning of
such period or who were nominated by at least two-thirds of the sitting
directors cease to be a majority of the Company's Board of Directors. These
officers of the Company are entitled to receive certain cash payments and health
benefits if they leave the Company, either one year before or within two years
after a Change in Control, for "Good Reason," "Disability," death or retirement
or if they were terminated without "Cause" (in each case as the foregoing terms
are defined in the agreements). Messrs. Pope and Lemon also have an additional
period after a Change in Control in which they can voluntarily leave the Company
and receive the benefits. The cash benefits provided for Mr. Pope will equal
200% of his annual salary on the date of termination. Mr. Lemon will receive
150% of the greater of his average salary and bonuses over the period of three
(3) fiscal years preceding the Change in Control or the period of three (3)
fiscal years preceding his termination. The other three officers each will
receive 75% of the greater of his average salary and bonuses over the three (3)
fiscal years preceding the Change in Control or the period of three (3) fiscal
years preceding his termination. In addition, the unvested options of Messrs.
Pope and Lemon shall become vested upon a Change in Control. All such benefits
shall be in lieu of any benefits provided under any such officer's employment
agreement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

           The following table sets forth certain information regarding the
beneficial ownership of each class of the Company's voting securities as of June
30, 1998 by (i) each of the Company's directors and Named Executives who
beneficially own Common Stock or Series C Preferred Stock, (ii) by all directors
and officers as a group, and (iii) based on reports filed by each person with
the Securities and Exchange Commission, by the known beneficial holders of more
than 5% of any class of outstanding shares of the Company's voting securities.
Beneficial ownership has been determined in accordance with Rule 13d-3 under the
Exchange Act. Under this Rule, certain shares may be deemed to be beneficially
owned by more than one person (such as where persons share voting power or
investment powers). In addition, shares are deemed to be beneficially owned by a
person if the person has the right to acquire the shares (for example, upon
exercise of an option) within 60 days of the date as of which the information is
provided; in computing the percentage ownership of any person, the amount of
shares outstanding is deemed to include the amount of shares beneficially owned
by such person (and only such person) by reason of these acquisition rights on
or before June 30, 1998. As a result, the percentage of outstanding shares of
any person as shown in the following table does not necessarily reflect the
person's actual voting power at any particular date.



                                       38.

<PAGE>   39

<TABLE>
<CAPTION>
                                                                                          SERIES C
                                                        COMMON STOCK(2)               PREFERRED STOCK
                                                  ------------------------------    -----------------------
                                                  NUMBER             PERCENTAGE     NUMBER      PERCENTAGE
NAME AND ADDRESS                                    OF                   OF           OF            OF
OF BENEFICIAL OWNER(1)                            SHARES             OUTSTANDING    SHARES      OUTSTANDING
----------------------                            ------             -----------    ------      -----------
<S>                                           <C>                    <C>            <C>         <C>
William D. Eberle                                55,127(3)               *            --            --
Charles B. Moss, Jr                             994,362(4)             15.7%        12,000         24.5%
  c/o B.S. Moss Enterprises
  225 North Hill Street,
  Aspen, CO 81611
Thomas R. DiBenedetto                         1,014,362(5)             16.0%        12,000(6)      24.5%
  c/o Junction Investors, Ltd. 
  84 State Street
  Boston, MA 02109
DiBenedetto Showscan Limited                    706,672(7)             11.1%        12,000         24.5%
 Partnership
  c/o Junction Investors, Ltd. 
  84 State Street
  Boston, MA 02109
United Artists Theatre Circuit, Inc.            946,032(8)             14.4%        25,000         51.0%
  9110 East Nichols Avenue
  Suite 200
  Englewood, CO 80112
Kurt C. Hall(9)                                    --                   --            --            --
  c/o United Artists Theatre
        Circuit, Inc. 
  9110 East Nichols Avenue
  Suite 200
  Englewood, CO 80112
Neuberger & Berman                              372,150(10)             6.6%          --            --
605 Third Avenue
New York, NY 10158
William C. Soady(11)                            273,250                 4.6%          --            --
Dennis Pope(12)                                 198,500                 3.4%          --            --
W. Tucker Lemon(13)                              55,750                  *            --            --
Michael B. Ellis(14)                             17,500                  *            --            --
Russell H. Chesley(15)                            8,750                 --            --            --
Rui C. Guimarais(16)                               --                   --            --            --

All Officers and Directors                    2,640,101                36.7%        24,000        100.0%
  as a Group (11 persons) (17)
</TABLE>

----------
*  Less than 1%.

(1)        Except as otherwise noted, the address of each beneficial owner
           listed in this table is c/o Showscan Entertainment Inc., 3939
           Landmark Street, Culver City, California 90232.

(2)        Unless otherwise noted, the Company believes that all persons named
           in the table have sole voting and investment power with respect to
           all securities beneficially owned by them.

(3)        Consists of 55,127 shares subject to currently exercisable stock
           purchase warrants.

(4)        Consists of (a) 468,577 shares underlying currently exercisable stock
           purchase warrants, 44,101 of which are held by Charles B. Moss, III,
           Mr. Moss' son, and 44,101 of which are held by Robin H. Moss, Mr.



                                       39.

<PAGE>   40
           Moss' ex-wife, as custodian for Elizabeth H. Moss, Mr. Moss'
           daughter, (b) 238,095 shares of Common Stock issuable upon conversion
           of Mr. Moss' Preferred Stock, (c) 155,000 shares of Common Stock held
           by the Charles B. Moss, Jr. Family Trust, (d) 6,200 shares of Common
           Stock held by M. F. P., LLC, a limited liability company whose
           members are Mr. Moss' children, (e) 21,900 shares of Common Stock
           held by Robin H. Moss, and (f) 104,590 shares of Common Stock owned
           by Mr. Moss. Robin H. Moss is the sole trustee of the Charles B.
           Moss, Jr. Family Trust. Mr. Moss disclaims beneficial ownership of
           the shares held by the Charles B. Moss, Jr. Family Trust, M. F. P.,
           LLC and Robin H. Moss and the warrants held by Charles B. Moss, III
           and by Robin H. Moss as custodian for Elizabeth H. Moss.

(5)        Includes (a) 238,095 shares of Common Stock issuable upon conversion
           of the Preferred Stock held by DiBenedetto Showscan Limited
           Partnership, a Delaware limited partnership, (b) 35,000 shares of the
           Common Stock owned by the DiBenedetto 1993 Family Trust, (c) 35,000
           shares of Common Stock owned by the DiBenedetto Family Trust U/A/D
           11/01/91 FBO Cory James DiBenedetto, (d) 35,000 shares of Common
           Stock owned by the DiBenedetto Family Trust U/A/D 11/01/91 FBO
           Christian Robert DiBenedetto, (e) 35,000 shares of Common Stock owned
           by the DiBenedetto Family Trust U/A/D 11/01/91 FBO Thomas Austin
           DiBenedetto, (f) 35,000 shares of Common Stock owned by the
           DiBenedetto Family Trust U/A/D 11/01/91 FBO Marc Anthony DiBenedetto,
           (g) 468,577 shares of Common Stock underlying currently exercisable
           stock purchase warrants held by DiBenedetto Showscan Limited
           Partnership, and (h) 132,690 shares of Common Stock owned by Mr.
           DiBenedetto. Mr. DiBenedetto has sole voting and dispositive power
           over the securities beneficially owned by DiBenedetto Showscan
           Limited Partnership. Linda M. DiBenedetto, Mr. DiBenedetto's wife, is
           co-trustee of the DiBenedetto 1993 Family Trust. Mr. DiBenedetto
           disclaims beneficial ownership of the shares of Common Stock held by
           the DiBenedetto 1993 Family Trust, the DiBenedetto Family Trust U/A/D
           11/01/91 FBO Cory James DiBenedetto, the DiBenedetto Family Trust
           U/A/D 11/01/91 FBO Christian Robert DiBenedetto, the DiBenedetto
           Family Trust U/A/D 11/01/91 FBO Thomas Austin DiBenedetto, and the
           DiBenedetto Family Trust U/A/D 11/01/91 FBO Marc Anthony DiBenedetto.

(6)        Consists of 12,000 shares of Preferred Stock owned by DiBenedetto
           Showscan Limited Partnership. Mr. DiBenedetto has sole voting and
           dispositive power over these securities.

(7)        Consists of 468,577 shares subject to currently exercisable stock
           purchase warrants and 238,095 shares of Common Stock issuable upon
           conversion of Preferred Stock.

(8)        Consists of 450,000 shares subject to currently exercisable stock
           purchase warrants and stock purchase warrants exercisable within 60
           days and 496,032 shares of Common Stock issuable upon conversion of
           Preferred Stock.

(9)        Kurt C. Hall is an executive officer of United Artists Theatre
           Circuit, Inc. Mr. Hall does not have voting or investment power with
           respect to the securities held by United Artists Theatre Circuit,
           Inc.

(10)       Neuberger & Berman disclaims beneficial ownership of 87,400 shares
           owned by certain of its individual partner(s) in their own personal
           accounts. Such shares were purchased with personal funds and each
           such partner has sole voting and dispositive power over the shares in
           his/her account.

(11)       Includes 271,250 shares of currently exercisable stock options and
           options exercisable within 60 days.

(12)       Includes 187,500 shares of currently exercisable stock options and
           options exercisable within 60 days.

(13)       Includes 53,750 shares of currently exercisable stock options (10,000
           of which are held by Mr. Lemon's wife) and options exercisable within
           60 days. Mr. Lemon does not have voting or investment power with
           respect to the securities held by his wife.

(14)       Includes 17,500 shares of currently exercisable stock options and
           options exercisable within 60 days.



                                       40.

<PAGE>   41
(15)       Includes 8,750 shares of currently exercisable stock options.

(16)       Rui C. Guimarais resigned from all positions with the Company in May,
           1998. All options held by Mr. Guimarais were canceled 30 days after
           his resignation.

(17)       Includes 1,553,531 shares subject to stock options and stock purchase
           warrants currently exercisable or exercisable within 60 days and
           476,190 shares of Common Stock issuable upon conversion of Preferred
           Stock.

           Showscan, United Artists Theatre Circuit, Inc. ("UA"), Charles B.
Moss, Jr. ("Moss"), Thomas R. DiBenedetto and DiBenedetto Showscan Limited
Partnership, a Delaware limited partnership (collectively, the "DiBenedetto
Entities") are party to that certain Voting Agreement, dated as of August 19,
1994, pursuant to which UA, Moss and the DiBenedetto Entities have agreed to
vote the securities held by them in favor of each other's designees for the
Company's Board of Directors.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

           MOSS/DIBENEDETTO VENTURES. On September 27, 1993, the Company entered
into that certain Purchase Agreement (the "Purchase Agreement") with Mr. Charles
B. Moss, Jr., a director of the Company ("Moss"), Mr. Thomas R. DiBenedetto, a
director of the Company ("DiBenedetto"), and DiBenedetto Showscan Limited
Partnership, a Delaware limited partnership affiliated with, and controlled by,
DiBenedetto ("DiBenedetto LP"), pursuant to which, among other things, Moss,
DiBenedetto and DiBenedetto LP collectively acquired the warrants to purchase an
aggregate of 850,000 shares of Common Stock, 150,000 shares of Series A
Preferred Stock, and 24,000 shares of Series B Preferred Stock. So long as Moss
and DiBenedetto collectively own shares of Common Stock or securities
convertible into shares of Common Stock representing in the aggregate 5% or more
of the then outstanding Common Stock, the terms of the Purchase Agreement
require that the Company continue to nominate Moss and DiBenedetto or their
designees to the Company's Board of Directors. Additionally, affiliates of Moss
and DiBenedetto have entered into two transactions for the purpose of owning,
operating, developing and financing the Company's motion simulation attractions.
The first transaction, a venture called the "Showscan City Walk Venture," was
formed for the purpose of operating one of the Company's motion simulation
attractions at Universal City Walk in Universal City, California which opened in
November 1993. The parties to that venture are Showscan City Walk, Inc., a
wholly-owned California subsidiary of the Company and the managing partner of
Showscan City Walk Venture, Moss Family LA Corp., a California corporation
controlled by Moss, and DiBenedetto City Walk Limited Partnership, a Delaware
limited partnership controlled by DiBenedetto. Initially, the Moss and
DiBenedetto affiliates together owned a 1% investment and had a right to acquire
a collective 50% investment in the venture for a price based on the cash flow of
the motion simulation attraction. The Moss and DiBenedetto affiliates exercised
the right to acquire the 50% investment in January 1994. Upon the exercise of
the option, the Moss and DiBenedetto affiliates each paid the Company $10,000.
The balance of the purchase price ($247,772) was paid in March, 1996. As of June
30, 1998, the Moss and DiBenedetto affiliates each owed the Company $46,250 with
respect to advances made to the Showscan CityWalk Venture on their behalf to
satisfy capital calls to cover operating expenses. On July 8, 1998, the Moss and
DiBenedetto affiliates indicated to the Company that they dispute their
obligation to pay these sums and the Company has reserved such amounts in its
Fiscal 1998 financial statements.

           The second venture, organized under the name "Showscan Attractions
Venture," was formed for the purpose of acting as the exclusive vehicle to
develop, own, manage and operate additional Showscan motion simulation
attractions throughout the world. The scope of the Showscan Attractions Venture
was subsequently narrowed in September 1994 to accommodate the venture with
United Artists Theatre Circuit, Inc. ("UA") discussed below. The parties to this
venture are Showscan Attractions, Inc., a wholly-owned California subsidiary of
the Company and the managing partner of Showscan Attractions Venture, Moss
Family O&O Corp., a California corporation controlled by Moss (the "Moss
Partner), and DiBenedetto O&O Limited



                                       41.

<PAGE>   42
Partnership, a Delaware limited partnership controlled by DiBenedetto (the
"DiBenedetto Partner"). Showscan Attractions, Inc., currently owns a 50%
interest in the Attractions Venture, the Moss Partner currently owns a 25%
interest in the venture, and the DiBenedetto Partner owns the remaining 25%
interest.

           The Showscan Attractions Venture agreement contemplates that the
parties thereto will jointly develop, own and operate the Company's motion
simulator attractions through the venture or through other corporations,
partnerships or entities formed by them. In accordance with the foregoing, the
parties to the Showscan Attractions Venture formed Cinemania (UK) Limited for
the purpose of developing, owning and operating the Company's motion simulator
attraction in London which opened in late September 1994 (the "London Theatre").
Showscan Attractions, Inc. owns 50% of the outstanding capital stock of
Cinemania (UK) Limited, the Moss Partner owns 25% of the capital stock, and the
DiBenedetto Partner owns 25%. As of June 30, 1998, funding for the Attractions
Venture has been provided by Showscan Attractions, Inc. $2,404,805; Moss Partner
$571,408; and DiBenedetto Partner $571,408. The rights contributed to the
Showscan Attractions Venture included the rights to two motion simulation
attraction leases and the rights to a trademark to be used in connection with
one motion simulation attraction. The services contributed, and to be
contributed in the future, consist of development services related to the London
motion simulation attraction, including coordinating the design and construction
of the facility and the opening and subsequent on-going management of the
facility. The London Theatre is managed by Showscan Attractions, Inc., as the
managing partner of the Showscan Attractions Venture, through a management
agreement with Robins Cinemas, Ltd. ("Robins"). Moss is a 5% stockholder and a
director of Robins. The stockholders of Cinemania (UK) Limited closed the London
Theatre on July 3, 1998 and have placed the company in liquidation.

           In August 1995, Showscan Attractions Venture and Maloney Development
Partnership Ltd. ("Maloney"), an unaffiliated Texas limited partnership, formed
a Texas limited liability company called Showscan Maloney, LLC to own and
operate the Company's motion simulation attraction in the San Antonio Riverwalk
District, in San Antonio, Texas. Showscan Attractions Venture and Maloney own
equal interests in Showscan Maloney, LLC; therefore, the Company's share in the
cash flow from the motion simulation attraction is 25% plus the annual film
rentals, royalties and management fees that Showscan Maloney, LLC is separately
required to pay to the Company. Day-to-day management of the motion simulation
attraction is handled by the Company as the sole manager of Showscan Maloney,
LLC. The partners of Showscan Maloney, LLC closed the theatre on September 7,
1997 and are liquidating its assets. The partners have further agreed to
distribute the theatre equipment to the Company, which is in the process of
negotiating to sell the equipment to a non-affiliated third party. The Company
expects to fully realize the carrying value of its investment in this venture
upon the completion of the liquidation and subsequent sale.

           In connection with the Showscan Attraction Venture and Cinemania (UK)
Limited, the Moss Partner and the DiBenedetto Partner each owed the Company
$108,970 and $89,373, respectively, as of June 30, 1998 with respect to advances
made to the Showscan Attractions Venture on their behalf to satisfy capital
calls to cover operating expenses at the theatres. On July 8, 1998, the Moss
Partner and the DiBenedetto Partner indicated to the Company that they dispute
their obligation to pay these sums and the Company has reserved such amounts in
its Fiscal 1998 financial statements.

           Pursuant to a Proprietary Property Acquisition and Management
Agreement dated as of September 27, 1993, between the Company and Showscan
Attractions Venture, the Company granted to the Showscan Attractions Venture
rights to utilize proprietary property and rights of the Company in connection
with the development and operation of the Company's motion simulation
attractions. Under that agreement, the Company has been retained to manage the
motion simulation attractions developed and operated by the venture. The venture
has also retained Moss Entertainment Corp., a corporation controlled by Moss,
and DiBenedetto Corp., an affiliate of DiBenedetto, to provide certain services
in connection with the acquisition of properties for the Company's motion
simulation attractions and the potential disposition of those attractions. Moss
Entertainment Corp. and DiBenedetto Corp. are to receive fees for providing
acquisition and disposition services upon the sale or other disposition of
certain of the initial theatres developed by the venture.



                                       42.

<PAGE>   43
THE UNITED ARTISTS VENTURE. On August 19, 1994, the Company entered into that
certain Purchase Agreement (the "UA Purchase Agreement") with UA, pursuant to
which, among other things, UA purchased 25,000 shares of Preferred Stock and
warrants representing the right to purchase an aggregate of 552,000 shares of
Common Stock. So long as UA owns shares of Common Stock or securities
convertible into shares of Common Stock representing in the aggregate of at
least 500,000 shares of Common Stock, the terms of the UA Purchase Agreement
require that the Company continue to nominate a designee of UA to the Company's
Board of Directors. Kurt C. Hall, a director of the Company and an executive
officer of UA, is the designee of UA. In connection with the transactions
effected by the UA Purchase Agreement, the Company and UA agreed to be equal
partners in a venture called Showscan/United Artists Theatres Joint Venture (the
"UA Venture"). The Company is managing partner of the UA Venture while UA is the
administrative partner. Pursuant to a Theater Rights Agreement, dated as of
August 19, 1994, as amended (the "Theater Rights Agreement"), whenever UA or the
UA Venture builds the Company's motion simulation attraction theatre, such
entity will have the exclusive rights to exhibit the Company's motion simulation
attraction films within a pre-agreed area surrounding such location. Also,
pursuant to the Theater Rights Agreement, UA will develop and coordinate the
construction of new and/or the conversion of existing theatres to the Company's
motion simulation attractions and will manage each theatre pursuant to
pre-negotiated terms. The Company, in turn, has agreed to pre-negotiated terms
for the sale of the Company's equipment, installation, servicing and the
licensing of the Company's motion simulation films. The Company will also make
available to both the UA Venture and UA its library of specialty films which
utilize the patented Showscan process, to the extent that either the UA Venture
or UA builds or converts existing theatres into specialty theatres for the
exhibition of specialty films.

           Pursuant to the Theater Rights Agreement, UA has agreed to offer to
the UA Venture for ownership and operation by the UA Venture, up to 24 theatre
sites at any time prior to August 19, 1999 for the installation of Showscan
Attractions in existing or to-be-built UA theatre complexes. If the UA Venture
declines to acquire a particular location, then UA must install a Showscan
motion simulation attraction theatre at the first 24 sites that the UA Venture
declines to acquire. As of June 30, 1998 UA has installed 8 Showscan
Attractions. The Theater Rights Agreement also contains certain provisions that
require UA to make payments to the Company if UA is unable to meet its
obligations under that agreement. The Theater Rights Agreement provided that two
motion simulation attraction theatres be installed and in operation in Malaysia
no later that December 31, 1995. UA was unable to meet this commitment and
therefore UA has an Obligation at March 31, 1998, to pay to the Company $712,000
together with interest thereon at the rate of 7.5% per annum (the "Obligation")
from January 1, 1996 until paid in full. In July 1998, the Company and UA
reached an agreement to settle the Obligation by means of a $318,000 payment in
July 1998, the purchase by the Company of certain new simulation equipment and
other assets owned by UA, the offset of certain amounts and the payment of the
remaining amounts over approximately one year. The Theater Rights Agreement
contains further provisions that require UA to make payments to the Company if
UA is unable to meet its obligations and that require the Company to make
payments to UA if the UA Venture is unable to meet certain of its obligations.
UA is obligated to pay the Company $330,000 for each Showscan Attraction which
is not purchased and installed by August, 1999 (presently 16 theatre sites) and
the Company is obligated to pay UA $165,000 if the UA Venture does not select a
joint venture site by August, 1999. UA may also satisfy its obligations to the
Company by actually paying to the Company at least $13,950,000 in the aggregate
for motion simulation and/or projection equipment; provided, however, that in
July, 1998 those provisions were modified so that only 50% of each order for
projection equipment sourced through the Company shall be counted towards the
target and any orders of projection equipment must result in an aggregate
benefit (as defined) to the Company of at least $3,200,000. To date, UA has
purchased approximately $7 million of equipment from the Company or
approximately one-half of the target amount. To date, UA has offered to the UA
Venture eight sites at new or existing UA movie theatre multiplexes. The UA
Venture declined seven of these sites because they did not meet the criteria of
the UA Venture. The UA Venture had accepted the offer by UA of the Showscan
Attraction site in Austin, Texas, which acceptance was to be effective July 1,
1997. During the process of finalizing documentation relating to the acquisition
of the Austin site, however, UA entered into a merger transaction with other
large theatre chains and circumstances surrounding the merger transaction
created uncertainty with respect to the Austin site. In conjunction therewith,
UA advised the UA Venture not to proceed with the Austin site acquisition,
accordingly, the UA Venture has terminated its plans to acquire ownership of the
Showscan Attraction at the Austin site.





                                       43.

<PAGE>   44
           In connection with the foregoing, the Theater Rights Agreement has
been amended by the Company and UA to eliminate certain installation
requirements in Malaysia and to add those requirements to the overall UA
obligations. In connection with the amendment, (a) UA relinquished its
exclusivity rights to Malaysia and eliminated its rights of first refusal in the
Asia Territory (as defined in the Theater Rights Agreement), (b) the Company
agreed to make certain payments (the "Payments") to UA each time the Company
sells a simulation theatre to a third party in Malaysia or the Asia Territory,
and (c) the Company agreed to certain reduced pricing for a certain number of
its 15/70 format theatre systems. In July 1998, the Theater Rights Agreement was
further amended (the "Third Amendment") as discussed above, to eliminate the
Payments after the offset of certain amounts and to increase through June 30,
1999 the level of percentage film rental that UA pays to the Company. These
amendments together with the purchase by the Company of certain motion base
equipment owned by UA were used in partial satisfaction of the Obligation. The
Third Amendment also amended the Theater Rights Agreement to expand the ability
of UA to source projection equipment through the Company. UA may now purchase
15/70, 8/70 and 4/35 projection equipment through the Company and 50% of each
such purchase shall apply towards the $13,950,000 equipment purchase target that
is an alternate way that UA may satisfy its obligations to the Company. The
Third Amendment also establishes that this expanded right to source projection
equipment through the Company must result in at least an aggregate benefit (as
defined) to the Company of $3,200,000.

           In connection with the formation of the UA Venture and the
modification to the Showscan Attractions Venture that it necessitated, the
Company entered into a royalty agreement with Moss and DiBenedetto Partner which
provides that each time that the UA Venture opens the Company's motion
simulation attraction theatre in one of the areas granted to UA, each of Moss
and DiBenedetto Partner will receive a one-time cash fee and thereafter will
receive an annual royalty based on the net cash flow (as defined) received by
the Company from the operations of such UA Venture theatre.






                                       44.

<PAGE>   45
                                     PART IV

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

a.(1)(2)  FINANCIAL STATEMENTS AND SCHEDULES.

           See the Index to Consolidated Financial Statements and Financial
Statement Schedule on Page F-1 hereafter, which is incorporated herein by
reference.

a.(3)  EXHIBITS



<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                DESCRIPTION
        -------                                -----------
<S>                   <C>
           2.1        Agreement and Plan of Reorganization, dated as of August
                      4, 1997, by and among Iwerks Entertainment, Inc., IWK-1
                      Merger Corporation and Showscan Entertainment Inc. (p)

           2.2        Amendment No. 1 to Agreement and Plan of Reorganization,
                      dated December 29, 1997, by and among Iwerks
                      Entertainment, Inc., IWK-1 Merger Corporation and Showscan
                      Entertainment Inc. (q)

           3.1        Restated Certificate of Incorporation.(j)

           3.2        Certificate of Amendment to Restated Certificate of
                      Incorporation, dated August 3, 1990.(j)

           3.3        Second Certificate of Amendment of Restated Certificate of
                      Incorporation of Showscan Corporation, dated August 18,
                      1994.(j)

           3.4        Certificate of Designations with respect to Series C
                      Convertible Preferred Stock of Showscan Corporation, as
                      filed with the Secretary of State of Delaware on August
                      22, 1994.(h)

           3.5        Certificate of Designations with respect to Series D
                      Participating Preferred Stock of Showscan Entertainment
                      Inc., as filed with the Secretary of State of Delaware on
                      November 9, 1994.(j)

           3.6        Bylaws of the Company, as amended.(n)

           4.1        Specimen certificate of the Common Stock, $.001 par value,
                      of the Company.(a)

           4.2        Stock Purchase Warrant, dated March 9, 1989, issued by the
                      Company to Columbia Pictures Industries, Inc.(a)

           4.3        Warrant Agreement, dated as of September 27, 1993, among
                      Showscan Corporation and Charles B. Moss, Jr. and
                      DiBenedetto Showscan Limited Partnership.(b)

           4.4        Form of Warrant Agreement entered into with William D.
                      Eberle.(g)
</TABLE>



                                       45.

<PAGE>   46
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                DESCRIPTION
        -------                                -----------
<S>                   <C>

           4.5        Registration Rights Agreement, dated as of September 27,
                      1993, among Showscan Corporation, Charles B. Moss, Jr.,
                      Thomas R. DiBenedetto and DiBenedetto Showscan Limited
                      Partnership.(b)

           4.6        Specimen Certificate of Series C Convertible Preferred
                      Stock, $.001 par value, of the Company.(j)

           4.7        Warrant Agreement, dated as of August 19, 1994, by and
                      between Showscan Corporation and United Artists Theatre
                      Circuit, Inc.(h)

           4.8        Registration Rights Agreement, dated as of August 19,
                      1994, by and between Showscan Corporation and United
                      Artists Theatre Circuit, Inc.(h)

           4.9        Rights Agreement, dated as of November 11, 1994, by and
                      between Showscan Entertainment Inc. and Continental Stock
                      Transfer & Trust Company.(i)

           4.10       Registration Rights Agreement, dated as of September 22,
                      1994, by and among Showscan Entertainment Inc., Charles B.
                      Moss, Jr. and DiBenedetto Showscan Limited Partnership.(j)

           4.11       Note Purchase, Paying and Conversion Agency Agreement,
                      dated as of August 14, 1995, by and between Showscan
                      Entertainment Inc. and Banca del Gottardo.(k)

           4.12       Global Note, dated September 1, 1995, made by Showscan
                      Entertainment Inc. in favor of Banca del Gottardo.(k)

           4.13       Agency Agreement, dated as of August 14, 1995, by and
                      between Showscan Entertainment Inc. and Banca del
                      Gottardo.(k)

           4.14       Pledge/Security Agreement, dated as of September 1, 1995,
                      by and between Showscan Entertainment Inc. and Banca del
                      Gottardo.(k)

           4.15       Amendment to Pledge/Security Agreement, dated as of
                      September 1, 1995, by and between Showscan Entertainment
                      Inc. and Banca del Gottardo.(k)

           4.16       Warrant Agreement, dated as of September 1, 1995, by and
                      between Showscan Entertainment Inc. and Jack M.
                      Ferraro.(l)

           4.17       Registration Rights Agreement, dated as of September 1,
                      1995, by and between Showscan Entertainment Inc. and Jack
                      M. Ferraro.(l)

           4.18       Warrant Agreement, dated as of September 1, 1995, by and
                      between Showscan Entertainment Inc. and Jack Erlanger.(l)

           4.19       Registration Rights Agreement, dated as of September 1,
                      1995, by and between Showscan Entertainment Inc. and Jack
                      Erlanger.(l)

           4.20       Warrant Agreement, dated as of October 3, 1995, by and
                      between Showscan Entertainment Inc. and Intralink Film
                      Graphic Design.(l)
</TABLE>



                                       46.

<PAGE>   47
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                DESCRIPTION
        -------                                -----------
<S>                   <C>
           4.21       Rights Agreement Amendment, dated as of August 4, 1997, by
                      and between Showscan Entertainment Inc. and Continental
                      Stock Transfer & Trust Company. (p)

           9.1        Voting Agreement, dated as of August 19, 1994, by and
                      among Showscan Corporation, United Artists Theatre
                      Circuit, Inc., Charles B. Moss, Jr., and Thomas R.
                      DiBenedetto.(h)

           10.1       Lease dated June 15, 1989 between the Company and Landmark
                      Investments Ltd. ("Lease").(d)

           10.2       Amendment No. 1 to Lease, dated February 20, 1991.(a)

           10.3       Amendment No. 2 to Lease, dated January 21, 1992.(e)

           10.4       Amendment No. 3 to Lease, dated February 18, 1993.(f)

           10.5       Amended and Restated Showscan Corporation 1987 Stock
                      Option Plan.(c)

           10.6       Showscan Entertainment Inc. 1992 Stock Option Plan, as
                      amended.(j)

           10.7       Modification, Consent and Assignment Agreement dated April
                      26, 1985 between the Company, Douglas Trumbull and
                      Brock/Trumbull Entertainment Corporation.(c)

           10.8       Agreement, dated June 27, 1985, between the Company and
                      Future General Corporation.(c)

           10.9       Agreement, dated February 23, 1987, between the Company
                      and Cinema Products Corporation (the "Camera
                      Agreement").(c)

           10.10      Amendment to Camera Agreement, dated July 20, 1988.(a)

           10.11      Amendment to Camera Agreement, dated February 1, 1989.(a)

           10.12      Showscan 1985 Agreement, dated April 16, 1985, and
                      Agreement, dated August 31, 1983, between Showscan
                      Investors and Brock-Trumbull Entertainment Corporation.(c)

           10.13      Amendment to Royalty Agreement, dated July 6, 1990,
                      between the Company and WLS Partners.(a)

           10.14      Amendment to payment terms of the Royalty Agreement, dated
                      November 13, 1990, between the Company and WLS
                      Partners.(a)

           10.15      Universal CityWalk Lease, dated November 24, 1992, by and
                      among the Company and MCA Development Company.(f)

           10.16      Purchase Agreement dated as of September 27, 1993, among
                      Showscan Corporation, Charles B. Moss, Jr., Thomas R.
                      DiBenedetto and DiBenedetto Showscan Limited
                      Partnership.(b)
</TABLE>



                                       47.

<PAGE>   48
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                DESCRIPTION
        -------                                -----------
<S>                   <C>
           10.17      Joint Venture Agreement, dated as of September 27, 1993,
                      among Showscan Attractions, Inc., Moss Family O&O Corp.,
                      and DiBenedetto O&O Limited Partnership, with respect to
                      the organization of Showscan Attractions Venture.(b)

           10.18      Joint Venture Agreement, dated as of September 27, 1993,
                      among Showscan CityWalk, Inc., Moss Family LA Corp., and
                      DiBenedetto CityWalk Limited Partnership, with respect to
                      the organization of Showscan CityWalk Venture.(b)

           10.19      Proprietary Property Acquisition and Management Agreement,
                      dated as of September 27, 1993, between Showscan
                      Corporation and Showscan Attractions Venture.(b)

           10.20      Development and Disposition Services Agreement, dated as
                      of September 27, 1993, among Showscan Attractions Venture,
                      DiBenedetto Showscan, Inc. and Moss Entertainment Corp.(b)

           10.21      Employment Agreement, dated May 3, 1994, between the
                      Company and Dennis Pope, as amended.(j)

           10.22      Purchase Agreement, dated as of August 19, 1994, by and
                      between Showscan Corporation and United Artists Theatre
                      Circuit, Inc.(h)

           10.23      Joint Venture Agreement, dated as of August 19, 1994, by
                      and between Showscan Corporation and United Artists
                      Theatre Circuit, Inc.(h)

           10.24      Theater Rights Agreement, dated as of August 19, 1994,
                      among Showscan Corporation, United Artists Theatre
                      Circuit, Inc. and Showscan/United Artists Theatres Joint
                      Venture.(h)

           10.25      First Amendment to Theater Rights Agreement, dated as of
                      March 30, 1995, by and among Showscan Entertainment Inc.,
                      United Artists Theatre Circuit, Inc. and Showscan/United
                      Artists Theatres Joint Venture.(j)

           10.26      Master Management and Development Agreement, dated as of
                      August 19, 1994, among Showscan Corporation, United
                      Artists Theatre Circuit, Inc. and Showscan/United Artists
                      Theatres Joint Venture.(h)

           10.27      Amendment No. 1 to the Showscan Attractions Joint Venture
                      Agreement, dated as of September 22, 1994, by and among
                      DiBenedetto O&O Limited Partnership, Showscan Attractions,
                      Inc., and Moss Family O&O Corp.(j)

           10.28      Standstill Agreement, dated as of August 22, 1994, by and
                      among Showscan Corporation, United Artists Theatre
                      Circuit, Inc., Charles B. Moss, Jr., Thomas DiBenedetto
                      and DiBenedetto Showscan Limited Partnership.(h)
</TABLE>



                                       48.

<PAGE>   49
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                DESCRIPTION
        -------                                -----------
<S>                   <C>
           10.29      Stock Exchange Agreement, dated as of September 22, 1994,
                      by and among Showscan Entertainment Inc., Charles B. Moss,
                      Jr., Thomas R. DiBenedetto, and DiBenedetto Showscan
                      Limited Partnership.(j)

           10.30      Royalty Agreement, dated as of September 22, 1994, by and
                      among Showscan Entertainment Inc., Moss Family O&O Corp.
                      and DiBenedetto O&O Limited Partnership.(j)

           10.31      Second Amendment to Theater Rights Agreement, dated as of
                      December 31, 1995, by and among Showscan Entertainment
                      Inc., United Artists Theatre Circuit, Inc. and
                      Showscan/United Artists Theatres Joint Venture.(l)

           10.32      Agreement, dated August 7, 1996, between the Company and
                      Dennis Pope.(m)

           10.33      Agreement, dated August 7, 1996, between the Company and
                      W. Tucker Lemon.(m)

           10.34      Credit Agreement, dated as of November 1, 1997, by and
                      between Showscan Entertainment Inc. and Eldee
                      Foundation.(o)

           21.1       List of Subsidiaries of the Company.(l)

           23.1       Consent of Ernst & Young LLP.

           27.1       Financial Data Schedule.
</TABLE>


----------

           (a)          Previously filed as an exhibit to the Company's
                        Registration Statement on Form S-1, Registration No.
                        33-40531, as amended, and incorporated herein by
                        reference.

           (b)          Previously filed as an exhibit to the Schedule 13D filed
                        with the Securities and Exchange Commission by Charles
                        B. Moss, Jr., Thomas R. DiBenedetto and DiBenedetto
                        Showscan Limited Partnership, dated September 27, 1993,
                        and incorporated herein by reference.

           (c)          Previously filed as an exhibit to the Company's
                        Registration Statement on Form S-1, Registration No.
                        33-13582, as amended, and incorporated herein by
                        reference.

           (d)          Previously filed as an exhibit to the Company's Annual
                        Report on Form 10-K for fiscal year ended March 31,
                        1990, and incorporated herein by reference.

           (e)          Previously filed as an exhibit to the Company's Annual
                        Report on Form 10-K for the fiscal year ended March 31,
                        1992, and incorporated herein by reference.

           (f)          Previously filed as an exhibit to the Company's Annual
                        Report on Form 10-K for fiscal year ended March 31,
                        1993, and incorporated herein by reference.



                                       49.

<PAGE>   50
           (g)          Previously filed as an exhibit to the Company's
                        Registration Statement on Form S-1, Registration No.
                        33-78236, as amended, and incorporated herein by
                        reference.

           (h)          Previously filed as an exhibit to the Company's Current
                        Report on Form 8-K dated August 19, 1994, as amended by
                        the Form 8-K/A dated November 7, 1994, and incorporated
                        herein by reference.

           (i)          Previously filed as an exhibit to the Company's Current
                        Report on Form 8-K dated November 11, 1994, and
                        incorporated herein by reference.

           (j)          Previously filed as an exhibit to the Company's Annual
                        Report on Form 10-K, as amended by the Form 10-K/A dated
                        September 25, 1995, for the fiscal year ended March 31,
                        1995, and incorporated herein by reference.

           (k)          Previously filed as an exhibit to the Company's Current
                        Report on Form 8-K dated September 1, 1995, and
                        incorporated herein by reference.

           (l)          Previously filed as an exhibit to the Company's Annual
                        Report on Form 10-K for the fiscal year ended March 31,
                        1996, and incorporated herein by reference.

           (m)          Previously filed as an exhibit to the Company's
                        Quarterly Report on Form 10-Q for the fiscal quarter
                        ended June 30, 1996, and incorporated herein by
                        reference.

           (n)          Previously filed as an exhibit to the Company's Annual
                        Report on Form 10-K, as amended by the Form 10-K/A's
                        dated July 29, 1997 and August 14, 1997, for the fiscal
                        year ended March 31, 1997, and incorporated herein by
                        reference.

           (o)          Previously filed as an exhibit to the Company's
                        Quarterly Report on Form 10-Q for the fiscal quarter
                        ended December 31, 1997, and incorporated herein by
                        reference.

           (p)          Previously filed as an exhibit to the Company's Current
                        Report on Form 8-K dated August 4, 1997, and
                        incorporated herein by reference.

           (q)          Previously filed as an exhibit to the Company's Report
                        on Form 8-K dated December 29, 1997, and incorporated
                        herein by reference.

b.         THE FOLLOWING REPORTS ON FORM 8-K WERE FILED DURING THE FOURTH
           QUARTER OF THE FISCAL YEAR ENDED MARCH 31, 1998.

                        NONE.



                                       50.

<PAGE>   51
                          INDEX TO FINANCIAL STATEMENTS
                           SHOWSCAN ENTERTAINMENT INC.



<TABLE>
<S>                                                                        <C>
Report of Independent Auditors.............................................F-2

Consolidated Balance Sheets at March 31, 1998 and 1997.....................F-3

Consolidated Statements of Operations for the years ended 
  March 31, 1998, 1997 and 1996............................................F-5

Consolidated Statements of Stockholders' Equity for the years 
  ended March 31, 1998, 1997 and 1996......................................F-6

Consolidated Statements of Cash Flows for the years ended 
  March 31, 1998, 1997 and 1996............................................F-7

Notes to Consolidated Financial Statements.................................F-9

Consolidated Financial Statement Schedule:

    Schedule II.    Valuation and Qualifying Accounts......................F-30
</TABLE>


           All other schedules have been omitted either as inapplicable or not
required under the instructions contained in Regulation S-X or because the
information is included in the Consolidated Financial Statements or the Notes
thereto listed above.



                                       F-1

<PAGE>   52




                         Report of Independent Auditors





Board of Directors and Stockholders
Showscan Entertainment Inc.

We have audited the accompanying consolidated balance sheets of Showscan
Entertainment Inc. as of March 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended March 31, 1998. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Showscan
Entertainment Inc. at March 31, 1998 and 1997, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended March 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.



Los Angeles, California
July 14, 1998



                                      F-2
<PAGE>   53

                           Showscan Entertainment Inc.

                           Consolidated Balance Sheets

                  (Dollars in Thousands, Except Share Amounts)


<TABLE>
<CAPTION>
                                                                        MARCH 31
                                                                    1998        1997
                                                                  --------------------
<S>                                                               <C>          <C>    
ASSETS
Current assets:
    Cash and cash equivalents                                     $ 2,492      $ 2,562
    Accounts receivable, net of allowances of $1,126 (1998)
       and $425 (1997)                                              2,161        2,716
    Unbilled receivables on uncompleted equipment
       contracts (Note 1)                                             708           --
    Due from affiliated entities, net of allowances (Note 8)          794          884
    Equipment sales inventory                                       1,186        1,289
    Prepaid expenses and other current assets (Note 1)                193        1,072
                                                                  --------------------
Total current assets                                                7,534        8,523




Film library, net (Note 1)                                          3,765        5,520

Equipment and leasehold improvements, less
    depreciation and amortization (Note 2)                            447          868

Investment in and advances to O&O theatres (Notes 1 and 7)            440        2,123

Patents and other intellectual properties, net of
    amortization (Note 1)                                             900        1,336

Other assets                                                          625        1,558
                                                                  --------------------
Total assets                                                      $13,711      $19,928
                                                                  ====================
</TABLE>

See accompanying notes.



                                      F-3
<PAGE>   54

<TABLE>
<CAPTION>
                                                                                                 MARCH 31
                                                                                           1998           1997
                                                                                         -----------------------
<S>                                                                                      <C>            <C>    
LIABILITIES AND STOCKHOLDERS' EQUITY
  Current liabilities:
    Accounts payable                                                                     $    752       $    654
    Customer advances on uncompleted film and equipment
      contracts (Note 1)                                                                    2,317          1,033
    Accrued expenses and other current liabilities (Note 1)                                 2,241          2,308
    Note payable (Note 4)                                                                   1,000              -
                                                                                         -----------------------
Total current liabilities                                                                   6,310          3,995

8% convertible notes (Note 3)                                                               5,690          5,690
                                                                                         -----------------------
Total liabilities                                                                          12,000          9,685
                                                                                         -----------------------
Commitments and contingencies (Note 11)

Stockholders' equity (Note 6):
    Series A Convertible Preferred Stock, $.001 par value;
       150,000 shares authorized, no shares issued and outstanding in 1998 and 1997            --             --
    Series C Convertible Preferred Stock, $.001 par value;
       100,000 shares authorized; 49,000 shares issued and outstanding in 1998
       and 1997, $100 per share liquidation preference (Note 5)                                --             --
    Common stock, $.001 par value; 20,000,000 shares
       authorized; shares issued and outstanding of
       5,642,058 in 1998 and 1997                                                               6              6
    Additional paid-in capital                                                             42,567         42,567
    Accumulated deficit                                                                   (40,862)       (32,330)
                                                                                         -----------------------
Total stockholders' equity                                                                  1,711         10,243
                                                                                         -----------------------
Total liabilities and stockholders' equity                                               $ 13,711       $ 19,928
                                                                                         =======================
</TABLE>

See accompanying notes.



                                      F-4
<PAGE>   55

                           Showscan Entertainment Inc.

                      Consolidated Statements of Operations

                  (Dollars in Thousands, Except Share Amounts)


<TABLE>
<CAPTION>
                                                                     YEAR ENDED MARCH 31
                                                             1998           1997           1996
                                                           --------------------------------------
<S>                                                        <C>            <C>            <C>     
Revenues (Note 10):
    Film licensing and production services                 $  5,726       $  6,236       $  9,039
    Equipment sales and related services                      4,688         11,475          8,426
                                                           --------------------------------------
                                                             10,414         17,711         17,465

Costs of revenues                                             8,756         10,854          8,399
                                                           --------------------------------------
Gross profit                                                  1,658          6,857          9,066

Other costs and expenses:
    General and administrative expenses                       7,860          6,904          7,576
    Depreciation and amortization                               875            961            971
                                                           --------------------------------------
                                                              8,735          7,865          8,547
                                                           --------------------------------------
Operating income (loss)                                      (7,077)        (1,008)           519

Other income (expense):
    Equity in net operations of O&O theatres (Note 7)          (540)          (694)          (217)
    Effect of impairment loss on equity in net
      operations of O&O theatres (Note 7)                      (313)        (1,771)             -
                                                                                                 
    Other income, including interest of $123 (1998),
      $241 (1997) and $250 (1996)                               127            250            358
                                                                                                
    Other expense, including interest of $703 (1998),
      $672 (1997) and $410 (1996)                              (725)          (692)          (555)
                                                           --------------------------------------
                                                             (1,451)        (2,907)          (414)
                                                           --------------------------------------
Income (loss) before taxes                                   (8,528)        (3,915)           105
Provision for income taxes                                        4              4              4
                                                           --------------------------------------
Net income (loss)                                          $ (8,532)      $ (3,919)      $    101
                                                           ======================================
Basic net income (loss) per common share (Note 1)          $  (1.51)      $  (0.70)      $   0.02
                                                           ======================================
Diluted net income (loss) per common share (Note 1)        $  (1.51)      $  (0.70)      $   0.01
                                                           ======================================
</TABLE>

See accompanying notes.



                                      F-5
<PAGE>   56

                           Showscan Entertainment Inc.
                 Consolidated Statements of Stockholders' Equity
                      (In thousands, except share amounts)


<TABLE>
<CAPTION>
                                              Series A         Series C 
                                            Convertible       Convertible
                                          Preferred Stock    Preferred Stock      Common Stock
                                         --------------------------------------------------------  Additional
                                           Number            Number             Number              Paid-In  Accumulated
                                         of Shares  Amount  of Shares  Amount  of Shares   Amount   Capital    Deficit      Total
                                         -------------------------------------------------------------------------------------------
<S>                                       <C>       <C>      <C>       <C>     <C>          <C>    <C>        <C>          <C>     
Balance at March 31, 1995                 150,000   $   -    49,000    $  -    5,242,859    $  5   $ 41,756   $(28,512)    $ 13,249
   Conversion of Series A Convertible
     Preferred Stock to common stock     (150,000)      -         -       -      165,380       -          -          -            -
   Exercise of stock options                                                       6,000                 30                      30
   Conversion of convertible notes
     payable to common stock                    -       -         -       -       66,085       -        345          -          345
   Other                                        -       -         -       -            -       -       (427)         -         (427)
   Net income                                   -       -         -       -            -       -          -        101          101
                                         -------------------------------------------------------------------------------------------
Balance at March 31, 1996                       -       -    49,000       -    5,480,324       5     41,704    (28,411)      13,298
   Conversion of convertible notes to
     common stock and other                     -       -         -       -      161,734       1        863          -          864
   Net loss                                     -       -         -       -            -       -          -     (3,919)      (3,919)
                                         -------------------------------------------------------------------------------------------
Balance at March 31, 1997                       -       -    49,000       -    5,642,058       6     42,567    (32,330)      10,243
   Net loss                                     -       -         -       -            -       -          -     (8,532)      (8,532)
                                         ------------------------------------------------------------------------------------------
Balance at March 31, 1998                       -   $   -    49,000    $  -    5,642,058    $  6   $ 42,567   $(40,862)    $  1,711
                                         ==========================================================================================
</TABLE>

See accompanying notes.


                                      F-6
<PAGE>   57

                          Showscan Entertainment Inc.

                      Consolidated Statements of Cash Flows

                             (Dollars in Thousands)


<TABLE>
<CAPTION>
                                                                                             YEAR ENDED MARCH 31
                                                                                         1998          1997      1996
                                                                                       --------------------------------
<S>                                                                                    <C>           <C>        <C>   
OPERATING ACTIVITIES
Net income (loss)                                                                      $(8,532)      $ (3,919)  $  101
Adjustments to reconcile net income (loss) to net 
  cash provided by (used in) operating activities:
      Depreciation and amortization                                                        875            961      971
      Amortization of film library                                                       2,782            613      481
      Amortization of debt issue costs                                                     199            198       85
      Provision for doubtful accounts receivable                                           970            270      440
      Provision for amounts due from affiliated entities                                   279              -        -
      Equity in net operations of O&O theatres, 
        including impairment loss                                                          853          2,465      217
      Accrued interest on note payable                                                      38              -        -
      Changes in operating assets and liabilities:
         Accounts receivable                                                              (415)        (1,101)    (279)
         Due from affiliated entities                                                     (189)           332     (319)
         Equipment sales inventory                                                         103            258      595
         Unbilled receivables on uncompleted equipment
           contracts                                                                      (708)         1,122     (252)
         Prepaid expenses and other assets                                                 879         (1,784)     (12)
         Investment in and advances to O&O theatres                                        830           (164)  (2,486)
         Accounts payable, accrued expenses and other                                       (5)          (992)   2,023
         Customer advances on uncompleted equipment
           contracts                                                                     1,284         (1,110)    (786)
                                                                                       -------------------------------
Net cash (used in) provided by operating activities                                       (757)        (2,851)     779

INVESTING ACTIVITIES
Purchases of short-term investments                                                          -              -   (3,086)
Redemptions of short-term investments                                                        -          3,086        -
Additions to film library                                                               (1,027)        (2,652)  (2,568)
Purchases of equipment and leasehold improvements 
  and other, net                                                                           844            (76)    (151)
                                                                                       -------------------------------
Net cash (used in) provided by investing activities                                    $  (183)       $   358  $(5,805)
</TABLE>


                                      F-7
<PAGE>   58



                           Showscan Entertainment Inc.

                Consolidated Statements of Cash Flows (continued)

                             (Dollars in Thousands)

<TABLE>
<CAPTION>

                                                                                             YEAR ENDED MARCH 31
                                                                                         1998          1997      1996
                                                                                      --------------------------------
<S>                                                                                   <C>        <C>         <C>   
FINANCING ACTIVITIES
Net proceeds from 11% short-term note payable                                         $   870     $     -     $     -
Proceeds from borrowings, net of debt issue costs                                           -           -       6,381
Repayment of subordinated note payable                                                      -           -      (3,121)
Proceeds from exercise of stock options                                                     -           -          30
                                                                                      -------------------------------
Net cash provided by financing activities                                                 870           -       3,290
                                                                                      -------------------------------
Net decrease in cash and cash equivalents                                                 (70)     (2,493)     (1,736)

Cash and cash equivalents at beginning of year                                          2,562       5,055       6,791
                                                                                      -------------------------------
Cash and cash equivalents at end of year                                              $ 2,492     $ 2,562     $ 5,055
                                                                                      ===============================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid                                                                         $   463     $   479     $ 1,818
                                                                                      ===============================
Income taxes paid                                                                     $     4     $     4     $     4
                                                                                      ===============================
</TABLE>

See accompanying notes.





                                      F-8
<PAGE>   59

                           Showscan Entertainment Inc.

                   Notes to Consolidated Financial Statements

                                 March 31, 1998


1. COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS OF THE COMPANY

Showscan Entertainment Inc. (the Company) is a leader in the production and
distribution of exciting movie-based entertainment attractions to the rapidly
expanding out-of-home entertainment marketplace. The Company's motion simulation
and specialty theatres are open or under construction around the world, located
in theme parks, motion picture mutiplexes, expos, world fairs, resorts, shopping
centers, casinos, museums and other tourist destinations.

The Company's simulation attractions combine the exhibition of a short action
film with multi-channel sound systems and synchronized theatre seat movement to
produce an immersive entertainment experience in which the theatre patron has
the perception of actually participating in the on-screen action. The
entertainment creates a "thrill ride" or action entertainment experience (such
as riding a runaway train or racing through outer space). The Company's
attractions incorporate various proprietary technologies, including the award
winning and patented 70mm filming and projection process known as Showscan(R).
The Company believes that films made and exhibited in the Showscan process
create a visual effect of depth, clarity and realism that is superior to any
other film format. The Showscan process is also used for the exhibition of films
in large screen specialty theatres at world fairs, tourist destinations, trade
conventions and other locations where the operator desires the impact of the
large-screen, intense image that a Showscan film provides.

The Company is presently in the business of: (i) licensing and distributing the
films in its library to all operators of simulation attractions (including those
produced using the Showscan Process and those acquired from other producers);
(ii) licensing the proprietary technologies necessary to produce and exhibit the
Company's films; (iii) selling and installing motion simulation attractions and
specialty theatres (including projectors, screens, sound systems,
synchronization and show control, and theatre design packages); (iv) producing
films using the Showscan process; and (v) to a limited extent, establishing
motion simulation attractions in which the Company has an economic interest (O&O
Theatres). The Company is also committed to the continued recognition of the
Showscan(R) brand name worldwide.



                                      F-9
<PAGE>   60

                           Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)




1. COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

BUSINESS OF THE COMPANY (CONTINUED)

The Company's primary business strategy is to develop high margin recurring
revenues from the licensing and distribution of movie-based software to all
owner/operators of simulation attractions (including those installed by Showscan
and those previously installed by competitors of Showscan) and from ticket sales
at, and the licensing of its movie-based software to, its O&O Theatres. The
Company seeks to increase the demand for its film library by significantly
increasing the installed base of both its motion simulation attractions and
specialty theatres.

BUSINESS PLANS, MANAGEMENT STRATEGIES AND BASIS OF PRESENTATION

The Company has since inception, incurred recurring losses and had losses
aggregating $12,451,000 during the fiscal years ended March 31, 1998 and 1997.
The Company, during fiscal 1998, has taken a substantial number of actions in
order to implement significant cost reductions, including the reduction in
employee head-count to 29 from 61 a little more than a year ago, thoroughly
revising its strategy in regards to O&O Theatres and closing five of the seven
O&O Theatre screens in London, England (two screens), San Antonio, Texas and
Framingham, Massachusetts (two screens), settled all major litigation, and has
also evaluated non-performing assets.

Company management has taken these steps without severely impacting operations.
Management believes that the substantial slowdown in new equipment sales during
the pendency of the merger with Iwerks Entertainment, Inc. had a materially
adverse effect on the Company's results for fiscal 1998 (announced on August 5,
1997 and eventually failed on March 31, 1998).

Company management may implement further cost reductions, including the
out-sourcing of certain operating functions (thereby further reducing employee
head count to approximately 20), relocating to smaller office space and other
actions.

The Company has limited capital resources and has debt obligations from two
different financial institutions which mature in November 1998 ($1,000,000) and
in September 1999 ($5,690,000). The Company has held preliminary discussions
with its European bank regarding additional financing in excess of the
$5,690,000 currently outstanding and has had preliminary discussions with both
creditors with regard to renegotiation of the debt repayment schedules.



                                      F-10
<PAGE>   61
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)



1.   COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

BUSINESS PLANS, MANAGEMENT STRATEGIES AND BASIS OF PRESENTATION (CONTINUED)

The Company believes that its existing funds, combined with the Company's
ability to generate cash from future operations, will be adequate to finance its
revised levels of activities and operations for the next twelve months; however,
based on the Company's current cash flow projections, it is anticipated that
cash generated from operations will not be sufficient to pay all of the
$5,690,000 due on September 1, 1999. The Company has certain alternatives
available to it, including the possible sale and/or licensing of assets,
renegotiation of debt re-payment schedules, pursuing the raising of cash through
debt and/or equity financings, the further curtailment of operating expenses and
the receipted payments by the Company from UA by August 1999 either through the
order of projection and/or motion simulation equipment or through the liquidated
damages provisions of the Theater Rights Agreement with UA (estimated to be at
least $3,200,000)(see Note 7).

The Company believes that it has sufficient business alternatives and
flexibilities in order to finance its operations for the foreseeable future.
Accordingly, the accompanying consolidated financial statements have been
prepared on the basis that the Company will continue as an operating entity.

CONSOLIDATION

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

The Company accounts for its investment in O&O Theatres (see Note 7) using the
equity method of accounting.




                                      F-11
<PAGE>   62
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)



1. COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

FILM LIBRARY

The Company's film library primarily consists of short "thrill-ride" or action
films that are exhibited in motion simulation attraction theatres worldwide.
Films are stated at the lower of unamortized cost or estimated realizable
values. The cost of a film includes the direct costs to produce or purchase the
film and the costs of production overhead, if any. The components of the
unamortized film library consist of the following:

<TABLE>
<CAPTION>

                                                                MARCH 31
                                                          1998            1997
                                                        ------------------------
<S>                                                     <C>              <C>    
Films in production                                     $   610          $ 2,399
Completed films in release                               13,054           10,239
                                                        ------------------------
                                                         13,664           12,638
Less accumulated amortization                             9,899            7,118
                                                        ------------------------
                                                        $ 3,765          $ 5,520
                                                        ========================
</TABLE>

Films are being amortized over their estimated future revenue stream (generally
five to seven years) as revised quarterly, if applicable; however, many of the
Company's films are expected to generate revenues for periods up to ten years or
longer. The Company estimates that approximately 80% of unamortized film costs
at March 31, 1998 will be amortized over the next four fiscal years.

PATENTS AND OTHER INTELLECTUAL PROPERTIES

Patents (expiring in fiscal year 2002) and other intellectual properties
represent the excess of the total purchase cost over the values assigned to
tangible assets at the date of acquisition of the Showscan process.

Amortization is provided on the basis of the ratio of annual revenues to
projected revenues over the lives of the patents, as revised quarterly, if
applicable, from the Showscan process with minimum annual amortization of
approximately $434,000 (equal to 1/15 of the original balance of $6,504,000).
Accumulated amortization of the patents and other intellectual properties was
$5,604,000 and $5,169,000 at March 31, 1998 and 1997, respectively.



                                      F-12
<PAGE>   63
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)



1. COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

EQUIPMENT SALES ACCOUNTING

Equipment sales inventory, consisting primarily of film exhibition and motion
simulation system equipment packages and related components, is valued at the
lower of average cost or market.

Equipment sales contracts are accounted for using the percentage-of-completion
method of accounting, generally measured by the percentage of labor hours
incurred to date to the estimated total labor hours for each contract. When
revenues and cost estimates for a contract indicate an ultimate loss, that loss
is recognized immediately.

EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Equipment and leasehold improvements are stated at cost.

Depreciation of equipment is computed using the straight-line method over the
estimated useful lives of the respective assets, generally 7 to 12 years.
Amortization of leasehold improvements is computed using the straight-line
method over the lease term. Depreciation and amortization of equipment and
leasehold improvements was $441,000, $527,000 and $537,000 for the years 1998,
1997 and 1996, respectively.

FILM LICENSING REVENUES

Revenues from film license agreements are recognized when the license period
begins and the film is available pursuant to the terms of the license agreement
and accepted by the customer.

INCOME TAXES

The Company accounts for taxes using Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" (SFAS No. 109). Under SFAS No. 109, the
liability method is used in accounting for income taxes. Under this method,
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities, and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.




                                      F-13
<PAGE>   64

                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)



1. COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

CASH EQUIVALENTS

The Company considers all highly liquid debt instruments purchased with an
original maturity of three months or less or investments in money market funds
to be cash equivalents.

CONCENTRATION OF CREDIT RISK

Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of accounts receivable. The Company performs
ongoing credit evaluations of its customers and maintains allowances for
potential credit losses. The Company generally requires customers to furnish
irrevocable letters of credit on equipment sales and to pay film licensing
revenues at the beginning of the license period in order to minimize the
Company's credit risk.

PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets include $600,000 at March 31, 1997 of
costs advanced for the joint defense of certain litigation against the Company
and a supplier. Such litigation was settled subsequent to year end, and the
Company realized the amounts capitalized.

ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Included in accrued expenses and other current liabilities are the following:

<TABLE>
<CAPTION>

                                                          1998           1997
                                                      --------------------------
<S>                                                   <C>             <C>       
Accrued participations and royalties                  $1,305,000      $  972,000
Accrued cost of film and equipment sales                 558,000         679,000
Other items                                              378,000         657,000
                                                      --------------------------
                                                      $2,241,000      $2,308,000
                                                      ==========================
</TABLE>




                                      F-14
<PAGE>   65
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


1. COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

STOCK-BASED COMPENSATION

In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). SFAS 123 established a fair value-based method of
accounting for compensation cost related to stock options and other forms of
stock-based compensation plans. However, SFAS 123 allows an entity to continue
to measure compensation costs using the principles of APB 25 if certain pro
forma disclosures are made. The Company has elected to account for its stock
compensation arrangements under the provisions of APB 25, "Accounting for Stock
Issued to Employees." The Company adopted the provisions for pro forma
disclosures requirements of SFAS 123 in fiscal year 1997 (see Note 6).

USE OF ESTIMATES AND ASSUMPTIONS

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

NET INCOME (LOSS) PER COMMON SHARE

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

Per share information has been determined on the basis of 5,642,058 and
5,594,245 weighted average shares outstanding for the years ended March 31, 1998
and 1997, respectively.



                                      F-15
<PAGE>   66
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


1. COMPANY BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

NET INCOME (LOSS) PER COMMON SHARE (CONTINUED)

For the year ended March 31, 1996, the weighted average shares outstanding used
in the computation of basic and diluted EPS were 5,344,945 and 7,471,949,
respectively. The weighted average shares for diluted EPS gives effect to the
assumed conversion of the Company's Convertible Preferred Stock (the effect of
all other common stock equivalents was anti-dilutive and thus not reflected in
the per share computation).

2. EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Equipment and leasehold improvements at March 31, 1998 and 1997 were as follows:

<TABLE>
<CAPTION>

                                                           1998          1997
                                                       --------------------------
<S>                                                    <C>            <C>       
Showscan equipment                                     $4,583,000     $4,580,000
Leasehold improvements                                    927,000        926,000
Office furniture and equipment                            665,000        652,000
                                                       -------------------------
                                                        6,175,000      6,158,000
Less accumulated depreciation and amortization          5,728,000      5,290,000
                                                       -------------------------
                                                       $  447,000     $  868,000
                                                       =========================
</TABLE>

3. 8% CONVERTIBLE NOTES

In September 1995, the Company completed a private placement of $7,000,000 in
Convertible Notes which mature on September 1, 1999 and bear interest at 8% per
annum payable semi-annually. The notes are secured by substantially all of the
assets of the Company, although the security excludes the Company's film library
and the capital stock of its subsidiaries, which includes its O&O Theatres. In
connection with the placement, $619,000 of debt issue costs were incurred and
are being amortized over the life of the notes.

The notes are convertible into common stock at the option of the holder at a
conversion price (subject to certain anti-dilution adjustments) of $5.75 per
share (the closing price on the Nasdaq National Market on the transaction
closing date). Through March 31, 1998, $1,310,000 of notes were converted into
227,819 shares of common stock, leaving an outstanding balance of $5,690,000.



                                      F-16
<PAGE>   67
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


3. 8% CONVERTIBLE NOTES (CONTINUED)

The fair value of the Convertible Notes was determined using valuation
techniques that considered cash flows discounted at current market rates and
management's best estimate for instruments without quoted market prices. At
March 31, 1998 and 1997, the carrying value of the Convertible Notes exceeded
the fair value by approximately $500,000 and $1,300,000, respectively.

4. 11% PROMISSORY NOTE

On November 1, 1997, the Company completed a placement of a $1,000,000
promissory note through an unaffiliated third party. The note bears interest at
a rate of 11% per annum. Principal and interest are payable in full on November
15, 1998. The note is secured by accounts receivable from the distribution of
the Company's film library and the proceeds thereof. In connection with the
placement, $130,000 of debt issue costs were incurred and are being amortized
over the life of the note.

5. PREFERRED STOCK

The Company is authorized to issue preferred stock in one or more series and to
fix the rights, preferences, privileges, qualifications, limitations,
restrictions and the number of shares constituting any such series.

The Company is authorized to issue a total of 10,000,000 shares of preferred
stock of which 49,000 shares are issued as of March 31, 1998. Accordingly,
9,951,000 shares of preferred stock are available for issuance.

SERIES C CONVERTIBLE PREFERRED STOCK (SERIES C)

The Company has 49,000 shares of Series C outstanding. The Series C is
convertible into common stock at $5.04 per share (subject to certain
anti-dilution adjustments), has a liquidation preference of $100 per share, and
provides voting rights as if such shares had been fully converted into common
stock. Each share of Series C entitles the holder to receive dividends in an
amount equal to 110% of the dividends per share declared on each share of common
stock. The Company may elect to pay dividends on the Series C either in cash or
in additional shares of Series C based on its liquidation preference of $100 per
share.



                                      F-17
<PAGE>   68
                          Showscan Entertainment Inc.
             Notes to Consolidated Financial Statements (continued)

5. PREFERRED STOCK (CONTINUED)

SERIES C CONVERTIBLE PREFERRED STOCK (SERIES C) (CONTINUED)

The Series C is senior to the common stock of the Company; additionally, a
majority of the holders of Series C must consent to (a) the issuance of any
equity securities ranking senior to, or on parity with, the Series C, and (b)
the repurchase or retirement of any equity securities of the Company other than
the Series C.

SERIES D PARTICIPATING PREFERRED STOCK (SERIES D)

The issuance of 10,000 shares of Series D was authorized in November 1994 in
connection with the adoption of the Company's stockholder rights plan.

In connection therewith, the Company issued a dividend of one preferred share
purchase right (a Right) for each outstanding share of common stock and for each
share of common stock issuable upon conversion of outstanding Series C to the
stockholders of record on November 11, 1994. Each Right entitles the registered
holder to purchase from the Company one one-thousandth of a share of Series D at
a purchase price of $40 per one one-thousandth of a share of Series D, subject
to adjustment (the Purchase Price).

The Rights may be exercised (a) 20 days after a person or group of persons has
become the beneficial owner of 20% or more of the common stock then outstanding
(an Acquiring Person), or (b) 20 business days after the date of commencement of
a tender or exchange offer the consummation of which would result in a person or
group of persons becoming an Acquiring Person. The Rights, which do not have any
voting rights, expire on November 11, 2004 and may be redeemed by the Company at
a price of $.01 per Right, subject to adjustment, at any time prior to their
expiration and prior to such time as any person or group of persons becomes an
Acquiring Person.

In the event that a person or group of persons becomes an Acquiring Person, each
Right will entitle its holder to purchase, at the Right's then Purchase Price, a
number of shares of common stock of the Company having a market value of twice
the Purchase Price. If certain mergers or sales of assets by the Company occur,
each Right shall entitle the holder to purchase, at the then Purchase Price, a
number of shares of common stock of the surviving corporation or purchaser
having a market value of twice the Purchase Price.



                                      F-18
<PAGE>   69
                          Showscan Entertainment Inc.
             Notes to Consolidated Financial Statements (continued)

6. STOCK OPTIONS AND WARRANTS

OPTIONS

The Company currently has two stock option plans in effect, the 1987 Option Plan
and the 1992 Option Plan (collectively, the Plans). The Plans provide for the
issuance of nonqualified and qualified stock options under the Internal Revenue
Code of 1986, as amended. An aggregate of 300,000 shares of common stock were
initially reserved for grant under the 1992 Option Plan to officers, directors
and employees as well as independent contractors and consultants who performed
services for the Company. In 1995, the 1992 Option Plan was amended to permit
the grant of up to 800,000 shares of common stock and such number of shares have
been reserved for grant at March 31, 1998. All remaining shares reserved for
grant under the 1987 Option Plan were cancelled upon adoption of the 1992 Option
Plan. Persons who are not employees of the Company are eligible to receive only
nonqualified stock options. The options may be granted for a term of up to ten
years. If an incentive stock option is granted to an individual owning more than
10% of the total combined voting power of all classes of the Company's stock,
the exercise price of the option may not be less than 110% of the fair market
value of the underlying shares on the date of the grant and the term of the
option may not exceed five years.

The Plans provide that the aggregate fair market value (determined at the time
the option is granted) of the common stock with respect to which incentive stock
options are exercisable for the first time by an optionee during any calendar
year shall not exceed $100,000.

The Company has elected to follow APB 25 (see Note 1) in accounting for its
employee stock options because, as discussed below, the alternative fair value
accounting provided for under SFAS 123 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 the Company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.

Pro forma information regarding net income and earnings per share is required by
SFAS 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS 123. 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 each of
the years ended March 31, 1997 and 1996 (there were no options granted in fiscal
1998): risk-free interest rates ranging from 5% to 6%, volatility factors of the
expected market price of the Company's common stock of .361, and a weighted
average expected life of the options ranging from 7 to 10 years.



                                      F-19
<PAGE>   70

                          Showscan Entertainment Inc.
             Notes to Consolidated Financial Statements (continued)

6. STOCK OPTIONS AND WARRANTS (CONTINUED)

OPTIONS (CONTINUED)

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 SFAS 123 on pro forma net income
and pro forma earnings 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:

<TABLE>
<CAPTION>

                                      1998             1997            1996
                                -----------------------------------------------

<S>                             <C>               <C>               <C>         
Pro forma net loss              $  (9,137,000)    $  (4,475,000)    $  (402,000)
Pro forma loss per share        $       (1.62)    $       (0.80)    $     (0.08)
</TABLE>




                                      F-20
<PAGE>   71
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


6. STOCK OPTIONS AND WARRANTS (CONTINUED)

OPTIONS (CONTINUED)

The following is a summary of Company stock options granted, exercised and
terminated through March 31:

<TABLE>
<CAPTION>

                                                  1998                     1997                  1996
                                          ----------------------------------------------------------------------
                                                       WEIGHTED                 WEIGHTED                WEIGHTED
                                                       AVERAGE                  AVERAGE                 AVERAGE
                                                       EXERCISE                 EXERCISE               EXERCISE
                                           OPTIONS      PRICE       OPTIONS      PRICE     OPTIONS       PRICE
                                          ----------------------------------------------------------------------

<S>                                        <C>         <C>          <C>         <C>        <C>         <C>     
Outstanding at beginning of year           774,250     $   6.75     605,750     $   7.51   619,500     $   7.58
Granted                                          -            -     200,000         4.75    32,250         6.53
Exercised                                        -            -           -            -    (6,000)        5.00
Canceled                                   (45,750)        7.48     (31,500)        8.81   (40,000)        6.06
                                          ---------------------------------------------------------------------
Outstanding at end of year                 728,500     $   6.34     774,250     $   6.75   605,750     $   7.51
                                          =====================================================================

Exercisable at end of year                 512,129     $   7.10     364,688     $   7.30   235,625     $   7.24
                                          =====================================================================

Weighted average fair value of options
    granted during year                                                         $   2.41               $   3.32
                                                                                ========               ========
                                                                                                      
                                                                                                      
</TABLE>

Exercise prices for options outstanding at March 31, 1998 ranged from $3.625 to
$9.06. The weighted average remaining contractual life of those options is 8
years. Options generally vest over a period of 4 or 5 years from respective
grant dates.

WARRANTS

During 1991, warrants to purchase an aggregate of 200,000 shares of common stock
were issued by the Company. Warrants for 150,000 shares expired on July 11, 1996
and the remaining warrants for 50,000 shares are exercisable at a price of $6.50
and expire on March 9, 1999, subject to certain anti-dilution adjustments.



                                      F-21
<PAGE>   72
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)

6. STOCK OPTIONS AND WARRANTS (CONTINUED)

WARRANTS (CONTINUED)

In October 1993, the Company issued a warrant to purchase an aggregate of 50,000
shares of common stock at an exercise price of $4.47 per share to the Chairman
of the Board of Directors. The warrant was issued as compensation for services
the Chairman provided to the Company. At March 31, 1997, the warrant has been
adjusted (due to anti-dilution adjustments) to permit the purchase of up to
55,127 shares of common stock at an exercise price of $4.05 per common share.
The warrant is exercisable at any time on or before October 26, 1998.

In September 1993, the Company issued to certain of its directors (and their
affiliates) warrants which initially allowed the purchase of up to 850,000
shares of common stock at the then exercise price of $4.00 per share. The
warrants have been adjusted (due to anti-dilution adjustments) to permit the
purchase of up to 937,155 shares of common stock at an exercise price of $3.63
per share and are currently exercisable and expire on September 27, 1998.

In August 1994, the Company issued to United Artists Theatre Circuit (UA)
warrants to purchase an aggregate of 552,000 shares of common stock, at exercise
prices ranging from $6.50 to $8.50, subject to certain anti-dilution
adjustments. The warrants become exercisable at dates from August 22, 1995
(300,000) and annually thereafter at 75,000 per year with the remaining 27,000
exercisable on August 22, 1999, and have expiration dates of either August 22,
1999 or August 22, 2000.

In September 1995, the Company issued warrants to purchase an aggregate of
150,000 shares of common stock at an exercise price of $5.75 per share, subject
to certain anti-dilution adjustments, to financial advisors who assisted in the
private placement of the Convertible Notes. The warrants became exercisable on
September 1, 1996 and expire on September 1, 2000.

In October 1995, the Company issued warrants to purchase an aggregate of 30,000
shares of common stock at an exercise price of $6.44, subject to certain
anti-dilution adjustments, to an outside marketing, film production and
consulting company. The warrants become exercisable on August 2, 1996 (15,000)
and August 2, 1997 (15,000) and expire on August 1, 1998.



                                      F-22
<PAGE>   73
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


6. STOCK OPTIONS AND WARRANTS (CONTINUED)

WARRANTS (CONTINUED)

Shares of the Company's common stock reserved for issuance upon exercise of
stock options, warrants, preferred stocks and convertible notes are as follows:
<TABLE>
<CAPTION>

                                      MARCH 31, 1998
                                         RANGE OF                 MARCH 31
                                      EXERCISE PRICES        1998         1997
                                      ------------------------------------------
<S>                                   <C>                 <C>         <C>     
 1987 and 1992 Option Plans           $3.625 - $9.0625      837,500*    837,500*
 Warrants                              $3.63 - $8.50      1,774,283   1,774,283
 Series C                                 $5.04**           972,222     972,222
 Convertible Notes                        $5.75**           989,567     989,567
                                                          ---------------------
                                                          4,573,572   4,573,572
                                                          =====================
</TABLE>

* At March 31, 1998 and 1997, there are 66,250 shares reserved for options which
  are still available for grant.

**Subject to certain anti-dilution provisions.

7. OWNED AND OPERATED THEATRES

The Company has thoroughly revised its policy related to O&O Theatres and has
successfully closed five of its seven theatre screens - London, England
(2-screens), San Antonio, Texas and Framingham, Massachusetts (2-screens). As a
matter of policy, the Company will generally limit its investment, if any, to a
10 to 15 percent interest, rather than owning 50% or more of these sites. The
Company has retained ownership interests of 50% in theatre attractions at
Universal CityWalk in Universal City, California (opened November 1993) and
Osaka, Japan (opened August 1995). Generally, in each of these arrangements, the
Company receives reimbursement for direct expenses (as defined), a percentage of
each theatre's cash flow (equal to its ownership percentage), and receives
separately annual film licensing revenues, and management fees (if applicable).




                                      F-23
<PAGE>   74
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)

7. OWNED AND OPERATED THEATRES (CONTINUED)

Affiliated Ventures

The Company and affiliates of certain directors have entered into two ventures
through March 31, 1998 with respect to owned and operated theatres:

a)       Universal CityWalk - The Universal CityWalk Venture (CityWalk Venture)
         is a joint venture which is 50% owned by a wholly-owned subsidiary of
         the Company, and 50% owned by affiliates of certain of the directors.
         The CityWalk Venture also entered into a ten-year profit sharing lease
         with the owner of Universal CityWalk pursuant to which the owner
         contributed one-half of the costs incurred for the construction of the
         theatre. In general, the CityWalk Venture is obligated to pay a base
         rent plus 50% of the cash flow, as defined, from the operations of the
         theatre.

b)       Trocadero  Arcade/Piccadilly  Circus - The Trocadero  Arcade/Piccadilly
         Circus theatres are owned by Cinemania (UK) Limited, a British
         corporation, which is 50% owned by a wholly-owned subsidiary of the
         Company, and 50% owned by affiliates of certain of the directors.
         Cinemania (UK) Limited has, on July 3, 1998, closed these theatres and
         is in the process of liquidation.

The accompanying statement of operations for the year ended March 31, 1998
includes a non-cash charge of $313,000 to reflect an impairment loss recognized
on the Company's investment in Cinemania (UK) Limited. The accompanying
statement of operations for the year ended March 31, 1997 includes a non-cash
charge of $1,771,000 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," by certain of the joint ventures. Under the equity method of
accounting, the Company has recognized its share of joint venture charges;
accordingly, the carrying value of investments in and advances to O&O theatres
in the accompanying consolidated balance sheets was reduced by these charges.

The Company has through other financing and/or joint venture arrangements
entered into the following additional theatre ventures:




                                      F-24
<PAGE>   75

                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)



7. OWNED AND OPERATED THEATRES (CONTINUED)

UA Venture

In August 1994, the Company and United Artists Theatre Circuit Inc. (UA) agreed
to be partners in a venture called Showscan/United Artists Theatres Joint
Venture (UA Venture).

           Pursuant to a Theatre Rights Agreement, as amended (TRA), UA has
agreed to offer to the UA Venture for ownership and operation by the UA Venture,
up to 24 theatre sites prior to August 19, 1999 for the installation of motion
simulation attraction theatres in or adjacent to existing or to-be-built UA
theatre multiplexes. If the UA Venture declines to acquire a particular site,
then UA must install a motion simulation attraction theatre at such site. As of
March 31, 1998, UA has offered eight sites of which the UA Venture declined
seven of these sites as these sites did not meet the criteria of the UA Venture.
On July 1, 1997, the UA Venture exercised its rights under the TRA and accepted
the offer by UA for the theatre site in Austin, Texas. This site was completed
by UA and was already open prior to acceptance by the UA Venture. Subsequently,
however, UA entered into a merger transaction with other large theatre chains
and the circumstances surrounding the merger transaction created uncertainty
with respect to the Austin site. In conjunction therewith, UA advised the UA
Venture not to proceed with the Austin site acquisition; accordingly, the UA
Venture has terminated its plans to acquire ownership of the Showscan Attraction
of the Austin site. The TRA contains certain provisions that require UA to make
payments to the Company if UA is unable to meet its obligations under that
agreement. The TRA provided that two motion simulation attraction theatres be
installed and in operation in Malaysia no later than December 31, 1995. UA was
unable to meet this commitment (see Note 8). The TRA contains further provisions
that require UA to make payments to the Company if UA is unable to meet its
obligations and that require the Company to make payments to UA if the Venture
is unable to meet certain of its obligations. UA is obligated to pay the Company
$330,000 for each Showscan Attraction which is not purchased and installed by
August 1999 (presently 16 sites) and the Company is obligated to pay UA $165,000
if the UA Venture does not select a joint venture site by August 1999. UA may
also satisfy its obligations to the Company by actually paying to the Company at
least $13,950,000 in the aggregate for motion simulation and/or projection
equipment; provided, however, that only 50% of each order for projection
equipment sourced through the Company shall be counted towards the target and
any orders of projection equipment must result in an aggregate benefit (as
defined) to the Company of at least $3,200,000. To date, UA has purchased
approximately $7 million of equipment from the Company or approximately one-half
of the target amount.

The TRA has been amended by the Company and UA to eliminate certain installation
requirements in Malaysia and to add those requirements to the overall UA
obligations. In connection with the amendment, UA relinquished its exclusivity
rights to Malaysia and eliminated its rights of first refusal in the Asia
Territory (as defined).



                                      F-25
<PAGE>   76
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


7. OWNED AND OPERATED THEATRES (CONTINUED)

Other O&O Theatres

The Osaka theatre is 50% owned by a wholly-owned subsidiary of the Company and
50% by Imagine Japan, Inc. Sega Enterprises, Ltd. operates the Osaka theatre in
exchange for a certain percentage of the gross receipts.

During 1998, 1997 and 1996, the Company sold equipment to several of these
ventures and eliminated the gross profit on such sales to the extent of its
ownership percentage ($0 in 1998, $38,705 in 1997, and $382,000 in 1996). The
amount of profit eliminated is being recognized into income over the
depreciation period of the related equipment.

8. RECEIVABLES FROM AFFILIATED ENTITIES

At March 31, 1998, the Company is due $712,000 from UA in connection with the
TRA as discussed in Note 7. The payment terms provide for (a) interest on the
unpaid principal balance to be charged at 7.5% and (b) principal and interest to
be paid in full on or before December 31, 1996 (Maturity Date); provided,
however, that if the UA Venture has not accepted one of the theatre sites it has
been offered by UA prior to the Maturity Date, the Maturity Date will be
extended 30 days after the date that the UA Venture does accept, but in no event
shall the Maturity Date be extended later than August 19, 1999. In July 1998,
the Company and UA reached an agreement to settle the amount owed by means of a
$318,000 payment, the purchase by the Company of certain new simulation
equipment and other assets owned by UA, the offset of certain amounts and the
payment of the remaining amounts over approximately one year. As part of this
agreement, the Company also agreed to expand the ability of UA to source
projection equipment through the Company and to apply 50% of such sourced
equipment to the $13,950,000 equipment purchase target that is an alternate way
that UA may satisfy its obligations to the Company. Any such sourcing of
projection equipment must result in at least an aggregate benefit (as defined)
to the Company of $3,200,000.

During the fiscal years ended 1998, 1997 and 1996, the Company charged
approximately $493,000, $909,000 and $897,000, respectively, to the O&O Theatre
joint ventures. Such amounts have either been recognized as film rentals and
royalties ($390,000 in 1998, $666,000 in 1997 and $565,000 in 1996), or offset
against general and administrative expenses ($103,000 in 1998, $243,000 in 1997
and $332,000 in 1996) in the accompanying consolidated statements of operations.
Such amounts represent film rentals and royalties, and management and
administrative services provided by the Company to the O&O Theatre joint
ventures. The joint ventures owed the Company approximately $103,000 and
$238,000 at March 31, 1998 and 1997, respectively (included in due from
affiliated entities), for such charges and for costs paid on behalf of the
ventures.


                                      F-26
<PAGE>   77
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


8. RECEIVABLES FROM AFFILIATED ENTITIES (CONTINUED)

At March 31, 1998, affiliates of certain directors owed the Company a combined
balance of $279,000 related to advances made by the Company on their behalf to
several O&O Theatres to satisfy capital calls to cover operating expenses at
such theatres. On July 8, 1998, the affiliates of the certain directors
indicated to the Company that they dispute their obligation to pay these sums.
Accordingly, the Company has fully reserved for such amounts in its accompanying
consolidated balance sheet at March 31, 1998.

9. INCOME TAXES

At March 31, 1998, the Company has net operating loss carryforwards for federal
and state income tax purposes of approximately $31,100,000 and $6,400,000,
respectively. The federal loss carryforwards expire through the year ending
2013. The state loss carryforwards expire through the year ending 2003. These
loss carryforwards can be used to offset future taxable income, if any. The
provision for income taxes for all years presented represents minimum state tax
liabilities.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts utilized for income tax purposes. Significant
components of the Company's deferred tax assets as of March 31, 1998 and 1997
are as follows (in thousands):

<TABLE>
<CAPTION>
                                                        1998              1997
                                                      -------------------------

<S>                                                   <C>              <C>     
Excess of book over tax depreciation                  $    498         $    402
Patent amortization                                        163              251
Amortization of film library                               655              236
Allowance for bad debts                                    570              170
Other                                                      535              316
Net operating loss carryforward                         11,475            9,765
                                                      -------------------------
                                                        13,896           11,140
Valuation allowance                                    (13,896)         (11,140)
                                                      -------------------------
Total deferred taxes                                  $      -         $      -
                                                      =========================
</TABLE>



                                      F-27
<PAGE>   78
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


10. GEOGRAPHIC INFORMATION AND SIGNIFICANT CUSTOMERS

Export revenues by geographic area for each of the three years ended March 31
consisted of:

<TABLE>
<CAPTION>

                               1998         1997           1996
                           ----------------------------------------

<S>                        <C>          <C>            <C>        
Africa                     $        -   $   215,000    $   281,000
Australasia                   647,000     1,976,000      2,574,000
Europe                      1,753,000     1,206,000      1,992,000
Far East                    4,051,000     6,048,000      5,628,000
Middle East                 2,399,000     1,340,000         48,000
Other                               -       159,000        125,000
                           ---------------------------------------
Total export revenues      $8,850,000   $10,944,000    $10,648,000
                           =======================================                                       
</TABLE>


During the fiscal year ended 1998, the Company earned export revenues of
$3,460,000 from two unaffiliated customers. During the fiscal years ended 1997
and 1996, the Company earned export revenues from an unaffiliated customer of
$3,117,000 and $3,407,000, respectively. During the fiscal years ended 1998,
1997 and 1996, the Company recognized domestic revenues from UA of approximately
$100,000, $5,405,000 and $3,126,000, respectively.

11. COMMITMENTS AND CONTINGENCIES

The Company is obligated under various operating leases for its corporate
office, storage premises and equipment. Future net minimum rental payments under
these leases at March 31, 1998 are as follows:

<TABLE>
<CAPTION>

<S>                                <C>       
               1999                $  438,000
               2000                   433,000
               2001                   433,000
               2002                   428,000
               2003                   413,000
                                   ----------          
                                   $2,145,000
                                   ==========         
</TABLE>


                                      F-28
<PAGE>   79
                          Showscan Entertainment Inc.

             Notes to Consolidated Financial Statements (continued)


11. COMMITMENTS AND CONTINGENCIES (CONTINUED)

The corporate office lease provides for rent adjustments based on increases in
the Consumer Price Index. The Company has provided a letter of credit to its
landlord in the amount of $307,000 which permits the landlord to draw against
the letter of credit upon default by the Company (as defined) under the terms of
the lease. The letter of credit is secured by a cash deposit in the amount of
$307,000; such amount is included in other assets in the accompanying
consolidated balance sheet.

Total rental expense charged to operations for the years ended March 31, 1998,
1997 and 1996 was $410,000, $400,000 and $389,000, respectively.

Under the terms of a film production agreement, the Company has guaranteed, for
four years beginning in 1996, a minimum amount per year ($287,500) of proceeds
to the outside investors in the film project. If revenues, as defined, from the
distribution of the film are less than the required minimum amount, the Company
will contribute the difference to the outside investors. The Company's current
projections indicate that the revenues to be earned from the distribution of
this film over the remaining term of the agreement (fiscal 1999 and 2000) will
be $330,000 less than the required minimum payments. The Company has accrued
this amount in the accompanying consolidated balance sheet at March 31, 1998.

The Company is obligated under various royalty agreements to pay royalties
(ranging from 1% to 3%) to various parties, generally based on the gross
receipts (as defined) from either the exploitation of the Showscan process (in
excess of certain amounts), the exploitation of Showscan feature-length motion
pictures, or other receipts.




                                      F-29
<PAGE>   80

                           Showscan Entertainment Inc.

                 Schedule II - Valuation and Qualifying Accounts

<TABLE>
<CAPTION>

-------------------------------------------------------------------------------------------------------
            COL. A                  COL. B        COL. C        COL. D        COL. E        COL. F
-------------------------------------------------------------------------------------------------------
                                  Balance at    Charged to    Charged to    
                                  Beginning     Costs and   Other Accounts  Deductions   Balance at End
         DESCRIPTION               of Year       Expenses      Describe      Describe        of Year
------------------------------------------------------------------------------------------------------
<S>                                <C>         <C>              <C>         <C>             <C>       
Year ended 1998:
Allowance for doubtful accounts    $425,000    $ 1,249,000      $      -    $269,000 (a)    $1,405,000
                                   ========    ===========     =========    ============    ==========

Product warrant liability          $180,000    $   (40,000)     $      -    $ 49,000 (b)    $   91,000
                                   ========    ===========     =========    ============    ==========

Year ended 1997:
Allowance for doubtful accounts    $215,000    $   270,000      $      -    $ 60,000 (a)    $  425,000
                                   ========    ===========     =========    ============    ==========

Product warrant liability          $182,000    $    67,000      $      -    $ 69,000 (b)    $  180,000
                                   ========    ===========     =========    ============    ==========

Year ended 1996:
Allowance for doubtful accounts    $254,000    $   440,000      $      -    $479,000 (a)    $  215,000
                                   ========    ===========     =========    ============    ==========

Product warrant liability          $187,000    $    77,000      $      -    $ 82,000 (b)    $  182,000
                                   ========    ===========     =========    ============    ==========
</TABLE>

(a) Represents write-off of uncollectible accounts receivable.
(b) Represents actual warranty expenditures.



                                      F-30
<PAGE>   81
                                   SIGNATURES

           Pursuant to the requirements of Sections 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.

Date:  July 29, 1998

                                       SHOWSCAN ENTERTAINMENT INC.



                                       By /s/ DENNIS POPE
                                          --------------------------------------
                                          Dennis Pope
                                          President and Chief Executive Officer




           Pursuant to the requirements of the Securities Exchange Act of 1933,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
        Signature                                 Title                                   Date
        ---------                                 -----                                   ----
<S>                                     <C>                                           <C>
/s/ WILLIAM D. EBERLE                   Chairman of the Board                         July 29, 1998  
----------------------------------
           William D. Eberle                                                                         
                                                                                                     
                                                                                                     
/s/ DENNIS POPE                         Director; President; Chief Executive          July 29, 1998  
----------------------------------      Officer (Principal Executive Officer)
           Dennis Pope                  
                                                                                                     
                                                                                                     
/s/ CHARLES B. MOSS, JR.                Director                                      July 29, 1998  
----------------------------------
           Charles B. Moss, Jr.                                                                      
                                                                                                     
                                                                                                     
/s/ THOMAS R. DIBENEDETTO               Director                                      July 29, 1998  
----------------------------------
           Thomas R. DiBenedetto                                                                     
                                                                                                     
                                                                                                     
/s/ KURT C. HALL                        Director                                      July 29, 1998  
----------------------------------
           Kurt C. Hall                                                                              
                                                                                                     
                                                                                                     
/s/ WILLIAM C. SOADY                    Director                                      July 29, 1998  
----------------------------------
           William C. Soady                                                                          
                                                                                                     
</TABLE>