<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C.  20549

                                   FORM 10-Q

(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 17,886,725 shares of common stock outstanding as of June 30,
1997.

Exhibit index is located on page 21
             
                                    Page 1
<PAGE>
 
                       INTERACTIVE ENTERTAINMENT LIMITED

                                     INDEX
<TABLE> 
<CAPTION> 

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

     Consolidated Balance Sheets - June 30, 1997 and February 28, 1997      4

     Consolidated Statements of Operations - Three Months and Four          5
     ended June 30, 1997 and June 30, 1996

     Consolidated Statements of Cash Flows - Three Months and Four          6
     Months ended June 30, 1997 and June 30, 1996

     Notes to Consolidated Financial Statements                             7

     Pro Forma Financial Data                                              14

     Pro Forma Statement of Operations - Year Ended February 28, 1997      15

     Pro Forma Statement of Operations - Four Months Ended June 30, 1997   16

     Notes to Pro Forma Statements of Operations                           17

Item 2.  Management's Discussion and Analysis of Financial Condition       18
         and Results of Operations


PART II. OTHER INFORMATION

Item 4.  Submission of Matters To a Vote of Security Holders               21

Item 6.  Exhibits and Reports on Form 8-K                                  22
</TABLE> 

                                      -2-
<PAGE>
 
                         PART I.  FINANCIAL INFORMATION
                         Item 1.  Financial Statements
 
     The accompanying unaudited Consolidated Financial Statements of Interactive
Entertainment Limited ("IEL" or the "Company"), a Bermuda exempted corporation,
have been prepared in accordance with the instructions to Form 10-Q, and
therefore do not include all information and notes necessary for complete
financial statements in conformity with generally accepted accounting
principles. The results for the periods indicated are unaudited, but reflect all
adjustments (consisting only of normal recurring adjustments) which management
considers necessary for a fair presentation of operation results. Results of
operations for interim periods are not necessarily indicative of a full year of
operations.

     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.

                                      -3-
<PAGE>


              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                                  (UNAUDITED)

<TABLE> 
<CAPTION> 
                                                                                         June 30,                February 28,
                                  ASSETS                                                   1997                      1997
                                                                                      -------------             -------------

CURRENT ASSETS:
<S>                                                                                    <C>                      <C>  
  Cash and cash equivalents                                                            $    302,094              $    626,074
  Accounts receivable                                                                        75,171                   119,768
  Prepaid expenses                                                                          201,190                    61,975
                                                                                       ------------              ------------
     Total current assets                                                                   578,455                   807,817
                                                                                       ------------              ------------

PROPERTY AND EQUIPMENT, at cost
  Land                                                                                      800,000                   800,000
  Equipment and vehicles                                                                    870,619                   843,595
                                                                                       ------------              ------------
                                                                                          1,670,619                 1,643,595
  Less:  accumulated depreciation                                                          (311,415)                 (284,705)
                                                                                       ------------              ------------
     Property and equipment, net                                                          1,359,204                 1,358,890

SOFTWARE UNDER DEVELOPMENT (Note 2)                                                       1,815,034                 1,357,869

EXCESS OF PURCHASE PRICE OVER NET ASSETS ACQUIRED (Note 2)                               14,753,961                        --
                                                                                       ------------              ------------
     Total assets                                                                      $ 18,506,654              $  3,524,576
                                                                                       ============              ============

                     LIABILITIES AND SHAREHOLDERS' EQUITY
                     
CURRENT LIABILITIES
   Accounts payable and accrued expenses                                               $    972,025             $     979,948
                                                                                       ------------              ------------
     Total current liabilities                                                              972,025                   979,948

CONVERTIBLE DEBENTURES (Note 3)                                                             654,834                        --

MINORITY INTEREST                                                                                --                   277,249

SHAREHOLDERS' EQUITY
  Common shares, $0.01 par value, authorized - 50,000,000 shares
    outstanding - 17,886,725 shares (Note 9)                                                178,867                   133,140
  Class A preferred shares, $0.01 par value, authorized - 3,000
    shares, outstanding - 2,737 shares (Note 6)                                                  27                        27
   Additional paid-in-capital                                                            46,218,370                17,348,313
   Accumulated deficit                                                                  (29,517,469)              (15,214,101)
                                                                                       ------------              ------------
                                                                                         16,879,795                 2,267,379
                                                                                       ------------              ------------
   Total liabilities and shareholders' equity                                          $ 18,506,654              $  3,524,576
                                                                                       ============              ============



                 The accompanying notes are an integral part 
                     of these consolidated balance sheets.
</TABLE>


                                      -4-
<PAGE>


<TABLE>
<CAPTION>

                                        INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

                                               CONSOLIDATED STATEMENTS OF OPERATIONS
                                                            (UNAUDITED)

                                                       Three Months Ended                           Four Months Ended
                                                 --------------------------------          --------------------------------------
                                                 Jun 30, 1997        Jun 30, 1996          Jun 30, 1997              Jun 30, 1996
                                                 ------------        ------------          ------------              ------------
<S>                                              <C>                 <C>                   <C>                       <C>
OPERATING EXPENSES                          
 General and administrative                          840,046             384,987               905,846                 1,034,895
 Consulting and contract labor                       294,613             108,357               391,549                   203,090
 Marketing                                            77,476              81,978                86,359                   148,180
 Management fees                                      48,534              48,000                66,034                    83,250
 Depreciation and amortization                       255,147              20,975               262,662                    31,985
                                                 -----------         -----------           -----------               -----------  
                                            
OPERATING LOSS                                     1,515,816             644,297             1,712,450                 1,501,400
                                                 -----------         -----------           -----------               -----------  

OTHER (INCOME) EXPENSE
 Interest income                                      (2,564)            (15,945)               (6,946)                  (44,658)
 Termination of Management Agreement (Note 1)     10,098,175                 -              10,098,175                       -
 Consulting Agreement (Note 8)                     2,417,567                 -               2,417,567                       -
                                                 -----------         -----------           -----------               ----------- 
                                                  12,513,178             (15,945)           12,508,796                   (44,658)
                                                 -----------         -----------           -----------               -----------  

NET LOSS                                         $14,028,994         $   628,352           $14,221,246               $ 1,456,742
                                                 ===========         ===========           ===========               ===========  

LOSS PER SHARE                                   $      0.94         $      0.05           $      0.96               $      0.11
                                                 ===========         ===========           ===========               ===========  

AVERAGE COMMON SHARES AND
 EQUIVALENTS OUTSTANDING                          14,952,548          13,227,377            14,801,904                13,017,690
                                                 ===========         ===========           ===========               ===========  

                                            The accompanying notes are an integral part
                                                 of these consolidated statements.
</TABLE>
                                      -5-
<PAGE>

<TABLE>
<CAPTION>

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

                                                       Three Months Ended                           Four Months Ended
                                                 -------------------------------           -------------------------------------
                                                 June 30, 1997     June 30, 1996           June 30, 1997           June 30, 1996
                                                 -------------     -------------           -------------           ------------- 
<S>                                              <C>               <C>                     <C>                     <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:

      Net cash used in operating activities        (1,660,876)          (388,914)            (1,737,583)              (1,020,577)
                                                 -------------       -----------           -------------             ----------- 

CASH FLOWS USED IN INVESTING ACTIVITIES
 Additions to property and equipment                  (24,691)           (56,707)               (27,024)                 350,705
 Software development cost                           (396,122)           (10,951)              (457,165)                (452,936)
                                                 -------------       -----------           -------------             ----------- 
      Net cash used in investing activities          (420,813)           (67,658)              (484,189)                (102,231)
                                                 -------------       -----------           -------------             -----------  

CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
 Proceeds from convertible debenture issuance         763,250                -                  763,250                      -
 Proceeds from stock issuance                       1,134,542          2,294,765              1,134,542                2,692,927
 Payments of notes payable                                -                  -                      -                   (326,575)
                                                 -------------       -----------           -------------             ----------- 
      Net cash provided by financing activities     1,897,792          2,294,765              1,897,792                2,366,352
                                                 -------------       -----------           -------------             -----------  

NET (DECREASE) INCREASE IN CASH AND
 CASH EQUIVALENTS                                    (183,897)         1,838,193               (323,980)               1,243,544

CASH AND CASH EQUIVALENTS,
 beginning of period                                  485,991            130,573                626,074                  725,222
                                                 -------------       -----------           -------------             ----------- 

CASH AND CASH EQUIVALENTS,
 end of period                                   $    302,094        $ 1,968,766           $    302,094              $ 1,968,766
                                                 =============       ===========           =============             ===========


SUPPLEMENTAL CASH FLOW INFORMATION:
 Cash paid for interest                          $    149,808        $    74,787           $    149,808              $   151,464
 Cash paid for taxes                             $      7,469        $    12,774           $      7,469              $    12,774

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

</TABLE>




                                      -6-
<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 Corp. hardware platform and operating system for its
interactive entertainment system. The Company has been attempting to integrate
its software with the Matsushita Avionics Systems Corp. 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

                                      -7-
<PAGE>
   
"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% ownership
interest in Old IEL and as consideration for the termination of the Management
Agreement. Of the total shares issued to Harrah's, 3,617,871 shares were
allocated to the acquisition of Harrah's 20% ownership interest in Old IEL and
2,261,169 shares were allocated to the termination of the Management Agreement.
This allocation was based on the Merger negotiation discussions held with
Harrah's.

The acquisition of minority interest, previously held by Harrah's, has been
accounted for under the purchase method.  The value of the purchase price was
based on the average quoted market price of the Company's Common Stock when the
Merger was announced, or $4.466 per share.  The preliminary allocation of the
purchase price and estimates of fair value of the Company's assets has resulted
in an allocation which differs from the tentative valuations and allocations set
forth in the pro forma financial statements contained in the Company's proxy
statement dated May 13, 1997, and such allocations and valuations are subject to
further change as management refines its analysis.  This transaction represents
a non-cash transaction for purposes of the Consolidated Statements of Cash
Flows.

The shares issued to terminate the Management Agreement were also valued at
$4.466 per share, and the total value of the shares is reflected as termination
of management agreement in the accompanying Consolidated Statements of
Operations for the quarter and four months ended June 30, 1997.  Prior to
termination, the Company paid Harrah's a monthly fee of $10,000 and was
obligated to pay Harrah's a percentage of future gross revenues.

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.  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.

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, 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
---------

                                      -8-
<PAGE>
    
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.  The amount of the excess purchase price over net
assets acquired as preliminarily determined by management differs from that set
forth in the pro forma financial statements contained in the Company's proxy
statement dated May 13, 1997 and may change further as management refines its
analysis.  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 $235,952.

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 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 and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
 
Consolidated Subsidiaries
-------------------------

                                      -9-
<PAGE>
 
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).  All material intercompany
transactions have been eliminated in consolidation.
   
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.

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

4.  STOCK OPTION PLANS

During fiscal 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, 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. The MIP is accounted for as a variable stock
purchase plan, and compensation expense is recognized to the extent the quoted
stock price of the Company's stock at the end of the period exceeds the exercise
price of the options. No compensation expense was recognized for the MIP during
the quarter ended June 30, 1997 as the quoted price of the Company's stock on
June 30, 1997 was $2.75, which is less than the $3.00 exercise price of the
options.
  
5.  STOCK WARRANTS

                                     -10-
<PAGE>
 
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 April 30, 1999.
   
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 at 12% per annum.  On February 28, 1997, the note to BEA, in the
approximate amount of $2.7 million (including accrued and unpaid interest), was
converted into 2,737 Class A Preference Shares at $1,000 per share.

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.

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 $2,000 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.


                                     -11-
<PAGE>
 
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.

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 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.

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 agreement 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                


                                     -12-
<PAGE>
 
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 Mergers which occurred June 17, 1997 constituted a major financing,
and, consequently, the 200,000 share success fee has vested.

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 price of  $.01 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, the Company has forgiven
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.

Each of Messrs. Clements and Fortescue and SGII have the right to include the
588,923 shares of Common Stock issued in connection with the Redemption
Agreement and the Redemption and Cancellation 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 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.               


                                     -13-
<PAGE>
 
              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

                           PRO FORMA FINANCIAL DATA

The following unaudited pro forma financial data illustrates the estimated
effects of the issuance of the Class A Preference Stock to B/E Aerospace, Inc.
in exchange for debt, the Mergers, the termination of the Management Agreement
with Harrah's, the conversion of shares issued under the Harrah's Loan
commitment and recent financing through issuance of convertible debentures. The
Pro Forma Statements of Income are based on the income statements of the Company
for the periods presented and assume the transactions were consummated at the
beginning of such periods.

The Pro Forma Statements of Income do not purport to represent what the results
of operations of the Company would actually have been if the transactions had in
fact been consummated on such date or at the beginning of the periods indicated
or to project the results of operations for any future date or period.  The pro
forma adjustments are based upon available information and upon certain
assumptions the management of the Company believes are reasonable in the
circumstances.  The estimated effects of the Mergers and the termination of the
Management Agreement differ from those set forth in the Company's proxy
statement dated May 13, 1997 and reflect changes in management's view of the
fair value of the assets acquired. As management finalizes its valuations and
allocations, historical results may continue to differ from those indicated by
the estimates contained in the following pro forma financial data.
              

                                     -14-
<PAGE>

              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
                         PRO FORMA STATEMENT OF OPERATIONS
                     FOR THE YEAR ENDED FEBRUARY 28, 1997
                                  (UNAUDITED)


<TABLE> 
<CAPTION> 
                                                                              Pro Forma
                                                       Historical            Adjustments        Pro Forma
                                                       ----------            -----------        ---------
<S>                                                    <C>                 <C>                 <C>  
OPERATING EXPENSES
  General and administrative                           $  871,359          $  (253,973)(a)     $   990,215
                                                                               372,829 (b)
  Consulting and contract labor                         1,108,492                                1,108,492
  Travel, marketing and promotion                         625,945                                  625,945
  Management Fees                                         211,000             (120,000)(c)          91,000
  Depreciation and amortization                            87,976            4,996,638 (d)       5,084,614
                                                       ----------          -----------         -----------

OPERATING LOSS                                          2,904,772            4,995,494           7,900,266

OTHER (INCOME) EXPENSE
  Interest income                                         (63,738)                                 (63,738)
  Termination of management agreement (Note 1)                  -                                        -
  Write down of assets                                  1,246,903 (e)                            1,246,903
  Consulting agreement (Note 9)                                 -                                        -
                                                       ----------          -----------         -----------
                                                        1,183,165                    -           1,183,165
                                                       -----------         -----------         -----------

NET LOSS                                               $4,087,937 (e)      $ 4,995,494         $ 9,083,431
                                                       ===========         ===========         ===========

LOSS PER SHARE                                         $    0.323 (e)                          $     0.517
                                                       ===========                             ===========

AVERAGE COMMON SHARES AND                              12,671,005            4,898,128  (f)     17,569,133
  EQUIVALENTS OUTSTANDING
</TABLE>

The accompanying notes are an integral part of this Pro Forma Statement of 
Operations.


                                     -15-
<PAGE>

              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
                       PRO FORMA STATEMENT OF OPERATIONS
                    FOR THE FOUR MONTHS ENDED JUNE 30, 1997
                                  (UNAUDITED)


<TABLE>
<CAPTION>
                                                                        Pro Forma
                                                   Historical          Adjustments           Pro Forma
                                                  ------------        -------------        ------------
<S>                                                <C>                <C>                  <C>

OPERATING EXPENSES
  General and administrative                       $   905,846                              $    905,846
  Consulting and contract labor                        391,548                                   391,548
  Travel, marketing and promotion                       86,359                                    86,359
  Management Fees                                       66,034             (35,667)(c)            30,367
  Depreciation and amortization                        262,662           1,429,594 (d)         1,692,256
                                                   -----------         -----------          ------------

OPERATING LOSS                                       1,712,449          1,393,927              3,106,376

OTHER (INCOME) EXPENSE
  Interest income                                       (6,946)                                   (6,946)
  Termination of management agreement (Note 1)      10,098,175                                10,098,175
  Write down of assets                                       -                                         -
  Consulting agreement (Note 9)                      2,417,594                   -             2,417,594
                                                   -----------          ----------          ------------
                                                    12,508,823                                12,508,823
                                                   -----------          ----------          ------------

NET LOSS                                           $14,221,272          $1,393,927          $ 15,615,199
                                                   ===========          ==========          ============

LOSS PER SHARE                                     $      0.96                              $       0.89
                                                  ============                              ============

AVERAGE COMMON SHARES AND                           14,801,904           2,767,229 (f)        17,569,133
  EQUIVALENTS OUTSTANDING
</TABLE>

The accompanying notes are an integral part of this Pro Forma Statement of 
Operations.


                                     -16-

<PAGE>
 
                       INTERACTIVE ENTERTAINMENT LIMITED

                  NOTES TO PRO FORMA STATEMENT OF OPERATIONS

(a)  Reflects the assumption that the note payable to B/E Aerospace was
     exchanged into Class A Preference Shares thereby eliminating interest on
     the note for the period.

(b)  Reflects elimination of the non-controlling interest previously held by
     Harrah's.

(c)  Reflects a reduction in expense from elimination of management fees
     assuming termination of the Management Agreement with Harrah's.

(d)  Reflects amortization of the excess purchase price over the net assets
     acquired.  (See Note 2 to the Consolidated Financial Statements.)

(e) Restated to reflect the reclassification of the write off of a note, which
     after review, management believes should have been recorded as an
     adjustment to the capital accounts rather than as an expense.

(f)  Shares outstanding are adjusted to reflect:

     1.   1,007,875 shares issued to Harrah's upon conversion of the $1,000,000
          loan plus accrued interest (See Note 1 to the Consolidated Financial
          Statements),

     2.   the agreement to tender 3,525,000 Performance Shares for cancellation
          and the issuance of 588,923 shares in replacement (See Note 9 to the
          Consolidated Financial Statements),

     3.   2,261,169 shares issued to Harrah's upon termination of the Management
          Agreement (See Note 1 to the Consolidated Financial Statements),

     4.   3,617,871 shares issued to Harrah's in exchange for its 20% interest
          in the former operating subsidiary, Old IEL. (See Note 1 to the
          Consolidated Financial Statements), and
 
     5.   947,290 shares issued to various parties assuming conversion of the
          convertible debentures issued through August 15, 1997. (See Note 3
          to the Consolidated Financial Statements.)                

                                     -17-

<PAGE>
 
              INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

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 Merger of Old IEL and
SGIH, the outstanding shares of Old IEL common stock held by Harrah's were
converted into 5,879,040 shares of Common Stock therefore making Harrah's the
largest shareholder of the Company holding approximately 38.6 % of the
outstanding shares.

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 principle 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.

                                     -18-

<PAGE>
 
Results of Operations
---------------------

Operating expenses for the quarter ended June 30, 1997, were approximately $1.5 
million compared to approximately $0.6 million for the same period of 1996. This
increase in operating expenses relates primarily to the Merger. The Company 
incurred approximately $220,000 of additional legal fees in conjunction with the
Merger during the three months ended June 30, 1997, as compared to the same 
period in 1996. Additionally, the Company incurred approximately $235,000 in 
amortization expense related to the excess of purchase price over net assets 
acquired and $61,000 in commissions related to the issuance of the convertible 
debentures during the three months ended June 30, 1997, which was not incurred 
in the same period in 1996. Consulting and contract labor also increased by 
approximately $186,000 from period to period.

Pursuant to the Management Agreement effective from December 30, 1994 to June
17, 1997, Harrah's managed the Company for a fee. 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 revenue as
defined. IEL was required to pay Harrah's $120,000 in management fees 
during the fiscal year ended February 28, 1997. As a result of the Merger, the
Management Agreement was terminated in exchange for 2,261,169 of the 5,879,040
shares of Common Stock given to Harrah's.

On June 17, 1997, the Company completed the buy-out of Harrah's agreement to
manage the operations of Old IEL. An early termination fee expense of
approximately $10 million was incurred for this transaction.


Liquidity and Capital Resources
-------------------------------

At June 30, 1997 the Company has a working capital deficit of $394,000. The
Company's primary source of funding has been through sales of its equity and
securities convertible into equity.

As of April 30, 1997, the Company issued to Dr. Rex E. Fortescue, formerly a
director of the company, and Anthony P. Clements, a director of the Company,
175,000 and 333,000 shares of Common Stock, respectively, as consideration for
agreements to tender 525,000 and 1,000,000 shares of Common Stock, respectively,
which are held in escrow pursuant to a performance carry-out, when such shares
are released from escrow.

As of April 30, 1997, the Company forgave the outstanding balance of a note made
by Sky Games International, Inc. ("SGII"), a company controlled by James P.
Grymyr, a director of the Company, and his wife to the Company in the
approximate amount of $549,651, and issued to SGII 80,590 shares of Common Stock
as consideration for SGII's agreement to tender 2,000,000 shares of Common Stock
owned by SGII which are held in escrow pursuant to a performance carry-out, when
such shares are released from escrow.

On May 13, 1997, the Company entered into a Funding Agreement with Harrah's
under which Harrah's provided a loan of $1,000,000. On June 17, 1997, the loan
plus accrued interest was converted into 1,007,875 shares of Common Stock. In
addition, pursuant to the funding agreement, for 90 days following June 17,
1997, the Company had the right to request Harrah's to purchase, under certain
conditions, 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.

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 at 12% per annum. The note to BEA, in the approximate amount of $2.7
million as of January 31, 1997 (including accrued and unpaid interest), was
converted into 2,737 Class A Preference Shares.

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. 

                                     -19-

<PAGE>
 
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. On April 11, 1997, warrants
were exercised for 19,615 shares of Common Stock.

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.

                                     -20-

<PAGE>

PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings.  NONE

Item 2.  Changes in Securities.  NONE

Item 3.  Defaults Upon Senior Securities.  NONE

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 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 (0.2%) abstained.

Item 5. Other Information.  NONE

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 

                                     -21-
<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



August 18, 1997                      BY:  /s/  David B. Lamm
                                         --------------------------------------
                                         Chief Financial Officer



August 18, 1997                      BY:  /s/ Michael A. Irwin
                                         --------------------------------------
                                         Director of Finance and Administration
                                         (Chief Accounting Officer)


                                     -22-