U.S. Securities and Exchange Commission
                             WASHINGTON, D.C. 20549

                                   FORM 10-QSB

               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                For the quarterly period ended September 30, 1999

                         Commission file number 0-29750

                             INTERACTIVE MAGIC, INC.
        (Exact name of small business issuer as specified in its charter)

                            North Carolina 56-2092059
        (State of incorporation) (I.R.S. Employer Identification Number)

                         215 Southport Drive, Suite 1000
                        Morrisville, North Carolina 27560
                     (Address of principal executive office)

                                 (919) 461-0722
                           (Issuer's telephone number)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act 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 12, 1999 (the most recent practicable date), there were
14,655,337 shares of the issuer's Common Stock, $.10 par value per share,
outstanding.

Transitional Small Business Disclosure Format (check one)

Yes |_|                    No | X |



<PAGE>
<TABLE>
<CAPTION>



                                              INTERACTIVE MAGIC, INC.

                                           Form 10-QSB Quarterly Report

                                                       INDEX

<S>     <C>    <C>    <C>    <C>    <C>    <C>
PART I                         FINANCIAL INFORMATION                                PAGE
Item 1                         Financial Statements                                  3

Item 2                         Management's Discussion and Analysis of Financial
                               Condition and Results of Operations                   22

PART II                        OTHER INFORMATION                                     28

Item 1                         Legal Proceedings                                     28

Item 2                         Changes in Securities and Use of Proceeds             28

Item 3                         Defaults Upon Senior Securities                       28

Item 4                         Submission of Matters to a Vote of Security Holders   28

Item 5                         Other Information                                     28

Item 6                         Exhibits and Reports on Form 8-K                      30

SIGNATURES                                                                           31
</TABLE>

                                                         2


<PAGE>
PART I.               FINANCIAL INFORMATION

ITEM 1.               FINANCIAL STATEMENTS

                             Interactive Magic, Inc.

                           Consolidated Balance Sheets
                        (IN THOUSANDS, EXCEPT SHARE DATA)



                                                  SEPTEMBER 30      DECEMBER 31
                                                      1999              1998
                                                   (UNAUDITED)       (AUDITED)
                                                 ------------------------------
ASSETS
Current assets:
   Cash and cash equivalents                        $ 1,570          $ 2,943
   Trade receivables, net of allowances of $713
   and $2,871, respectively                             475            2,109
   Inventories                                           61              892
   Advance royalties, net                               231            1,586
   Software development costs, net                        -              912
   Prepaid expenses and other                           128              252
                                                 ------------------------------
Total current assets                                  2,465            8,694

Property and equipment, net                           1,110            1,082

Noncurrent assets:
   Royalties receivable                                  73              726
   Goodwill, net                                      3,750                0
   Other                                                  -               18
                                                 ------------------------------
Total noncurrent assets                               4,933              744



                                                 ------------------------------
Total assets                                        $ 7,398          $10,520
                                                 ==============================


<PAGE>
                             Interactive Magic, Inc.

                     Consolidated Balance Sheets (continued)
                        (IN THOUSANDS, EXCEPT SHARE DATA

<TABLE>
<CAPTION>
                                                                                SEPTEMBER 30      DECEMBER 31
                                                                                    1999              1998
                                                                                 (UNAUDITED)       (AUDITED)
                                                                              ------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
<S>                                                                              <C>              <C>
   Accounts payable and accrued expenses                                         $    2,241       $    1,698
   Royalties and commissions payable                                                    239              768
   Lines of credit                                                                    1,023            1,348
   Current portion of capital lease obligations                                          50               23
                                                                              ------------------------------------
Total current liabilities                                                             3,553            3,837

Noncurrent liabilities:
   Accrued interest payable to related parties                                          183              117
   Long-term debt                                                                     2,156                -
   Capital lease obligations, less current portion                                       13               15
                                                                              ------------------------------------
Total noncurrent liabilities                                                          2,352              132

Stockholders' equity (deficit):
   Preferred Stock, $.01 par value; 25,000,000 shares authorized; none
      issued and outstanding                                                              -                -
   Common stock, $.10 par value; 50,000,000 shares authorized; 12,505,337
      and 9,850,867 shares issued and outstanding at September 30, 1999 and
      December 31, 1998, respectively                                                 1,250              985
   Additional paid-in capital                                                        40,239           31,522
   Accumulated deficit                                                              (39,861)         (25,862)
   Accumulated other comprehensive loss                                                (135)             (94)
                                                                              -------------------------------------
Total stockholders' equity (deficit)                                                  1,493           (6,551)
                                                                              -------------------------------------
Total liabilities and stockholders' equity (deficit)                             $    7,398       $   10,520
                                                                              =====================================
</TABLE>

SEE ACCOMPANYING NOTES.


<PAGE>


                             Interactive Magic, Inc.

                      Consolidated Statements of Operations
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                            THREE MONTHS ENDED             NINE MONTHS ENDED
                                                               SEPTEMBER 30                   SEPTEMBER 30
                                                            1999           1998            1999            1998
                                                      -----------------------------------------------------------
NET REVENUES:
<S>                                                  <C>             <C>             <C>             <C>
   CD-ROM PRODUCT SALES                              $        373    $      1,903    $        934    $      8,455
   ONLINE SALES                                               464             473           1,429           1,257
   ROYALTIES AND LICENSES                                      12             293              19           1,692
   ADVERTISING AND CONTRACT REVENUE                           659            --             1,265            --
                                               ------------------------------------------------------------------
TOTAL NET REVENUES                                          1,508           2,669           3,647          11,404

COST OF REVENUES:
   COST OF PRODUCTS AND SERVICES                              238             957           2,588           2,529
   ROYALTIES AND AMORTIZED SOFTWARE COSTS                    --               709             311           2,079
                                                -----------------------------------------------------------------
TOTAL COST OF REVENUES                                        238           1,666           2,899           4,608
                                                -----------------------------------------------------------------
GROSS  PROFIT                                               1,270           1,003             748           6,796

OPERATING EXPENSES:
   SALES AND MARKETING                                        912           2,446           4,003           6,161
   PRODUCT DEVELOPMENT                                      1,000           1,273           4,193           3,234
   GENERAL AND ADMINISTRATIVE                                 521             460           2,643           1,479
   GOODWILL AMORTIZATION                                      376            --               932            --
                                               ------------------------------------------------------------------
TOTAL OPERATING EXPENSES                                    2,809           4,179          11,771          10,874
                                                -----------------------------------------------------------------
OPERATING LOSS                                             (1,539)         (3,176)        (11,023)         (4,078)

OTHER (INCOME) EXPENSE:
   NET INTEREST EXPENSE - THIRD PARTIES                     1,198              78           3,771             593
   INTEREST EXPENSE - RELATED PARTIES                          21              22              59             114
   OTHER                                                       16            (179)           (906)           (160)
                                                -----------------------------------------------------------------
TOTAL OTHER (INCOME) EXPENSE                                1,235             (79)          2,924             547
                                                -----------------------------------------------------------------
LOSS BEFORE INCOME TAXES                                   (2,774)         (3,097)        (13,947)         (4,625)
INCOME TAX EXPENSE                                             10              28              52             156
                                                -----------------------------------------------------------------
LOSS BEFORE EXTRAORDINARY ITEM                       $     (2,784)   $     (3,125)   $    (13,999)   $     (4,781)
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT           --              (387)           --              (387)
                                                =================================================================
NET LOSS                                             $     (2,784)   $     (3,512)   $    (13,999)   $     (5,168)
                                                =================================================================
BASIC LOSS PER SHARE:
 LOSS BEFORE EXTRAORDINARY ITEM                      $      (0.25)   $      (0.35)   $      (1.31)   $      (0.88)
                                                =================================================================
 EXTRAORDINARY ITEM                                  $      (0.00)   $      (0.04)   $      (0.00)   $      (0.07)
                                                =================================================================
 NET LOSS PER SHARE                                  $      (0.25)   $      (0.39)   $      (1.31)   $      (0.95)
                                                =================================================================
WEIGHTED AVERAGE SHARES USED IN COMPUTING BASIC
    LOSS PER SHARE                                     11,013,733       8,992,650      10,674,069       5,420,773
                                               =================================================================
</TABLE>

SEE ACCOMPANYING NOTES.

<PAGE>

                             Interactive Magic, Inc.

                      Consolidated Statements of Cash Flows
                                 (IN THOUSANDS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                     NINE MONTHS ENDED SEPTEMBER 30
                                                                                       1999                1998
                                                                                -----------------------------------
OPERATING ACTIVITIES
<S>                                                                               <C>                <C>
Net loss                                                                          $    (13,999)      $     (5,168)
Adjustments to reconcile net loss to net cash used in operating
   activities:
     Issuance of warrants                                                                  172                  -
     Depreciation and amortization                                                       1,116                305
     Extraordinary Loss                                                                      -                387
     Gain on the sale of advance royalties (NOTE 3)                                       (855)                 -
     Amortization of capitalized software development costs                                329                745
     Noncash interest expense                                                            2,775                 59
     Write-off of capitalized software development costs                                   611                  -
     Changes in operating assets and liabilities net of effects of purchase of
       MPG-Net (NOTE 4)
       Trade and royalties receivables                                                   2,402             (1,855)
       Inventories                                                                         831                (96)
       Advance royalties                                                                     5               (446)
       Prepaid expenses and other                                                          (89)                48
       Accounts payable and accrued expenses                                               251               (520)
       Royalties and commissions payable                                                  (529)                92
       Accrued interest to related party                                                    66               (485)
                                                                                -----------------------------------
Net cash used in operating activities                                                   (6,914)            (6,934)

INVESTING ACTIVITIES
Acquisition of MPG-Net (NOTE 4)                                                            (15)                 -
Proceeds from the sale of advance royalties (NOTE 3)                                     2,315                  -
Purchase of property and equipment                                                         (31)              (208)
Increase in notes receivable                                                              (200)                 -
Software development costs                                                                 (37)            (1,423)
                                                                                ----------------------------------
Net cash provided by (used in) investing activities                                      2,032             (1,631)

FINANCING ACTIVITIES
Proceeds from issuance of common and preferred stock                                       245             23,760
Proceeds (Repayments) on long-term debt                                                  3,660             (4,950)
Repayments on notes payable to related parties                                               -               (870)


<PAGE>


                                              Interactive Magic, Inc.

                                 Consolidated Statements of Cash Flows (continued)
                                                  (IN THOUSANDS)
                                                    (UNAUDITED)


                                                                                  NINE MONTHS ENDED SEPTEMBER 30
                                                                                    1999                1998
                                                                             -----------------------------------
Net repayments from lines-of-credit                                                    (325)            (3,342)
Payments on capital lease obligations                                                   (30)               (38)
                                                                             -----------------------------------
Net cash provided by financing activities                                             3,550             14,560

Effect of currency exchange rate changes on cash and cash equivalents                   (41)               (25)
                                                                             -----------------------------------

Net (decrease) increase in cash and cash equivalents                                 (1,373)             5,970
Cash and cash equivalents at beginning of period                                      2,943                384
                                                                             -----------------------------------
Cash and cash equivalents at end of period                                       $    1,570         $    6,354
                                                                             ===================================

NONCASH INVESTING AND FINANCING ACTIVITIES
Conversion of notes payable into common and preferred stock                      $     831       $      2,600
                                                                             ===================================
Issuance of common stock in settlement of accrued interest payable to
    related parties                                                            $         -       $        319
                                                                             ===================================
Conversion of preferred stock into common stock                                $         -        $     3,169
                                                                             ===================================

Issuance of common stock in connection with acquisition of MPG-Net (NOTE 4)    $     3,858       $          -
                                                                             ===================================
Issuance of common stock in connection with acquisition of Virtual Business
    Designs, Inc. (NOTE 4)                                                     $       288       $          -
                                                                             ===================================
Contingently issuable warrants provided to holder of convertible debenture
    (NOTE 6)                                                                       $ 1,067       $          -
                                                                             ===================================
Issuance of warrants to broker in connection with convertible debenture
    (NOTE 6)                                                                      $    390       $          -
                                                                             ===================================

</TABLE>


SEE ACCOMPANYING NOTES.
<PAGE>



                             Interactive Magic, Inc.

                   Notes to Consolidated Financial Statements

(INFORMATION AS OF SEPTEMBER 30, 1999 AND FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 1999 AND 1998 IS UNAUDITED)



1. DESCRIPTION OF BUSINESS

Interactive Magic, Inc. (or the "Company") is a developer and publisher of
Internet and online games and an operator of online game services. The Company
develops and publishes proprietary online multi-player games and is building the
Company Entertainment Network ("iEN"), an Internet distribution infrastructure
which will offer online gamers a variety of free, subscription and pay-per-play
games and services, including simulation, parlor, strategy, role playing and
action games.

         The Company is the exclusive game site operator for AT&T WorldNet, an
Internet service provider ("ISP"), and has been contracted to provide online
games for America Online, the world's leading online Internet services company.
The Company seeks to establish itself as a major provider of online gaming
services for ISPs, Internet portals and online services in order to broaden its
audience of users. GameHub, AT&T WorldNet's co-branded online gaming service,
was launched in January 1999 and is currently being marketed by AT&T to new
WorldNet subscribers as a premium service included with their subscription. The
GameHub site offers consumers a mix of free and pay-per-play games in all
categories, including strategy, role playing, simulation, action and parlor
games. In addition to games, GameHub will offer chat rooms, forums and shopping
areas. GameHub is expected to generate revenue from subscriber premiums,
e-commerce and advertising. GameHub complements the Company's online gaming
strategy by expanding the Company's network of player communities.

2. BASIS OF PRESENTATION

The condensed consolidated financial statements include the accounts of
Interactive Magic, Inc. (the "Company"), a North Carolina corporation, and its
wholly owned subsidiaries, iMagicOnline Corporation, Interactive Magic Ltd. And
Interactive Magic GmbH. All significant intercompany accounts and transactions
have been eliminated.

The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. As shown in the consolidated
financial statements during the nine months ended September 30, 1999 the Company
incurred losses of $13,999,000 and has experienced negative cash flows from
operations. These factors, among others, indicate that the Company may be unable
to continue as a going concern for a reasonable period of time. The consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of liabilities that might be necessary should
the Company be unable to continue as a going concern. The Company's continuation
as a going concern is dependent upon its ability to generate sufficient cash
flow to meet its obligations on a timely basis, to obtain additional financing
or refinancing as may be required, and ultimately to attain profitability.

<PAGE>



                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)


2. BASIS OF PRESENTATION (CONTINUED)

While the financial information furnished is unaudited, the condensed
consolidated financial statements included in this report reflect all
adjustments (consisting only of normal recurring adjustments) which the Company
considers necessary for the fair presentation of the results of operations for
the interim periods covered and of the financial condition of the Company at the
date of the interim balance sheet. The results for interim periods are not
necessarily indicative of the results for the entire year. The condensed
consolidated financial statements should be read in conjunction with the
Interactive Magic, Inc. consolidated financial statements and the notes thereto,
included in the Company's Annual Report on Form 10-KSB for the year ended
December 31, 1998.


3. DISPOSITION OF ASSETS

On May 25, 1999, the Company executed an Agreement Regarding Assignment of
Contracts (the "Agreement") to sell its rights under certain development
contracts for CD-ROM products between the Company and third party developers
(and assume certain liabilities thereto) for $2.5 million. The Agreement
provides the Company a license to use these products on the Internet. The
transaction was consummated on June 30, 1999. Cash proceeds to the Company, net
of related expenses, were $2.3 million. The carrying value of net assets sold
(primarily CD-ROM advance royalties) was $ 1.6 million. The Company recognized a
gain of $855,000 related to the sale, which is included in other (income)
expense in the consolidated statements of operations.


4. BUSINESS COMBINATION

On August 27, 1999 the Company purchased all right, title and interest in and to
all of the tangible and intangible assets of Virtual Business Designs, Inc.,
doing business as The Gamers Net ("The Gamers Net"), for 107,143 shares of its
common stock valued at approximately $288,000. The merger was accounted for as a
purchase in accordance with Accounting Principles Board Opinion No. 16 and,
accordingly, the operating results of The Gamers Net have been included in the
Company's consolidated financial statements since the date of acquisition.
The purchase price is being amortized over 2 years.

On February 12, 1999 the Company completed the acquisition of MPG-Net, Inc.
("MPG-Net") Company by exchanging 600,000 shares of its common stock valued at
approximately $3.1 million for all of the outstanding common stock of MPG-Net
and issuing 150,000 shares of its common stock valued at approximately $0.8
million in full settlement of certain debt obligations of MPG-Net. MPG-Net is
primarily in the business of developing, publishing and distributing
interactive, real time 3-D entertainment for multi-user online/Internet play, as
well as creating entertainment platforms on the Internet such as online game
channels, game hubs and websites. The merger was accounted for as a purchase in
accordance with Accounting Principles Board Opinion No. 16 and, accordingly, the
operating results of MPG-Net have been included in the Company's consolidated
financial statements since the date of acquisition. The excess of the aggregate
purchase price over the fair market value of the net assets acquired of
approximately $4.3 million is being amortized over 3 years.

<PAGE>

                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)



4. BUSINESS COMBINATION (CONTINUED)

The following unaudited consolidated pro forma data summarizes the combined
operating results of the Company and MPG-Net as if the acquisition had occurred
at January 1, 1998:
<TABLE>
<CAPTION>
                                                                --------------------------- --------------------------
                                                                    NINE MONTHS ENDED           NINE MONTHS ENDED
                                                                    SEPTEMBER 30, 1999         SEPTEMBER 30, 1998
                                                                --------------------------- --------------------------

<S>                                                                          <C>                      <C>
Net revenues                                                                 $3,741                   $ 11,588
Net loss before extraordinary item                                           (14,459)                    (6,988)
Net loss                                                                     (14,459)                    (7,375)
Loss per share                                                                $(1.34)                    $(1.20)
</TABLE>


5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include amounts in demand deposit accounts and
investments with an original maturity date of three months or less when
purchased.

INVENTORIES

Inventories consist of pre-packaged CD-ROM software packages and related
materials and are stated at the lower of cost or market. Costs are determined
using the first-in, first-out ("FIFO") cost flow assumption.

<TABLE>
<CAPTION>
Inventories consist of the following (IN THOUSANDS):
                                                                    SEPTEMBER 30, 1999       DECEMBER 31, 1998
                                                                  -------------------------------------------------
<S>                                                                  <C>                    <C>
     Finished goods                                                  $    243               $        1,065
     Components                                                            93                          117
                                                                  -------------------------------------------------
                                                                          336                        1,182
     Inventory valuation reserve                                         (275)                        (290)
                                                                  -------------------------------------------------
                                                                     $     61               $          892
                                                                  =================================================
</TABLE>

ADVANCE ROYALTIES

Advance royalties represent prepayments made to independent software developers
under development agreements. Advance royalties are expensed as part of
royalties and amortized software costs at the contractual royalty rate based on
actual net product sales. Management continuously evaluates the future
realization of advance royalties, and charges to cost of revenues any amount
that management deems unlikely to be amortized at the contractual royalty rate
through product sales. At September 30, 1999 and December 31, 1998, the reserve
for advance royalties was $36,000 and $1,654,000, respectively.


<PAGE>


                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)




5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)


SOFTWARE DEVELOPMENT COSTS

Costs incurred in the development of software for sale to customers are
capitalized after a product's technological feasibility has been established.
Capitalization of such costs is discontinued when a product is available for
general release to customers. Capitalized software development costs are
capitalized at the lower of cost or net realizable value and amortized using the
greater of the revenue curve method or the straight-line method over the
estimated economic life of the related product. Amortization begins when a
product is ready for general release to customers.

Information related to net capitalized software development costs is as follows
(IN THOUSANDS):
<TABLE>
<CAPTION>

                                                             SEPTEMBER 30, 1999       DECEMBER 31, 1998
                                                           -------------------------------------------------

<S>                                                           <C>                     <C>
   Balance at beginning of period                             $     912               $       425
   Capitalized                                                       37                     1,450
   Written off                                                     (620)                        -
   Amortized                                                       (329)                     (963)
                                                           -------------------------------------------------
   Balance at end of period                                   $       -               $       912
                                                           =================================================
</TABLE>

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying value of cash and cash equivalents, trade receivables, accounts
payable and other liabilities approximates fair value at September 30, 1999 and
December 31, 1998.

REVENUE RECOGNITION

In October 1997, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position (SOP) 97-2 Software Revenue Recognition as amended in
March 1998 by SOP 98-4 and October 1998 by SOP 98-9. These SOPs provide guidance
on applying generally accepted accounting principles in recognizing revenue on
software transactions. The Company adopted SOP 97-2 for software transactions
entered into beginning January 1, 1998. Based on the current requirements of the
SOPs, application of these statements did not have a material impact on the
Company's revenue recognition policies.

<PAGE>

                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)




5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)



However, AcSEC is currently reviewing further modifications to the SOP with the
objective of providing more definitive, detailed implementation guidelines. This
guidance could lead to unanticipated changes in the Company's operations and
revenue recognition practices

Revenue from CD-ROM product sales is recognized at the time of product shipment.
Revenue from online sales is recognized at the time the game is played and is
based upon actual usage by the customer on an hourly basis. Revenue from
royalties and licenses is recognized when earned under the terms of the relevant
agreements with original equipment manufacturers ("OEMs"), international
distributors and other third parties. With respect to license agreements that
provide customers the right to multiple copies in exchange for guaranteed
amounts, net revenue is recognized upon delivery of the product master or the
first copy; provided collectibility is probable. Per copy royalties on sales
that exceed the guarantee are recognized as earned. The Company accepts product
returns and provides price protection on certain unsold merchandise. Revenue is
recorded net of an allowance for estimated future returns, markdowns, price
protection and warranty costs. Such reserves are based upon management's
evaluation of historical experience, current industry trends and estimated
costs.

Revenue from certain software development contracts with fixed price components
is recognized on the percentage of completion basis in accordance with the
American Institute of Certified Public Accountants' SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts." In
accordance with SOP 81-1, the Company recognizes percentage of completion
revenue based upon the ratio of accumulated incurred costs to the total
estimated costs to complete each contract.

The accounts receivable allowance consists primarily of reserves for product
returns, markdowns, price protection and warranty costs. The allowance also
includes a reserve for doubtful accounts, which management records based on
historical experience and current evaluation of potential collectibility issues.
The Company does not require collateral for unpaid balances. Credit losses have
historically been within management's expectations.




<PAGE>


                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)




5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)


PRODUCT DEVELOPMENT

Product development expenses (excluding capitalized software development costs)
are charged to operations in the period incurred and consist primarily of
payroll and payroll related costs.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Significant estimates include provisions for doubtful accounts, sales returns
and allowances, warranty provisions, and estimates regarding the recoverability
of prepaid royalty advances and inventory. Actual results could differ from
those estimates.

FOREIGN CURRENCY TRANSLATION

The Company follows the principles of the Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign
Currency Translation," using the local currency of its operating subsidiaries as
the functional currency. Accordingly, all assets and liabilities outside the
United States are translated into U.S. dollars at the rate of exchange in effect
at the balance sheet date. Income and expense items are translated at the
weighted average exchange rate prevailing during the period. Adjustments
resulting from translation of financial statements are reflected as a component
of accumulated other comprehensive loss.

INCOME TAXES

The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes". Under SFAS No. 109, the liability method is used
in accounting for income taxes and deferred tax assets and liabilities are
determined based on differences between the financial reporting and tax bases of
assets and liabilities.


COMPREHENSIVE LOSS

The following chart details the Company's comprehensive loss for the periods
presented:
<TABLE>
<CAPTION>
                                             -------------------------------------------- ---------------------------------------
                                                  THREE MONTHS ENDED SEPTEMBER 30               NINE MONTHS ENDED SEPTEMBER 30
                                             ------------------- ------------------------ --------------------- -----------------
                                                   1999                   1998                    1999                  1998
                                             ------------------- ------------------------ --------------------- -----------------
<S>                                              <C>                    <C>                    <C>                    <C>
Net Loss                                         $ (2,784)              $ (3,512)              $ (13,999)             $ (5,168)
Other comprehensive (loss) - (foreign
currency translation adjustment)                      (84)                    (4)                    (41)                  (25)
Comprehensive loss                               $ (2,868)              $ (3,516)              $ (14,040)             $ (5,193)
</TABLE>
<PAGE>

                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)




5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)


BASIC NET LOSS PER SHARE

Basic net loss per share has been calculated in accordance with SFAS No. 128,
"Earnings Per Share". SFAS No. 128 requires companies to compute earnings per
share under two different methods (basic and diluted). Basic net loss per share
is calculated by dividing net loss by the weighted average shares of common
stock outstanding during the period. All shares used in computing basic net loss
per share reflect the retroactive effect of the Company's July 1998 one-for-two
reverse stock split.

Had the Company been in a net income position, diluted earnings per share would
have been presented and would have included potential common shares related to
outstanding options and warrants. The diluted earnings per share computation is
not included, as all potential common shares are antidilutive. The Company
evaluated the requirements of the Securities and Exchange Commission Staff
Accounting Bulletin No. 98 ("SAB 98"), and concluded that there are no nominal
issuances of common stock or potential common stock which would be required to
be shown as outstanding for all periods as outlined in SAB 98.

6. LONG-TERM DEBT

On January 25, 1999, the Company issued a $4 million convertible debenture ("the
debenture") for net cash proceeds to the Company of approximately $3.7 million.
The Company also issued 200,000 warrants to the broker of the debenture, which
represented additional debt issuance costs, valued at $390,000. These warrants
were recorded as additional paid-in capital and the resulting debt issuance
costs will be amortized to interest expense over the term of the debenture.
These warrants have a weighted average exercise price of $4.85 and were
exercisable upon issuance. For the three and nine months ended September 30,
1999, amortization of the debt issuance costs was approximately $159,000 and
$259,000, respectively.

The debenture accrues interest at an annual interest rate of 6% and is due with
principal on January 25, 2002. The holder of the convertible debenture may
convert all or any portion of the debenture into the Company's common stock
where the number of shares to be issued will be determined by dividing the
principal plus interest due by the conversion price. The conversion price will
be equal to the lesser of a conversion price ranging from 77% to 93% of the
market price of the Company's common stock (as defined in the securities
purchase agreement) or a conversion price ranging from 104% to 120% of a fixed
conversion price (as defined in the securities purchase agreement). On the date
of conversion, if the Company's common stock trades at a price higher than the
fixed conversion price, the Company is obligated to issue to the holder of the
debenture warrants to purchase the Company's stock at a one-for-two ratio of
common stock issued as a result of the debenture conversion at an exercise price
equal to the debenture conversion price (the "contingently issuable warrants").

Subsequent to May 11, 1999 the debenture accrues additional interest at a
monthly rate of 4% of the outstanding principal balance until such time as the
Company's registration statement effecting the shares issuable under the
debenture becomes, and remains effective. For the nine months ended September
30, 1999, the Company recorded approximately $743,000 of interest expense
related to this provision.

<PAGE>


                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)


6. LONG-TERM DEBT (CONTINUED)


The contingently issuable warrants were valued at approximately $1.1 million at
the date of issuance and were recorded as additional paid-in capital. The
beneficial conversion feature of the debenture also resulted in a portion of the
proceeds of the debenture being allocated to the conversion feature based on its
intrinsic value of $2.1 million, which was recorded as additional paid-in
capital. However, the debenture was convertible at the date of issuance and
therefore the value of the conversion feature was immediately recorded as
additional interest expense and accreted into the carrying value of the
debenture. Based on the recorded fair value of the contingently issuable
warrants, the carrying value assigned to the debenture at the date of issuance
was $2.9 million. The difference between the initial carrying value of the
debenture and the $4 million face value will be accreted into the carrying value
as additional interest expense over the term of the debenture. For the three and
nine months ended September 30, 1999, the Company recorded approximately
$232,000 and $380,000 in interest expense related to such accretion,
respectively.

For the three and nine months ended September 30, 1999, interest expense related
to this debenture totaled $1.2 million and $3.7 million, respectively.

On or about September 15, 1999 the holder of the debenture elected to convert
$830,611 of principal and the related accrued interest into 1,683,786 shares of
the Company's common stock.

7. STOCK OPTIONS, STOCK PLANS AND WARRANTS

The following table summarizes the activity under the Company's Stock Option
Plans for the nine months ended September 30, 1999:
<TABLE>
<CAPTION>
                                                     OPTIONS        WEIGHTED-AVERAGE EXERCISE PRICE
                                                   OUTSTANDING                 PER SHARE
                                              -------------------------------------------------------
<S>                      <C> <C>                       <C>                        <C>
    Balances at December 31, 1998                      1,981,968                  2.72
       Options granted                                 1,146,830                  3.21
       Options exercised                                (113,541)                 2.26
       Options canceled                                 (772,344)                 4.37
                                              -------------------------------------------------------
    Balances at September 30, 1999                     2,242,913                 $2.53
                                              =======================================================
</TABLE>

At September 30, 1999 the Company had 1,380,231 options exercisable at exercise
prices ranging from $1.00 - $6.00 per share.

<PAGE>


                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)


7. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)

STOCK WARRANTS
The following summarizes the activity of warrants for the nine months ended
September 30, 1999:

                                                        WARRANTS
                                                       OUTSTANDING
                                                      ------------
Balance at December 31, 1998                              729,172
Issued                                                    639,998
Cancelled                                                 (27,058)
Exercised                                                   -
                                                      ------------
Balance at September 30, 1999                           1,342,112
                                                      ============


All of the Company's outstanding warrants at September 30, 1999 were exercisable
at prices ranging from $1.00 to $9.60 per share.


8. SUBSEQUENT EVENTS

Subsequent to the close of the September 30, 1999 quarter, the Company has
completed the following transactions in an effort to improve its financial
position:

         A)   On November 11, 1999, RGC International Investors, LDC (Rose Glen)
              converted the remainder of its unconverted debenture, which as of
              September 30, 1999 had an outstanding principal balance of
              $3,310,844 and a recorded value of $2,156,000 into 3,310.844
              shares of the Company's newly created Series D Preferred Stock
              with a stated value of $1,000 per share. In addition, Rose Glen
              converted $500,000 of all other accrued amounts under the
              debenture into 500 shares of Series D Preferred Stock, and agreed
              to waive all other accrued amounts which totaled $260,000. The
              difference between the recorded value of the debt and the
              outstanding principal balance along with the $260,000 waived
              interest accrual were netted and charged to additional paid-in
              capital. Interest expense related to these debentures was
              $3,679,000 for the nine months ended September 30, 1999.

         B)   On November 11, 1999 Rose Glen purchased 1,100 shares of Series D
              Preferred Stock for $1,100,000.

         C)   On November 11, 1999 Vertical Financial Holdings purchased 700,000
              shares of common stock for $700,000.

         D)   On November 11, 1999 - Value Management & Research AG purchased
              400,000 shares of common stock for $400,000.
<PAGE>

                             Interactive Magic, Inc.

             Notes to Consolidated Financial Statements (continued)




8. SUBSEQUENT EVENTS (CONTINUED)

         E)   On November 9, 1999, J.W. Stealey, former CEO of the Company,
              released the Company from the line of credit indebtedness to BB&T
              in the amount of $1,000,000 in exchange for 1,000,000 shares of
              common stock. The Company also paid $15,000 due on this line.
              Interest expense on this line of credit was $78,000 and $158,000
              for the nine months ended September 30, 1999 and the year ended
              December 31, 1998 respectively. In addition, as part of these
              transactions, Mr. Stealey's resignation agreement dated August 16,
              1999 has been amended such that his consulting services are no
              longer being used and the sole remaining consideration due him has
              been reduced to one lump sum payment of $200,000 (less the value
              of 12 months health insurance payments and car lease payments
              totaling approximately $20,000) and 50,000 shares of the Company's
              common stock valued at $62,500. This payment was made November 12,
              1999. The Company has agreed to convey to Mr. Stealey all
              trademarks and available rights to the name Interactive Magic,
              pending shareholder approval of the Company name change to
              iEntertainment Network. Mr. Stealey agreed to waive the interest
              due him from the Company in the amount of $183,000 under the terms
              of the line of credit with BB&T that he had personally guaranteed;
              in consideration of which the Company incurred additional interest
              expense of $59,000 for the nine months ended September 30, 1999
              and $107,000 for the year ended December 31, 1998. The amount of
              waived interest has been reflected as a credit to additional
              paid-in capital.

The following unaudited pro forma consolidated financial data present the
unaudited pro forma consolidated balance sheet of Interactive Magic as of
September 30, 1999 and the unaudited pro forma consolidated statements of
operations of Interactive Magic for the nine months ended September 30, 1999 and
the year ended December 31, 1998. The unaudited pro forma consolidated balance
sheet data reflects the following adjustments, as described above, as if they
had occurred on September 30, 1999:

         o    Conversion of Rose Glen indebtedness

         o    All issuances of preferred and common stock

         o    Severance accrual for former CEO

         o    Release of the Company from the BB&T line of credit indebtedness

The unaudited consolidated statements of operations data reflect the release of
the BB&T line of credit indebtedness and the former CEO's personal guarantee as
if they had occurred on January 1, 1998.

The unaudited pro forma consolidated financial data are based on historical
financial statements of Interactive Magic and the aforementioned adjustments.
The unaudited pro forma financial data do not purport to represent what
Interactive Magic's financial position or result's of operations would actually
have been if the transactions had in fact occurred on the dates indicated and
are not necessarily representative of Interactive Magic's financial position or
results of operations at any future date or for any future period.
<PAGE>

                             Interactive Magic, Inc.
            Unaudited Condensed Consolidated Pro Forma Balance Sheet
                        (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                                                          PRO FORMA
                                                                  SEPTEMBER 30            PRO FORMA      SEPTEMBER 30
                                                                      1999               ADJUSTMENTS         1999
                                                               --------------------------------------------------------
ASSETS
Current assets:
<S>                                                                <C>                          <C>         <C>
   Cash and cash equivalents                                       $ 1,570             B        1,100       $ 3,575
                                                                                       C          700
                                                                                       D          400
                                                                                       E          (15)
                                                                                       E         (180)
   Other current assets                                                895                                      895
                                                               --------------------------------------------------------
Total current assets                                                 2,465                      2,005         4,470

Property and equipment, net                                          1,110                                    1,110
Goodwill and intangible assets                                       3,750                                    3,750
Other                                                                   73                                       73

                                                               ========================================================
Total assets                                                       $ 7,398                    $ 2,005       $ 9,403
                                                               ========================================================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable and accrued expenses                          $    2,241           A           (760)   $    1,501
                                                                                       E             20
   Lines of credit                                                     1,023           E         (1,015)            8
   Royalties and other current liabilities                               289                                      289
                                                               --------------------------------------------------------
Total current liabilities                                              3,553                     (1,755)        1,798

   Long-term debt                                                      2,156           A         (2,156)            -
   Other noncurrent liabilities                                          196           E           (183)           13

Stockholders' equity:
   Preferred Stock, $.10 par value; 25,000,000 shares
      authorized; of Series D Preferred Stock, stated
      value $1,000 per share. 4,910.844 shares
      authorized, issued and outstanding                                   -          A,B             1             1
   Common stock, $.10 par value; 50,000,000 shares
      authorized; 12,505,337 and 14,655,337 shares issued and
      outstanding at September 30, 1999 and pro forma
      September 30, 1999, respectively                                 1,250           C             70         1,465
                                                                                       D             40
                                                                                       E            105
</TABLE>
<PAGE>


                             INTERACTIVE MAGIC, INC.
      Unaudited Condensed Consolidated Pro Forma Balance Sheet (continued)
                        (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                                                  PRO FORMA
                                                       SEPTEMBER 30            PRO FORMA        SEPTEMBER 30
                                                           1999               ADJUSTMENTS           1999
                                                     -----------------------------------------------------------
<S>                                                        <C>                         <C>          <C>
   Additional paid-in capital                              40,239           A          2,915        46,385
                                                                            B          1,100
                                                                            C            630
                                                                            D            360
                                                                            E          1,141
   Accumulated deficit                                    (39,861)          E           (263)      (40,124)
   Accumulated other comprehensive loss                      (135)                                    (135)
                                                     ------------------------------------------------------------
Total stockholders' equity                                  1,493                      6,099         7,592
                                                     ===========================================================
Total liabilities and stockholders' equity             $    7,398                $     2,005    $    9,403
                                                     ===========================================================

</TABLE>

<PAGE>
                             Interactive Magic, Inc.

            Unaudited Pro Forma Consolidated Statements of Operations
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
                                                                                                           PRO FORMA
                                                     NINE MONTHS ENDED                                 NINE MONTHS ENDED
                                                    SEPTEMBER 30, 1999                                 SEPTEMBER 30, 1999
                                                                                                     ---------------------
                                                                                  PRO FORMA
                                                                                 ADJUSTMENTS
                                                  ------------------------------------------------------------------------
NET REVENUES:
<S>                                                   <C>                                                <C>
   CD-ROM PRODUCT SALES                               $       934                                        $       934
   ONLINE SALES                                             1,429                                              1,429
   ROYALTIES AND LICENSES                                      19                                                 19
   ADVERTISING AND OTHER                                    1,265                                              1,265
                                                  ------------------------------------------------------------------------
TOTAL NET REVENUES                                          3,647                                              3,647

COST OF REVENUES:
   COST OF PRODUCTS AND SERVICES                            2,620                                              2,620
   ROYALTIES AND AMORTIZED SOFTWARE COSTS                     279                                                279
                                                  ------------------------------------------------------------------------
TOTAL COST OF REVENUES                                      2,899                                              2,899
                                                  ------------------------------------------------------------------------
GROSS  PROFIT                                                 748                                                748

OPERATING EXPENSES:
   SALES AND MARKETING                                      4,003                                              4,003
   PRODUCT DEVELOPMENT                                      4,193                                              4,193
   GENERAL AND ADMINISTRATIVE                               2,643                                              2,643
   GOODWILL                                                   932                                                932
                                                  ------------------------------------------------------------------------
TOTAL OPERATING EXPENSES                                   11,771                                             11,771
                                                  ------------------------------------------------------------------------
OPERATING LOSS                                            (11,023)                                           (11,023)

OTHER (INCOME) EXPENSE:
   NET INTEREST EXPENSE/(INCOME) - THIRD PARTIES            3,771             A               (3,679)             14
                                                                              E                  (78)
   INTEREST EXPENSE - RELATED PARTIES                          59             E                  (59)              -
   OTHER                                                     (906)                                              (906)
                                                  ------------------------------------------------------------------------
TOTAL OTHER (INCOME) EXPENSE                                2,924                             (3,816)           (892)
                                                  ------------------------------------------------------------------------
LOSS BEFORE INCOME TAXES                                  (13,947)                            (3,816)        (10,131)
INCOME TAX EXPENSE                                             52                                                 52
                                                  ------------------------           -------------------------------------
NET LOSS                                                $  (13,999)                           (3,816)      $  (10,183)
BASIC LOSS PER SHARE:
 NET LOSS PER SHARE                                     $    (1.31)                                        $    (0.80)
                                                  ========================================================================
WEIGHTED AVERAGE SHARES USED IN COMPUTING BASIC
    LOSS PER SHARE                                      10,674,069                                         12,774,069
                                                  ========================================================================
</TABLE>
<PAGE>

                             Interactive Magic, Inc.

                 Consolidated Pro Forma Statements of Operations
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>

                                                                                  PRO FORMA                UNAUDITED
                                                                                                           PRO FORMA
                                                     YEAR ENDED DECEMBER                              YEAR ENDED DECEMBER
                                                          31, 1998                                          31, 1998
                                                    ----------------------
                                                                                 ADJUSTMENTS
                                                    ----------------------
                                                                                 ITEM
                                                    --------------------------------------------------
NET REVENUES:
<S>                                                     <C>                                              <C>
   CD-ROM PRODUCT SALES                                 $     9,177                                      $     9,177
   ONLINE SALES                                               1,773                                            1,773
   ROYALTIES AND LICENSES                                     1,616                                            1,616
                                                    ----------------------
                                                                                     ---------------------------------------
TOTAL NET REVENUES                                           12,566                                           12,566

COST OF REVENUES:
   COST OF PRODUCTS AND SERVICES                              3,157                                            3,157
   ROYALTIES AND AMORTIZED SOFTWARE COSTS                     2,942                                            2,942
                                                    ----------------------           ---------------------------------------
TOTAL COST OF REVENUES                                        6,099                                            6,099
                                                    ----------------------           ---------------------------------------
GROSS  PROFIT                                                 6,467                                            6,467

OPERATING EXPENSES:
   SALES AND MARKETING                                        8,490                                            8,490
   PRODUCT DEVELOPMENT                                        5,983                                            5,983
   GENERAL AND ADMINISTRATIVE                                 2,684                                            2,684
                                                                                     ---------------------------------------
                                                    ----------------------
TOTAL OPERATING EXPENSES                                     17,157                                           17,157
                                                    ----------------------           ---------------------------------------
OPERATING LOSS                                              (10,690)                                         (10,690)

OTHER (INCOME) EXPENSE:
   NET INTEREST EXPENSE/(INCOME) - THIRD PARTIES                554           E                 (158)            396
   INTEREST EXPENSE - RELATED PARTIES                           134           E                 (107)             27
   OTHER                                                       (161)                                            (161)
                                                    ----------------------           ---------------------------------------
TOTAL OTHER (INCOME) EXPENSE                                    527                             (265)            262
                                                    ----------------------           ---------------------------------------
LOSS BEFORE INCOME TAXES AND EXTRAORDINARY ITEM             (11,217)                            (265)        (11,952)
INCOME TAX EXPENSE                                               28                                               28
                                                    ----------------------           ---------------------------------------
LOSS BEFORE EXTRAORDINARY ITEM                          $   (11,245)                            (265)    $   (10,980)

BASIC LOSS PER SHARE:
 LOSS BEFORE EXTRAORDINARY ITEM                         $    (1.73)                                      $    (1.27)
                                                    ======================           =======================================
WEIGHTED AVERAGE SHARES USED IN COMPUTING BASIC
    LOSS PER SHARE                                        6,515,213                                        8,615,213
                                                    ======================           =======================================
</TABLE>
<PAGE>



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


RESULTS OF OPERATIONS

OVERVIEW

On June 30,1999 the Company received $2,500,000 from Ubi Soft Entertainment
S.A.for the sale of the rights the Company had for the development of certain
CD-ROM games. The Company retained the online rights for these games. The sale
of the development rights marked the Company's exit from the CD-ROM business.
The three month and nine month financial statement comparisons are therefore
heavily impacted by the disposition of the CD-ROM business.

NET REVENUES

Net revenues decreased by 43% to $ 1.5 million for the three months ended
September 30, 1999 from $2.7 million for the three months ended September 30,
1998. Net revenue decreased from $11.4 million in the first nine months of 1998
to $3.6 million in the first nine months of 1999.

The following table summarizes the changes in revenue from 1998 to 1999:
<TABLE>
<CAPTION>
-------------------------------------------- ------------------------------------ ------------------------------
-------------------------------------------- ------------------------------------ ------------------------------
                                               Three Months ended September 30    Nine months ended September 30
                                                           ($000)                                ($000)
-------------------------------------------- ------------------------------------ ------------------------------
<S>                       <C>                              <C>                                   <C>
Revenue for the period in 1998                             $2,669                                $11,404
-------------------------------------------- ------------------------------------ ------------------------------
Increase/ (Decrease) in CD-ROM revenue                     (1,530)                               (7,521)
-------------------------------------------- ------------------------------------ ------------------------------
Increase/ (Decrease) in Online Revenue                       (9)                                   172
-------------------------------------------- ------------------------------------ ------------------------------
Increase/(Decrease) in Royalty & Licensing                  (281)                                (1,673)
-------------------------------------------- ------------------------------------ ------------------------------
Increase in Advertising & Other                              659                                  1,265
-------------------------------------------- ------------------------------------ ------------------------------
Revenue for the period in 1999                             $1,508                                $3,647
-------------------------------------------- ------------------------------------ ------------------------------
</TABLE>


COST OF REVENUES.

 Cost of revenues consist of costs of products sold (including cost of Internet
access) and royalties and amortization of software development costs. Cost of
revenues in the third quarter of 1999 decreased to $ 0.2 million from $1.7
million in the same period of 1998. The decrease was due to the Company's exit
from the CD-ROM business. For the nine month period, cost of revenue in 1999 is
$1.7 million below the comparable period for 1998. The decrease reflects the
considerably lower level of CD-ROM shipments, offset partially by the expenses
in the second quarter for the establishment of reserves and inventory
write-downs associated with the exit from the CD-ROM business.



<PAGE>



OPERATING EXPENSES

Operating expenses decreased $1.4 million or 33% from the third quarter of 1998
to the same period in 1999. On a year-to-date basis, operating expenses were
$0.9 million higher in 1999 than they were in 1998. Included in the 1999 results
was $376,000 and $932,000 for the three and nine month periods, respectively,
due to amortization of goodwill associated with the MPG-Net acquisition. The
following is a summary of major variances:
<TABLE>
<CAPTION>
------------------------------------------------ ------------------------------------- -------------------------------
------------------------------------------------ ------------------------------------- -------------------------------
                                                   Three Months ended September 30     Nine months ended September 30
                                                                ($000)                                ($000)
------------------------------------------------ ------------------------------------- -------------------------------
<S>                                  <C>                        <C>                                   <C>
Operating Expenses for the period in 1998                       $4,179                                $10,874
------------------------------------------------ ------------------------------------- -------------------------------
Increase/ (Decrease) Sales and Marketing                       (1,534)                                (2,158)
------------------------------------------------ ------------------------------------- -------------------------------
Increase/ (Decrease) Product Development                        (273)                                   959
------------------------------------------------ ------------------------------------- -------------------------------
Increase/ (Decrease) General and Administrative                   61                                   1,164
------------------------------------------------ ------------------------------------- -------------------------------
Increase/ (Decrease) Goodwill Amortization                       376                                    932
------------------------------------------------ ------------------------------------- -------------------------------
Operating Expenses for the period in 1999                       $2,809                                $11,771
------------------------------------------------ ------------------------------------- -------------------------------
</TABLE>


SALES AND MARKETING. Sales and marketing expenses declined significantly during
the quarter due to the exit from the CD-ROM business, and declined for a similar
reason year-to-date, which was coupled with a significant decrease in market
development funds spending in 1999 compared to 1998.

PRODUCT DEVELOPMENT. Product development expenses decreased in the quarter due
to the exit from the CD-ROM business, but higher year-to-date due to increased
development for on-line games, as well as the write-off of unamortized
development costs associated with the exit from the CD-ROM business.

GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
slightly for the three month period, and were higher on a year-to-date basis due
to the additional expense of being a publicly-held company; relocation expenses
relating to the consolidation of our Florida and Texas operations to North
Carolina; as well as employee severance.

Goodwill Amortization. Goodwill from the MPG-Net acquisition is being amortized
to income over 36 months.

OTHER (INCOME) EXPENSE

For the first nine months of 1999 compared to 1998 there is additional expense
of $2,379,000. The higher expense level is due to the interest expense relating
to the recognition of the beneficial conversion feature of the $ 4,000,000
convertible debenture, and related warrants, which were issued in the first
quarter of 1999; as well as the interest expense on these debentures, which is
partially offset by the gain on the sale of the CD-ROM business in the second
quarter.


INCOME TAX EXPENSE

The Company recorded $53,000 in income tax expense for the first nine months of
1999 compared to $156,000 for the same period in 1998. The entire tax expense in
each period is attributable to earnings in Europe.

<PAGE>


LIQUIDITY AND CAPITAL RESOURCES

The Company's capital requirements have been and will continue to be
significant, and, to date, its cash requirements have exceeded its cash flow
from operations. The Company historically has satisfied cash requirements
through borrowings, the private sale of equity securities, and its initial
public offering.

The following is a condensed table of cash on hand and major cash flow items
from December 31, 1998 to September 30, 1999:
<TABLE>
<CAPTION>
              ----------------------------------------------------------------- ------------------
                                                                                      $ Million
              ----------------------------------------------------------------- ------------------

              ----------------------------------------------------------------- ------------------
<S>                                  <C> <C>                                            <C>
              Cash on hand, December 31, 1998                                           $2.9
              ----------------------------------------------------------------- ------------------

              ----------------------------------------------------------------- ------------------
              Net loss for the first nine months                                       (14.0)
              ----------------------------------------------------------------- ------------------
              Add: non-cash charges and expenses                                         5.0
              ----------------------------------------------------------------- ------------------
              Less: non-cash gain on sale of CD-ROM                                     (.9)
              ----------------------------------------------------------------- ------------------
              Changes in working capital                                                 3.0
              ----------------------------------------------------------------- ------------------
                     Net Cash Used in Operations                                        (6.9)
              ----------------------------------------------------------------- ------------------
              Net proceeds from sale of CD-ROM                                           2.3
              ----------------------------------------------------------------- ------------------
              Net proceeds from issuing convertible debentures                           3.7
              ----------------------------------------------------------------- ------------------
              Other investing and financing activities                                  (.4)
              ----------------------------------------------------------------- ------------------

              ----------------------------------------------------------------- ------------------
              Net change in cash for the nine months ended September 30, 1999           (1.3)
              ----------------------------------------------------------------- ------------------

              ----------------------------------------------------------------- ------------------
              Cash on hand, September 30, 1999                                          $1.6
              ----------------------------------------------------------------- ------------------
</TABLE>

The Company maintains lines of credit arrangements with a bank for $1.0 million.
The principal balance is payable on July 10, 2000 with interest payable monthly
at interest rates ranging from 6.45% to the bank's current prime rate plus 0.5%
(8.75% as of September 30, 1999). The balance outstanding under this line as of
September 30, 1999 was $ 1.0 million. Advances on the line of credit are
collateralized by a personal guarantee of the Company's largest shareholder
prior to November 1999.

The Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing or refinancing as may be required, and ultimately to
attain profitability. Management expects the disposition of its CD-ROM
operations will reduce its operating losses and expects to be able to attract
additional capital, if needed, for its online operations. However, there can be
no assurance that management's plans will be executed as anticipated.

Subsequent to the close of the September 30, 1999 quarter, the Company has
completed the following transactions in an effort to improve its financial
position:

         A)   On November 11, 1999, RGC International Investors, LDC (Rose Glen)
              converted the remainder of its unconverted debenture, which as of
              September 30, 1999 had an outstanding principal balance of
              $3,310,844 and a recorded value of $2,156,000 into 3,310.844
              shares of the Company's newly created Series D Preferred Stock
              with a stated value of $1,000 per share. In addition, Rose Glen
              converted $500,000 of all other accrued amounts under the
              debenture into 500 shares of Series D Preferred Stock, and agreed
              to waive all other accrued amounts which totaled $260,000. The
              difference between the recorded value of the debt and the
              outstanding principal balance along with the $260,000 waived
              interest accrual were netted and charged to additional paid-in
              capital. Interest expense related to these debentures was
              $3,679,000 for the nine months ended September 30, 1999.

         B)   On November 11, 1999 Rose Glen purchased 1,100 shares of Series D
              Preferred Stock for $1,100,000.

         C)   On November 11, 1999 Vertical Financial Holdings purchased 700,000
              shares of common stock for $700,000.

         D)   On November 11, 1999 - Value Management & Research AG purchased
              400,000 shares of common stock for $400,000.
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES  (CONTINUED)


F)       E)   On November 9, 1999, J.W.  Stealey,  former CEO of the  Company,
              released the Company from the line of credit indebtedness to BB&T
              in the amount of $1,000,000 in exchange for 1,000,000 shares of
              common stock. The Company also paid $15,000 due on this line.
              Interest expense on this line of credit was $78,000 and $158,000
              for the nine months ended September 30, 1999 and the year ended
              December 31, 1998 respectively. In addition, as part of these
              transactions, Mr. Stealey's resignation agreement dated August 16,
              1999 has been amended such that his consulting services are no
              longer being used and the sole remaining consideration due him has
              been reduced to one lump sum payment of $200,000 (less the value
              of 12 months health insurance payments and car lease payments
              totaling approximately $20,000) and 50,000 shares of the Company's
              common stock valued at $62,500. This payment was made November 12,
              1999. The Company has agreed to convey to Mr. Stealey all
              trademarks and available rights to the name Interactive Magic,
              pending shareholder approval of the Company name change to
              iEntertainment Network. Mr. Stealey agreed to waive the interest
              due him from the Company in the amount of $183,000 under the terms
              of the line of credit with BB&T that he had personally guaranteed;
              in consideration of which the Company incurred additional interest
              expense of $59,000 for the nine months ended September 30, 1999
              and $107,000 for the year ended December 31, 1998. The amount of
              waived interest has been reflected as a credit to additional
              paid-in capital.


We do not have any current arrangements or commitments for any future financing
beyond those referenced above. We may not be able to obtain sufficient
additional financing to satisfy cash requirements. We may be required to obtain
financing on terms that are not favorable to us and our shareholders. If we are
unable to obtain additional financing when needed, we may be required to delay
or scale back product development and marketing programs in order to meet our
short-term cash requirements, which could have a material adverse effect on our
business, financial condition and results of operations.


YEAR 2000 ISSUE

The Company's products are of a nature that they are not date dependent or
subject to failure because of Year 2000 issues. The Company however, has
assigned full-time information technology professionals to the task of
identifying and resolving Year 2000 problems that may affect the Company's
business, and has adopted a Year 2000 compliance plan. Under the Company's Year
2000 compliance plan, the Company has and will continue to inventory and collect
documentation on all of its computers, computer related equipment, and equipment
with embedded processors. In addition, the Company has been and plans to
continue contacting critical vendors and suppliers to obtain assurances of their
ability to ensure smooth delivery of products and services after December 1999.
Additionally, the Company plans to prioritize and implement any necessary
repairs or replacements to equipment in order to achieve Year 2000 compliance,
which it expects to complete by the end of 1999. The Company will also implement
a testing program, scheduled for completion by the end of 1999. The Company has
not prepared estimates of costs for correction of Year 2000 problems. Based on
information available at this time, including the Year 2000 compliance status of
equipment that has been examined as well as the anticipated replacement schedule
for equipment, the Company does not believe that the cost of remedial actions
will have a material adverse effect on the Company's results of operations or
financial condition. There can be no assurance, however, that there will not be
a delay in, or increased costs associated with, the implementation of
corrections as the Year 2000 compliance plan is performed. Failure to implement
such changes could have an adverse effect on future results of operations. In
addition, unexpected costs of correcting equipment that has not yet been fully
evaluated could have an adverse effect on future results of operations.


EURO CONVERSION

On January 1, 1999, the European Community began denominating significant
financial transactions in a new monetary unit, the Euro. The Euro is intended to
replace the traditional currencies of the individual EU member countries. The
Company's operations in Europe are continuing to operate in the traditional
currencies and are not converting internal financial systems to the Euro as a
functional currency. The Company is evaluating when to convert its local
currency in Europe to the Euro with as little disruption to customer and vendors
as possible. The Company does not intend to make such a conversion in 1999.
<PAGE>


PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

None.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

(a)      Not applicable.

(b)      Not applicable.

(c)      From July 1, 1999 through September 30, 1999 the Company issued
         warrants to purchase 100,000 shares to members of the Board of
         Directors in recompense for services;(2) granted options to purchase
         206,000 shares to 16 employees; (3) issued 107,143 shares of Common
         Stock to Virtual Business Designs, Inc. d/b/a/ the Gamers Net ("Gamers
         Net") in connection with the Company's acquisition of the assets of the
         Gamers Net.

(d)      Not applicable.



ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         None.

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

         None.



ITEM 5. OTHER INFORMATION

Subsequent to the close of the September 30, 1999 quarter, the Company has
completed the following transactions in an effort to improve its financial
position:

         A)   On November 11, 1999, RGC International Investors, LDC (Rose Glen)
              converted the remainder of its unconverted debenture, which as of
              September 30, 1999 had an outstanding principal balance of
              $3,310,844 and a recorded value of $2,156,000 into 3,310.844
              shares of the Company's newly created Series D Preferred Stock
              with a stated value of $1,000 per share. In addition, Rose Glen
              converted $500,000 of all other accrued amounts under the
              debenture into 500 shares of Series D Preferred Stock, and agreed
              to waive all other accrued amounts which totaled $260,000. The
              difference between the recorded value of the debt and the
              outstanding principal balance along with the $260,000 waived
              interest accrual were netted and charged to additional paid-in
              capital. Interest expense related to these debentures was
              $3,679,000 for the nine months ended September 30, 1999.

         B)   On November 11, 1999 Rose Glen purchased 1,100 shares of Series D
              Preferred Stock for $1,100,000.

         C)   On November 11, 1999 Vertical Financial Holdings purchased 700,000
              shares of common stock for $700,000.

         D)   On November 11, 1999 - Value Management & Research AG purchased
              400,000 shares of common stock for $400,000.

<PAGE>

         ITEM 5. OTHER INFORMATION  (CONTINUED)

E)       E)   On November 9, 1999, J.W. Stealey, former CEO of the Company,
              released the Company from the line of credit indebtedness to BB&T
              in the amount of $1,000,000 in exchange for 1,000,000 shares of
              common stock. The Company also paid $15,000 due on this line.
              Interest expense on this line of credit was $78,000 and $158,000
              for the nine months ended September 30, 1999 and the year ended
              December 31, 1998 respectively. In addition, as part of these
              transactions, Mr. Stealey's resignation agreement dated August 16,
              1999 has been amended such that his consulting services are no
              longer being used and the sole remaining consideration due him has
              been reduced to one lump sum payment of $200,000 (less the value
              of 12 months health insurance payments and car lease payments
              totaling approximately $20,000) and 50,000 shares of the Company's
              common stock valued at $62,500. This payment was made November 12,
              1999. The Company has agreed to convey to Mr. Stealey all
              trademarks and available rights to the name Interactive Magic,
              pending shareholder approval of the Company name change to
              iEntertainment Network. Mr. Stealey agreed to waive the interest
              due him from the Company in the amount of $183,000 under the terms
              of the line of credit with BB&T that he had personally guaranteed;
              in consideration of which the Company incurred additional interest
              expense of $59,000 for the nine months ended September 30, 1999
              and $107,000 for the year ended December 31, 1998. The amount of
              waived interest has been reflected as a credit to additional
              paid-in capital.

On August 27, 1999 the Company purchased all right, title and interest in and to
all of the tangible and intangible assets of Virtual Business Designs, Inc.,
doing business as The Gamers Net, for 107,143 shares of common stock. In
addition, the Company agreed to pay David Heath, former owner of The Gamers Net,
a consulting fee for services rendered in the amount of $276,000 in eight equal
amounts on the first day of the month of each quarter commencing September 1,
1999 assuming the required services are provided. The first of eight quarterly
payments was made in cash in the amount of $34,500.00, with the balance to be
paid in Company common stock with the number of shares to be determined by the
quotient of $34,500.00 divided by the price per share as reported in the Wall
Street Journal one (1) trading day prior to the first day of each quarter.


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(A)      EXHIBITS

         3.02     Articles of Amendment establishing the Series D Preferred
                  Stock of Interactive Magic, Inc., filed with the North
                  Carolina Secretary of State on November 10, 1999.
         10.37    Securities Purchase and Exchange Agreement dated November 8,
                  1999 between Interactive Magic, Inc. and RGC International
                  Investors, LDC
         10.38    Registration Rights Agreement dated November 11, 1999 by and
                  among Interactive Magic, Inc., Vertical Financial Holdings,
                  J.W. Stealey and Value Management & Research AG.
         10.39    Asset Purchase Agreement dated August 27, 1999 by and among
                  Interactive Magic, Inc., Virtual Business Designs, Inc., d/b/a
                  The Gamers Net, and David Heath.
         27.01    Financial Data Schedule


       (B)   REPORTS ON FORM 8-K

Since the filing of the Company's 1999 Second Quarter Form 10-QSB, the Company
filed current reports on Form 8-K in conjunction with the following events:

o    Resignation and the terms thereof of John W. (Bill) Stealey as CEO, and
     election of Jacob Agam as Chairman of the Board, filed August 25, 1999
o    Pro Forma financial information in regard to the sale of the Company's
     CD-Rom business to Ubi Soft Entertainment S.A. for $2,500,000 in cash,
     filed September 7, 1999 ( as amended).
o    Notice that the Company's common stock will trade on the NASDAQ SmallCap
     market pending satisfaction of NASDAQ requirements, filed October 15, 1999
o    Termination of negotiations to acquire three entertainment-hobby product
     distributors: Berkeley Topline, Inc., Zocchi Distributing, Inc., and
     Alliance Games Distribution, Inc., filed October 26, 1999

<PAGE>


                                   SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

                                              INTERACTIVE MAGIC, INC.

                             By: /s/ Michael C. Pearce
                                ----------------------
                             Michael C. Pearce
                             Chief Executive Officer

                             By: /s/ Robert L. Hart
                                ----------------------
                             Robert L. Hart
                             Chief Financial Officer