<PAGE>
 
================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-Q

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

               For the quarterly period ended September 30, 1996

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

                        Commission file number  0-22558

                           IWERKS ENTERTAINMENT, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
                                        
        Delaware                            95-4439361
       (STATE OR OTHER JURISDICTION         (I.R.S. EMPLOYER IDENTIFICATION NO.)
        OF INCORPORATION  OR ORGANIZATION)

                            4540 West Valerio Street
                        Burbank, California  91505-1046
             (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)

                                 (818) 841-7766
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

       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 and Exchange
     Act of 1934 during the preceding 12 months (or for such shorter period that
     the Registrant was required to file such reports), and (2) has been subject
     to such filing requirements for the past 90 days.
     Yes     X        No
            ---          ---
     As of November 5, 1996, the Registrant had 11,678,785 shares of Common
     Stock, $.001 par value, issued and outstanding.
================================================================================


<PAGE>
 
                          IWERKS ENTERTAINMENT, INC.

                                     INDEX


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

Item 1 - Financial Statements
-----------------------------
 
Condensed Consolidated Balance Sheets as of September 30, 1996
and June 30, 1996                                                    2
 
Condensed Consolidated Statements of Operations for the Three
Months ended September 30, 1996 and 1995                             4
 
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended September 30, 1996 and 1995                             5
 
Notes to the Condensed Consolidated Financial Statements             6
 
 
Item 2 - Management's Discussion and Analysis of
------------------------------------------------
       Financial Condition and Results of Operations                 8
       --------------------------------------------- 

PART II - OTHER INFORMATION
 
Item 1 - Legal Proceedings                                          12
--------------------------
 
Item 6 - Exhibits and Reports on Form 8-K                           12
----------------------------------------- 

Signatures                                                          13

</TABLE>
<PAGE>
 



                          IWERKS ENTERTAINMENT, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                    ASSETS
                                (in thousands)

<TABLE>
<CAPTION>

                                                                  September 30,     June 30,
                                                                     1996            1996
                                                                  ------------     ---------
                                                                   (unaudited)
<S>                                                                  <C>            <C>
Current assets:

  Cash and cash equivalents                                          $10,573        $12,674

  Investment in debt securities                                       12,465          6,782

  Trade accounts receivable, net of allowance
    for doubtful accounts                                              5,707          4,872

  Costs and estimated earnings in excess of
    billings on uncompleted contracts                                  6,088          5,583

  Inventories and other current assets                                 4,035          3,166
                                                                     -------        -------
      Total current assets                                            38,868         33,077

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

  Properties, net:

   Portable simulation theaters at cost, net of
     accumulated depreciation                                          8,825          9,084

  Property and equipment at cost, net of
    accumulated depreciation and amortization                          3,704          3,519

  Film inventory at cost, net of amortization                          3,156          3,372

  Goodwill                                                            17,134         17,360

  Other assets                                                         1,139            688
                                                                     -------        -------
      Total assets                                                   $72,826        $72,926
                                                                     =======        =======
</TABLE>

                            See accompanying notes.

                                       2
<PAGE>
 



                          IWERKS ENTERTAINMENT, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                     LIABILITIES AND STOCKHOLDERS' EQUITY
                     (in thousands, except share amounts)

<TABLE>
<CAPTION>

                                                             September 30,  June 30,
                                                                 1996         1996
                                                             ------------   -------
                                                             (unaudited)
<S>                                                            <C>         <C>
Current liabilities:
Accounts payable                                                $ 2,960    $ 2,634
Accrued expenses                                                  6,539      7,667
Notes payable to related parties, current
  portion                                                           875        875
Notes payable, current portion                                      462        571
Billings in excess of costs and estimated
  earnings on uncompleted contracts                               1,490      1,106
Deferred revenue                                                    279         61
Capital leases, current portion                                     689        615
                                                                -------    -------
    Total current liabilities                                    13,294     13,529


Notes payable, excluding current portion                              -         81
Capital lease obligations, excluding
  current portion                                                 2,437      2,651

Stockholders' equity:
  Preferred stock, $.001 par value, 1,000,000 authorized,
   none issued and outstanding                                        -          -
  Common stock, $.001 par value, 20,000,000 shares
   authorized; issued and outstanding 11,663,061
   and 11,588,048, respectively                                      56         56
  Additional paid-in capital                                     76,595     76,340
  Accumulated deficit                                           (19,556)   (19,731)
                                                                -------    -------
Total stockholders' equity                                       57,095     56,665
                                                                -------    -------
  Total liabilities and stockholders' equity                    $72,826    $72,926
                                                                -------    -------
</TABLE>
                            See accompanying notes.

                                       3
<PAGE>
 
                          IWERKS ENTERTAINMENT, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (unaudited)
                      (in thousands except share amounts)


<TABLE>
<CAPTION>


                                                         For the three months ended
                                                               September 30,
                                                         --------------------------
                                                            1996                1995
                                                            ----                ----
<S>                                                       <C>                 <C>
Revenue                                                $    9,594          $   10,096

Cost of sales                                               6,236               5,720
                                                       ----------          ----------
  Gross profit                                              3,358               4,376

Selling, general, and administrative expenses               3,202               4,241

Research and development                                      179                  90
                                                       ----------          ----------
  (Loss) income from operations                               (23)                 45

Interest income                                               314                 204
Interest expense                                             (117)               (108)
                                                       ----------          ----------
  Net income                                           $      174          $      141
                                                       ----------          ----------
  Net income per common share                          $      .01          $      .01
                                                       ----------          ----------
Weighted average shares outstanding                    12,556,012          11,700,107
                                                       ----------          ----------

</TABLE>


                            See accompanying notes.

                                       4
<PAGE>
 



                          IWERKS ENTERTAINMENT, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (unaudited)
                                (in thousands)

<TABLE>
<CAPTION>
                                                               For the three months ended
                                                                     September 30,
                                                                     ------------
                                                                   1996      1995
                                                                   -----     -----
<S>                                                              <C>        <C>
OPERATING ACTIVITIES
Net income                                                       $   174    $   141
Depreciation and amortization                                      1,462      1,656
Changes in operating assets and liabilities                       (2,542)     1,648
                                                                 -------    -------
   Net cash (used) provided by operating activities                 (906)     3,445
                                                                 -------    -------
INVESTING ACTIVITIES
Investment in joint ventures                                        (322)         -
Investment in portable simulation theaters                          (108)      (140)
Purchases of property and equipment                                 (466)      (133)
Additions to film inventory                                         (367)       (59)
Investment in debt securities                                        142     (3,683)
                                                                 -------    -------
   Net cash used in investing activities                          (1,121)    (4,015)

FINANCING ACTIVITIES
Repayment of notes payable                                          (190)      (300)
Payments on capital leases                                          (139)       (30)
Exercise of stock options                                            241         19
Other                                                                 14         29
                                                                 -------    -------
   Net cash used in financing activities                             (74)      (282)
                                                                 -------    -------
Net decrease in cash                                              (2,101)      (852)

Cash and cash equivalents at beginning of period                  12,674     13,814
                                                                 -------    -------
Cash and cash equivalents at end of period                       $10,573    $12,962
                                                                 -------    -------
Supplemental disclosures of cash flow information:

   Cash paid during the period for interest                      $   102    $    62
                                                                 =======    =======
   Cash paid during the period for income taxes                        -         -
                                                                 =======    =======
</TABLE>

                            See accompanying notes.

                                       5
<PAGE>
 
                          IWERKS ENTERTAINMENT, INC.
             Notes to Condensed Consolidated Financial Statements
                                  (unaudited)


Note 1 - Introduction

       The accompanying condensed consolidated financial statements of Iwerks
Entertainment, Inc. (the "Company") have been prepared without audit pursuant to
the rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the disclosures made are adequate to make information
presented not misleading. In the opinion of management, all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
financial position of the Company as of September 30, 1996 and the results of
its operations for the three months ended September 30, 1996 and 1995 and the
cash flows for the three months ended September 30, 1996 and 1995 have been
included. Certain reclassifications have been made to the previously reported
financial information in order to conform with September 30, 1996 presentation.
The results of operations for interim periods are not necessarily indicative of
the results which may be realized for the full year. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's latest Annual Report on Form 10-K as filed with the SEC.

Note 2 - Income Taxes

       At June 30, 1996, the Company had available federal and state tax net
operating loss carryforwards of approximately $18,093,000 and $8,240,000,
respectively expiring through 2011. As a result of these net operating losses,
the Company's effective tax rate was negligible and consequently no income tax
provision was recorded in either quarter presented.


                                       6
<PAGE>
 
Note 3 - Depreciation and Amortization

       Depreciation and amortization expense is computed using the straight line
method over the estimated useful lives of the assets and consists of the
following:


<TABLE>
<CAPTION>
                                                             Three Months ended September 30
                                                             ------------------------------- 
                                                                   1996         1995
                                                                   ----         ----
<S>                                                             <C>          <C>
            Depreciation and amortization on fixed assets       $  280,000   $  527,000
            Depreciation on touring equipment                      367,000      335,000
            Amortization of film                                   584,000      550,000
            Amortization of goodwill and other                     231,000      244,000
                                                                ----------   ----------   
            Total depreciation and amortization                 $1,462,000   $1,656,000
                                                                ==========   ==========
</TABLE>

       Depreciation and amortization included in cost of sales was $964,000 and
$897,000 for the quarter ended September 30, 1996 and 1995, respectively.

Note 4 - Net Income Per Common Share:
-------------------------------------

       The net income per share for the three month periods ended September 30,
1996 and 1995 are based on the weighted average number of common and common
equivalent shares outstanding during the period. Common equivalent shares
consisting of outstanding stock options and warrants have been included in the
calculation to the extent they are dilutive. Fully diluted amounts for the three
months ended September 30, 1996 and 1995 do not materially differ from the
amounts presented herein.


Note 5 - Litigation
-------------------

       Fred Hollingsworth III, a former director of Iwerks Entertainment, Inc.
and former chief executive officer and founder of Omni Films International,
Inc., filed suit on or about April 9, 1996 against the Company and seven of its
current or former officers and directors. The complaint seeks unspecified
damages arising from misconduct, including alleged misstatements and omissions,
in connection with the acquisition by Iwerks of Omni Films International, Inc.
in May 1994. The Company believes it has meritorious defenses regarding this
matter and, therefore, intends to vigorously defend against this action.
However, due to the uncertainties inherent in litigation, and because no
discovery has yet been undertaken, the ultimate outcome of this matter cannot be
ascertained at this time.


                                       7
<PAGE>
 
Note 6 - Subsequent Event
-------------------------

       The Company announced on October 24, 1996, that the Board of Directors
has approved a stock repurchase program by which up to 300,000 shares of its
common stock may be acquired in the open market. This repurchase program will
terminate on October 20, 1997 unless extended by the Board of Directors.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Results of Operations
---------------------

       For the three months ended September 30, 1996 Iwerks Entertainment, Inc.
(the "Company") recorded revenues of $9,594,000 compared to $10,096,000 for the
same period last year. Net income for the three months ended September 30, 1996
was $174,000 or $ .01 per share compared to $141,000 or $ .01 per share for the
same period last year.

REVENUES
--------

       The Company's revenues are derived primarily from the manufacture and
sale of specialty theater systems (hardware), the licensing of film software to
the installed base of these systems and the participation in joint ventures, as
well as the ownership and operation ("O&O") of both fixed and mobile specialty
theatre entertainment venues. The following table presents summary information
regarding these revenues (amounts in thousands):

<TABLE>
<CAPTION>

                                 Three Months ended September 30,
                                 -------------------------------
                                    1996             1995
                                    ----             ----
<S>                                <C>              <C>
    Hardware Sales & Service       $5,116          $ 4,337    
    Owned and Operated              3,269            4,344    
    Film Licensing                  1,104              872    
    Film Production and other         105              543    
                                   ------          -------
        Total                      $9,594          $10,096     
                                   ======          ======= 
</TABLE>

       Hardware sales and service revenue increased as compared to the same
period last year primarily due to a quicker completion process than that of the
prior year as well as higher parts and service revenue. Although existing
projects are being

                                       8
<PAGE>
 
completed quicker, the Company has had some delays in receiving additional
deposits on signed contracts for the installation of simulation theatres in
China, which could result in revenue and earnings shortfalls for the second
quarter.

       The O & O revenue includes sponsorship, contract and admission revenues
from the Company's fleet of 17 Reactors (mobile simulation theaters). The
decrease in O & O revenue over the same quarter of the prior year resulted from
the decreased number of sponsorship days from a significant sponsor, along with
a lower average daily rate as compared with this sponsors contract in the same
period in the first fiscal quarter of last year. The contract with this major
sponsor also expired during the first quarter of fiscal 1997. The Company is
actively seeking additional sponsors and evaluating other alternatives regarding
the touring operations. If the Company is unable to obtain additional sponsors,
O & O revenues will be adversely affected in future periods. As O & O revenues
have historically been seasonal, a decline in admission revenues in the second
and third fiscal quarters is expected.

       Film licensing revenue increased as a result of the increasing base of
installed theaters that license the Company's film software. 

       Film production and other decreased as compared to the same quarter last
year due to the Company recognizing revenues in the prior year from an exclusive
distribution agreement of approximately $400,000. The exclusive period was for a
three year period that ended December 1995.

COST OF SALES AND GROSS PROFIT
------------------------------

       The overall gross profit margin percentages for the three months ended
September 30, 1996 and 1995 were 35.0% and 43.3%, respectively. The decrease in
the gross profit margin was primarily due to higher operating costs of the
mobile simulation theaters. Reactor revenues were lower as discussed above,
however, the increase in Reactor operating expenses was due to additional usage
in general admission events in an attempt to make up for the shortfall in
sponsorship revenue. Additionally, the general admission events were typically
of a shorter duration and the revenue per day was lower than in the first
quarter of last year resulting in higher touring operating costs. Also film
royalty expenses were higher due to one film release made in the spring of 1996
which has a higher royalty fee.


SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
--------------------------------------------

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

                                       9
<PAGE>
 
       SG & A costs for the quarter ended September 30, 1996 and 1995 were
$3,202,000 and $4,241,000, respectively. The $1,039,000 decrease resulted
primarily from a reduction in legal fees and lower depreciation. The higher
legal expenses in the first quarter of the last fiscal year were associated with
the settlement of the class action suits against the Company, and the higher
depreciation resulted from accelerated amortization of certain leasehold
improvements.

RESEARCH AND DEVELOPMENT
------------------------

       Research and development costs for the quarter ended September 30, 1996
were $179,000 compared to $90,000 for the same period last year. The increase
reflects an on going effort to improve the Company's products, develop new
products and reduce production costs.

INTEREST INCOME AND EXPENSE
---------------------------

       Interest income for the three months ended September 30,1996 and 1995 was
$314,000 and $204,000, respectively, and is derived from the Company's
investments, primarily in U.S. Treasury Notes. The increase in interest income
resulted primarily from the increase in the invested balances in the comparable
periods.

       Interest expense for the three months ended September 30, 1996 and 1995
was $117,000 and $108,000, respectively, and is primarily financing costs on
portable simulation theaters.


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

       The Company's operating activities for the three months ended September
30, 1996 generated a negative cash flow of $906,000. This was mainly due to an
increase of $835,000 in accounts receivable and $685,000 in inventories along
with a decrease of $1,128,000 in accrued expenses. Investing activities for the
three months ended September 30,1996 consisted primarily of investments in joint
ventures, representing the Company's investment in completed projects, as well
as increases to property and equipment for joint venture and owned and operated
projects which are still in process. Cash used in financing activities consisted
primarily of payments for notes payable and capital leases.

       The Company maintains a bank line of credit in the amount of $5 million.
At September 30, 1996 and 1995, there were no amounts outstanding on the line of
credit. With the existing cash balances and short-term investments in debt
securities on hand at September 30, 1996, the Company believes that it has
adequate liquidity to meet its cash requirements for at least the next twelve
months, after which time it may be required to raise additional cash through the
sale of equity or debt securities. In addition, to the extent the Company
experiences growth in the future, or its cash flow from operations is less than
anticipated, the Company may be required to obtain additional sources of cash.

                                      10
<PAGE>
 
       The Company does not anticipate the need to retire its debt security
investments before maturity to meet cash requirements, however, should
unanticipated events require early retirement of these investments, the Company
could incur a loss on their sale. At September 30, 1996, the investment in debt
securities are classified as available-for-sale and are stated at fair market
value.

OUTLOOK AND RISK FACTORS
------------------------

       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 costs of sales and the ability
of the Company to maintain pricing at a level to maintain gross profit margins,
the level of selling, general and administrative costs, the performance by the
Company under its existing purchase contracts and the ability to obtain new
contracts, the success of the Company's owned and operating strategy, the
ability of the Company to 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.

                                      11
<PAGE>
 
PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS
-------------------------

       Iwerks has been named as a defendant in an action filed on or about April
9, 1996, entitled Hollingsworth v. Iwerks Entertainment, Inc., et al., Circuit
Court of the 12th Judicial District for Sarasota, Florida, Case No. CA-01 96-
1930. Fred Hollingsworth III, a former director of Iwerks Entertainment, Inc.
and former chief executive officer and founder of Omni Films International,
Inc., filed suit against the Company and seven of its current or former officers
and directors. The complaint seeks unspecified damages arising from alleged
misconduct, including alleged misstatements and omissions, in connection with
the acquisition by Iwerks of Omni Films International, Inc. in May 1994. The
case has now been removed to the United States District Court for the Middle
District of Florida. The Company believes it has meritorious defenses regarding
this matter and, therefore, intends to vigorously defend against this action.
However, due to the uncertainties inherent in litigation, and because no
discovery has yet been undertaken, the ultimate outcome of this matter cannot be
ascertained at this time.

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


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits:

        11.1   Earnings per share
        27.1   Financial Data Schedule

(b)  Reports on Form 8-K filed during the quarter ended September 30, 1996:

        None


                                      12
<PAGE>
 
                                  SIGNATURES



       Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the city of Burbank,
State of California on the 5th day of November, 1996.



                        Iwerks Entertainment, Inc.
                              (Registrant)



                        By: /s/  Bruce C. Hinckley
                            -------------------------------
                            Executive Vice President
                            Chief Financial Officer
                           (Principal Finance Officer)


                        By: /s/    Jeffrey M. Dahl
                            -------------------------------
                            Vice President / Controller
                            (Principal Accounting Officer)

                                      13