<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C.  20549

                               FORM 10-Q/A No. 2

(Mark One)

( ) QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED __________

                                       OR

(X) TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES
    EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM March 1, 1997 to   
    June 30, 1997

Commission file number    0-22622

                       INTERACTIVE ENTERTAINMENT LIMITED
             (Exact name of registrant as specified in its charter)


            BERMUDA                             98-0170199
(State or other Jurisdiction of              (I.R.S. Employer
Incorporation or Organization)            Identification Number)


                        845 CROSSOVER LANE, SUITE D-215
                               MEMPHIS, TN 38117
                    (Address of principal executive offices)

                                 (901) 537-3800
              (Registrant's telephone number, including area code)

     Indicate by check mark whether the registrant:

     (1) has filed all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1932 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and

                           Yes   X         No 
                               -----          ----- 

     (2) has been subject to such filing requirements for the past 90 days.

                            Yes            No   X  
                                -----         -----

The registrant had 18,436,590 shares of common stock outstanding as of August
15, 1997.

Exhibit index is located on page 17

                                     Page 1
<PAGE>
 
                       INTERACTIVE ENTERTAINMENT LIMITED

                                     INDEX
<TABLE>
<CAPTION>


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

         Consolidated Balance Sheets - June 30, 1997 and February 28, 1997          3

         Consolidated Statements of Operations - Three Months and Four Months       4
         ended June 30, 1997 and June 30, 1996

         Consolidated Statements of Cash Flows - Four Months ended June 30, 1997    5
         and June 30, 1996

         Notes to Consolidated Financial Statements                                 6

Item 2.  Management's Discussion and Analysis of Financial Condition               14
         and Results of Operations


PART II. OTHER INFORMATION

Item 4.  Submission of Matters To a Vote of Security Holders                       17

Item 6.  Exhibits and Reports on Form 8-K                                          17
</TABLE>

                                     Page 2
<PAGE>
 

Item 1.  Consolidated Financial Statements

              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                ASSETS
                                ------                           June 30,                February 28,
                                                                   1997                      1997
                                                               ------------              ------------
<S>                                                            <C>                       <C> 
CURRENT ASSETS                                                 
    Cash and cash equivalents                                  $    317,420              $    626,074
    Accounts receivable                                              75,171                   119,768
    Prepaid expenses                                                201,190                    61,975
                                                               ------------              ------------
            Total current assets                                    593,781                   807,817
                                                               ------------              ------------
PROPERTY AND EQUIPMENT, at cost                                
    Land                                                            800,000                   800,000
    Furniture, fixtures and equipment                               674,327                   643,492
                                                               ------------              ------------
                                                                  1,474,327                 1,443,492
    Less: accumulated depreciation                                 (323,723)                 (294,189)
                                                               ------------              ------------
      Property and equipment, net                                 1,150,604                 1,149,303
                                                               
SOFTWARE UNDER DEVELOPMENT                                        2,251,105                 1,357,869

SINGAPORE AIRLINES AGREEMENT                                      1,855,800                         -
                                                               
OTHER ASSETS                                                        427,440                   209,587
                                                               
EXCESS OF PURCHASE PRICE OVER NET ASSETS ACQUIRED                25,204,156                         -
                                                               ------------              ------------
            Total assets                                       $ 31,482,886              $  3,524,576
                                                               ============              ============
            LIABILITIES AND SHAREHOLDERS' EQUITY               
            ------------------------------------               
                                                               
CURRENT LIABILITIES                                            
    Accounts payable and accrued expenses                      $    931,126              $    979,948
                                                               ------------              ------------
            Total current liabilities                               931,126                   979,948
                                                               
CONVERTIBLE DEBENTURES                                              654,834                 2,600,000
                                                               
MINORITY INTEREST                                                         -                   277,249
                                                               
SHAREHOLDERS' EQUITY                                           
    Common shares, authorized - 50,000,000 shares;             
      outstanding - 18,086,725 par value US$.01                
      and 9,789,020 par value C$.01                                 180,867                   106,752
    Class A preferred shares, $.01 par value, authorized -     
      3,000 shares; outstanding - 2,737 shares                           27
    Additional paid-in-capital                                   56,315,356                16,027,379
    Accumulated deficit                                         (26,599,324)              (16,466,752)
                                                               ------------              ------------
                                                                 29,896,926                  (332,621)
                                                               ------------              ------------
            Total liabilities and shareholders' equity         $ 31,482,886              $  3,524,576
                                                               ============              ============
</TABLE>

The accompanying notes are an integral part of these consolidated balance
sheets.

                                    Page 3
<PAGE>
 

              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                          Three Months Ended            Four Months Ended
                                      --------------------------     ------------------------  
                                       June 30,        June 30,        June 30,      June 30,
                                         1997            1996            1997          1996
                                      -----------     ----------     -----------    ---------  
<S>                                   <C>             <C>            <C>            <C>
OPERATING EXPENSES
    General and administrative        $ 1,020,025     $  203,037     $ 1,094,864    $ 279,779
    Consulting and contract labor       2,694,740        153,069       2,754,168      217,034
    Marketing                              88,585        101,891         104,992      126,118
    Management fees                        55,667         48,000          73,167       63,250
    Legal                                 299,722         43,084         345,118       60,427
    Interest expense                    3,688,904         74,786       3,689,015       99,764
    Depreciation and amortization         329,099         20,975         336,614       25,086
    Interest income                        (5,820)       (15,945)         (7,868)     (22,289)
                                      -----------     ----------     -----------    ---------  

LOSS BEFORE MINORITY INTEREST
    AND EXTRAORDINARY ITEMS             8,170,922        628,897       8,390,070      849,169
    Minority Interest                    (163,842)       (77,355)       (163,842)    (106,057)
                                      -----------     ----------     -----------    ---------  
LOSS BEFORE EXTRAORDINARY ITEM          8,007,080        551,542       8,226,228      743,112
EXTRAORDINARY ITEM                      1,824,222              -       1,824,222            -
                                      -----------     ----------     -----------    ---------  
NET LOSS                              $ 9,831,302     $  551,542     $10,050,450    $ 743,112
                                      ===========     ==========     ===========    =========
LOSS PER SHARE                   
    Before extraordinary item         $      0.73     $     0.06     $      0.77    $    0.09
    Extraordinary item                       0.16              -            0.17            -
                                      ===========     ==========     ===========    =========
NET LOSS                              $      0.89     $     0.06     $      0.94    $    0.09
AVERAGE COMMON SHARES
    OUTSTANDING                        11,061,656      8,701,573      10,743,497    8,651,538
                                      ===========     ==========     ===========    =========
</TABLE> 

                  The accompanying notes are an integral part
                       of these consolidated statements.

                                    Page 4
<PAGE>
 

              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                                             Four Months Ended
                                                     June 30, 1997        June 30, 1996
                                                   -----------------     ----------------
<S>                                                <C>                   <C>
CASH FLOWS USED IN OPERATING ACTIVITIES           
     Net cash used in operating activities                $ (594,397)         $(1,020,919)
                                                   -----------------     ----------------
                                                   
CASH FLOWS USED IN INVESTING ACTIVITIES            
  Additions to property and equipment                        (30,835)                   -
  Proceeds from disposition of property and 
    equipment                                                      -              350,705
  Software development cost                                 (446,672)            (452,936)
                                                   -----------------     ----------------
     Net cash used in investing activities                  (477,507)            (102,231)
                                                   -----------------     ----------------
                                                   
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES        
  Proceeds from convertible debenture issuance               763,250                    -
  Proceeds from stock issuance                                     -            2,692,927
  Payments of notes payable                                        -             (326,575)
                                                   -----------------     ----------------
     Net cash provided by financing activities               763,250            2,366,352
                                                   -----------------     ----------------
                                                   
NET (DECREASE) INCREASE IN CASH AND                
  CASH EQUIVALENTS                                          (308,654)           1,243,202
                                                   
CASH AND CASH EQUIVALENTS,                         
  beginning of period                                        626,074              725,564
                                                   -----------------     ----------------
                                                   
CASH AND CASH EQUIVALENTS,                         
  end of period                                           $  317,420          $ 1,968,766
                                                   =================     ================
</TABLE> 
 
                  The accompanying notes are an integral part
                       of these consolidated statements.

                                    Page 5
<PAGE>
 
              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   ORGANIZATION AND BASIS OF PRESENTATION

The consolidated financial statements of Interactive Entertainment Limited and
Subsidiaries (the "Company") included herein have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC"). In
management's opinion, these financial statements include all adjustments,
consisting only of normal recurring adjustments necessary for a fair
presentation of the results of operations for the interim periods presented.
Pursuant to SEC rules and regulations, certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
from these statements unless significant changes have taken place since the end
of the most recent fiscal year. For this reason, the consolidated financial
statements and notes thereto should be read in conjunction with the financial
statements and notes included in the Company's Form 20-F for the year ended
February 28, 1997.

The Company is a Bermuda exempted company which, in June 1997, changed its name
from Sky Games International, Ltd. ("SGI") to Interactive Entertainment Limited.
The Company's principal business objective is to develop, implement and manage
computerized, remote gaming software for use by passengers on international
airline flights.

The Company has entered into a contract to provide its gaming software to one
international airline, Singapore Airlines. Singapore Airlines has selected the
Matsushita Avionics Systems Corporation ("MASC") hardware platform and operating
system for its interactive entertainment system. The Company has been attempting
to integrate its software with the MASC network and operating system, and other
third party provided software with which the Company's software is also required
to be integrated pursuant to its agreements with Singapore Airlines, for over a
year with limited success. Although the Company believes the software will
ultimately be successfully integrated, there is no assurance of such success,
or, if it does occur, when it will occur. Management continues to believe the
success of its software on Singapore Airlines will be critical to its ability to
secure additional airline contracts. The Company has yet to receive any revenues
under its agreement with Singapore Airlines and may never receive any such
anticipated revenues if its software cannot be successfully integrated with the
network and operating system utilized by Singapore Airlines.

Until the Company receives sufficient cash flow from operations, additional
funding will be required to allow the Company to continue operations. Based on
discussions with potential investors, management believes the Company will be
successful in obtaining sufficient financing to enable the Company to continue
its operations for the foreseeable future.

Prior to June 17, 1997, the Company operated its principal business activities
through its indirectly 80%-owned subsidiary, Interactive Entertainment Limited
("Old IEL"). The remaining 20% of Old IEL was held by an affiliate of Harrah's
Entertainment, Inc. (which, together with its affiliates, is referred to herein
as "Harrah's"). Harrah's also managed the operations of Old IEL pursuant to a
management agreement effective December 30, 1994, (the "Management Agreement").

Effective June 17, 1997, pursuant to a Plan and Agreement of Merger and
Amalgamation dated May 13, 1997, Old IEL was merged into the Company (the
"Merger"). As part of the Merger, the Management Agreement with Harrah's was
terminated. Harrah's received a total of 5,879,040 shares of the Company's $.01
par value common stock (the "Common Stock") in exchange for its 20%


                                    Page 6

<PAGE>
 
ownership interest in Old IEL and as consideration for the termination of the
Management Agreement. 

The Merger has been accounted for under the purchase method. The shares issued
to Harrah's were valued at $26,255,793 based on the average quoted market price
of the Company's Common Stock when the Merger was announced, or $4.466 per
share. The total value of the shares issued was allocated among the assets
acquired, including the Company's agreement with Singapore Airlines and the
Company's software under development. This transaction represents a non-cash
transaction for purposes of the Consolidated Statements of Cash Flows.

Prior to the Merger, Harrah's had agreed, pursuant to a funding agreement, to
loan up to $1,000,000 (the "Harrah's Loan") to Old IEL.  Upon closing of the
Merger, the outstanding principal and accrued interest of the Harrah's Loan
converted automatically into 1,007,875 shares of Common Stock at $1.00 per
share.  Since the Harrah's Loan was convertible into Common Stock at less than
the current market, a beneficial conversion feature was included in the Harrah's
Loan.  This beneficial conversion feature was valued at $3,466,000 and has been
included in interest expense for the four months ended June 30, 1997.  In
addition, pursuant to the funding agreement, for 90 days following June 17,
1997, the Company had the right, under certain circumstances, to request
Harrah's to purchase up to 650,000 shares of Common Stock at a price of $1.00
per share to provide working capital for the Company.  However, the Company has
notified Harrah's that it will not exercise its rights with respect to the
650,000 shares.

On April 23, 1997, the Board of Directors of the Company approved and adopted a
resolution changing the fiscal year end of the Company to December 31 of each
year from the last day of February of each year.  Therefore, the Consolidated
Financial Statements are presented as transition statements including the four
month period ending June 30, 1997.


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and Cash Equivalents
-------------------------

The Company considers cash on hand, deposits in banks and short-term investments
with maturities of three months or less as cash and cash equivalents.

Software Development
--------------------

All software production costs (i.e., external and internal programmers, graphic
design and testing) are being capitalized until the software is available for
general release to customers, in accordance with the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed."  Once
capitalization ceases, 

              
                                     Page 7
<PAGE>
 
the software costs will be amortized using the straight-line method over the
remaining estimated economic life of the product currently estimated at three to
five years.

Equipment
---------

The Company's equipment is recorded at cost and depreciated over its estimated
economic life which is generally three to five years. Additions and improvements
that materially extend the useful lives are capitalized, while repairs and
maintenance costs are expensed as incurred.

Excess of Purchase Price over Net Assets Acquired
-------------------------------------------------

The excess of purchase price over net assets acquired, which arose from the
acquisition of the minority interest of Old IEL discussed in Note 1, will be
amortized on a straight-line basis over three years, which management estimates
is the related benefit period. Management regularly evaluates whether or not the
future undiscounted cash flows of the Company are sufficient to recover the
carrying amount of this asset. Additionally, management continually monitors
such factors as the status of new or proposed legislation, the competitive
environment and advances in the computer software and hardware industries. If
the estimated future undiscounted cash flows are not sufficient to recover the
carrying amount of this asset and, accordingly, an impairment has occurred,
management intends to write down the carrying amount to its estimated fair value
based on discounted cash flows. The amount of amortization expense recorded for
the period from the date of the acquisition (June 17, 1997) through June 30,
1997, totaled $307,080.

Singapore Airlines Agreement
----------------------------

In conjunction with the acquisition of the minority interest of Old IEL, the
Company allocated approximately $1,856,000 of the purchase price to the value of
the agreement with Singapore Airlines. This amount will be amortized on a
straight-line basis over the term of the agreement. The agreement is for an
initial three year term which begins upon the earlier of (a) nine months from
the date of the first successful commercial installation of the software or (b)
upon installation of the software in eight aircraft. Therefore, the financial
statements do not include an expense for amortization of the amount allocated to
the value of the agreement.

Impairment of Long-Lived Assets
-------------------------------

In accordance with SFAS No. 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of," management continually
evaluates whether events or changes in circumstances indicate that the carrying
amount of long-lived assets may not be recoverable. Based on management's
evaluations, no significant impairments of long-lived assets occurred through
June 30, 1997.

Loss Per Share
--------------

Loss per share was computed by dividing net loss (increased by dividends on
preferred shares) by the average common shares outstanding plus the dilutive
effect of Common Stock equivalents outstanding and convertible securities, using
the treasury stock method based on the average market price of the Company's
Common Stock. Fully diluted loss per share is not materially different from
primary loss per share.

Reclassifications
-----------------

Certain reclassifications have been made to the historical financial statements
as of February 28, 1997, and for the three and four months ended June 30, 1996,
to conform to the presentation of the financial statements as of and for the
three and four months ended June 30, 1997.

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 disclosure of
contingent assets and liabilities at the date of the financial statements 


                                    Page 8
<PAGE>
 
and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

Consolidated Subsidiaries

The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries: Sky Games International Corp. (a Nevada
corporation), Creator Island Equities Inc. (a British Columbia corporation) and
IEL (Singapore) Pte. Ltd. (a Singapore corporation). For comparable periods
ending in 1996, the consolidated financial statements also include the accounts
of SGI Holding Corporation Ltd. and the Company's 80% ownership of Old IEL. All
material intercompany transactions have been eliminated in consolidation.

Pro Forma Information

The table below shows pro forma information as if the purchase of the minority
interest had occurred at the beginning of each period:

<TABLE>
<CAPTION>
 
                            Four Months Ended  Four Months Ended
                              June 30, 1997      June 30, 1996
                            -----------------  -----------------
<S>                         <C>                <C>
 
Pro Forma Loss Before
     Extraordinary Item           $10,918,000         $3,684,000
 
Pro Forma Net Loss                $12,742,000         $3,684,000
 
Pro Forma Loss Per Share          $      0.78         $     0.24
</TABLE>


3.  CONVERTIBLE DEBENTURES

As of June 30, 1997, the Company had issued $763,250 of 8% convertible
debentures due March 31, 1999, $108,416 of which had been converted to 53,280
shares of Common Stock. The outstanding balance of convertible debentures as of
June 30, 1997, totaled $654,834.

One-third of the debentures are convertible at any time 60 days after the
subscription date, one-third are convertible 90 days after the subscription
date; and the balance are convertible 105 days after the subscription date into
Common Stock at the lower of 85% of the average of the closing bid prices of the
Common Stock for the five trading days immediately preceding the execution by
the subscriber of its individual subscription for debentures or 77.5% of the
average of the closing bid prices of the Common Stock for the five trading days
immediately preceding the date of conversion.

The debentures contain a feature that provides for conversion into Common Stock
at a price below the current market at the time of issue. The value of this
beneficial conversion feature, totaling $221,589, has been capitalized in other
assets with a corresponding increase to additional paid-in capital. Placement
fees of $61,060 incurred upon sale of the debentures are also capitalized. The
value of the conversion feature and the placement fees are amortized to interest
expense over the original life of the debenture. Any unamortized amount is
expensed upon conversion of the debenture. At June 30, 1997 the unamortized
deferred interest charge of $217,853 is included in other assets. A total of
$64,796 was expensed during the three month and four month periods ending June
30, 1997.

An additional $1.1 million of convertible debentures due July 31, 1999 were sold
in July, 1997.

                                    Page 9
<PAGE>
 
4.  STOCK OPTION PLANS

On August 27, 1996, the Company established, and the Company's shareholders
approved, the 1996 Stock Program for the then upper management, directors and
major shareholders of the Company. The options issued under the 1996 Stock
Program were exercisable upon the grant date and expire during 2001 through
2006. As of June 30, 1997, options outstanding under the 1996 Stock Program
totaled options for 1,130,000 shares of Common Stock.

The Company adopted on December 6, 1996, a Directors Option Plan covering
500,000 shares of Common Stock pursuant to which all directors holding office at
December 10th of each year will automatically be granted options for 10,000
shares of Common Stock at the trading price on such day. As of June 30, 1997,
options outstanding under the Directors Option Plan totaled 60,000 shares, all
of which were exercisable immediately.

Effective June 16, 1997, the Company established a Management Incentive Plan
(the "MIP") by authorizing the issuance of options for 4,070,105 shares of
Common Stock. The Company's Board of Directors (the "Board") has the authority
to determine the allocation and vesting requirements for such options under the
MIP. It is the Board's intention that vesting of the options to be issued under
the MIP will create performance incentives for management because a percentage
of the options under the MIP will only be exercisable upon the achievement of
significant increases in the trading price of the Common Stock and another
percentage will vest upon satisfaction of continued employment and other
performance goals. As of June 30, 1997, options outstanding under the MIP
totaled 1,200,000 shares, all of which will vest specifically on sustaining
certain stock price levels. No compensation expense was recognized for the MIP
during the quarter ended June 30, 1997.

5.  STOCK WARRANTS

As of June 30, 1997, the Company had outstanding stock warrants for 408,528
shares of its Common Stock at an exercise price of $3.00 per share. Warrants for
308,528 shares expired on July 31, 1997. The balance of the warrants, totaling
100,000 shares, have an expiration date of December 31, 1997.

6.  PREFERENCE SHARES OF STOCK

In December 1994, the Company discontinued an engineering and marketing
arrangement with B/E Aerospace, Inc. ("BEA"). As part of the termination, the
Company issued to BEA a promissory note in the original principal amount of $2.5
million bearing interest at 12% per annum. On February 28, 1997, an agreement
was reached with BEA to exchange the note, including accrued and unpaid
interest, for Class A Preference Shares at $1,000 per share. The exchange for
2,737 Class A Preference Shares was completed in June, 1997.

The Class A Preference Shares are convertible at any time into a number of
shares of Common Stock, determined by dividing $1,000 per share of Class A
Preference Shares, plus any accrued and unpaid dividends thereon by: (i) prior
to February 28, 1999, a conversion price equal to 70% of the average mean of the
closing bid and ask prices of the Common Stock for the 20 trading days prior to
the conversion (the "Market Price"); (ii) after February 28, 1999 and prior to
August 31, 1999, a conversion price equal to 65% of the Market Price; and (iii)
after August 31, 1999, a conversion price equal to 60% of the Market Price.
Dividends on the Class A Preference Shares are cumulative and payable quarterly
at an annual dividend rate of 9%. The Company, at its option, may redeem the
Class A Preference Shares, in whole or in part, at any time and from time to
time, at a redemption price of $1,000 per share plus any accrued and unpaid
dividends thereon. The Company is not required to redeem the Class A Preference
Shares. Upon liquidation, holders of the Class A Preference Shares will be
entitled to repayment of an amount equal to $1,000 per share plus accrued and
unpaid dividends, prior to any distributions to holders of Common Stock. The
Class A Preference Shares do not have any voting rights.

                                    Page 10
<PAGE>
 
 
Since the Preference Shares were convertible into Common Stock at less than the
market value at the time of issue, a beneficial conversion feature existed
requiring that the Preference Shares be valued at the market value of the
underlying Common Stock. Since the resulting valuation of the Preference Shares
exceeded the balance of the note, an extraordinary expense of $1,824,000 was
incurred for early extinguishment of debt.

As part of the Merger, Harrah's entered into the "Registration and Preemptive
Rights Agreement" under which, among other things, Harrah's has the right to
receive additional shares of Common Stock at $.01 per share in order to maintain
their ownership percentage in the Company in the event that the Class A
Preference Shares held by BEA are converted into Common Stock. Had BEA elected 
to convert the Preference Shares into Common Stock as of the June 17, 1997 
Merger date, Harrah's would have received an additional 573,483 shares. The 
actual number of shares that would be issued to Harrah's in the event of 
conversion by BEA depends on a number of factors including, among others, the 
number of shares issued to BEA upon conversion, the number of "fully diluted" 
shares of Common Stock outstanding at the time of any such conversion and 
Harrah's ownership of Common Stock at the time of any such conversion. The value
of any such shares of Common Stock issued to Harrah's will be accounted for as 
an adjustment to the purchase price incurred in the Merger when and if such 
shares are issued.

7.  INCOME TAXES

As a Bermuda exempted company, IEL is not currently subject to income tax filing
requirements in Bermuda. Accordingly, with the exception of U.S. earned interest
income, which is subject to U.S. taxation, there are no income tax provisions,
benefits, liabilities or assets reflected in the accompanying financial
statements. U.S. tax expense related to interest income was approximately $1,000
and $1,500 for the three and four month periods ended June 30, 1997,
respectively, and $17,000 for the three and four month periods ended June 30,
1996, respectively, and is included in general and administrative expenses.

8.  RELATED PARTY TRANSACTIONS

Pursuant to the Management Agreement, Harrah's managed Old IEL. The Management
Agreement provided for Harrah's to receive a management fee equal to the greater
of $10,000 per whole fiscal month, as defined, or a percentage of gross
revenues, as defined. Management fees totaled $30,000 for the three month
periods ending June 30, 1997 and 1996. Management fees totaled approximately
$36,000 and $40,000 and for the four month periods ending June 30, 1997 and
1996, respectively. The Management Agreement was terminated June 17, 1997, in
conjunction with the Merger.

Under the terms of the Management Agreement, the Company transferred cash to
Harrah's for payments made on the Company's behalf to support its operations,
including accounts payable, payroll and capital expenditures. The net transfers
for the three month periods ending June 30, 1997 and 1996 totaled approximately
$135,000 and $627,000, respectively. The net transfers for the four month
periods ending June 30, 1997 and 1996 totaled approximately $143,000 and
$774,000, respectively.

In conjunction with the termination of the Management Agreement, certain
employees of Harrah's became employees of the Company. The Company agreed to
honor accrued vacation earned while these employees were employees of Harrah's.
The Company assumed a liability of approximately $17,000 for which it was
reimbursed by Harrah's.

The Company was charged a fee by Harrah's for administrative services (including
legal, accounting, information technology and office occupancy). The Company was
charged approximately $147,000 and $117,000 for the three month periods ending
June 30, 1997 and 1996, respectively. The Company was charged approximately
$150,000 and $163,000 for the four month periods ending June 30, 1997 and 1996,
respectively. This arrangement ended with termination of the Management
Agreement.

                                    Page 11
<PAGE>
 
On June 17, 1997, the Company entered into a Continuing Services Agreement with
Harrah's under which Harrah's will provide certain telecommunications, computer
systems support and consulting services to the Company. The Company incurred a
cost of approximately $11,000 during June, 1997.

Effective June 5, 1997, the Company entered into a lease (the "Sublease
Agreement") with Harrah's for the office space occupied by the Company. The
Sublease Agreement is for a period of 23 months at a monthly cost of
approximately $11,000. In conjunction with the Sublease Agreement and with the
Merger, the Company purchased certain leasehold improvements, computer hardware,
computer software and office equipment from Harrah's. The total purchase price
was approximately $42,000.

During 1996, the Company entered into a sublicense agreement with Harrah's,
which provides the Company with rights to use an immediate authorization
credit/debit system that Harrah's is developing. The Company reimburses Harrah's
for a portion of the development costs which totaled $30,000 and $40,000 for the
three month and four month periods ending June 30, 1997, respectively.

On June 17, 1997, in conjunction with the Merger, the Company entered into a
Software License Agreement with Harrah's (the "License Agreement"). The License
Agreement is a non-exclusive, fully-paid, perpetual, world-wide license to
Harrah's and its affiliates to use the Company's gaming technology in non-
competitive uses in traditional casino venues owned, operated or managed by
Harrah's affiliates. The License Agreement includes source codes for all
software, but neither party to the License Agreement has any obligations to
share or provide any improvements or modifications with the other party. There 
was no additional consideration paid by Harrah's for the License Agreement.

The Company paid approximately $87,000 and $55,000 during the three month
periods ending June 30, 1997 and 1996, respectively, to directors and companies
with common directors for management and consulting services. The Company paid
approximately $115,000 and $73,000 during the four month periods ending June 30,
1997 and 1996, respectively.

On April 30, 1997, the Company entered into a Consulting Agreement with James P.
Grymyr, a director of the Company, whereby Mr. Grymyr would provide consulting
services to the Company as requested by the Company from time to time. Under the
terms of the Consulting Agreement, the Company has issued to Mr. Grymyr 586,077
shares of Common Stock as consideration for all such consulting services both
past and future. The Company expects any future consulting services to be
minimal. The value of the stock (approximately $2.4 million) is reflected in the
Statements of Operations for the three and four month periods ending June 30,
1997, as consulting and contract labor expense.

Geller & Co., of which Laurence Geller is Chairman and CEO, performed consulting
services for the Company pursuant to a retainer agreement that commenced in
February, 1996 and terminated August 14, 1997. Geller & Co. was paid a monthly
retainer of $5,000. Pursuant to Geller & Co.'s retainer, a grant of options for
200,000 shares of Common Stock with an exercise price of $3.00 and a term of ten
years was also made to Geller & Co. In addition, Geller & Co. received 200,000
shares of Common Stock that vest upon the closing of a major financing. The
Board has determined that the Merger which occurred June 17, 1997 constituted a
major financing, and, consequently, the 200,000 share success fee has vested,
and an expense of $650,000 was recognized. Mr. Geller has been Chairman of the
Board of Directors of the Company since September 30, 1996.

9.  AGREEMENT REGARDING REDEMPTION OF PERFORMANCE SHARES

When the Company acquired the rights to the in-flight gaming software from Sky
Games International, Inc. ("SGII") on November 7, 1991, a portion of the
consideration was 3,000,000 shares of Common Stock which, according to then
applicable requirements, were placed in escrow, to be released on the basis of
one share for each U.S. $1.78 of net cash flow generated from the assets over a
ten-year period (the "Performance Shares"). The Performance Shares were issued
at a deemed price of
                    
                                    Page 12
<PAGE>
 
$.1155 per share with 2,000,000 shares issued to SGII (87% of the outstanding
stock of which is owned by James P. Grymyr, a director of the Company, and his
wife) and 1,000,000 shares were issued to Anthony Clements, a director of the
Company. An additional 525,000 shares, which were issued to Dr. Rex E.
Fortescue, formerly a director of the Company, are held in the escrow on the
same terms and are also included as Performance Shares. Each of Messrs. Clements
and Fortescue, as of April 30, 1997, have agreed to allow the Company to redeem
and cancel the Performance Shares when and if they are released from escrow for
any reason whatsoever (the "Redemption Agreement"). As consideration for such
agreement to tender the Performance Shares for cancellation by the Company in
the event they are ever released from the escrow, the Company has issued to
Messrs. Clements and Fortescue, 333,333 and 175,000 shares of Common Stock,
respectively. SGII, as of April 30, 1997, has also agreed that it will tender
the 2,000,000 Performance Shares which it holds for cancellation by the Company
when and if such Performance Shares are released from escrow for any reason
whatsoever. As consideration of such agreement, in February, 1997, the Company
expensed the outstanding balance of a note made by SGII to the Company in the
approximate amount of $550,000 and has issued to SGII 80,590 shares of Common
Stock (the "Redemption and Cancellation Agreement"). In the event the
Performance Shares are not released prior to six months after the end of the
Company's financial year ending in the year 2002, the Performance Shares will
automatically be canceled in accordance with the terms of the escrow agreement.
The value of the 588,923 shares of Common Stock issued as consideration for the
agreement was determined to be $1,840,000. This amount is included as additional
purchase price for the acquisition of Harrah's 20% ownership interest in Old 
IEL.

Each of Messrs. Clements and Fortescue have the right to include the 508,333
shares of Common Stock issued in connection with the Redemption Agreement in
certain registered offerings conducted by the Company prior to February 25,
1999. As part of the agreements to allow the redemption and cancellation of the
Performance Shares, the holders of the Performance Shares have issued an
irrevocable proxy to First Tennessee Bank which has agreed not to vote the
Performance Shares at any General Meeting of Shareholders or otherwise. The
irrevocable proxy and the agreement not to vote the Performance Shares will
terminate upon the cancellation of the Performance Shares.

The escrow agent is prohibited from canceling the Performance Shares under the
escrow agreement; however, it is management's opinion that the Performance
Shares should be treated as canceled and have no rights and should be excluded
from all per share calculations.

                                    Page 13
<PAGE>
 
Item 2:  MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS


Overview

Interactive Entertainment Limited ("IEL" or the "Company"), formerly known as
Sky Games International Ltd. ("SGI") is a Bermuda exempted company which was
incorporated on February 28, 1981. The Company's activities are focused on
providing in-flight gaming software and services by developing, implementing and
operating a computer-based interactive video entertainment system of gaming and
other entertainment activities on, but not limited to, the aircraft of
international commercial air carriers.

On December 30, 1994, the Company entered into a Shareholders Agreement with SGI
Holding Corporation Limited ("SGIH"), a wholly-owned subsidiary of SGI, and
Harrah's Interactive Investment Company ("HIIC"), an indirect wholly-owned
subsidiary of Harrah's Entertainment, Inc., the result of which was that Old IEL
became owned 80% by SGIH and 20% by HIIC. Pursuant to the Management Agreement,
Old IEL was managed by Harrah's Interactive Entertainment Company ("HIEC"), an
affiliate of Harrah's.

At a Special General Meeting of shareholders held on June 16, 1997, pursuant to
a Plan and Agreement of Merger and Amalgamation dated May 13, 1997, Old IEL was
merged into SGIH (the "Subsidiary Merger") and then into SGI (the "Parent
Merger"). Prior to the Merger, Harrah's owned 20% of the capital stock of Old
IEL and did not own any capital stock or other securities of SGI and had no
representatives on the Board. As a result of the amalgamation of Old IEL and
SGIH and the termination of the Management Agreement, the outstanding shares of
Old IEL common stock held by Harrah's were converted into 5,879,040 shares of
Common Stock of the Company, therefore making Harrah's the largest shareholder
of the Company holding approximately 38.6% of the outstanding shares at the
time of the amalgamation.

Pursuant to the Amalgamation Agreement, Harrah's was provided with the right to
appoint persons to the Board and to specified committees in a number generally
proportionate to their share holdings. Additionally, Harrah's was provided with
the right to approve specified significant corporate actions by the Company for
as long as the ownership of Common Stock by Harrah's is in excess of 20% (10% in
some cases) of the outstanding voting shares computed on a fully-diluted basis.

Upon consummation of the Parent Merger, SGI changed its name to Interactive
Entertainment Limited and installed Gordon Stevenson as President and Chief
Executive Officer. The Company is in the process of consolidating certain
operations formerly performed at its Vancouver, British Columbia office into its
Memphis, Tennessee headquarters.

The Company has yet to generate any operating revenues and has no assurance of
future revenues. Its principal activities through June 30, 1997, consisted of
developing, testing and marketing the in-flight gaming software. As of June 30,
1997, IEL had one airline contract to provide its gaming software to Singapore
Airlines, which has various termination provisions. The contract provides for a
six-month minimum trial period for the parties to assess the operation of the 
in-flight gaming system and public acceptance of the in-flight gaming business.
The Company and Singapore Airlines are not yet in the six-month trial period.
During this trial period, the airline has no affirmative obligation to install
the system on any or all of its aircraft; although, if 12 aircraft are not
installed with the system within 18 months from the date in-flight gaming
begins, IEL may terminate the contract. In addition, gaming is prohibited on the
aircraft of U.S. commercial air carriers and on all flights to and from the
United States. Other countries may introduce similar prohibitions, which could
result in termination of the contract.

                                    Page 14
<PAGE>
 
Results of Operations

Three Months Ended June 30, 1997 and June 30, 1996

Total expenses for the quarter ended June 30, 1997 were approximately $9.8
million and $.6 million during the same period of 1996. This increase in
expenses relates to increased staffing levels and to the Merger.

General and administrative expenses increased to $1,020,000 from $203,000 or
approximately $817,000. Payroll related expenses increased by $734,000 as the
Company built a permanent staff in 1997 to reduce reliance on contractors. Audit
and accounting expenses increased by $41,000 and travel expenses increased by
$25,000.

Consulting and contract labor costs increased to $2,695,000 from $153,000 or
approximately $2,542,000. The increase is primarily due to the $2.4 million
expense for the Grymyr consulting agreement.

Legal expenses increased to $300,000 from $43,000. The increase is due to costs
of the Merger, financing activities and compliance with U.S. reporting
requirements.

Interest expense increased by approximately $3.6 million of which $3.5 million
is attributable to the bargain conversion feature of the Harrah's loan and
$65,000 is attributable to amortization of the deferred finance charges related
to the convertible debentures.

Depreciation and amortization for the 1997 period includes $307,000 in
amortization expense related to the excess of the purchase price over assets
acquired when the Company purchased the minority interest in Old IEL from
Harrah's.

An extraordinary expense of $1,824,000 was recorded in the period for early
extinguishment of the note due to BEA when it was exchanged for the Class A
Preference Shares. There was no extraordinary expense in the 1996 period.

Four Months Ended June 30, 1997 and June 30, 1996

Total expenses for the four months ended June 30, 1997 were approximately $10.1
million as compared to $.7 million in the 1996 period. Except for the items
noted above, expenses for both periods were comparable.

Liquidity and Capital Resources

At June 30, 1997 the Company had a working capital deficit of approximately
$337,000. The Company's primary source of funding has been through sales of its
equity and securities convertible into equity.

                                    Page 15
<PAGE>
 
The Company retained London Select Enterprises, Ltd. to make a private placement
of up to $3.5 million of 8% convertible debentures due March 31, 1999. As of
June 30, 1997, sales had been closed on $763,250 of the debentures. As of June
30, 1997, debentures with a principal amount of $108,416 had been converted into
53,280 shares of Common Stock. A second tranche of $500,000 and a third tranche
of $600,000 were closed subsequent to the end of the quarter. Management does
not believe that any additional capital will be raised from this source.

The Company has not yet generated any operating revenue under its agreements
with Singapore Airlines. Until the Company receives sufficient cash flow from
operations, additional funding will be required to allow the Company to continue
operations during fiscal year 1997. Absent sufficient cash flow from operations,
the short-term viability of the Company and the Company's ability to continue
its operations is directly dependent upon the completion of significant
additional financing.

New Financial Accounting Standards

The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 128, "Earnings Per Share". This statement, effective
for fiscal years ending after December 15, 1997, simplifies the standards for
computing earnings per share previously found in APB Opinion No. 15, "Earnings
per Share," and makes them comparable to international EPS standards. Early
adoption of this standard is not permitted, and the Company has not determined
the future financial statement impact of adopting this statement.

Forward-Looking Information

Except for historical information contained herein, the matters discussed in
this Quarterly Report on Form 10-Q are forward-looking statements (within the
meaning of Section 27A of the Securities Act of 1993, as amended and Section 21E
of the Securities Exchange Act of 1934, as amended) that are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those set forth in such forward-looking statement. Such risks and
uncertainties include the inability to complete integration and testing of the
Company's software with the Matsushita system and the implementation of the
software by Singapore Airlines.

                                    Page 16
<PAGE>
 
PART II.  OTHER INFORMATION

Item 4.  Submission of Matters To a Vote of Security Holders

     The Company held a Special General Meeting of stockholders on June 16,
1997. The following matters were voted upon at the meeting:

1. a resolution to:  a. amend the Bye-Laws of the Company,

                     b. change the name of the company from Sky Games
                     International, Ltd. to Interactive Entertainment Limited,

                     c. change the par value of Common Stock from Cdn.$.01 to
                     US$.01,

                     d. authorize the creation of 3,000 Non-Voting Convertible
                     Redeemable Class A Preference Shares of par value US$.01
                     and 5,000,000 Class B Redeemable Preference Shares of par
                     value US$.01, and

                     e. authorize the Directors to issue the Non-Voting
                     Convertible Redeemable Preference Shares and the Redeemable
                     Preference Shares on terms as the Directors deem
                     appropriate.

There were 6,703,686 shares voted at the meeting. Of these 6,292,589 (93.9%)
voted in favor of the resolution, 398,500 (5.9%) opposed the resolution, and
12,327 (.02%) abstained.

Item 6.  Exhibits and reports on Form 8-K

         (a)  Exhibits

              27.  Financial Data Schedule

         (b)  Reports on Form 8-K

              8-K filed June 27, 1997 for events occurring on June 16, 1997
              8-KA filed July 30, 1997 amending the above.
              8-K filed July 30, 1997 for events occurring on July 15, 1997

                                    Page 17
<PAGE>
 
                                   Signature

Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                     INTERACTIVE ENTERTAINMENT LIMITED


July 8, 1998                         BY: /s/ David B. Lamm
                                         --------------------------
                                         Chief Financial Officer



July 8, 1998                         BY: /s/ Michael A. Irwin
                                         --------------------------
                                         Director of Finance and Administration
                                         (Chief Accounting Officer)


                                    Page 18
<PAGE>
 

                       INTERACTIVE ENTERTAINMENT LIMITED

<TABLE> 
<CAPTION>                                         
Exhibit 27

<S>                                                                 <C>
Period - type.................................................            4-MOS
Fiscal year end...............................................      DEC-31-1997
Period starting date..........................................      MAR-01-1997
Period ending date............................................      JUN-30-1997
Cash and cash items...........................................          317,420
Marketable securities.........................................                0
Notes and accounts receivable-trade...........................           75,171
Allowances for doubtful accounts..............................                0
Inventory.....................................................                0
Total current assets..........................................          593,781
Property, plant and equipment.................................        1,474,327
Accumulated depreciation......................................          323,723
Total assets..................................................       19,614,919
Total current liabilities.....................................          931,126
Bonds, mortgages and similar debt.............................          654,834
Preferred stock-mandatory redemption..........................                0
Preferred stock-no mandatory redemption.......................               27
Common stock..................................................          180,867
Other stockholders' equity....................................       58,875,996
Total liabilities and stockholders' equity....................       18,028,959
Net sales.....................................................                0
Total revenues................................................            7,868
Cost of tangible products.....................................                0
Total costs and expenses applicable to sales and revenues.....                0
Other costs and expenses......................................       22,826,545
Provision for doubtful accounts and notes.....................                0
Interest and amortization of debt discount....................          223,015
Income before taxes and other items...........................      (22,654,835)
Income tax expense............................................                0
Income/loss from continuing operations........................      (22,654,835)
Discontinued operations.......................................                0
Extraordinary items...........................................       (1,824,222)
Cumulative effect-changes in accounting principles............                0
Net income or loss............................................      (24,479,057)
Earnings per share-primary....................................            (2.28)
Earnings per share-fully diluted..............................                0
</TABLE>

Amounts inapplicable or not disclosed as a separate line item on the Balance
Sheet or Statement of Operations are reported as 0 herein.

                                    Page 19